Brokers and Bureaucrats: Building Market Institutions in Russia

3. Benign Neglect: Self-Governance on Currency Futures Markets

CHAPTER 3 Benign Neglect Self-Governance on Currency Futures Markets In an irony typical of the transition period, currency futures trading in the postcommunist world began in a spacious pavilion previously dedicated to the USSR's Exhibition ofthe Achievements of the People's Economy (Vystavka Dostizheniia Narodnogo Khoziastva [VDNKh]) in October 1992. Few observers expected this relatively sophisticated form of trading to flourish in the highly uncertain economic environment of Russia. Trading currency futures requires quick judgments about future events that could change the price of the currency. Dramatic swings in price can bring large profits for brokers and their clients, or bankruptcy for those caught on the wrong side of the market. Despite these difficulties, brokers were trading several hundred million dollars worth of currency futures per month on two different exchanges in Moscow by early 1994. This chapter examines the efforts ofthese two groups of brokers to conduct self-governance on their respective currency futures exchanges in Moscow between 1992 and 1996.1 As suggested by the economic theory of self-governance, the small number of homogeneous brokers with relatively low discount rates on the Moscow Exchange managed to create a relatively reliable SGO, but the heterogeneous brokers with far higher discount rates on the Moscow Central Stock Exchange failed in their initial attempt to conduct self-governance. These findings offer less support for sociological theories of self-governance. Social ties among brokers on both exchanges were sparse, but outcomes differed across the cases. The two case studies find that when the state takes a "hands-off' approach of low taxes and little delegation, the economic theory of self-governance provided a better account for institutional outcomes than did the sociological approach. Previous chapters have emphasized the importance of introducing state agents into models of self-governance, but in these two case studies state agents played a minor role. These cases are presented to examine the logic of self-governance that is predominant in the literature. By initially exploring self-governance on markets in which state agents assume a "hands-off' policy , we can gain a deeper understanding of the causes and effects of state intervention on self-governance in later chapters. These cases allow the dis56 Benign Neglect 57 tinction between existing literature and the more political approach to selfgovernance to be drawn more clearly later in this work. I begin by explaining the operation of futures markets. I then highlight the nature ofthe contracting problems facing brokers by describing the trading mechanisms that guide futures trading, the means ofself-governance, and the most prominent types of failures on these markets. After describing the hands-offstate policy on this market, I conduct two case studies that examine the sociological and economic approaches to self-governance. Futures Markets The emergence of organized futures markets can be traced to the Chicago Board of Trade (CBOT) which opened in 1842.2 Initially, brokers at the Chicago Board of Trade bought and sold grain grown on the plains of the Midwest in spot markets.3 Spot trading produced great seasonal variation in prices and quantities delivered to the market. Each spring, farmers had difficulty obtaining full value for grain that would be delivered to the market in the fall due to uncertainty. Moreover, each autumn produced a steep drop in prices as many farmers sought to sell their grain at the same time. These fluctuations in the market led to vast price uncertainty for farmers, brokers, and consumers. By the 1860s brokers began to reduce price uncertainty by trading futures contracts in grain that gave farmers a firm price for their goods that would be delivered to the market at a specified future date. Brokers then traded these contracts with one another based on their expectations of future prices. These contracts allowed farmers to lock in a price and brokers to speculate on fluctuations in market price months before the grain was delivered to market.4 Brokers on futures markets trade a standard contract that offers a guaranteed price today for goods that will be delivered on a specified future date (Telser 1980; Kolb 1985; Duffy 1989). A futures broker who bears the risk that he can profit from the change in the market price that will occur over time agrees to pay the producer a fixed rate at a specified future date. The broker then sells this contract at some time to another broker who thinks that the market price ofthe contract will increase at some time in the future...