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SURPLUS TO SHORTAGE PROBLEMS

At harvest each year, farmers hauled to town the grain they could not use as livestock feed. Chicago became a natural basin for this excess grain because of transportation routes. Harvest was a time of surpluses. Grain users (feed companies, stockyards, processors, etc.) pressed for low prices, often forcing farmers to accept ridiculously low offers.

Grain merchants stockpiled as much grain as they could afford at the low harvest prices, but storage facilities were limited. As the year progressed, the supply of stored grain shrank and users were forced to bid aggressively for the remaining supply still stored on farms. Thus began the annual cycle of surpluses to shortages. Violent price swings from harvest lows to late-season highs drove the grain industry to search out an alternative marketing method. For­ward contracts were born.

It's impossible to appreciate the development of the modern futures contract without taking a close look at the forward contract—a still popular vehicle that allows users to manage risk. A forward contract is an agreement between two parties. The first party agrees to deliver a certain product to the second party at a specified time for a price agreed upon in advance. The term forward refers to a date forward in time.

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Forward contracts have been around for ages, but they gained particular popularity in the Midwest in the early and middle nineteenth century as farmers began to cultivate the vast prairie. Finding themselves far from the market centers in the East, producers often had little choice but to transport their excess grain long distances.