Originally published September 8, 1986
DURING THE last couple of years a new fungus has been welling in the dark of the financial moon – the securities futures market, or markets. The most prominent of these trades guesses about the future of the Dow-Jones Index. This trading is said to be similar to that on the commodities exchanges, where you can bet on the future price of sugar or platinum or pork bellies; but the similarity is merely superficial.
If I were crazy enough or shrewd enough to play the commodities markets, I’d go in for pork bellies, because that solemn game appeals to my sense of the ridiculous. The unit of trading is a contract to buy (or sell) 38,000 pounds of the stuff (which I suppose is a carload: a carload of book paper is 40,000 pounds) at a specified price at some future date. That’s a giggling amount of bacon to bring home.
As I write this, the price for next March is 63.4 cents a pound. Let’s say you purchase a contract to buy and, come March, the price is 73.4 cents a pound: You sell your contract at that price and pocket the difference, or $3,800, less a trifling brokerage charge and taxes. You don’t have to feed the pigs; you don’t hear them squeal; you never even put up any real money; and you can sell any time before if you think the price is right. You simply pick up a piece of change for guessing right. Of course, if you guess wrong, you take a bath in the trough.
The commodities markets are gambling dens for millionaires. Conscience stricken brokers (there are some such) claim that the trading stabilizes prices and so helps farmers plan. We don’t have to take this claim seriously to see that, in the end, someone winds up with some actual bacon to sell to someone else who has not been persuaded by Jane Brody to give up the ingestion of animal fats.
The stock market futures are something else. There, what is traded is the right to buy a bundle of stocks already a couple of markets away from anything you can get your teeth into. After all, the stock market itself is said to stabilize the cost of capital and help General Motors to plan production. Again, this is a claim we don’t have to take seriously. And when we read in the business press that the securities futures market stabilizes the stock market, which stabilizes the cost of capital, we know we are in the land of make believe. Why not a market in options to buy futures, thus stabilizing the futures market?
Now, it is true that stock market futures have some slight appeal to people engaged in productive enterprise. Enterprisers deal with the future all the time anyhow. The local bookstore orders its Christmas stock in July; the publisher sent the manuscript to press in January; the printer and paper manufacturer have to order their machines years ahead.
It takes time to do business, and during that time the prices of things change unpredictably. If you contract today for a $10 million warehouse to be ready a year from now, you worry that by that future date the real estate market may have tumbled so that your competitor can buy one standing empty for $8 million and be in a position to underprice you. You may worry so much that you decide to hedge your bet by selling stocks short. Then if prices fall, the money you gain by selling short will offset the value lost on the warehouse. And if prices rise, the increased value of the warehouse will offset the money lost on the stocks.
Obviously, when you hedge a bet you narrow your possible gains as well as your possible losses; and you may be ready to do this because you want the warehouse to do business in, not to speculate with.
Since the stock futures market is an organized way of selling short, it is convenient for businessmen with heavy commitments they would like to hedge. Once the market is in operation, it offers a field day for big-time gambling on a sure thing. For various reasons, a gap will open from time to time between the futures market and the prices of the underlying stocks. When the gap is big enough (maybe only a point or two), arbitragers will buy in the cheaper market and sell in the dearer. It’s a riskless gamble, but you have to act fast, and you have to have access to an enormous amount of money to make the game worth the trouble and expense.
The gaps that open between the markets are not exactly the doings of the famous invisible hand. Those who run futures markets pride themselves on developing what they call “products” that will appeal to traders. (It would be hard to imagine anything less like a tangible product or more airy-fairy than the chits that are traded.) A successful “product”- one that has, as they say, a great deal of sizzle – is one that is extra volatile. The more volatile the markets, the bigger the possible gaps. The bigger the gaps, the more trading. The more trading, the more volatility.
Recently a vice president of the New York Stock Exchange, which usually pictures itself as sedate and conservative, talked pretty smugly during a TV interview about a new “product” the Exchange is pushing. It is called the Beta Index. Stocks that are highly volatile are said to have a high Beta characteristic, and the Beta Index is a weighted average of the 100 most volatile stocks on the Exchange. Beta Index futures, it is hoped, will be not only volatile but sizzling. There’ll be big gaps for sparks to jump.
Trading to take advantage of gaps is an old way of making money. It has a better claim than Marx’s elaborate analysis as the method of primitive accumulation that made capitalism possible. In The Wheels of Commerce, the second volume of his trilogy Civilization and Capitalism, 15th-18th Century, Fernand Braudel makes much of the fact that the first large Renaissance fortunes resulted from long-distance trade.
The money wasn’t earned in haulage; the function of distance was to open gaps in information, and consequently in prices, that enabled well-informed experienced traders to buy cheap and sell dear. Like the arbitragers of today, they used other people’s money: partnership funds, bank deposits, and ultimately credit, some of it not unlike junk bonds. Fortunes accumulated very fast.
What fascinates people about stock index futures is that the big trades are dictated by computers, and when they aren’t” down” they still have an aura of magic. It’s all done in seconds, as compared with months or even years a half millennium ago. On a recent day, some 40 million shares were traded in the last few seconds before the market closed. A brief four or five years ago, 40 million shares made a big day on Wall Street; on Black Tuesday in 1929, only 16,410,000 shares were traded. Today’s buy and sell orders are programed, which seems different from human agency (though programmers are presumably human). But the principle is the same. Also the same is the uneasiness aroused in the breasts of ordinary citizens by the extraordinary winnings of the traders.
THE UNEASINESS is certainly justified. The old curse (variously said to be Chinese, Jewish, or Hungarian) can be paraphrased to read, “May you live in volatile times.” Yet the stock Exchange itself could scarcely exist if it were not inherently volatile. It is disingenuous or ignorant to contend, as many do, that the market is an efficient way of valuing the nation’s industries. There is much fluttering in economic dovecotes if the GNP varies in a year as much as 2 per cent from its secular trend line, yet the stock market can rise or fall that much in a single session.
In a rational world, the value of a nation’s industries would be a function of what they produce. In the world of Wall Street, the nation’s industries are merely an occasion or an excuse for buying and selling pieces of paper. What is being valued is not the corporations that issued the paper but the traders’ guesses about what the Federal Reserve Board will do next. An offhand remark by Chairman Paul A. VoIcker will trigger a bigger rise or fall in the market than any conceivable news about actual production. Indeed, favorable news of production is likely to cause the market to fall, because it is thought likely to frighten VoIcker into tightening the money supply and raising the interest rate in order to try to exorcise the inflation banshee. Commentators will intone a few traditional homilies about the effects of high interest rates on industry, but what really matters is that a rise in the interest rate reduces the capitalized value of every income-earning asset.
The business press is fond of pointing out that everyone who guesses VoIcker is in a good mood is matched by someone who guesses he is in a foul mood. Otherwise there wouldn’t be any trading. The implication is the shaking and baking all evens out and doesn’t matter.
Unfortunately, it does matter. The New York Times estimates that $11 billion is now committed to the stock futures markets alone. This $11 billion, invested in “products” that neither are products nor produce products, is unavailable to productive industry. As far as enterprise is concerned, the stock futures markets have caused the money supply to fall $11 billion. An even more potent factor in the misuse of the money supply is the resurgent takeover wave, which must carry off upwards of $100 billion in its undertow.
Not so long ago, college endowment funds, pension funds and the like were invested almost exclusively in high-grade bonds. Bit by bit they all have been seduced into playing the market, where they are managed by “experts” with an eye to churning the accounts and so picking up a fraction of a point here or there, day after day. It can all add up, just as a vegetable market makes a tiny profit on sales but a tidy profit on investment by turning its inventory almost daily.
As the market has risen with the fall in interest rates, the results of this activity have been spectacular. Given the record, it will not be surprising if the managers of these funds are tempted by the stock futures markets, where the winnings can be two or three times those of the stocks themselves. As this comes to pass, more and more of our money will be frozen in nonproductive speculation. The resulting Ice Age will leave our industries, once a justifiable source of pride, high and dry.
The New Leader