Financial History Issue 127 (Fall 2018) - Page 26

GRAIN TRAITORS A History of the US Futures Contract By Joseph M. Santos In Frank Norris’s 1903 classic, The Pit: A Story of Chicago, cornering wheat on the Chicago Board of Trade consumes protagonist Curtis Jadwin. As the world’s food supply hangs in the balance, Jadwin buys enormous quantities of futures con- tracts, a 19th-century financial innovation that enables buyers and sellers to trade Trading pit for buying and selling grain at the Chicago Board of Trade, July 1907. a quantity and grade of an underlying asset—wheat, for example—at a specified price and future date. True to the literary Naturalism that The Pit exemplifies, the inescapable and indifferent forces of capi- talism ultimately breach Jadwin’s corner; broken and impoverished, he leaves Chi- cago to begin again farther west. The Pit was published posthumously, a year after Norris’s untimely passing at age 32. The novel was to be the second in a trilogy, Epic of the Wheat, in which Norris was to chronicle production (The Octopus, a Story of California [1901]), 24    FINANCIAL HISTORY  |  Fall 2018  | distribution (The Pit: A Story of Chi- cago [1903]) and consumption (The Wolf, a Story of Europe). Born in Chicago in 1870, Norris came of age (in California) when futures trading, and the corners it allegedly provoked, stirred the imagina- tions of Gilded-Age and Progressive-Era Americans. Norris was no exception. His inspiration for Curtis Jadwin was 28-year- old Joseph Leiter, who failed spectacularly to corner wheat on the Chicago Board of Trade between 1897 and 1898. Not surprising, perhaps, farmers were deeply suspicious of futures trading, which they equated to gambling—on grain, no less. However, despite literary representations and popular perceptions to the contrary, futures trading well served the nation’s grain trade, especially by the mid-19th cen- tury, as agriculture moved from subsistence to commercial production. Financing com- mercial production, storage and transpor- tation required a financial innovation that enabled commercial interests to trade away their price risk to those who preferred to bear it. By the late 19th century, the futures contract met this requirement. In the early 19th century, short-term sight drafts, written on the credit of mer- chants, and consignment contracts, writ- ten between commission agents and grain dealers, were the instruments of grain- trade finance. For example, an eastern miller who required grain secured a mer- chant’s line of credit in the form of 60- or 90-day sight drafts. Western commission agents attached grain warehouse receipts to these sight drafts and discounted them locally for bank notes, which agents advanced to grain dealers for a portion of the grain’s market value at that time; agents paid dealers the remainder when the grain sold in eastern terminal markets. This system worked well enough when grain prices were mostly stable from har- vest to consumption; however, such price stability was rare. During credit crises, hinterland banks often refused to discount sight drafts, depriving the grain trade of it precious credit. The problem was that trading on consignment meant that com- mercial interests could not trade away price risk. Put differently, financial mar- kets were incomplete; trades that would suit hedgers and speculators alike did not occur for lack of an appropriate market, complete with an institutional framework that sufficiently reduced transaction costs. Following the Panic of 1857, “the credit