Like other financial markets, commodities exchanges have hosted a lot of speculative activity and outright manipulative trading. Prior to the 20th century, this trading venue, like the stock and bond markets, was essentially unregulated, at least by governments. In the United States, a series of events brought the activities of commodities traders and exchanges into the national spotlight and the focus of political critique and this prompted new regulation. The First World War and its aftermath was particularly transformational to the industry.

Commodities Trading

            New York had seven commodities exchanges by the eve of the First World War though some of these specialized in very narrow sets of goods. Yet, New York was only a secondary venue for trading commodities, Chicago being a larger center for this business. The Chicago Board of Trade, formed in 1848, introduced trading in futures contracts and regulated them somewhat starting from 1865. These contracts allowed someone to lock in a price for future delivery. Still, some commodities exchanges remained simple cash markets where commodities could be bought only for current use.

Chicago Board of Trade, 1904-1913, Photographed by Barnes-Crosby (Source: chicagology.com)

           Futures trading was largely welcomed by official bodies as a way for farmers and the like to hedge price risk and perhaps even limit wild price fluctuations to begin with. Unfortunately, manipulative trading on exchanges was common. The exchanges had differing rules to restrict trading which made it difficult to eradicate certain practices. For example, some went so far as to ban ‘contracts for difference’ or options while others did not.

Early Regulation

            The first legislative bill which included a regulation on futures trading in the United States was introduced in 1884. In a significant development, the Hughes Committee was empowered to investigate securities markets after the Panic of 1907 and it looked into the matter further. Between 1907 and 1909 alone, twenty-five bills were introduced in the U.S. Congress to regulate futures trading. This pace was frequent but not unusual; in the longer period between 1884 and 1922, more than two hundred such bills had been introduced in total.

           Some of these bills would have outright prohibited futures trading. Perhaps to get ahead of government intervention, the Council of Grain Exchanges was formed in 1908. This was a self-regulatory organization for the industry. It sought to harmonize rules and procedures across American commodities exchanges.

           The Council of Grain Exchanges was short-lived as exchanges were reluctant to give up control to this body, even if it was established by the industry itself. This does not mean that exchanges did nothing. Controls implemented by the exchanges themselves were intended to limit manipulation, such as the fabrication of trading data by affiliates trading amongst themselves, as well as speculation triggered by letters sent by exchange members to their clients. Besides the failed Council of Grain Exchanges, none of the efforts to regulate the entire industry introduced before 1910 went anywhere.

            The issue remained front of mind though. The Democratic Party platform for the 1912 presidential election included proposing legislation to “suppress the pernicious practice of gambling in agricultural products by organized exchanges or others”. An outcome of their election victory was the Cotton Futures Act of 1914. This law set a two-cents-per-pound tax on certain cotton futures contracts and created a uniform system of grading for cotton.

Wartime Controls

            The First World War would change the business of trading commodities on exchanges. The war caused food prices to rise sharply, increasing between 50% to 400% between 1914 and mid-1916 for the most important commodities. Retail prices were rising accordingly. Matters got so bad that early in 1917 there were food riots in Philadelphia. When the U.S. entered the First World War in April 1917, commodity prices rose sharply higher still.

           Foreign demand drove prices but so too did hoarding, or put more gently, advance purchases in anticipation of future scarcity. The latter is a more speculative type of purchasing activity which can actually make anticipated price rises self-fulfilling since abnormal demand creates unprecedented imbalances in the market as unusual patterns in demand outpaced the ability of supply to adjust. Low interest rates were also blamed, as credit-availability increased demand for commodities and may have also empowered speculators. This was considered to be an important factor at the time.

           Whatever the cause, wheat prices on the Chicago Board of Trade rose 125% from $1.44 per bushel on February 3, 1917 to $3.25 on May 11. The average price in July 1914, just before the war started, was only $0.90. After this rise, the exchange soon suspended trading in wheat. Other exchanges also suspended some trading and the Chicago Board of Trade extended its suspension to corn in July. In November, the exchange also set daily price limits and restrictions on how much volume any one trader can trade.

            Intervention by the government was seen as critical both for protecting American consumers but also the war efforts of Allied governments, which relied on imports of American crops. If food prices rose, their ability to stay in the war would have been compromised. In a communication to the Council of National Defense, economists had recommended reforms that included controlling speculation and raising interest rates.

            President Woodrow Wilson was empowered by Congress to set the price of wheat so long as that price was at least $2.00 a bushel, already a considerable premium to pre-war prices. The Food and Fuel Control Act, passed in 1917, created a new Food Administration which would control prices; future President Herbert Hoover was placed in charge.

           Exchanges would gradually end trading in various commodities as requested by the Food Administration. In August 1917 for example, the New York Coffee and Sugar Exchange and the New York Cotton Exchange were instructed to end sugar and cotton futures trading respectively. Price controls did create their own problems; in 1918, jealous of the prices given to wheat farmers by the Food Administration, cotton farmers were threatening to withhold their crop and reduce their acreage for the following year, lifting cotton prices.

            On May 24, 1917, a federal grand jury indicted eighty-eight dealers for trying to corner the market for onions. Because financial market regulation was limited, prosecutors instead made charges under antitrust legislation to those looking to control a market. Other speculators faced similar charges. Even with the controls and enforcement, wartime prices were still high, nearby double pre-war prices. Some speculators may have made a fortune but so too did corporations. The price rise led to the creation of large profits by food manufacturers and distributors compared to pre-war levels. So, besides speculators, large corporations received a great deal of scrutiny too.

            To limit speculation, the Chicago Board of Trade recommended that its members restrict their letters to clients to conveying statistical information alone. In February 1918, the Chicago Board of Trade outright banned its members from sending market letters, opinions, or advice in the areas of corn and oats. In April, it prohibited calendar spreads in these commodities, a type of trade where offsetting contracts are entered into with the goal of profiting from price movements that occur within specific windows of time.

1920s

            At the end of the war, the government interventions and those by the exchanges were lifted. Initially, prices continued to rise in 1919. This meant discontent among working people remained and the Wilson administration felt forced to intervene when railroad workers were demanding large wage increases. Strikes generally became more common. In response, Wilson proposed extending the Food and Fuel Control Act. His attorney-general was suggesting penalties of $5,000 and two-years of imprisonment to deter ‘profiteering’.

            From here though, prices for farm products fell precipitously. Wheat fell from $2.19 per bushel in 1919 to $1.05 in 1922. The government again blamed the speculators. In any case, the Federal Trade Commission and the Department of Agriculture published a report on the matter. They reported on the practices of exchanges, which still varied considerably. For example, some required margin to be posted by traders while others did not. Low-or-no margin requirements, the FTC thought, made market movements more violent. Smaller trades, options, and other market features were also scrutinized.

Commodity Exchange Act

            After Wilson left office, Herbert Hoover, now the Commerce Secretary, favored some more regulation. The result, the Futures Trading Act of 1921, punitively taxed futures contracts that traded outside licensed exchanges and required that large trades be well documented. The law was designed to hamper speculation and manipulation. It would be rewritten as the Grain Futures Act of 1922 after the original law was ruled unconstitutional on trivial matters.

            Yet, large swings in commodity prices continued and speculation was blamed again; some movements seemed both particularly large and without fundamental basis. It didn’t help the reputations of commodities traders and exchanges that trading scandals continued. No doubt making the skeptics especially nervous, new commodities exchanges were opening; would these simply be new venues for speculation?

           Experience meant the old legislation was exposed as insufficient. Thus, the Commodity Exchange Act of 1936 complemented the old law with bans on options contracts for certain commodities, an outlawing of various manipulative practices, the implementation of position limits, new registration requirements, and more. Further, the regulatory reach of the legislation would be extended to more commodities over the coming decades.

Lesson

             Financial reforms are often prompted by financial crises and wars. Within less than three decades, regulation of commodities markets, and futures markets in particular, was shaped by the Panic of 1907, the First World War, the Agricultural Recession of the early-1920s, and the Great Depression.  For the uninitiated, the world of commodities trading can be easily overlooked but it is perhaps the most important market for the basic functioning of the economy. Scrutiny of commodities traders and exchanges seems warranted even outside of the particular circumstances brought on by a crisis. 

More from the Tontine Coffee-House

           Read about a minor defunct commodities exchange, the New York Produce Exchange and efforts to corner the market in silver and gold a century apart. Consider subscribing to this blog’s newsletter or checking out book recommendations, which include many of the sources often referenced in my posts. 

Further Reading

1.      Campbell, Donald A. “Trading in Futures under the Commodity Exchange Act.” George Washington Law Review, no. 26, 1958, pp. 215–254.

2.      Howenstine, E. Jay. “The High-Cost-of-Living Problem after World War I.” Southern Economic Journal, vol. 10, no. 3, Jan. 1944, p. 222.

3.      Markham, Jerry W. A Financial History of the United States. Vol. 2, Armonk, NY; London, M.E. Sharpe, 2002.

4.      Van Hise, Charles R. “The Necessity for Government Regulation of Prices in War Time.” The Annals of the American Academy of Political and Social Science, vol. 74, no. 1, 1 Nov. 1917, pp. 224–235.

Leave a comment

Your email address will not be published. Required fields are marked *

Social Share Buttons and Icons powered by Ultimatelysocial
LinkedIn