Foreword

There are some books that change our way of looking at a subject. Dr. Richard Sandor's book is one of them.

Our modern life, with all its comfort, convenience, and freedom unimaginable to early generations, depends critically on the smooth, joint working of an intricate web of interconnecting markets, from fairs and supermarkets to commodity exchanges and financial futures. In most cases, these markets appear to work so effortlessly that many of us take their existence and operation for granted. But they are human creations.

In this book, Dr. Richard Sandor presents a personal account of how new derivative markets have come to be invented over the past few decades, a time of explosive growth of financial instruments, most of which we still poorly understand today. It is an engaging and informative tale of how markets are created.

Although economists claim to study the working of the market, in modern economics, exchange takes place without any specification of its institutional setting. When economists say that the market works, what usually comes to their mind is a diagram in which the demand schedule intersects the supply schedule, giving rise to the equilibrium point at which the price and quantity are mutually determined. The demand and supply schedules, which Alfred Marshall referred to as the two blades of the price scissors, are theoretical constructions. While we cannot conduct economic reasoning without certain basic concepts and some relevant theories, economic reasoning cannot be all and only about a theoretical world and detached from the real economy. Unfortunately, modern economics for the most part has become a theory-driven subject. I have referred to this kind of economics as blackboard economics. Economics professors can proudly and conveniently teach it to students in the classroom without obliging themselves and their students to investigate how the real economy works.

But the diagram of demand and supply schedules is too detached from reality to inform students and their professors about how the markets actually operate in the economy. In the first place, the markets do not exist automatically. When economists discuss the choice between the pricing mechanism and administrative ordering, they usually assume that the two choices are readily available, not so different from the situation in which a consumer decides which car to purchase, a Toyota or General Motors. But as Dr. Sandor shows, the creation of markets is a lengthy struggle, full of surprises and uncertainties. Dr. Sandor details the endless meetings and exhausting negotiations that he held with other entrepreneurs, lawyers, and financiers, as well as government officials and regulatory agents in the process of creating those markets. This account opens a window to the complex reality of market making in the real world. It brings to light what is really involved when economists say that the market mechanism is used in resource allocation.

Markets are social institutions that exist to reduce the cost of carrying out exchange transactions and thus facilitate exchange and the division of labor. An important source of such costs in creating new markets is convincing the potential beneficiaries as well as the regulators of the economic value of the exchange that will be facilitated by the new markets. While it is obvious that a grain market benefits both consumers and farmers, it requires far more effort and ingenuity to convince the public of the value of a market for carbon dioxide emission rights, a market for climate exchanges, or a market for interest rate futures. Early research by Dr. Sandor in the late 1960s to implement an all-electronic, demutualized exchange did not advance despite being ahead of its time both conceptually and technologically but it eventually became the prevalent model in the exchange sector. The creation of new markets is frequently complicated and sometimes even thwarted by ideological enmity, political resistance, fear of uncertainty, or mere ignorance.

As Dr. Sandor illustrates well in this book, the creation of markets is always a social enterprise. It requires the collective actions of many individuals, organizations, and government agents. As in all collective efforts, human relations matter. The market does not and cannot reduce flesh and blood people with distinct identities into machine-like atomistic agents. Market participants certainly calculate and reason; but they remain social animals. The operation of the market also requires complicated rules and structures, which in turn requires concerted efforts and planning. Rules and norms are frequently needed. Many such rules and norms are self-enforced. But the state is often involved in enacting rules and providing credible third-party enforcement. All of this is discussed in Dr. Sandor's book.

I first met Richard Sandor many years ago when I was editor of the Journal of Law and Economics at the University of Chicago Law School. He submitted a paper on the development of a plywood futures contract. It was a most interesting article and I was very happy to publish it. Dr. Sandor was upset that the market failed because it did not attract enough customers to cover the costs. It did not upset me at all. On the contrary, it showed how difficult it was to create and maintain markets. In the years since then, Dr. Sandor has turned himself from an academic economist into a full-time entrepreneur, a market maker. In this book, he recounts how his study of economics at the University of Minnesota got him interested in economics problems in the real world. I hope this book will get more economists to leave their studies and look into the real world, without changing their careers.

RONALD COASE