Well, today I want to talk about what, to me, is a very

interesting topic, and that is futures markets.

Not very interesting to most people.

Most people have no idea what they are.

But I think that, well, futures markets, what we're

really talking about is --

There are different ways of viewing it.

Futures markets for things like agricultural commodities,

or interest rates, or financial securities, are

markets about the future.

They're markets that, in some sense, predict the future.

And future matters, right?

We live a life.

We have a long horizon.

I said before, I think that your planning horizon must be

at least a century, because you'll probably live that long

anyway, with modern medicine.

And you care about other people, too.

So, the beauty of futures markets is that we have prices

for the future.

We talked already about forward markets.

We talked about forward interest rates.

And that is related to what we're talking about.

Forwards and futures are similar concepts.

Futures is the more precise concept.

Or the more developed concept.

And I'll explain the difference between forwards

and futures.

But just in a nutshell, futures markets are organized

markets, like the stock market, that trade

standardized contracts, representing things that will

happen at future dates.

And because they're

standardized, they're worldwide.

Everybody looks at them and uses them.

Whereas forward markets are more specialized markets that,

typically, are not as easy to interpret or as clear.

So, futures markets are, in some sense, more fundamental

and important.

I have a particular interest --

I've been interested in futures markets myself for

many years.

And wondering, why they're not even

bigger and more important.

So, in 1993, I wrote a book called Macro Markets, about

let's make our markets bigger and more

important, and more pervasive.

And I've been trying to do that.

Notably, in 2006, I was working with the Chicago

Mercantile Exchange, which is the biggest futures

market in the world.

And we created home price futures.

And they've been trading now for five years.

But I'm not really going to talk about them, because they

have so far disappointed.

They're not important, at least not yet.

But I'm going to talk about some

important futures markets.

First, I want to put just a couple of definitions up.

Futures, that's what we're going to talk about most in

this lecture, and it has a special meaning in finance.

And I was contrasting that to forwards.

But both of these together are derivatives.

And that means that the price in these markets derives from

a price in some other market.

There's a primary or underlying market, which has

its own price.

And then there's a derivative market that has a futures

price or a forward price.

I guess I'm speaking in kind of abstract terms. Well, let

me just start --

I want to give you an example, and we'll see better what I'm

talking about.

But let me just first comment just on this word,

derivatives.

To people in finance, derivatives are an exciting

development of financial markets.

We start out with a simple market and we develop

derivative markets, that add more detail and information

than was in the underlying or primary market.

That's exciting.

I find it exciting.

However --

I don't know how often you hear this word, derivative --

it's become a four-letter word.

It's become an ugly word.

Why is that?

I think it's, because people blame the current financial

crisis on derivatives, whether rightly or wrongly.

And it's because, I think, there's a public anger about

derivatives that is largely due to misunderstanding.

I mentioned before that I think that finance tends to

attract sociopaths.

I mentioned that, I defined that for you.

People who want to manipulate, and fool, and deceive people.

But I don't think the financial community is

particularly populated by sociopaths.

You might think so, reading some accounts.

But I think, it's not true.

And I think, it's not true, because the financial

community knows about this problem

and ejects such people.

They get caught.

And you can't make a career in finance if you're a sociopath.

So, if you think you have this problem, that you have

sociopathic tendencies, I would advise you not to go

into finance, because you will get caught and ejected.

So, save yourself the trouble.

Don't go into finance.

Pick some field where you can't hurt anybody.

And that would be a smart thing to do, if

you have such a problem.

So, I think we need to regulate derivatives markets,

and that's what I'm talking about.

And we need self-regulation of the markets themselves, but we

need government regulation as well.

But there's nothing evil about derivatives.

And in fact, derivatives are fundamental to the way I think

a modern economy works.

So, I had you read an article --

I put it on an earlier section of the reading list --

by Charles Conant, who wrote a book in 1904 called Wall

Street and the Country.

And you should have read that by how.

He starts out by saying, it's just amazing, how public

opinion thinks that speculation is evil.

And they don't understand that speculation is just business.

I mean, business decisions involve

guesses about the future.

And so, when you have well-developed markets, these

guesses become market prices.

And so, the prices go into the calculations

that everyone makes.

And the calculations are just done better.

Somehow, there's just a failure for most people to

understand it.

And I'm hoping in this lecture to try to give some more

understanding of these markets.

I think they're fascinating.

Most people apparently don't, because you don't hear them

brought up very much.

I want to just say a little bit more about hostility

toward derivative markets and futures markets, and

speculation in general.

In 1991, that was 20 years ago, I wrote a joint

paper with a --

I don't remember whether I mentioned this,

probably not --

with a Russian, a young man from Russia that I met when I

was visiting the Soviet Union, just before the end of the

Soviet Union.

And we were talking about how antagonistic Russians are

toward capitalism.

And he said, this is a big problem.

Russia just can't embrace capitalism.

These people hate it.

They hate the profit makers and the financiers.

And I said to him, well, you know, it's the same in the

U.S. How do you know it's any worse in Russia?

And so, we decided to do a questionnaire survey.

And I was going to read one of the questions, comparing

people in Moscow and people in New York, to see, which one

understands capitalism better.

So, one of the questions that we had was the following --

We wrote these questions and translated them into Russian.

And we tried to make them exactly the same questions

between Russian and English.

So, here's the question we asked in both cities: ''Grain

traders in capitalist countries sometimes hold grain

without selling it, putting it in temporary storage in

anticipation of higher prices later.

Do you think this speculation will cause more frequent

shortages of flour, bread and other grain products?

Or will it cause such shortages to become rarer?''

What do you think, people said?

Does the process of speculating in grain cause

problems or solve problems?

Well, we found that, in the USA, 66% said it will make

shortages more common.

But in the Soviet Union, in Moscow, only 45% thought it

would make shortages more common.

Both of them were wrong.

A lot of them were wrong, but the Russians were better,

closer to the truth than the Americans.

Living in the financial capital of the USA, most

people think that speculating in grain creates problems. But

wait a minute, what is speculation in grain?

That means holding it off, expecting higher

prices later, right?

Isn't that what you have to do if you are

managing a grain market?

Now, think of it this way -- and I'm coming now to

agricultural futures.

In the simplest world, there's one harvest

of wheat every year.

And that harvest comes in a certain time of the year,

every year.

Once a year.

And it has to be held in storage over the year, right?

Because people don't eat it all at once.

You eat it over the whole year.

So, somebody is storing grain.

This is a fundamental problem.

That's a business.

So, you have to know that somewhere there's some

warehouse holding the grain that you will be consuming in

six months time.

And that warehouse is run by some

professionals who do that.

If they think prices are higher later, they'll keep it

longer in the warehouse.

And what does that do?

That evens out the price.

It doesn't make it worse.

If they think there's going to be a shortage of grain, they

hold it back now and the price of grain goes up.

And so, everyone starts consuming a little less

because of the higher price, and it smoothes things out and

it works better.

And this is elementary economics, but it's not

understood, I think, by most people.

And the futures markets are just sophisticated markets

that help that process.

So, I'm going to start with agricultural futures in

talking about this.

And I want to start also with a very homely -- it's not

homely -- it's a very elementary example, because

it's the first futures market.

So, where do you think futures markets started?

You would think, it started in New York, or Chicago, or

London, or Paris.

It actually started in Japan in a place called Dojima,

which is in the city of Osaka.

And they started in the 1600s.

So, let's go back.

If we can go back to the year 1673, in Osaka in Japan.

Japan was heavily dependent on rice.

And the rice farmers would farm all over Japan, but there

was a rice market in Dojima, which was the

national rice market.

And I have data here.

According to a study, there were 91 rice warehouses in

Dojima in 1673.

That's a long time ago, isn't it?

So, it was a big storage place for rice, and they were

storing it all year.

And people would come, people who were merchants for rice,

and they would come to Dojima and they would sign contracts

to get rice.

I live in some town 20 miles from

here, I'm a rice merchant.

I need a regular supply of rice from your warehouse.

Can you supply it to me?

And the guy would give you a terms, and that would be a

forward contract.

And this is what was happening before the futures market.