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I think that, as in grains and livestock, an active and expanded futures market in potatoes can be a useful instrument in restructuring the potato industry to a more profitable level. That the potato futures market is a useful forward pricing and hedging medium for growers, shippers, merchants, and processors has been well documented in these hearings and I will not restate the case.

I particularly commend the statement of Mr. Caldwell of the CEA. The point that I would like to make is that speculative markets, if used extensively by the industry concerned, particularly producers, are useful in readjusting production to profitable levels.

Speculators are in the business of anticipating events to come and discounting their impacts into forward prices. They put money at hazard in guaranteeing those forward prices. If producers contract their services forward when futures prices are at profitable levels and decrease production when futures prices are not at profitable levels, production is adjusted to amounts that speculators, in the aggregate, judge to be appropriate. If the speculators are right they make money, and if they are wrong they lose. The profit-loss results of speculation tend to improve its quality and, thus, its effectiveness in guiding production to appropriate levels.

Producers of commodities that are actively traded on futures markets need never produce at unprofitable prices. As futures prices are at profitable levels they can contract their services forward and as they are at unprofitable levels they can refuse to produce until prices rise appropriately. If they go ahead and produce when forward prices are below profitable levels in the hope that prices will rise, they have only themselves to blame if they lose money.

My suggestion to potato growers is, rather than blame futures markets for their competitive problems, that they make effective use of the markets.

I thank you very much for the opportunity to be heard.
Mr. FOLEY. Thank you very much, Dr. Hieronymus.

I also would like to ask you to remain at the witness table.

The next witness is Dr. Mark J. Powers, vice president, Chicago Mercantile Exchange.


Mr. POWERS. Thank you, Mr. Chairman.

My name is Mark J. Powers. I reside in Lake Bluff, Ill. I am and have been since late December 1969, a vice president of the Chicago Mercantile Exchange. Prior to that time, I was associate professor of economics in South Dakota State University, Brookings, S. Dak.

I am grateful for this opportunity to appear before you on behalf of the Chicago Mercantile Exchange in opposition to the enactment of H.R. 7287 which proposes to prohibit futures trading in Irish potatoes.

The issue before us today is far more than a consideration of whether futures trading in Irish potatoes ought to be continued or not. Indeed, it is a question of whether or not producers, handlers,

and processors are to be provided fewer or more alternatives in marketing their products-whether they are to be provided a competitive means of discovering price and a wider or narrower latitude in timing their purchases and sales. The issue strikes at the heart of the free enterprise system and has implications for all of agriculture. Indeed, for our entire society.

Prof. John D. Black, one of the most respected Harvard economists of this century, or any other, for that matter, noted some years ago that futures trading is as much a social invention as property rights, trial by jury, constitutional government, and commercial banks. Futures trading, as did these other elements, evolved as a natural part of our society as people demanded improvements in their system of property exchange.

One of the fundamental precepts of our society is that it is Government's role to improve the functioning of the exchange system by fostering a financial system that enables resources to be used most productively. Futures trading is one of the financial institutions a well developed exchange economy needs for efficient allocation of its


The marketing and exchange systems for such perishable agricultural commodities as potatoes, live cattle, live hogs, eggs, and others all proceeded through the evolutionary stages of gift giving, barter, spot markets, contract markets, and finally to the ultimate method of exchange, futures markets. It would be a serious mistake and a step backward to interfere in this natural, evolutionary process and remove this institution from the marketing system for potatoes.

Others, in their testimony opposing this bill, have covered some of the basic economic arguments in favor of futures trading. It is my intent, in the few minutes I have, to attempt to put some aspects of this issue in its proper perspective so that it may be better understood and to discuss some of the charges made by the supporters of this bill. The market system at least deserves to be understood before it is condemned, and presently it is being condemned without proper understanding.

Let me turn first to some misconceptions about hedging.

Much of the past testimony of proponents of this bill rests on an oversimplified and misunderstood concept of hedging; namely that hedging is used solely as a risk avoidance procedure. That concept of hedging is simply not descriptive of the ways in which industry people utilize futures markets in conjunction with their businesses.

In reality, handlers of a commodity use the markets as a legitimate business management tool in a diverse number of ways, depending on the special circumstances of their lines of business. For this reason, the traditional textbook concept of hedging is misleading. Dr. Holbrook Working, noted agricultural economist, after careful and extensive observation of the business use of the futures market by handlers of commodities, defined and identified a number of legitimate business uses of the market. Although I shall not go into a lengthy discourse on the different types of hedges identified by Dr. Working, I believe his concept to be of such importance to a correct understanding of hedging that I shall briefly summarize his description of the multipurpose uses of hedging.

First, he described the carrying-charge hedge. This is undertaken for purposes of obtaining at least partial payment for the cost of storing products, as in the case of a grain-elevator operator who buys corn in November with the intent of storing it until the following


(b) The operational hedge: This involves the placing and lifting of hedges over short time periods as temporary substitutes for merchandising transactions. It is widely used in the milling industry.

(c) Anticipatory hedge: This involves the purchase or sale of futures in anticipation of a formal merchandising commitment to be made later. The operator carries an open position in the futures market for a time without an offsetting cash commitment.

(d) The selective hedge: This characterizes the practice of hedging or the basis of price expectations. The motivation is not so much to avoid risk as such, but to avoid major losses. Thus, a firm would hedge incompletely and would put on short hedges only when a price decline is expected and would not carry short hedges at all when a price increase is expected.

(e) The risk avoidance of insurance hedge: This involves the carrying of equal and opposite positions in the same commodity in the futures market and the cash market. It is the typical textbook example.

Dr. Working's description of the use of the futures market as a valuable management tool makes clear, I believe, the flexibility the futures market provides an entire industry in the selection of alternative strategies for timing its purchases and sales, and the timing of the pricing of its products.


Among the points made by testimony presented to this committee on January 20, 1972, by Mr. Chipman C. Bull, were the following:

Price movements are more erratic as futures activity increases: and

Trading on the potato futures exchange is largely between and influenced by persons having no connection with or knowledge of the actual product or its true value.

Let's examine these two propositions for their validity.

Implied in the above proposition is the argument that in the absence of a futures market, prices are "determined by supply and demand" in some automatic way, independently of human judgments, and that existence of a futures market interfers with the "invisible hand." In point of fact, the price of any commodity in a free and competitive market, whether futures or cash, whether it is for automobiles, or lemons, or potatoes, is determined only indirectly by physical supply and demand for final use. Its direct determinants at any time are human judgments influenced by more or less accurate knowledge of supply and demand conditions. If prices formed initially on such judgments are wrong, the basic facts of supply and demand will presently change those judgments. But the new price that results still will be determined directly by human judgments based on currently available information. This is true whether it's a futures

price or a spot price. Hence, the price of a commodity is subject to essentially the same influences whether a futures market exists or not. The futures market is merely the thermometer which registers the impact of these influences.

Whether existence of a futures market tends to make prices fluctuate more or less than they would otherwise, can be determined conclusively only by comparative studies of price fluctuations under the two conditions. Such studies have been done in the past and not a single study supports the contention of the proponents of this bill. For example, I found in a study, while I was still at South Dakota State prior to my present position, in a study of live cattle prices, a commodity much more perishable than potatoes that the random fluctuations that is, those fluctuations that could not be attributable to fundamental economic conditions, were reduced dramatically with the introduction of a futures market. Similar results were also found in a study of pork belly prices. (These studies are reported in the June 1970 issue of the American Economic Review.) Studies on the onion market, as reported to you by other witnesses, have yielded similar results.

Let us turn to the second proposition. This has been touched on by the previous witness, Mr. Hieronymus: Who are the participants in Maine potato futures trading and are they knowledgeable about the actual product and its true value?

Dr. Aaron Johnson of the University of Wisconsin recently completed a study, which will be published in a forthcoming publication of the Stanford Food Research Institute, in which he classified the participants of the futures market for Maine potato futures on the basis of their occupation. Evidence was presented which showed that the Maine potato futures market is basically utilized by persons connected with the potato industry in Maine or as a minimum, by persons who are quite likely to be familiar with the production and marketing conditions, as they related to the process of price determination. Dr. Johnson concluded from his study, which covered the years 1955 to 1965:

Industry traders participated to a considerable extent in future trading. For the ten year period, handlers of potatoes accounted for 49 percent of the long side of the market, and 70 percent of the short side, leaving 51 percent of the long side and 30 percent of the short side for nonindustry traders. Considerable year-to-year variation has existed, however. For example, in 1955, 1956, and 1958 industry traders held over 60 percent of the long side and over 50 percent in the years 1960, 1961, and 1963. Thus, in six of the ten years, industry traders held in excess of one half of the long side of the market. The lowest held by this group was 38 percent in 1965. On the short side, in two years industry held over 80 percent of the open interest and in four years this group held over 70 percent. The lowest proportion of the short side held by industry traders was 62 percent in 1965.

If one were willing to accept the argument that persons in the potato industry are not "outstanding" in the sense that they are unaware of basic supply and demand conditions, these results clearly suggest that the role of outsiders in the price making process may be somewhat minimal. If one were willing to go a step further, and argue that professional speculators (as classified by the Commodity Exchange Authority) are also knowledgeable concerning basic supply and demand conditions in the industry, a presumption which seems somewhat reasonable since their livelihood depends upon making proper price forecasts, then the result if that about 55 percent of the long

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side of the open interest is held by knowledeable traders and about 75 percent on the short side is held by knowledgeable traders.

A study recently completed-and Dr. Hieronymus touched on this -by the U.S. Department of Agriculture and not included in Johnson's data, showed that in the fall of 1970, when their data was collected, approximately 34 percent of all the long and 30 percent of all the short open contracts were held by members of the potato industry. These statistics clearly raise a serious question concerning the validity of the charge that prices on futures markets are determined primarily by outsiders who know nothing of basic supply and demand conditions.


This participation in the potato futures markets by industry people is of key importance for the existence of the market. Studies conducted by a number of economists, including myself, indicate that speculators tend to be attracted to markets in which there is a large amount of hedging, and conversely tend to leave markets when hedgers desert them. Dr. Holbrook Working concluded from his comparison of 11 different commodities that there is a very close relationship between the total open speculative contracts and the total open hedge contracts. He concluded that it is hedgers who attract the speculators to the market.

Dr. Hogert Gray of the Stanford Food Research Institute studied the relationship between the three principal wheat futures markets and found that as hedgers were attracted to the market, speculators were attracted to it also. In some cases, though, not enough speculation was attracted. Hence, the hedging load for the market became burdensome, and of course, this increases the cost of hedging. My own study of the pork belly futures market, as reported in the November 1967 issue of the Journal of Farm Economics bears out the relationship by Gray and Working. That is, as hedgers are attracted to a market, speculators are drawn to use it, and conversely, as hedgers leave the market, speculators tend to leave it also.

The very first prerequisite for a successful futures market is that it be attractive to hedging use. The second is that a market must attract speculation. Hence, if this market were not performing a useful economic function for the potato industry, it would have died a natural death long ago, as industry people would have refused to participate in it, and the statistics I have just quoted will point out that they definitely have used it.

Let me turn my attention briefly to a most important aspect of this issue before us. It relates to farmer bargaining. All farmers are going through a frustrating period in pricing their products.

The Governor earlier pointed out some of the problems that they are having throughout the State of Maine. Markets in which cash merchandising transactions are executed in an open competitive bargaining atmosphere have virtually disappeared. And where they do exist only a tiny fraction of all trading is conducted on them. Because of the thinness of these markets, the representativeness of the

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