NEEDS NO ECONOMIC JUSTIFICATION
at the Annual Meeting of the American Bar Association,
August 13, 1975.
Commodity Futures Trading Commission (CFTC) came into existence
by Congressional Act, in 1974. The debate that preceded this
legislation was heated and extensive. Because we believed that
the CFTC was inevitable, we felt we could do more good for
the futures industry by partaking in the process. Accordingly,
we became an official advisor in the Congressional proceedings
that created this federal agency. However, we never lost sight
of the fact that—at best—it was to be a mixed blessing. Thus,
while generally supportive of the CFTC Act, we labored to remove
some of the more onerous provisions proposed. We were not always
particular grave concern to me were the "economic justification" provisions
that remained. I believed those provisions were inherently
dangerous since they provided the Commission with a means—wittingly
or unwittingly—to impede innovation. Innovation was to us the
very soul of futures market existence. I like to believe that
as a consequence of our influence and continued pressure in
this respect, the provisions of Section 5 have never become
the detrimental force they might have otherwise been.
spoke Senator Herman Talmadge:
trading has become a very important part of the nation's economy.
During 1973, the total volume in futures contracts was over $500
billion. This is twice the volume of trading in all stock exchanges
in the country. Currently, futures markets perform a vital function
for agricultural producers, for manufActurers, for exporters,
for consumers and for others.
these words, the Chairman of the Senate Committee on Agriculture
and Forestry introduced to the Senate the final version of the
Commodity Futures Trading Commission (CFTC) Act of 1974 thereby
creating this new federal agency. Although Senator Talmadge spoke
those words in justification of the Act, the uninitiated may
have wondered whether the Senator's words were used to justify
the legislation or to condemn it.
by 1973 futures trading had become so big and so important to
the nation's economy without the Federal government,
why was it necessary for the government to now come to its rescue.
Weren't there unsuccessful or failing segments of our economy
for the Senate to rescue? And if futures had become so important
to the well-being of our economy without a major congressional
Act, might not such an Act be detrimental to their further growth
and service to the nation?
the Commodity Futures Trading Commission Act is now a fact of
life and it will be of small purpose to debate its merit or necessity.
What is of vital importance is that the Act be administered wisely
in order to fulfill what we believe to be its primary purpose:
the continued service of the futures industry to our nation's
Act is probably a better instrument than we had a right to expect.
After all, its subject matter—futures markets—is highly complex
and technical while the mechanism is arcane and highly sophisticated.
Moreover, the legislators were not market experts or traders.
It can be easily understood how errors or omissions could develop.
Fortunately, few exist. The major aspects of futures were fully
and comprehensively covered.
are, for instance, especially gratified that the Act placed all
contract markets under one roof. We are also pleased that the
Act provided the CFTC with strong Federal authority in those
areas that were in need of regulation. In sum total, therefore,
we believe the Act can achieve its intended purposes, i.e.,
to promote the futures industry, insure fair practices and provide
protection to the producer and consumer.
Act can accomplish these goals because it has breadth and flexibility,
ingredients critical to its successful implementation. Without
breadth, the CFTC would be too limited in scope to function properly;
without flexibility, industry rules would become too rigid for
it to succeed. But it is not the words within the Act that will
control. Ultimately, as is the case with most legislation, the
final determinants of the Act's good or evil will be the Commissioners
and staff who implement it.
me, therefore, to address CFTC Commissioners and staff, present
and future, and to focus on one aspect of the Act that is the
most critical to the growth of our industry and its continued
ability to serve our national interests. The subject is close
to my heart. It concerns provisions in the Act which should have
treated differently and thus needs careful interpretation. It
will require much of the CFTC's wisdom and a good deal of its
flexibility. It is my fervent hope that with these remarks I
can leave a legacy of understanding, and provide an ounce of
prevention in place of a pound of cure.
5 of the Act deals with contract market designation. Its provisions
contain requirements that a board of trade must meet before a
given instrument can be approved for trade. As a result of historical
application of this Section and the report of the Senate-House
Conference Committee, the CFTC has accepted past interpretations
of these requirements to mean that an exchange must demonstrate "economic
justification" of a proposed contract prior to approval.
In other words, there must be proof of economic purpose before
any new futures contract can come into being.
foregoing requirement—to which we vehemently object—is further
complicated by the provision of paragraph (g) which requires "the
board of trade to demonstrate that transactions for future delivery
in the commodity for which designation as a contract market is
sought will not be contrary to the public interest." In practice, economic
justification and public interest, the two main
requisites for designation under Section 5, will merge to act
exchanges have fought in vain against enactment of the foregoing
requirements. We will continue to battle against their strict
interpretation. Separately, these requirements are dangerous
and onerous, and can act as serious impediments to expansion
of our markets. In combination, they can become a market strait-jacket
and the greatest barrier to innovation—the unique and quintessential
characteristic of futures markets.
1632, Galileo Galilei published his Dialogue on the Two Principal
Systems of the World. In non-scientific terminology, his
work can be described as claiming that Copernicus was right;
the earth did, in fact, revolve around the sun. Unfortunately,
Galileo's discovery was deemed contrary to the public interest
of the times and he was forced to recant. For the next 200 years,
the sun continued to obediently revolve around the earth.
1957, after 250 million dollars on research, design and development,
the Ford Motor Company brought into production the "hottest new
automobile of the century"—a car that passed every economic justification
test that could be devised. Thus, the Edsel was born and died
ignominiously two years later. Today, the Edsel is in great demand,
not as an automobile, but as a nostalgia relic.
is replete with great discoveries, inventions, and ideas that
failed to meet either the public interest or economic justification
test of the day. Ideas that were consequently crushed or died
aborning, often to be rediscovered and hailed years later. And
no doubt there are many suppressed great ideas that remain dormant
waiting to be rediscovered. History is equally replete with discoveries,
inventions, and ideas that met the public interest and economic
justification test of the day with flying colors, only to be
subsequently discarded as evil or useless.
market contracts are no different in this respect from other
inventions and ideas. The demands of economic justification and
public interest seem reasonable and logical enough on the surface.
However, one can never be sure that the criteria used to predetermine
the foregoing are the correct standards to apply. Just as beauty
is often in the eye of the beholder, so is one man's poison another
predetermined test for economic justification has never by itself
been a sure-fire ingredient to guarantee a successful futures
contract. At the time the Chicago Mercantile Exchange's shrimp
futures were instituted, the economic need for such a market
was well established. However, the market never took off the
ground and was delisted in less than two years. Examples of such
contracts have occurred at every futures exchange in the country.
any Commissioners be foolish enough to guarantee an exchange
the success of a new contract simply because it passed the justification
and public interest tests? Futures markets require many ingredients
to succeed—some tangible, some intangible. My belief is that
there are thirteen components necessary to insure a successful
contract—twelve of them we know, the last one we don't. But it
is the thirteenth element which is the most critical and controlling.
ultimate and only test for economic justification is the marketplace
itself. If justification is indeed lacking, the market will surely
fail. No foreordained set of standardized, pre-packaged rules
or requirements can make that determination. We must have faith
in the free market and the competitive arena of ideas and products.
A better test has yet to be devised.
a recent speech, the Chancellor of the University of Rochester,
W. Allen Wallis succinctly stated that what concerns him most
about government today is the "powerful movement away from limited
government and individual freedom toward pervasive government
and collective control of all activities ..." "It is a shift
away," he regrets to say, "from trust in good faith, competence
and responsibility toward reliance on detailed prescriptions
by government and documentation by individuals of their actions,
intentions and motives." Such a shift as it relates to our economy,
the Chancellor sadly concludes, is resulting in a "dampening
of enterprise innovation, initiative and industriousness."
do not know the exact and detailed prescriptions for economic
justification of a futures market. They are not the same for
every commodity, nor are they always tangible, nor do they remain
constant. Often, the actual economic uses of a futures market
are determined, created, or become visible only after the market
is in existence.
futures contracts are forced to show compliance with and evidence
of strict and stringent justification prescriptions, there will
be few new markets. Strict and automatic justification regulations
will, as Chancellor Wallis said, directly stifle any attempt
at innovation, any thought of pioneering, any move towards change.
so many years ago, it was an accepted and inexorable truth that
to be the product of a successful futures market, the commodity
had to be storable. Every existing futures contract up to that
time included this essential prerequisite. To suggest a futures
market in a live commodity was unthinkable. Without question
an economic justification test of that day would have applied
the foregoing principal. Were this the case, the Chicago Mercantile
Exchange would not have pioneered its live cattle futures concept.
As a result, one of the most successful and most important futures
markets in existence today would never have been instituted.
Like with Galileo, the idea would have had to be rediscovered
if the Commissioners of that day overlooked the issue of storable
versus live, the CME revolutionary cattle concept would still
have failed to meet the other more standard prescriptions of
justification. The CME would have had to bring forth—as is required—sufficient
numbers of respectable cattle raisers and feeders to testify
that they could and would use such a market for hedging purposes.
At the time, the cattle industry was generally opposed to our
proposed new market. Their negative bias stemmed from normal
resistance to a new concept that would alter entrenched and established
modes of operation. Today, the CME's cattle futures contract
can boast that up to 50% of its open interest is comprised of
cattle hedgers positions—an extremely high percentage of hedge
the most striking example is the International Monetary Market
(IMM). At the time the idea was conceived, it would have been
impossible to pass present day criteria for economic justification.
Indeed, at the time of application for currency futures, the
world monetary order would still have been governed by the fixed
parity regime of Bretton Woods. Clearly, no futures market could
flourish under a fixed-pricing system. And, even later, under
the Smithsonian Agreement, when currency rates were permitted
to fluctuate 2.25% up or down from fixed parities, it is highly
doubtful that our idea would have been approved. Since rates
were not permitted to fluctuate significantly, hedging was not
a necessity. Who needs a free market within a world system that
has a prescribed limitation for price movement? More important,
there were precious few bankers or economists that would have
supported the necessity for our revolutionary idea. Futures markets
were solely for agricultural products.
we pioneered the IMM concept, we believed the fixed exchange
rate system was doomed and that sooner or later the world would
be forced to accept the idea of floating or flexible exchange
rates. We believed that the principles of futures markets that
served agriculture all these years could be successfully applied
to finance. But we could not prove it at the time. Nor should
we have had to. No body of regulators—no matter how well-meaning
their purpose—should be allowed to prescribe necessary criteria
before a new idea can be tested against the harsh reality of
currency futures are an accepted concept. The IMM would pass
any economic justification or public interest test. Today, most
economists and bankers would subscribe to the market's necessity,
but it might be too late—the IMM might already exist on another
what about so many other new concepts, new instruments, new ideas
yet unborn? Will they be able to meet a foreordained system of
economic justification? They shouldn't be required to. The CFTC
will do this nation a great service if it remembers this fundamental
principle of our free market economy.
the risk of adding one more ism to the multitude that
already exist, allow me to conclude that pioneerism,
by definition, needs no economic justification.
by permission. Excerpted from Melamed on the Markets, by Leo
Melamed. John Wiley & Sons, 1993
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