Rethinking Markets

Cedric Cowing, in his wonder book Populists, Plungers, and Progressives, writes about the distinctions between futures and options in the 19th century and the tenuous myth of deliverability:

Probably the greatest difficulty the exchange forces faced was the task of differentiating between a simple option and a futures contract. Options permitting fulfillment by settlement of differences alone were regarded by the courts as gambling contracts and hence unenforceable, so it was vital that the brokers draw a careful distinction between futures contracts, their principal form of business, and these illegal options. In theory the difference was that a simple option could always be settled by cash, whereas the purchaser of a futures contract could demand delivery of the actual product. In practice, however, the distinction was meaningless, because futures contracts were settled just as simple options – by the payment of differences. In only 3 per cent of the futures trades was there actual delivery; in fact, to demand delivery was to brand oneself a miscreant and led to ostracism by the brokers.

This distinction might have seemed tenuous to the layman, but it was fundamental according to prevailing legal thought. The right to require delivery, contained in the futures contract, made it possible to say that the seller at the time of the sale intended to make delivery and therefore, his intent being legitimate, the contract was legal and binding. The simple option, on the other hand, was inescapably a wagering contract because the purchaser could offer no intent other than a desire to profit by a price change. The intent to profit, where no goods were exchanged, was held to be socially unjustifiable. Thus it was only the delivery provision in the futures contract that enabled traders to refer to themselves as brokers and speculators rather than gamblers, and decided whether – at least in the legal mind – they were assets or liabilities to society.

Two things are important here. The first is that it was necessary to create a fiction that allowed early exchanges to distinguish speculation from gambling. Because the public found ‘risk transfer’ (or rank market speculation) unconvincing. And second, a failure of economics as a discipline was (here at least) its imposition of ‘market efficiency’ as a socially desirable end in and of itself. By late 20th century, speculation as a form of risk transfer was promoted as a way to make markets more efficient. And market efficiency obviated the need for some kind of ‘real economy’ justification.