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  • PROFESSOR ROBERT SHILLER: OK, good morning.

  • Well, today I want to talk about what, to me, is a very

  • interesting topic, and that is futures markets.

  • Not very interesting to most people.

  • Most people have no idea what they are.

  • But I think that, well, futures markets, what we're

  • really talking about is --

  • There are different ways of viewing it.

  • Futures markets for things like agricultural commodities,

  • or interest rates, or financial securities, are

  • markets about the future.

  • They're markets that, in some sense, predict the future.

  • And future matters, right?

  • We live a life.

  • We have a long horizon.

  • I said before, I think that your planning horizon must be

  • at least a century, because you'll probably live that long

  • anyway, with modern medicine.

  • And you care about other people, too.

  • So, the beauty of futures markets is that we have prices

  • for the future.

  • We talked already about forward markets.

  • We talked about forward interest rates.

  • And that is related to what we're talking about.

  • Forwards and futures are similar concepts.

  • Futures is the more precise concept.

  • Or the more developed concept.

  • And I'll explain the difference between forwards

  • and futures.

  • But just in a nutshell, futures markets are organized

  • markets, like the stock market, that trade

  • standardized contracts, representing things that will

  • happen at future dates.

  • And because they're

  • standardized, they're worldwide.

  • Everybody looks at them and uses them.

  • Whereas forward markets are more specialized markets that,

  • typically, are not as easy to interpret or as clear.

  • So, futures markets are, in some sense, more fundamental

  • and important.

  • I have a particular interest --

  • I've been interested in futures markets myself for

  • many years.

  • And wondering, why they're not even

  • bigger and more important.

  • So, in 1993, I wrote a book called Macro Markets, about

  • let's make our markets bigger and more

  • important, and more pervasive.

  • And I've been trying to do that.

  • Notably, in 2006, I was working with the Chicago

  • Mercantile Exchange, which is the biggest futures

  • market in the world.

  • And we created home price futures.

  • And they've been trading now for five years.

  • But I'm not really going to talk about them, because they

  • have so far disappointed.

  • They're not important, at least not yet.

  • But I'm going to talk about some

  • important futures markets.

  • First, I want to put just a couple of definitions up.

  • Futures, that's what we're going to talk about most in

  • this lecture, and it has a special meaning in finance.

  • And I was contrasting that to forwards.

  • But both of these together are derivatives.

  • And that means that the price in these markets derives from

  • a price in some other market.

  • There's a primary or underlying market, which has

  • its own price.

  • And then there's a derivative market that has a futures

  • price or a forward price.

  • I guess I'm speaking in kind of abstract terms. Well, let

  • me just start --

  • I want to give you an example, and we'll see better what I'm

  • talking about.

  • But let me just first comment just on this word,

  • derivatives.

  • To people in finance, derivatives are an exciting

  • development of financial markets.

  • We start out with a simple market and we develop

  • derivative markets, that add more detail and information

  • than was in the underlying or primary market.

  • That's exciting.

  • I find it exciting.

  • However --

  • I don't know how often you hear this word, derivative --

  • it's become a four-letter word.

  • It's become an ugly word.

  • Why is that?

  • I think it's, because people blame the current financial

  • crisis on derivatives, whether rightly or wrongly.

  • And it's because, I think, there's a public anger about

  • derivatives that is largely due to misunderstanding.

  • I mentioned before that I think that finance tends to

  • attract sociopaths.

  • I mentioned that, I defined that for you.

  • People who want to manipulate, and fool, and deceive people.

  • But I don't think the financial community is

  • particularly populated by sociopaths.

  • You might think so, reading some accounts.

  • But I think, it's not true.

  • And I think, it's not true, because the financial

  • community knows about this problem

  • and ejects such people.

  • They get caught.

  • And you can't make a career in finance if you're a sociopath.

  • So, if you think you have this problem, that you have

  • sociopathic tendencies, I would advise you not to go

  • into finance, because you will get caught and ejected.

  • So, save yourself the trouble.

  • Don't go into finance.

  • Pick some field where you can't hurt anybody.

  • And that would be a smart thing to do, if

  • you have such a problem.

  • So, I think we need to regulate derivatives markets,

  • and that's what I'm talking about.

  • And we need self-regulation of the markets themselves, but we

  • need government regulation as well.

  • But there's nothing evil about derivatives.

  • And in fact, derivatives are fundamental to the way I think

  • a modern economy works.

  • So, I had you read an article --

  • I put it on an earlier section of the reading list --

  • by Charles Conant, who wrote a book in 1904 called Wall

  • Street and the Country.

  • And you should have read that by how.

  • He starts out by saying, it's just amazing, how public

  • opinion thinks that speculation is evil.

  • And they don't understand that speculation is just business.

  • I mean, business decisions involve

  • guesses about the future.

  • And so, when you have well-developed markets, these

  • guesses become market prices.

  • And so, the prices go into the calculations

  • that everyone makes.

  • And the calculations are just done better.

  • Somehow, there's just a failure for most people to

  • understand it.

  • And I'm hoping in this lecture to try to give some more

  • understanding of these markets.

  • I think they're fascinating.

  • Most people apparently don't, because you don't hear them

  • brought up very much.

  • I want to just say a little bit more about hostility

  • toward derivative markets and futures markets, and

  • speculation in general.

  • In 1991, that was 20 years ago, I wrote a joint

  • paper with a --

  • I don't remember whether I mentioned this,

  • probably not --

  • with a Russian, a young man from Russia that I met when I

  • was visiting the Soviet Union, just before the end of the

  • Soviet Union.

  • And we were talking about how antagonistic Russians are

  • toward capitalism.

  • And he said, this is a big problem.

  • Russia just can't embrace capitalism.

  • These people hate it.

  • They hate the profit makers and the financiers.

  • And I said to him, well, you know, it's the same in the

  • U.S. How do you know it's any worse in Russia?

  • And so, we decided to do a questionnaire survey.

  • And I was going to read one of the questions, comparing

  • people in Moscow and people in New York, to see, which one

  • understands capitalism better.

  • So, one of the questions that we had was the following --

  • We wrote these questions and translated them into Russian.

  • And we tried to make them exactly the same questions

  • between Russian and English.

  • So, here's the question we asked in both cities: ''Grain

  • traders in capitalist countries sometimes hold grain

  • without selling it, putting it in temporary storage in

  • anticipation of higher prices later.

  • Do you think this speculation will cause more frequent

  • shortages of flour, bread and other grain products?

  • Or will it cause such shortages to become rarer?''

  • What do you think, people said?

  • Does the process of speculating in grain cause

  • problems or solve problems?

  • Well, we found that, in the USA, 66% said it will make

  • shortages more common.

  • But in the Soviet Union, in Moscow, only 45% thought it

  • would make shortages more common.

  • Both of them were wrong.

  • A lot of them were wrong, but the Russians were better,

  • closer to the truth than the Americans.

  • Living in the financial capital of the USA, most

  • people think that speculating in grain creates problems. But

  • wait a minute, what is speculation in grain?

  • That means holding it off, expecting higher

  • prices later, right?

  • Isn't that what you have to do if you are

  • managing a grain market?

  • Now, think of it this way -- and I'm coming now to

  • agricultural futures.

  • In the simplest world, there's one harvest

  • of wheat every year.

  • And that harvest comes in a certain time of the year,

  • every year.

  • Once a year.

  • And it has to be held in storage over the year, right?

  • Because people don't eat it all at once.

  • You eat it over the whole year.

  • So, somebody is storing grain.

  • This is a fundamental problem.

  • That's a business.

  • So, you have to know that somewhere there's some

  • warehouse holding the grain that you will be consuming in

  • six months time.

  • And that warehouse is run by some

  • professionals who do that.

  • If they think prices are higher later, they'll keep it

  • longer in the warehouse.

  • And what does that do?

  • That evens out the price.

  • It doesn't make it worse.

  • If they think there's going to be a shortage of grain, they

  • hold it back now and the price of grain goes up.

  • And so, everyone starts consuming a little less

  • because of the higher price, and it smoothes things out and

  • it works better.

  • And this is elementary economics, but it's not

  • understood, I think, by most people.

  • And the futures markets are just sophisticated markets

  • that help that process.

  • So, I'm going to start with agricultural futures in

  • talking about this.

  • And I want to start also with a very homely -- it's not

  • homely -- it's a very elementary example, because

  • it's the first futures market.

  • So, where do you think futures markets started?

  • You would think, it started in New York, or Chicago, or

  • London, or Paris.

  • It actually started in Japan in a place called Dojima,

  • which is in the city of Osaka.

  • And they started in the 1600s.

  • So, let's go back.

  • If we can go back to the year 1673, in Osaka in Japan.

  • Japan was heavily dependent on rice.

  • And the rice farmers would farm all over Japan, but there

  • was a rice market in Dojima, which was the

  • national rice market.

  • And I have data here.

  • According to a study, there were 91 rice warehouses in

  • Dojima in 1673.

  • That's a long time ago, isn't it?

  • So, it was a big storage place for rice, and they were

  • storing it all year.

  • And people would come, people who were merchants for rice,