FUTURES MARKETS IN THE DIGITAL CENTURY

Presented at The Derivatives and Risk Expo
New York, N.Y.
May 11-12, 1999

In George Orwell's classic novel, 1984, the author warned of a coming social order wherein the truth would be concealed from the people by a tyrannical government. Indeed, as the Twentieth Century unfolded, this dire prediction came dangerously close to coming true in many parts of the world. However, what Orwell could not possibly know when his novel was published in 1948, was the incredible advances in information technology which would ultimately prove his premise wrong.

Aldous Huxley, on the other hand, in his 1932 sci-fi novel, Brave New World, depicted a laboratory-produced population that is enslaved by drugs, mass-propaganda, and informational nonsense. Some might say, present advances in biological cloning, a spreading drug problem, and the Internet's ability to disseminate misinformation make, Huxley's prediction a bit too close for comfort. But again, the information revolution in the later half of this century has acted as a powerful safeguard against any government that is bent on keeping the truth from its people.

In 1977, I wrote an article for the Hofstra University Law Review in which I categorically stated that futures exchanges can only succeed within an open-outcry transaction architecture. I based that opinion on the knowledge then available. In 1977, personal computers were science fiction, windows were what you peered through, Bill Gates was still in college, and the apple was but a fruit.

The obvious point I am making is how difficult it is predict with certainty what lies ahead. Case in point, the Twentieth Century. Who among us would have predicted that within the same 100 years, our civilization could rise from the ashes of two World Wars, the Holocaust, and the dual threats of fascism and communism to bring freedom to a majority of nations on the planet. Who would have thought possible that our civilization could so quickly eradicate such deadly afflictions as, say, yellow fever, polio and smallpox. Who would have predicted the incomprehensible advances in technology, where transportation would advance from the horse and buggy to Apollo Eleven and the moon, where Marconi's 1896 radio patent would be transformed into a global cellular communications system, and where Wilbur and Orville Wright's flight at Kitty Hawk in 1903 would produce something called the Titan missel and the Apache Helicopter. Who among us would have believed that the policies of governmental activism espoused by John Maynard Keynes and so pervasively embraced by world powers would in a few decades be thoroughly rejected in favor of the free market principles of Milton Friedman.

Or for that matter, who among us would have predicted that futures contracts in pork bellies would evolve into the complex set of Eurodollar bundles or stock index futures on the floor of the Chicago Mercantile Exchange. I dare say precious few. For that reason it is futile, even foolish, to pretend that any of us can peer over the horizon into the next century and know with certainty what it will bring or what its markets will look like.

Think back. Isn't it hard to believe that at the dawn of the present century, a brief 100 years ago, Britannia was still the empire on which the sun never sets; the railroads were in their Golden Age, automobiles were considered but a fad, heroin was considered an excellent cough syrup, the phonograph was the most popular form of home entertainment, life expectancy for the American male was 48, and futures markets, those that did exist in a formal fashion, dealt exclusively in agriculture--grains, coffee, cotton, wool, butter and eggs--an evolutionary extension of the "to arrive" contracts of the previous century.

Oscar Wilde, Friedrich Nietzsche, Giuseppe Verdi died, but Louis Armstrong, Humphrey Bogart, Spencer Tracy, and Thomas Wolfe, were born. And in Europe, Sigmund Freud just published his "Interpretation of Dreams," while Albert Einstein, the foremost thinker of the century was preparing to forever change the destiny of mankind with his theories on relativity, and economist Friedrich von Hayek dared to publicly espouse free enterprise philosophies.

How could anyone have known that one of the most profound events that would direct much of our present century would occur long before it began--back in 1848--smack dab in the middle of the Nineteenth Century. In that year, Karl Marx and his associate, Friedrich Engels, published the Communist Manifesto. The concept of Marxism, more commonly known in practice as communism, would dominate the political thought of Europe and later Asia for most of the Twentieth Century.

Today, some 150 years after the concept was conceived, we know it to have been an unmitigated failure. Indeed, those of us, citizens of planet Earth, fortunate enough to be present in the final decade of the Twentieth Century, have been privileged to witness events equal to any celebrated milestone in the history of mankind. In what seemed like a made for TV video, we were ring-side spectators at a global rebellion when in less than an eye-blink the Berlin Wall fell, Germany was unified, Apartheid ended, Eastern Europe was liberated, the Cold War ceased, and a doctrine that impaired the freedom of three generations, wrecked the economies of scores of nations, and misdirected the destiny of the entire planet for seven decades, was decisively repudiated.

What a magnificent triumph of democracy and freedom. What a glorious victory for capitalism and free markets. Surely these represented the defining moments of the Twentieth Century. But let us be clear, if there is a single lesson to be gained from these events, it will not be found in the political or economic arena, but rather in the sciences. For it is axiomatic: human events are but links of an unending chain forged to the greatest extent by the inexorable march of science and technology.

Indeed, the lynch-pin of all that occurred was devised precisely one hundred years after the Communist Manifesto--on December 23, 1947--smack dab in the middle of Twentieth Century. For on that day, John Bardeen, Walter Brattain, and William Shockley, all Bell Laboratory scientists who would receive the Nobel Prize a decade later, demonstrated a device made of strips of gold foil, a chip of semiconducting material, and a bent paper clip, that could take an electric current, amplify it, and switch it on and off. They had invented the first transistor. It was the birth of a technology that would serve to dominate the balance of this century and much of the next as well. The Digital Age was upon us.

Transistors and their offspring, the microchip, transformed everything: the computer, the space program, the television, the automobile, telecommunications, and, to be sure, the markets. We had migrated said Walter Wriston of Citicorp to the "information standard." Modern telecommunications capabilities fostered instant mass informational flows in total disregard of internal prohibitions or national boundaries. This proved to be the common denominator for the dramatic upheavals we witnessed. The truth could no longer be hidden from the people. Thus, as it has throughout the history of mankind, science and technology again dictated fundamental reform in our social structure and reshaped both the political and economic landscape of our planet.

In fact, the transistor caused planet Earth to shrink. We called it globalization. As a result, today, for the first time in human history, nearly every country on the planet has a market-oriented economic system and is attempting to be a competitor in the global marketplace. For the past 20 years when we spoke of a global economy, we were talking about only 25% of mankind—mostly North America, Western Europe, and Japan. And as recently as 1988, almost 70% of mankind was living under Marxist or socialist economic systems. Today, suddenly, there are three billion more participants in the capitalist system.

Fortunately, ten years after I wrote the Hofstra article, at the introduction of GLOBEX in 1987, I had no trouble telling our members that I was wrong and that it was imperative we change. That technology and globalization had placed demands on our markets which could not be met by past transaction mechanisms. The lesson implicit is quite simple: when we make predictions, we must never become wedded to them lest we become victims of what Rose and Milton Friedman call The Tyranny of the Status Quo.

Within the context of the foregoing qualification, let me state that in stark contrast to the signals at the turn of the last century, the evidence today is overwhelming that the next century will be dominated by the information standard. As Dr. Carver Mead of the California Institute of Technology stated: "The entire Industrial Revolution enhanced productivity by a factor of about a hundred, but the microelectronic revolution has already enhanced productivity in information-based technology by a factor of more than a million"—and you've seen nothing yet!  Today, millions of transistors are etched on wafers of silicon. On these microchips, all the world's information can be stored in digital form and transmitted to every corner of the globe via the Internet. Thus, as Harry Seegers, chief executive of GE Information Services, said, "Information technology will be to the Twenty-First Century what electricity has been to the Twentieth Century."

Indeed, the Digital Revolution will change, and is changing, the way we live, work, play--and trade. One can no more deny the fact that technology has and will continue to engulf every aspect of financial markets than one can restrict the use of derivatives in the management of risk. The markets of the future will be automated. The traders of the future will trade by way of the screen. Those who dare ignore this reality face extinction. Today's cyber-wizards have combined the sorcery of electrical and electromagnetic waves, and propelled them at incredible speed, about three-quarters of the way to the moon with every second. In doing so, they have produced a wave of energy that can carry a computer command, the human voice, or virtually any program including market information, quotations, analysis, and orders from anywhere to anywhere. The new technology will create a world in which applications impossible with wires will result in not just a series of new technological marvels, but a spectacular lifestyle emancipation.

By unplugging us from existing infrastructures, networks of information, and communication hookups, we will suddenly have many more choices about where we live, work, or how we trade.

Everyone will be connected, carrying small pocket devices that can be used to communicate, or as a computer, or a fax, to download money, or to trade. Tiny chips might even be implanted in our bodies that could act as a universal credit card, passport, driver's license, or even to transmit buy and sell orders. Telephones as we knew them will be history. Wireless e-mail in the Twenty-First Century will be the dominant personal telecommunications instrument and the trading mechanism of choice. Surely, national and economic borders which have already been blurred, may dissolve completely, as communication satellites enable consumers and traders to do transactions in cyber-space. And now that we have seen the birth of the euro, representing a single currency for much of the European zone, and there is serious talk of a similar dollar zone for the Americas, perhaps it won't be so long before there is one world currency—digital money.

To be sure, the Age of Cyberspace will cause an enormous shift of power from producer to user. Technology is a force for democracy and individual empowerment. The consumer will become king because the Internet changes the old rules. Consumers who don't like what they see will just click, delete and move on to the next screen. Those corporations who are currently merging and are betting that bigger is better may be looking in the rear view mirror and could be completely wrong. With the cost of entry lower and easy access to the global marketplace via the Internet, competition may come from smaller entities with a flexibility to offer innovative services. In the past, success had a lot to do with location; in the future, where you are located may not matter. Since what will be true for the consumer will be equally true for the trader, you begin to fathom the implications of digital technology to exchanges.

In the early part of this century, the respected U.S. Supreme Court Justice Louis Brandeis defined an exchange as a set of rules that assure open access to many sizes and kinds of buyers and sellers. In 1969, when I was first elected chairman of the CME, the President of the Merc, Everette B. Harris, sat me down and explained what Judge Brandeis meant in simple language, "The exchange is a dance hall," Mr. Harris said, "the administration provides the music and the traders do the dancing." Both their definitions remain valid for the digital century, provided exchanges continue to exist. And the answer to that question is very much in doubt. In the face of foreign and OTC competition, organized U.S. exchanges are in a difficult position. The CME's attorney, Jerrold Salzman, has correctly verbalized the obvious. The exchanges, he said, have three choices: level the regulatory playing field so that they can fairly compete, transfer control to the major FCM community, or demutualize and operate as a business enterprise for profit. I agree, but would emphasize that the situation is much more serious than is generally understood.

Allow me therefore to conclude with the following sobering thought: If the futures exchanges fail to quickly embrace current technological and competitive demands, and if the U.S. regulatory regime fails to quickly remove the chains that prevent American futures exchanges from meeting their competitive challenges, then our exchanges may well be doomed. And if this were to pass, it would deal a telling blow to the American financial service sector, a result clearly not in the best interests of the American economy.

For we must never forget, nor underestimate, the critical role played by derivatives markets, both on and off exchanges, in fueling the economic engine that brought the U.S. and the world the current state of unprecedented prosperity. Allow me to offer no less a source than Alan Greenspan when he recently stated that, "By far the most significant event in finance during the past decade has been the extraordinary development and expansion of financial derivatives."(1) Consider that according to the most recent Bank of International Settlements survey, the estimated size of the global OTC market today is at an aggregate notional value of $70 trillion, and rising. Indeed the notional value of derivatives, either on or off exchanges, grew more than 30 percent last year, the most rapid annual growth since 1994. And as Mr. Greenspan explained,

The reason that growth has continued despite adversity, or perhaps because of it, is that these new financial instruments are an increasingly important vehicle for unbundling risks. These instruments enhance the ability to differentiate risk and allocate it to those investors most able and willing to take it.....a process that has undoubtedly improved national productively growth and standards of living.(2)

And where, might one ask, was the primordial derivatives soup that fostered the necessary financial environment for OTC engineers to use their computers and break up all forms of finance into tiny bundles of risk for trade? The correct answer is that it existed primarily on the floors of American futures exchanges: the veritable hub of innovation throughout the 1970s and 80s which nourished many of the original ideas and spurred the birth of today's blazing derivatives market. Indeed, U.S. futures exchanges represent a precious American asset, one that is still the hub of innovation, and one that we dare not impair.

Thus, I beseech both the leadership of U.S. exchanges, as well as our legislators in Congress, to be mindful of this history and to use their power to preserve and protect the viability and integrity of American futures markets as we enter the digital age of the Twenty-First Century.

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     (1) Remarks by Chairman Alan Greenspan, before the Futures Industry Association, Boca Raton, Florida, March 19, 1999.

     (2) Ibid

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