The Chicago Board of Trade: 165 Years of American Ag Capitalism

In the grain markets, which follow the planting and harvest cycle, the old crop from last year’s harvest is ebbing and the new crop is coming in. Wearing brightly colored jackets, open outcry traders crowd the octagonal pits on the floor of the world’s largest futures exchange (see sidebar), shouting and using hand signals to buy and sell orders. Scraps of paper and sunflower seeds litter the floor, while electronic tickers and display boards constantly update with new trade data on the walls above.

One hundred and sixty-five years ago, this was a farmers market.

In 1848, Chicago was the perfect place for farmers to sell their harvests from the surrounding prairie. Here, buyer and seller could meet face-to-face at a central location, enabling growers to receive a fair price for their goods and buyers to walk away with higher quality products. Having a centralized location for buying and selling crops also turned out to have another effect: The prices of farm products across the Midwest began to stabilize for the first time.

Futures 101

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A commodity futures contract is an agreement to buy or sell a commodity, such as corn or wheat, at a future date for a specific, agreed upon price. A futures exchange is the place where these contracts are bought and sold. Buying or selling a futures contract can only be done on the floor of a futures exchange, in this case, on the trading floor in the Chicago Board of Trade building. Because they are futures contracts, they also forecast the value of a commodity in the future.
Many factors determine a commodity’s price. For example, the price of corn is affected by weather, global demand, biofuel policy, the amount of farmland available for growing the crop, macroeconomics (such as the value of the U.S. dollar against other currencies around the world), government policies (such as tariffs), disease and pests, energy costs, geopolitical conflicts and the amount of grain held in reserves, according to the CME Group Inc.
The trading floor at the Chicago Board of Trade building is also where options exchanges take place. An options contract allows its holder to buy or sell a commodity at a fixed price, called the strike price, on or before a specified date.

Although the market was successful, farmers continued to earn more during harvest time and much less, or nothing at all, throughout the rest of the year. Farmers faced an even more difficult time if there was a bad crop.

“They needed a mechanism to manage risk. So, in the late 1870s, futures commodities developed. Over the next 100 years, it was discovered that the same type of contracts would be helpful in other areas, such as currencies or fuel,” says David Lehman, managing director of commodity research and product development at CME Group Inc., which owns the Board of Trade.

Today, “the prices [of commodities] in Europe, South America and Asia are premium to Chicago; the Chicago Board of Trade futures price is the benchmark for the world,” he says.

As the farmers market evolved into a futures and options exchange, seasonal production, primitive cold storage facilities and disorganized markets led to the creation of another type of market nearby. The Chicago Butter and Egg Board was organized in 1898, and evolved into the Chicago Mercantile Exchange in 1919. As cold storage and transportation technologies advanced, markets for potatoes, frozen pork bellies, live hogs and live beef cattle were added.

In 2007, the Chicago Board of Trade and the Chicago Mercantile Exchange merged to form CME Group Inc., the world’s largest and most diverse exchange. Today, CME also owns the Dow Jones stock and financial indexes and derivatives and futures exchanges in New York City and Kansas City.

Farmers can use futures and options exchanges to estimate their costs and returns; which hopefully helps them to be profitable or at least cover their costs, Lehman says.

And, while the markets help farmers make business decisions, they surprisingly don’t affect food prices all that much. In today’s world of mass production, there are many factors that go into the price of a loaf of bread, such as the cost of the energy to transport the ingredients and then transport the finished product, labor costs to produce it, global demand, government policies, decreasing amounts of available farmland due to development, weather and more, he explains.

“For one loaf of bread, the cost of wheat is just eight to 10 cents,” he says. “Wheat is about $6 a bushel today, but a year ago it was almost $12 a bushel, but that doesn’t mean bread is half the price today as it was last year at this time.”

Today, the farmer’s market-turned-futures and options exchange is continuing its evolution.

Computerized trading can be done faster and on a larger scale than open outcry trading, causing a decline in the portion of trading attributed to open outcry. In August this year, for example, trading volume was up 18 percent, to 12.2 million contracts per day, compared with August 2012. However, 85 percent of the more than 268 million contracts were traded electronically, according to CME data.

The CME Globex platform was the first electronic trading system for futures and options, allowing producers to access products in 160 countries, Lehman says. Users can access the platform through regular Internet connections, direct connections and several telecommunication hubs located around the globe.

The playing field between open outcry and electronic trading is also being leveled. In the past, open outcry traders set pricing benchmarks. But in 2012, CME began combining prices from the pits with prices on the Globex trading platform to set volume-weighted benchmark prices. Because electronic trading is now the majority, many feel this further marginalizes open outcry.

Although foot traffic on the trading floor is waning, the business of trading commodities electronically is booming. When the last trader steps out of the pits and switches on a screen full time, one wonders what will become of the historical art deco building that anchors LaSalle Street. A farmer’s market, perhaps?

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