On Sept. 23, Leo Melamed, widely known as the father of financial futures, addressed an audience of Futures industry professionals at the CTA Expo, offering personal stories of his experiences that got him to where he is today.
Melamed said that the first lesson his father taught him occurred when their family was in Lithuania. His father held up one Polish złoty and one Lithuanian litas, asking the young Melamed how much they were worth in relation to each other. Melamed could only guess that they were the same, as the government had dictated. His father then took him to a bakery and bought a piece of bread, worth one Lithuanian litas. But when his father tried to pay with one złoty, the baker stopped him and said, “Two złoty, one litas.”
“It was a lesson I never forgot,” Melamed said. “Because what my father explained was the Milton Friedman doctrine…only the free marketplace can give you the true value of nearly anything.”
Many years later, Melamed would carry that lesson with him as he entered the world of futures and revolutionized it beyond recognition. Perhaps echoes of the baker’s words resounded in Melamed’s head as he observed the global fixed exchange rate system, which had been established at the Bretton Woods conference in 1944, and realized that a new system would be coming.
“By [the 1960s], I recognized that the world had totally changed,” Melamed said. Not only had the international balance of power changed—Japan, the U.K., and Germany were now much more powerful and influential—communication capabilities had also developed over the past few decades. Information traveled “at lightning speed,” and as a result, the value of currencies could change just as quickly. If a finance minister said something that would have an effect on the country’s currency, the news could spread within minutes.
Melamed saw that a fixed exchange rate system would no longer be sustainable with these new developments. “By 1970, I was convinced that the world was going to reject the fixed-rate system and was going to adopt a different system, probably for floating rates,” he said. And this gave him a novel idea—currency futures.
At that time, the Chicago Mercantile Exchange was struggling and in no mood to entertain wild ideas from a 30-year-old trader. Even if Melamed could convince the CME’s (NASDAQ:CME) old and entrenched board to take a flyer on this revolutionary concept, he knew he would have to gain legitimacy for the concept through a trusted source outside the niche futures industry. He chose future Nobel Laureate in Economics Milton Friedman, who was teaching at the University of Chicago at the time and whose lectures Melamed would often attend.
The world-famous economist loved his idea and encouraged him to go forward with launching a futures market in currencies; Friedman was even willing to write up a feasibility study, but at a price.
“Seventy-five hundred [dollars] for a feasibility study on why currencies will make a good futures market,” Melamed recounted, smiling. “$7,500! The Merc today is worth $22 billion. That was the best trade I ever made.”
Friedman’s name worked its magic wherever Melamed went. Secretary of the Treasury George Shultz told him, “If it’s good enough for Milton, it’s good enough for me.”
“That was the magic of his name,” Melamed said. He was elated. The Board of Directors at the CME gave him approval to go forward with the idea, and the futures market was transformed. Melamed realized quickly that a new exchange was needed after a meeting with Billy Salomon, who worked at New York investment firm Salomon Brothers at the time. Melamed could not list currency futures with to the agricultural ones if he wanted influential and wealthy traders to become members and use the new market. “We can’t be trading currencies right next to pork bellies. We needed a separate exchange.”
The International Monetary Market (IMM) was created to list these new currency futures. Melamed added that, though a separate exchange, the pit was physically next to the pork belly pit.
Melamed concluded by summarizing a few things he wanted the audience to learn from the story. The history of financial derivatives is not very long, and as an instrument of finance, it can be used in both right and wrong ways, just like other financial instruments. He noted, however, than in 2007, the CME clearinghouse did not encounter any problems. “The futures system works,” he said. “We didn’t go under, even though Lehman Brothers was one of our biggest customers.” He also confidently asserted that “financial instruments of this sort are not going away.”
He pointed out that the industry, as his story shows, has the ability to change and indicated that futures markets could provide the answer to the vexing issue of health care insurance costs. Speaking of the current law, he said, “Futures could probably do it better.”
Melamed ended his speech by praising America’s financial system and atmosphere of experimentation. “This story represents the beauty of this nation,” he said. “There’s no other system that allows people like me or others to use their imagination as they do in America.”
He had started out as a boy in Poland who was unsure of the relative worth of the Polish złoty, and he went on to revolutionize the American financial system. A combination of lessons from his past, as well as open minds, carried him to this day. “So this story, in a way, epitomizes the greatness of this nation,” Melamed concluded.
About the Author
Skylar Zhang is an undergraduate student at Northwestern University’s Medill School of Journalism, focusing on magazine journalism. She is also majoring in economics. She is currently an intern for Futures magazine. In her free time, she enjoys writing, taking pictures, and beating her engineering friends at math.