Red-Blooded Risk: The Secret History of Wall Street

CHAPTER 10

The Story of Money: The Future

The replacement for paper money was born around 1850 in the northern drainage basin of the Mississippi River, what was called at the time the Northwest United States. Boards of trade appeared in the major cities and began trading futures contracts. A futures contract is a promise by one party to buy, and a promise by the other party to sell, a specified amount and quality of some commodity at a specified future time and place, for a specified price. It has three additional defining features.

First, the amount, quality, time, and place are standardized.

Second, there are actually two contracts. Each side contracts with an institution called a clearinghouse. The clearinghouse only takes pairs of offsetting contracts. If I agree to sell you 5,000 bushels of #2 soft red winter wheat delivered on March 14 to an exchange-approved silo for $5,000, I do not actually sign a contract with you. I sign a contract to sell the wheat to the clearinghouse for $5,000, and you sign a contract to buy the wheat from the clearinghouse at that price. We each post margin, say $500, with the clearinghouse to guarantee performance. The advantage of this is I don't have to know or trust you. Also, if I later want to get out of the contract, I don't have to find you and negotiate. I can agree with anyone to buy 5,000 bushels of wheat on March 14; then we both go to the clearinghouse with our offsetting contracts. I now have two contracts with the clearinghouse, one ...