CHAPTER II. ECONOMIC EFFECTS OF ACTIONS TAKEN SECTION 1. THE MARKET BACKGROUND War Food Order No. 144 As already noted, War Food Order No. 144, adopted as a measure necessary to enable the Government to meet its commitments, not only required all grain merchants and country shippers, on and after Saturday, March 2, 1946, to offer to Commodity Credit Corp., at the end of each week, all wheat owned in excess of that required to fill approved preference orders, but it also cut across existing contracts by requiring that: "The restrictions of this order shall be observed without regard to existing contracts or any rights accrued thereunder."24/ Thus the effect of War Food Order No. 144 was twofold. It not only made it impossible for grain merchants to accumulate and hold wheat in terminal market warehouses "regular" for future delivery, but also made it impossible to accumulate wheat in country elevators preparatory to moving it to Chicago, or any other contract market, preparatory to delivery on futures. It likewise made it equally impossible for merchandisers to accumulate and hold supplies of wheat for forward delivery on cash contracts other than those having approved preference. Second, the order, in effect, set aside all private contracts not having approved preference status as defined in the order. Marketwise, the effect of the Government taking over control of the dwindling supply of wheat was to create a situation in commodity exchange markets somewhat similar to a nation-wide corner or squeeze except that the Government rather than a private manipulative trading interest controlled the supply of cash wheat and made it unavailable for satisfaction of future contracts. The interference with normal procedures both with respect to cash and futures was very real, while the fact that the order set aside contract rights respecting wheat turned over to Government control at least strongly suggested that similar procedure be followed by the Board of Trade with respect to futures. The Chicago Board of Trade, citing the interference of W. F.O. No. 144, accordingly ordered all open May contracts settled forthwith at the then existing ceiling 25/ against which the price of the future had been frozen for months. Other Conditions Another unusual and important fact that was undoubtedly well recognized by exchange managements long before March 1946, was that whenever futures prices went up to Government-imposed ceilings, the only thing to be speculated on became a possible decrease in price. Consequently, professional speculation in futures (without which, incidentally, futures markets cannot offer adequate hedging protection) had become predominantly speculation on the short side of the market (i. e.) speculative sales in the hope that prices would sag away from ceilings, thereby affording opportunity to cover short positions at a profit.26/ 24/W.F.O. No. 144, par. p. 25/Chicago Board of Trade Regulation 1893, adopted March 26, 1946. 26/The U. S. Department of Agriculture, Commodity Exchange Authority, in a study entitled "Effect on Futures Trading in Grains of Changes in Price Ceilings of May 13, 1943," released August 12, 1946, states: "It was found that, contrary to the usual situation, speculators in wheat and corn futures as a group were net short while hedgers as a group were not long. Particularly unusual was the fact that small speculators were predominantly short.' " Equally abnormal was the fact that with grain at ceilings and in short supply, hedging became predominantly on the long side of the market in the form of purchases of futures against forward sales of cash grain not yet bought by the hedger. With little grain in store and cash and futures pressing strongly against ceilings, as evidenced by the giving of something in barter in order to get grain, there was little incentive to hedge even small stocks owned by the sale of futures (hedging on the short side of the market). Under these circumstances the long side of the market consisted of long hedgers and some speculators willing to take delivery of grain if they could get it on futures, while the short side became very largely speculative. Since the shortage of supply made purchase of cash grain difficult, even though something of value other than the cash purchase price was given (such as finding a carload of coal or a specified number of pairs of nylon stockings for the country shipper), neither hedgers nor speculators in long positions were willing to sell their futures, preferring to hold them in the expectation that somehow their validity as a source of grain might be preserved or, failing that, that cash settlement, at least at the prevailing ceiling price, would be forthcoming in case of default in the terminal month. This situation automatically resulted in freezing short speculators in their open positions. All this occurred before March 1946. In fact, except that the supply situation was more aggravated with respect to wheat in March 1946, it did not differ greatly from the situation which resulted in defaults in July 1945 corn and in December 1945 wheat, corn and barley contracts.27/ Furthermore, the closing out of the September 1945, corn future for reasons of short visible supply on August 1, 1945, nearly two months before defaults could occur 28/ furnished a perfect precedent for the action taken by the Chicago Board in prematurely closing out 1946 contracts. Closing out earlier defaulted wheat, corn and barley futures at prevailing ceilings and, at the same time, suspending penalties for defaults, 29/ undoubtedly had the effect of creating in the minds of short speculators, including both members and nonmembers of the Chicago Board of Trade, a feeling that they might safely sell futures at ceilings and default without danger of penalty. Commission merchants would benefit from any increased volume of trading resulting, and Clearing House members would be freed of responsibility for collecting penalties from their clients in case of default. All this undoubtedly accentuated the swing of speculative trading to the short side of the market. Between March 26 and May 1, 1946, the supply situation became increasingly tight. The "black market" in corn, which it was claimed as early as January 1946, made supplies short in regular channels of trade, still continued. In addition, the Commodity Credit Corporation began paying premiums of 30 cents per bushel for corn on April 22 and for wheat on May 3, 1946.30/ Board of Trade of Chicago representatives visited Washington, arguing that, in effect, the Government was conducting a "black market" in these grains and urged, especially, that the ceiling price of corn be advanced 30 cents to kill off the black market in corn in the country. This general situation added to conditions imposed by Food Distribution Order No. 144 made it impossible for anyone except preferred processors, exporters, and the Government to accumulate and hold in store any appreciable amount of either wheat or corn. Three-agency Announcement of Policy May 8, 1946 In a joint bulletin dated May 8, 1946, announcing advances in ceiling prices of grains effective May 13, 1946, the Office of Economic Stabilization, the U. S. Department of Argiculture and the Office of Price Administration concluded the announcement as follows: "The Government Agencies involved in today's actions request and recommend to the governing boards of the grain exchanges that all futures contracts open at the close of business on May 11 be settled at present appreciable ceiling prices. It is further requested and recommended that all cash contracts be handled on a similar basis."31/ Following the three-agency announcement of May 8, there was a meeting in Chicago on May 11, 1946, attended by representatives of the Chicago, Minneapolis and Kansas City grain exchanges and a representative of the Office of Price Administration. It appears that at this meeting the exchange representatives were advised to follow the request and recommendation of the three-agency announcement. One Chicago Board of Trade director, who personally did not favor the action taken, but joined in it on the basis that it was what the Government desired, stated that the Government representative practically said the Government would take over grain distribution altogether if the futures were not closed out. On the following day the directors of the Chicago Board of Trade met, decided they had no legal authority to interfere with cash contracts as recommended, but, citing the Board's Emergency Rule No. 251, stopped trading until further notice in all "old" futures outstanding May 11, except for liquidation at or below the ceilings in effect on that date, and further stated that no consideration would be given to the increase in ceiling prices effective May 13, in considering penalties on defaults arising through failure of sellers to deliver on any old futures outstanding on May 11. Members of the Board of Directors of the Chicago Board of Trade state that this action was taken under the belief that the Government agencies would back up their request and recommendation by a positive directive setting aside future contract rights similar to that contained in paragraph (p) of War Food Order No. 144.32/ Whether or not these statements are altogether self-serving, the fact that is of importance here is that the request and recommendation laid the basis for protection of professional speculators who are more important in the operations of the Chicago Board of Trade than they are in the lesser exchanges, and who were predominantly in short position where they were practically certain to be frozen by refusal of longs to sell, at least as long as supplies of wheat, corn, rye and barley were critically short and prices remained at ceilings. Oats, which were in more plentiful supply and tended to fall away from their ceiling, actually presented less difficulty, although Regulation 1894 required all old oats contracts to be closed out at the old ceiling. Only May oats contracts, however, were so closed out. In addition to protecting short speculative interests, Regulation 1894 also freed clearing members of the Chicago Board of Trade from the necessity of dipping into their own funds to cover their responsibility to the Clearing Corporation to cover any under margined short accounts, either of their own or for customers, in case trading was continued and futures prices moved up to the new ceilings, as there was every reason to believe they would do. 31/Joint Announcement of Government Grain Price Policy issued by O. E.S., U. S. Dept. of Agriculture and O. P.A., May 8, 1946. 32/Paragraph (p) of W. F.O. No. 144 states: "The restrictions of this order shall be observed without regard to existing contracts or any rights accrued or payments made thereunder." Naturally the financial interest of commission houses as well as speculators on their own account, both within the Board of Trade and outside its membership, would tend to make them favor closing out outstanding "old" contracts at the old ceilings and starting trading anew with "new" contracts. This was done by Regulation 1894 even though such protective action destroyed the validity of contracts as hedges, wiped out the potential profits of long speculators, and, in general, undermined public confidence in the integrity and validity of futures contracts. It is to be kept in mind, however, that in doing this, the Chicago Board of Trade was following the request and recommendation of the three-agency announcement of grain policy of May 8, 1946. Having taken this action on May 12, the Board of Trade management asked the three Government agencies for a positive directive along the line of the request and recommendation. When such a directive was not forthcoming, the Board of Directors reversed itself with respect to the settlement of defaulted old May futures inwheat, corn, oats, and barley, and ordered resumption of trading in all other "old" contracts under the new ceilings, such trading to begin June 3. After a period of ten days of trading during which all old futures, even including oats which were in fairly plentiful supply, moved up to the new ceilings, they, together with certain of the so-called "new" futures, were all closed out at ceiling prices prevailing at the close of trading on June 13. This last action was taken in anticipation of price increases which it was believed would follow the expected expiration of price controls on July 1. The net effect of closing out defaulted May futures and permitting trading in other old futures until they reached new ceilings was to shift the financial responsibility for the May 13 ceiling price increases back to the frozen in shorts, while that of closing out all old futures and some new ones prematurely on June 13 was to relieve shorts of any further responsibility for price increases which might occur after the anticipated expiration of price controls on July 1. With these general background facts in mind, the ensuing section presents measures of the financial effects produced and the incidence of profits and losses arising out of the various actions of the Chicago Board of Trade in closing out futures contracts from March 26 through June 13, 1946. SECTION 2. TOTAL VOLUME OF GRAIN FUTURES Contracts Involved As already indicated, the Chicago Board of Trade, by regulations adopted under its Emergency Rule 251, restricted trading in all grain futures at some time during the period from March 26 to June 13, 1946, and closed out altogether the following "old"33/ and "new"34/ futures on or before June 13: 33/Old futures are those traded in under ceilings in effect from March 4 to May 12, 1946. 34/New futures are those authorized for trading under the new ceilings effective May 13, 1946. 35/July, Sept. and Dec. Oats were affected only by the limitation of trading to liquidation during the period May 13 to May 31. May 1946, wheat was closed out by special regulation on March 26.36/ All other May futures except rye were subjected to special regulation limiting trading to liquidation from May 13 to the end of trading and all May futures, including rye, were closed out by special regulation covering quantities defaulted on May 31.37/ For all other old futures for all five grains, trading was limited to liquidation from May 13 to June 3, then open trading was permitted through June 12, and on June 13, all except oats were closed out.38/ And finally, all outstanding new futures for wheat and rye, on which open trading had been permitted from May 13 through June 12, were closed out by special order on June 13.39/ Total Quantity Affected Table 5 presents the overall picture of total quantities of open old futures affected by the various special regulations of the Chicago Board of Trade. The table also shows the financial effect of various liquidations made, such effects being computed for each grain on the basis of its increase in ceiling price which became effective on May 13. The purpose of the table is twofold: (1) to indicate clearly the total volume of old futures affected by the various regulations, and (2) to indicate the total losses and gains to particular interests due to the fact that part of the futures affected for each grain was settled at the old ceiling price while the remainder, except in the case of oats, was closed out on June 13 at the new ceiling effective after May 13. 36/Regulation 1893. 37/Regulations 1894, 1895 and 1897. 38/Regulations 1894, 1898 and 1899. 39/Regulations 1894 and 1899. |