Cornering the wheat market Archives

Reconsideration:

The Pit by Frank Norris

“Norris, who easily grasped the drama of the sales on the floor of the pit, . , .had difficulty comprehending how a man could sell a thousand bushels of wheat when he did not own them,” Franklin Walker writes in the only full-length biography of Frank Norris.

The reason Norris worked so hard—he said it was the most difficult task he had ever performed—to understand commodity futures trading was because he was writing a novel about a man who succeeds in cornering the wheat market.

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The problem Norris had in understanding how a man can sell wheat he does not own is the problem most people have when they attempt to understand commodity future trading. What takes place on future exchanges such as the Chicago Board of Trade is not that people buy and sell wheat and other commodities. Rather they buy and sell the future delivery of commodities.

When Norris’s hero realized he could corner the wheat market, it was April. The wheat he was buying in the octagonal pit of the Chicago Board of Trade was wheat to be delivered to Chicago in May.

For about 99 percent of the sales taking place today on the floor of the Chicago Board of Trade, wheat “buyers” do not want it delivered to them; wheat sellers have no actual wheat to sell.

Rather, buyers and sellers are hoping to make money on price fluctuations from the time the May wheat contract is first traded until the month of May. In May, when it comes time for delivery, traders who have bought wheat frantically “sell” it; those who have “sold” wheat frantically buy. By the deadline for delivery of May wheat, buyers and sellers resolve their contracts. As a consequence virtually all buyers and sellers have offset their positions; nobody has to deliver any wheat to anybody.

“It’s a case of gamble, but it’s legal and faro isn’t,” one trader told the Chicago Tribune in 1892.

“The late 1900s were filled with incidents of public outrage against alleged speculative abuses in commodities . . . markets,” a publication of the Chicago Board of Trade says. “The self-regulatory efforts of the exchanges went far to correct the problems.” Today futures trading is a form of insurance.

When the market is not being manipulated—an occurrence that takes place more frequently than generally known—the farmer has the opportunity to make a decent living by selling his wheat at a reasonable price; the miller has the opportunity to make a decent living by paying a reasonable price; the speculator assumes the risk the price will change considerably after the farmer has sold it and before the miller receives it. The speculator has the opportunity to profit from his risk.

The farmer’s risk is if he waits to sell his wheat until the miller actually needs it, there may, for example, be good weather resulting in an unexpectedly large crop and in disastrously low prices.

The risk to the miller is if he waits to buy wheat until he actually requires it, there may, for example, be a drought wiping out half the wheat crop resulting in disastrously high prices. So, the speculator in wheat futures protects the farmer against low prices, the miller against high prices, and the consumer against paying too much for a loaf of bread.

The speculator’s function is socially desirable only if he is taking risks with natural market forces. If he attempts to act not as an insurance man but as a manipulator of the market, he becomes a menace to society.

In The Pit, Frank Norris took an example out of history and described dramatically and with remarkably up-to-date accuracy the manipulation of commodity futures markets:

“Why, look here,” he cried. “Don’t you see? Don’t you see . . . “

“See what?” demanded the broker, puzzled by the other’s vehemence. . . . “

” Great Scott! I’ll choke in a minute.

“See what? Why, I own ten million bushels bushels of wheat already, and Europe will take eighty million out of the country. Why, there ain’t going to be any wheat left in Chicago by May!

“If I get in now and buy a long line of cash wheat, where are all these fellows who’ve sold short going to get it to deliver to me? Say, here how are they going to get it? Come on now, tell me, where are they going to get it?”

Let me explain.

A man who sells May wheat—wheat he does not own—is required to deliver it to the buyer when the month of May rolls around.

The requirement that the commodity be delivered—”It keeps the contract honest” one broker told me—is a contractual.

At the turn of the Twentieth Century, courts overturned laws in Iowa, Massachusetts, Texas, and other states where irate agrarian interests had succeeded in outlawing future contracts by redefining them as a form of gambling. Courts ruled they were not wagering contracts because a person who buys a wheat future can demand delivery on the due date.

Suppose a man holding a significant number of contracts promising delivery of May wheat to him were to tell each of the traders he is not interested in having them settle their obligation with money—as takes place with about 99 percent of the contracts—but with wheat.

Suppose, at the same time the May contract comes due, the man demanding delivery of wheat also happens to own all the wheat there is. Then, those people who have legally obligated themselves to sell him wheat (“these fellows who’ve sold short”) can only buy from one source.

From him.

They have to buy the wheat from him at whatever price he demands because they have a contractual obligation to sell it to him. He has them in a corner.

That is what the hero of Frank Norris’s novel does. Actually, Curtis Jadwin does not need to own all the wheat in the world to corner the market. He simply has to own all the deliverable supply,” i.e. all the wheat that can conceivably be shipped to Chicago in time for the contract to come due.

The real character on whose life Curtis Jadwin was based was loseph Leiter. In 1897, Leiter bought up all the nation’s known supply of wheat.

By doing so, he raised the price so high the Russians ate rye and shipped their wheat to Chicago. Throughout the United States and the world, wheat not thought to exist appeared suddenly as if by magic.

Using tugs with steel prows, Armour plowed up the ice in the Great Lakes and moved six million bushels of wheat into Chicago in the middle of winter. Though Leiter finally owned 50 million bushels of wheat, he did not have “absolute control of the deliverable supply.” When Leiter could no longer afford to buy any more, the wheat flooding Chicago lowered the price; his corner was destroyed. He was ruined financially–

Even though Leiter failed to corner the wheat market, he succeeded in “squeezing ” it, a term used to describe what is today an illegal manipulation of the market for the purpose of artificially raising the price. The hero of The Pit succeeded in his attempt to corner the market the following year only to discover the manipulation of price had so stimulated production there was too much wheat:

“The Wheat had broken from his control. For months, he had, by the might of his single arm, held it back; but now it rose like the upbuilding of a colossal billow.”

Critics of The Pit have uniformly failed to deal with the book as a fictional but true to life account of how the price of the wheat is determined. The Pit is the second novel in The Epic of the Wheat.

The third and final book in the trilogy Norris had decided to call The Wolf. The Wolf, left uncompleted by Norris’ sudden death would have described how the wheat produced in California and created in Chicago is used for, in Norris’s words, “relieving of a famine in an Old World community,”

What Norris could have done with grain companies such as Cargill, Continental, and Cook in their shipments of grain to Russia or towns like those in Bangladesh make us mourn the loss of this final book in the trilogy.

Realistic novels are supposed to provide us with a version of truth which we cannot get from works of nonfiction. The PIT is, Norris’s best novel. Wheat—capitalized and made the central character of the book—controls the action.

In The Epit of thf Wheat, Norris tries to show how the most elemental of powers—food—affects those who come into contact with it.

In Volume I, The Octopus. there are too many characters and digressions. The author cannot resist the temptation to take sides. The Pit succeeds as The Octopus doesn’t because Norris has more clearly defined what he is trying to do.

The mystical question, asked in The Octopus—When does wheat become Wheat?—is answered in The Pit. When the price is high enough.

A successful speculator is one in touch with the forces of nature who can anticipate how much the world will need. (Aren’t laws of supply and demand natural forces?)

Curtis Jadwin’s rivals, the Bears, had been artificially manipulating the price so it would go down, so farmers would go out of business, so wheat would not be planted, and so the hungry would not have food to eat.

Jadwin becomes a hero because —unlike the corrupt speculators around him — he believed that people required wheat and he was successful in predicting when they required it. Jadwin believed the price should go up. He believed more wheat had to be planted and more people needed for food. He was correct.

Jadwin was at one with the conditions of the time, fighting against the manipulators and for the Wheat.

Power was on his side but the power possessed him. It nearly destroyed his marriage. Fortunately for the marriage, his wife Laura could never quite find it in herself to love Jadwin’s artist-rival Sheldon Corthell.

Corthell was a dilettante—dabbling at creating stained glass windows —while Jadwin worked in the real world of power. Yes, Laura is tempted to commit adultery with the available dilettante. Norris makes clear, tempted though she might be, Laura’s only real choice was to be faithful to her husband–a real man in a real world.

Still, Jadwin became so obsessed by power he attempted to corner the market a second time. This time he was fighting against nature.

His friend and broker says, “I see that the farmers all over the country are planting wheat as they’ve never planted it before. Great Scott, J., you’re fighting against the earth itself.”

It is a fight comprehensible to those who understand the love for power. It is a fight which an obsessed man cannot help but make and which he is bound to lose. This is what makes The Pit a great novel.

Post Script. One reason for the failure of the critics to approach Norris’s work as an accurate picture of the forces that come into play when the government does not regulate agriculture is from 1933 to 1972 the government DID regulate agriculture and the role of the futures market was limited when it came to determining the livelihood of farmers and their productivity.

During that period, the commodity ticker in the farmer’s office did not determine what he planted. Recently, however, when the Secretary of Agriculture was asked by the House Agriculture Committee how farmers decided how much to plant, he opened up The Wall Street journal and read off the previous day’s future prices for wheat, corn, and soybeans at the Chicago Board of Trade.

William T, Bagley, Chairman of the Commodity Futures Trading Commission, created by Congress as a consequence of the future-market scandals following the 1972 Russian wheat deal, told me his agency is too busy getting organized to effectively regulate the $598 billion a year commodity industry.

In May 1976 the impossible happened in the potato futures at the New York Mercantile Exchange. There were more contracts than there were Maine potatoes. The market went crazy as owners of potato futures insisted on delivery of potatoes they presumably owned but did not exist.

The Commodity Futures Trading Commission (CFTC) had to close down the exchange temporarily and try to sort out the mess. In April 1977, the CFTC filed suit in federal court against members off the Hunt family of Dallas and “a company controlled by one of them for holding soybean futures” on the Chicago Board of Trade representing about a third of the country’s crop. (Soybeans are a primary ingredient in the production of meat, poultry, and milk.)

“Maybe I ought to read the book, “Bagley said when I told him about The Pit. He said he had never heard of Frank Norris.

Joel Solkoff

loel Solkoff was a Washington writer specializing in agriculture when this article was first published.

Published on November 19, 1977 by The New Republic.

Relevance to February 2014. This month President Obama signed into law a farm bill. For years the House and Senate had different versions of farm bills each of which was a waste of taxpayer dollars and a sham at pretending USDA would have, as a consequence any significant role in determining our country’s food supply.

About two thirds of USDA’s budget goes for food stamps and nutritional feeding programs. Most USDA employees work for the forest service conserving trees. The press to fund food stamps is what finally caused Congress to come to agreement. Under the law signed in February, the livelihood of our country’s wheat farmers is dependent, as described above, on the price of wheat at the future pit (now replaced by computer screens) at the Chicago Board of Trade.

Truly, the more things change, the more they stay the same. Sadly, the bill Obama signed into law provide subsidies to sugar farmers who do not require subsidies. The subsidies artificially manipulate the future market in sugar and are being objected to strenuously by indignant European countries furious the U.S. does not abide by the free trade principles we espouse.

Meanwhile, during the period from 1977 to 2014, there has been an explosion of epic proportions of the use of future contracts. Future contracts have been extended to the equity market. Now you can get speculate on whether the price of a share of IBM will go up or down.

Hedge funds make it possible to speculate not only on the price of a share of stock, but on the option to buy or sell a share an option new future markets make possible. Using powerful computers, it is now possible to win or lose fortunes on minute price fluctuations between actual stock prices and future prices.

The Commodity Futures Trading Commission has been made impotent in its ability to regulate by the sheer volume of futures markets. My prediction is if you set out to corner the wheat market and have the money and skill to do so, the Commodity Futures Trading Commission would never catch you.