Richard Sandor: Creating a market to fund climate change

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Interviewed By Emmanuel Daniel

In this wide-ranging conversation, American Financial Exchange (AFX) founder and chairman Richard Sandor talks about the creation of the rates index Ameribor and his ongoing involvement in environmental markets.

Richard Sandor had a long and notable career as an economist and entrepreneur and has helped shape the history of the US finance sector. He was a professor of economics at the University of California Berkeley before becoming the chief economist and vice president of the Chicago Board of Trade in the 1970s. He also served in the following exchange committees through the years: Chicago Mercantile Exchange, London International Financial Futures Exchanges, Intercontinental Exchange, to name a few.

Sandor is also widely recognised for his contributions in the field of environmental finance, having founded the Chicago Climate Exchange, which is described as “the world’s first exchange to facilitate the reduction and trading of greenhouse gases” in North America and Brazil. He was an affiliate on the climate exchanges in China, Canada and Australia. All these, along with his other known work for the environment, earned him the title of “the father of carbon trading”.

At 80, the “father of financial futures” continues to keep a watchful eye on the world economy as he works to bring his other plans involving water, information and data into fruition.

The following key points were discussed:

The following is the edited transcript of the interview:

Emmanuel Daniel (ED): I’m very grateful, happy and excited to be able to speak to Dr. Richard Sandor, father of financial futures at the Chicago Board of Trade in the 1970s. He is the originator of the interest rate futures that the entire financial services industry, the banking system, depends on for the cost of funds. 

Over the years, he’s been involved in building the commodities futures market and in days long forgotten, the climate change futures for clean air and all of that is happening today with the Paris accord and the United Nations Climate Change Conference (COP26) initiative. 

When I look at Richard Sandor’s CV or his life story, I get this impression that he is the father of markets in general. Every time he solved a problem, he thought that the best solution for that problem is the creation of a market. Because it’s the best platform to realise the price and the costs of resolving a risk of any kind, whether it’s commodities or the environment. So I’m very happy today to be able to speak to the man himself.  

There are a few people who I actually wish that I had met before in my life. I’d say Walter Wriston would have been one of them for the innovations that he did in the banking industry, John Boyle in the fund management industry, and so on. And along with these legends is Richard Sandor. So Richard, I’m so happy to be able to have this chat with you. And I have a lot of basic first principles to check with you in this conversation.

Richard Sandor (RS): Thank you. It’s an honour to be speaking to you again and I’m excited as you are about the dialogue. I want to say thank you to anybody who might be listening and viewing for opening up your computer or your home to this dialogue.

ED: This is the legendary picture of you with the hat in a relaxed Chicago style. Were you born in Chicago? Are you native to Chicago?

RS: No. I was born in Brooklyn, New York and grew up there, born and bred, and went to graduate school and got a Doctor of Philosophy from the University of Minnesota. I had a wonderful economics teacher and he said to me, “You really should study economics as it is the queen of the social sciences”. So I went to graduate school in Minnesota. I left there and then got the privilege of teaching and landing at Berkeley, California, in 1966. I taught there for six years. So it was the birth of everything different: of civil rights, of every sort of agenda, diversity, gay, straight, whatever came out of the Berkeley campus. But out of that same campus, Emmanuel, came an open mind that’s towards finance. It was the birth of modern finance theory. It was 1966. It was Harry Markowitz. It was Myron Scholes for the Black-Scholes. It was vibrant, the Berkeley Stanford finance attitude and you had to realise that the world was changing. And that became a petri dish to grow all kinds of new objects and bacteria, not only transistors and Silicon Valley, but a lot of modern finance came out of California in those days.

ED: That’s interesting that you put it that way, because you’re saying that California is the tail that wags the dog because a lot of what the US financial system today is from that so-called birth of Berkeley mafia. 

RS: Yes, it was and it was the nature of the times. You couldn’t walk out on campus and watch 20 different student advocacy groups whether, as I said, it was for gender equality, racial equality, or every sort of student rights. Remember, that was called the Free Speech Movement, which began in 1964. As a student of history, you will know the whole idea of curriculums being open, that students had rights to learn, the open dialogues, especially confrontation between faculty and students were encouraged. So it was not only the birth of Silicon Valley but the birth of ideas about social change at the time.

ED: From everything that you’re saying, that’s a conversation in itself. Because when we think about everything that the US and the world is going through today because of the pandemic, how far can we take the idea of liberalism maybe, but the idea to be able to think freely and to create freely and whether we’ve now arrived at a point where some form of control is possible. That’s a conversation in itself.  

RS: Absolutely, in itself. I have said to people who have questioned me about climate and things like that and in the book that I wrote, I said if you want to look at the future, look to California and China. The best leading indicators are what’s happening in those geographies. My mentor and friend Ronald Coase wrote a book when he was 101 years old. It’s called ‘How China Became Capitalist’. The fundamental hypothesis was they started with a blank piece of paper in the late 1970s when the first class of Peking University came back after the Cultural Revolution. There was no model so they had to make it up and they had no legacy problems. California was the same thing in the United States. It was three hours from Washington. Nothing much mattered. It was a gold rush state. Institutions were built from scratch and there were no legacies that distracted them and forced them to do things the same way that others do.

ED: In some ways, they made it up as they went and in some ways they constantly checked. The difference between China and California would be that China kept checking with so-called best practice leaders around the world. They were actually agnostic as to whether they were learning from the US or from Europe or from some other parts of the world, what made the best sense for them. They constructed something that is unique to themselves but they borrowed and they benchmarked. They compared themselves to the structures that were put in place. That’s where I come talking about you, which is when China thinks about markets, especially today in emissions trading, they think about you, Doc. You set the tone, the standard and you helped them with some of the infrastructure, didn’t you?

RS: Yes, I did. I am very proud of the fact that I was able to confer with the head of the central bank, the head of the five-year Planning Commission, the Natural Resources Defense Council, Inc. (NRDC), and the various mayors of cities. And I found what you said an incredible open mind because when we first made our speech – we were invited by the United Nations (UN), that was 2005 or 2006, about 16 years ago – I said I have a novel idea that as you get wealthier, you, like all nations, will have to address environmental issues. It is the Kuznets curve of a famous economist that if you figure a correlation between wealth and environmental activism, it’s directly related. So the wealthier you get, the more you turn to your environment. 

An open mind

RS: In some sense, China was totally open to the idea that yes, that they would at some point have to deal with an environment as you and I spoke in Beijing with no sun days or 20 sun days a year, that there was a change going on and after wealth had been achieved, and hundreds of millions had been taken out of poverty, as public policymakers, they were going to face a challenge. In other countries, people have said it, “You’re really a little crazy here”. Even when I gave a talk in the UN at the Rio Summit in 1992 for market and carbon, it was pretty bizarre. But I did not have that problem in China. The answer was, “Really? And how would you do that?” And we ended up partnering with China National Petroleum Corporation (CNPC). We were an American firm and the biggest oil company in China, yes, Petro China, became our partner. This was back in 2007. Fifteen years ago, we were partnering with the biggest oil company and one of the biggest polluters in China to fashion a public policy that would work for the Chinese people. And, that was pretty out there.

ED: When I look at your career, you created the interest rate futures market. You created the climate bond futures market or the market itself. You were instrumental in the creation of the commodities risk paradigm that the Chicago Board of Trade (CBOT) uses today. This is just throwing it at you but whenever you solve a problem, you saw markets as being the way to solve them? Is that a fair generalised statement?

RS: Yes, and let me put it in a general theory. So I’ll give you my experience and then my views as a student of economics. We will put it in two buckets. So let me give you my bucket one. If you take a look at the history of financial innovation, I’ll give you four examples: the invention of the limited liability corporation in 1605 and the financing of the Dutch East India Company. Let’s talk about the birth of rice trading in Osaka in 1697. Now let’s talk about the birth of agricultural futures wheat in 1848 in Chicago, then let’s take a look at the birth of the mortgage back certificate in 1970 in the US and then let’s take a look at the birth of climate and environmental goods and services. They all follow the same pattern. The pattern is simply, boom! There’s a big structural change then there’s a need for capital. So in the case of the Dutch East India Company, the Europeans had to finance the development of the spice trade and they needed to raise capital and there wasn’t a financial way to do it. There were only partnerships and shares were invented then that allowed capital to be raised. After the structural change occurs, you have to grade it. So the share certificate became a homogeneous instrument. So you need the legal evidence of ownership for a market to work on ambiguous property rights. After that, trading comes out formally then exchanges, then derivatives, then complex financial contracts. 

I could go on but there is a pattern that goes and what’s most important for people listening is to realise financial innovation may have been the reason for European hegemony for 500 years. The invention of double entry bookkeeping and the limited liability corporation were incredibly important as much as gunpowder for any industrial invention. There’s no authorship generally. 

When I see an inefficiency that could be solved, I consider all of the policies that could be done. And one of these, markets, served to provide Japan with food, America with wheat, the Dutch with an exchange, the British with cotton. But if we take a look at the people who develop the standards for a product, they own the world. And that’s a very important thing to consider.

ED: There are actually three inflection points that I want to test with you from just what you’ve said. The person that you keep referring to as being your mentor, obviously, is Ronald Coase. I’m in the process of completing my first book and I actually mentioned Ronald Coase in the same sentence as Adam Smith because Adam Smith, funnily enough, was not a friend or not a fan of institutions, of big business. He thought that the small business owner was the best arbitrator of price discovery. But then, civilisation evolved since Adam Smith’s time to today, creating this big business as the repository of profit, of information, of organisation to get things done. 

I came across Ronald Coase’s name because he gave a reason why big businesses eventually became the repository of commerce. His basic point was that information wasn’t readily available to the small business so the big business was the best form. In his own data, institution was the best form to gather information on what to pay workers, what price discovery of goods are and so on. Yet he promoted the idea of markets in order to liberalise that price discovery mechanism and you are his number one student in that regard. You’ve made a reality in terms of everything that we see in markets today.  

Honestly, this conversation can go in 10 different directions, but I just want to pin it down to the one thing that matters today – emissions trading. When you look at the prices that are being traded today – and I’m just going straight to the point on this one – in Europe, in Switzerland, in the markets where there is a lot of regulation, the price for carbon trading seems to be more workable. In other words, the price for which the parties are willing to pay for carbon is the kind of right price for it to be able to be used to go out there and rectify all the problems created by carbon emission. Then the markets that are actually free, the price is trading between $7 and $10, which seemed to be not enough. It seemed that you need a little bit of regulation, a little bit of policy help to make markets work. So I’m going to throw that at you and maybe you could give me a sense of do you think that we are arriving at a point where markets need to be constructed, it needs to be coiffured

RS: I am of the belief that basically the environmental markets that are transparent, properly regulated and set caps correctly are the best and most efficient ways to achieve reduction. And it is like Adam Smith or David Ricardo that the best way to achieve specialisation, where the people who are most capable of reducing emissions are incentivised to do it. In fact, it’s a palindrome because it’s a mapping. Because if I am the polluter and I’m no good at cutting emissions but you are, I have to buy your reductions and I’m forced to pay for my pollution. You on the other hand have a profit incentive to produce those reductions. So the market, by a price, rewards the people who are doing the stewardship and the reductions and punishes it not by a fee, but the market sorts out the incentives properly. 

Now, what’s very important to recognise and it’s very important to recognise this in China and for your audience, the European carbon market is now 16 years old. It began in 2005, there was a pilot phase, there was a goal from 2008-2012 to achieve Kyoto Protocols. The caps were insufficient. The caps were tightened and we finally got it with no disastrous impacts on the economy. They’ve been getting better and better in reducing emissions. But it’s taken 16 years. 

Generational markets

RS: So it’s very important to realise that markets take 20 years: zero to two is infancy, two to five is kind of adolescence, five to 10 is young adults and 10 to 20 is maturity. It’s very important to understand it’s generational. You don’t start with a 777 or an Airbus as your first invention. You have a basic invention and then improvement inventions. The hypothesis says it’s going to take 20 years, no different than it took 20 years to get to the internet. It took another 12 years to get to the smartphone. It took another 10 years to get to the cloud. You know what? It’s not instant gratification. Ronald Coase said to me, “You have the 10-year story because most of the economics profession think markets are like spontaneous combustion, that you rub two sticks together”. What you have to do is you have to be sure that the timing is right. That’s important. You have to make sure there’s perfect competition, there are institutions for price discovery, there’s an adequate cash market. You have to educate the regulators, the lawyers, the accountants, the back office and structural people. After you do all of that, you have to then educate the traders, the liquidity capital that’s provided, the speculators, the market makers. I always focus on where I failed because I used to get depressed about it and talk about a plywood contract. And he said, that’s not it. It just shows how difficult it is by the fact that 99 out of a hundred new markets fail. It is a complex web of economics, sociology, psychology, regulation, and in a lot of cases, legislation. So financial futures required an act of Congress, a new regulatory agency, a redefinition of what a futures was. And it took 20 years to mature. They don’t happen overnight.

ED: I resonate with what you’re saying. Thank you for taking time to build that message because you’re actually speaking like a businessman who’s built something from scratch. I’m familiar with the people who started Alibaba in China and also hear stories about Amazon. Even on the platform, the markets, you have to make it happen. It’s not ‘we will build it and it will come’. You’ve got to get your first client, your second client, your third client then show that it’s working and then you get the whole market mechanism moving. 

RS: The World Bank retained me to take a look at why financial futures failed the first time that it was tried and I did a report. I said, “Look, you started to look to trade bond futures when you didn’t have an organised price discovery in the spot market”. You didn’t have a repo market. There was no lending so people couldn’t go short against the cheap futures. You had no institutional knowledge. Twenty years later I was involved with the Chinese financial futures exchange and worked with them and the design of the bond futures that now trades in China. There’s a set of challenges, particularly in China because that’s your audience. 

Marketing strategy

RS: I say this and I believe it in my heart, markets have to be designed specifically to fit the culture of the country in which you’re in. So what is good for the US is not necessarily good for China. Alternatively, at the risk of being politically incorrect, a big challenge in China is the control speculation. There is a very big difference between gambling and speculation. Speculators provide an important social role. The venture capitalist allows an investor to separate the financial risk from the scientific risk and doesn’t have to worry about the capital. You take other people’s money, that’s what it does. In financial futures, a farmer who doesn’t want the price risk of the crop that he’s planting gives it to a speculator. In all cases with speculation, you are transferring a risk that exists. That is different from gambling where you’re creating the risk for recreational value. So we have to be very careful to encourage speculation but not gambling. Gambling doesn’t have anything other than a recreational value but the idea, and it was important in China when we said you have to be very careful because it’s a culture that cherishes and has sayings about chance and luck and these are key elements to the Chinese culture. Given that predilection, you have to carefully regulate these markets. 

ED: The big difference between China and the US is that here, things like markets can be driven by policy. You are the father of the Chicago Climate Exchange. You’re the founder. You’re basically the founder of a nationwide exchange for climate change, for emissions trading. Amazing achievement. What’s unique? What did it take to build a nationwide exchange in the US? In China as in many other countries, it’s very policy driven whereas in the US you have to go out and talk to different people and persuade them to bring it together. So what did it take to bring it together? 

RS: It took incredible amounts of personal time with the right people: decision makers, policy makers. And in different organisations, the identification of a decision maker at Ford, IBM or Intel, or American Electric Power, or Southern California Edison, or Wisconsin Power. In some instances, they joined and agreed to cut emissions voluntarily. In Ford’s case, because the younger Ford wanted to make an imprimatur on Ford being a green company like his predecessors had invented mass manufacturing. So the idea of making a transformational change was good. Second of all, it was practical because if they learned how to control emissions in their Fremont, California plant or their Detroit plant, their Flint plant, they can use that technology and it’s more safe for their assembly there and that was going to be regulated. So they saw it coming. DuPont saw a profit opportunity. They could change the refrigerants, which are highly sensitive, they’re high impact. Intel saw that they could change how they scratch chips and make money from it and reduce emissions. Some people did it for the press release because they were in a consumer products business. So this requires building and it is a network of like-minded people. It is very difficult and a long task because at every point you have to recruit as many people who can effectively reduce emissions and partner them with people who need to buy the services of emissions reductions. So every time there was supply, you had to create demand. Every time there was demand, you had to create supply. So it was a constant pulling of one player here accountable there, an industrial user of coal with a producer of wind energy. It was a question of taking a complex network and making sure that the different ends of the pipes met.

ED: What’s amazing about you, Doc, is that you’re not just a man who created markets in the 1970s and 1980s, and then into the 1990s. I just love the fact that you just published a book in 2018, “Electronic Trading and Blockchain: Yesterday, Today and Tomorrow”. So I have this theory and it comes from someone I read from the RAND Corporation, someone called David Ronfeldt, who says that society moves from its tribal origins to its institutionalised forms and then into markets. Then it’s moving into the future into networks. 

As the man who created markets on so many different levels, markets for financial institutions, markets for commodities, markets for carbon trading and the environment, you’re also involved in the initiative to build a US replacement for the Libor market as well. Do you see this transition? Markets in an institutionalised framework in every country, every place has its own market and they are institutions on their own and they represent their territory as it were. But in the networked world, we can be global, we can trade with each other, we are all nodes connected to each other. Do you see that transition? And how would you describe it in what you see taking place? And how are markets changing because of networks?

Information commodities 

RS: The biggest and simplest answer is that the commodity of this century is information. If we look at wealth creation since the end of World War II from about 1945 to 1970, it was manufacturing. The biggest company in the world was General Motors. And the saying was “How goes General Motors, that’s how America goes”. In the 1970s, the value proposition was in energy and food the first and second was the Arab oil embargos. In 1973 and 1979, failures of crops in China, failure of crops in Russia, anchovies not running off the coast of Peru, record food prices, all of that. By the 1980s, the value proposition was in asset liability management, the consolidation of world capital markets. In the 1990s, it was in 1986 that Microsoft went public. So it was an age of computational skills. That’s been followed by information and the social media is the value. So now it’s an information age. The manufacturing value added, the food value added, the reorganisation value added, the commodity of this 100 years is information and the underlying technology, which allows it to be transferred. 

ED: Data itself is the commodity that’s being traded on your exchanges. So, you could see market for data. 

RS: Data is artificial intelligence data. Oil pales by comparison. Look at the market capitalisations of companies and see where the oil companies are relative to the information. It’s right before our eyes. We are creating and living in a world where the allocation, the production and distribution of data and information is the commodity of this century. In my humble opinion.  

ED: Data has always been a commodity in the market, right? In the futures market that you created, you’re actually creating based on expectations. But having created a market for interest rates, for commodities, for carbon, what do you see the market for data looking like? What would be its essential characteristic?

The idea for Ameribor

RS: It’s the business that I’m in now, the exchange that I’m in now. If you’ll forgive me for talking about my current passion and love. In 2011 somebody called me up and said the Royal Bank of Scotland just fired four people for manipulating Libor. I said, no surprise. We had sold our Climate Exchange, we’re looking at water markets in China, in California. I called my staff in and I said, this is the end. Libor is going because when a bank fires its own employees, you all know that it’s not only one. As an economist, it’s very simple. You can’t collude unless you have two. And if you have two, you’re likely to have four and the whole system was broken. There was no national interest rate in 2007-2008. There were people that surprisingly enough, a commodity which had no transport cost deferred. The interest rate in California was different from Birmingham, Alabama, and different from Lexington, Kentucky. 

How could it be that the world’s largest economy, that the price of money, non-physical commodity could be 30% higher in one locale than the other? It meant the system was broken. That if I could connect the bank in Appalachia to lend money to a Brooklyn, New York bank to finance an Uber, I would unlock a huge amount of capital flows in the United States. That there was cash rich areas on one part. That the US was a series of regional economies. Then why is that of interest? It’s of interest because if you took the average price of all that, that’s really the American interest rate. It’s not what gets traded between big banks. It’s the flows of capital between 5,300 spread over 4 million square miles compared to 90,000 in the UK. Five thousand banks that represent $11 trillion in assets. 

So I got on a plane, I went to Green Bay, Wisconsin. It was zero degrees in winter. I went to Tupelo, Mississippi, where Elvis Presley was born in the heat of summer. I went to the east and west, north and south. I visited 125 small banks and developed a network. Once the network was developed, I could be the honest platform for interbank borrowing and lending and nobody need to set price because a hundred different banks expressing their view about it, none of which were big enough to influence price would create Ameribor national interest rate. That was the dream. That was 2012. I did that for four years. I got on a plane to Washington. Another advice for potential financial innovators. I have three rules: never surprise a regulator, never surprise a regulator, never surprise a regulator. I got on a plane with the leading attorney, Rodgin Cohen at Sullivan & Cromwell. I briefed the Federal Reserve, I briefed the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC). I said, “I have a dream. This is what I’m going to do”. We’re going to come back every year. I don’t want anything from you. I have nothing to criticise about your behaviour. But I’m going to go in the private sector and try to develop a benchmark because Libor is dangerous and it’s going to fall apart. I came back every year and briefed them about what we were doing.  

The end of Libor is in four months and we’ll see if I got it right or got it wrong. And it’ll be interesting. No matter what happens. Because it is really an incredible film or movie when you think about what can go wrong and what can go right and can you link 5,000 financial institutions into a network and if it succeeds, it’s interesting. Why? And if we fail, it’s interesting as well. It’s a clinical study. So I’m excited. I think we have done the right thing. We are promoting the interests of small towns that disproportionately create jobs in America. The local bank is important when you’ve got a country of four million square miles. They need financial literacy. And their banker provides it. 

ED: Is banking the only institutional form for pricing the cost of money today?  

RS: We started with three or four small banks. We now have $5.2 trillion in assets and the American financial exchange is 25% of US banking by volume and by numbers, 1,100-1,200 banks. We have 44 non-banks and because now, there’s so much liquidity outside of the bank so we have corporates like John Deere and American Electric Power. We have insurance companies like Northwestern Mutual. We have money managers like Guggenheim Investments. So we have financial institutions, industrial companies and insurance companies because there are flows of funds that are so large, and the balance sheets of companies are so fantastic that there is a better way for supply and demand to meet.

ED: What would we see at the end of it? Is it another exchange? 

RS: You will see we have something called the American Financial Exchange and we’ll either take it public, which we did the Climate Exchange, then it was bought by the Intercontinental Exchange. Our investors did handsomely. They made 7.5 to 15 times their money. And the dream is that we take this public and the Chicago Mercantile Exchange or the New York Stock Exchange buys it, or maybe the Hong Kong Exchange and we create a new American Financial and then I will come back and talk about water with you because I have a dream about water and information, and data that I want to get on with. 

ED: Doc, you’re an intellectual, you’re a markets creator, you’re a businessman, all in one. This conversation really could go in many different directions. Just one last question just for this conversation. I must come back to visit with you on all of the other points that we’ve touched on today. When you see the equities market going the way it’s doing now, in fact, last night both Nasdaq and Wall Street did very, very well. It looks like there is no end to that. What do you think of when you see equities going so well? Is it at the expense of everything else? Or do you think there should be some kind of a reckoning and a balancing in the US economy? 

RS: Yes, I think there is at some time but the difference is today, we’ve created $4 trillion or $5 trillion in the US of new money. If you look at the alternatives, the 10-year at $112, gold at $1,800 an ounce, fixed income 30 years at 2.3% mortgages, Government National Mortgage Association’s (Ginnie Mae) at 3.0. Equities on a relative basis are cheap. Now, having said that, I think somebody’s got to be really cautious here that these are hitting unmatched highs.

Unmapped territory. There’s liquid oxygen seeping out and then I can either propel a rocket or the rocket falls over so it’s not like we’re ready for escape velocity into a new orbit. I think people have to be careful and measure the risks. It’s not to say it’s not going to continue to go up but I think prudence is widely misused and that people should think about it. It’s not as easy as it looks. And remember, two things as a trader and a last wisdom: It never looks worse than at the bottom of the market and it never looks better at the top of a market. 

ED: As a trader, absolutely! Now, why does that sound so true? So? We all worry about how the US economy is evolving. It’s in uncharted territory. The so-called quantitative, putting so much money out into the marketplace, it’s never been done before. And when you thought 2008 was already the height of printed money, it’s now going on to another realm altogether.

RS: I worry about that, I really do. Because it is unchartered. And these are very smart people. But this is a $22 trillion economy and if you get it wrong, it’s not like a rowboat where you take one out of the water and you change direction. It’s $22 trillion. It’s got to be carefully handled. So far, the grades are very good. I applaud the chairman of the Fed and in the last three or four, they’ve been great. They’ve done a great job. But I’m always worried about the things I don’t see and I don’t know and I don’t know what’s going on structurally. You can have unending growth. The business cycle is not over, in my opinion. We’re going to have to be prudent as we watch this. Having said that, I have worries about what economists call rent-seeking, the purchase of economic power through political power. It’s very dangerous in the United States that there’s one end that’s proven regulation and there’s another where the regulation is purchased. The economists call that economic rent and I worry about purchase regulation as opposed to prudential regulation. By and large, it has been, since I grew up forever, a very bad idea to short America’s ingenuity. It’s not a good trade. 

ED: Well, the rest of us are invested. The big thing about the US economy is that it is the most externalised economy in the world. The rest of us hold US debt and the single biggest US debt is the dollar. I’m told that nearly 40% of the US dollar circulates outside the US or rather US assets circulate outside the US. It might be higher for the dollar itself. The rest of us are invested. 

So it’s in our interest to make sure that it takes us somewhere. Like someone once said, if you owe the bank $10,000, you’re in trouble. But if you owe the bank $100 million dollars, the bank’s in trouble. So it is an economy that’s now $27 trillion in debt. And as you say, the GDP is about $22 trillion. The ability to meet its obligation is stretched at this point. And having said that, so much of GDP today is created on digital and the future, we are back to 1901, which is the productivity gains and so on, justifies it as we go along. So, in a lot of ways, all of us continue to be guided by the innovations that are taking in place in the US. Your career as an outsider looking in is predicated by the US leaving the gold standard in 1971 and then the price of money floated and had to discover it’s a new mechanism and you created the markets for that. The interest rates futures and we are back there. Last point, in that book on blockchain, what are you saying? I just want to capture your sense on blockchain, on crypto, as I said, the network aspect of the economy.

RS: The message was simple and consistent with the conversation the two of us have just had in the warm exchange of ideas. I did work at Berkeley in the 1960s and developed the first schematics for electronic trading as a young professor and it went dormant for years. Then all of a sudden, patents on it came about and I used that as a vehicle story to say electronic trading the first application of it, there was the work we did in Berkeley in 1969 to develop a wild model. It was the world would someday have electronic markets that were for profit, as opposed to physical markets that were mutually owned. So this was a whole new buzz model. I was to create a new exchange in San Francisco because they weren’t on the West Coast and they were commodities indigenous, like palm oil and other commodities, which there would be a natural home. I did some consulting in 1986 with the Arthur Andersen Consulting and the first people to enjoy and embrace it were the Swiss. The next were the Germans in 1990. They upended the English floor model and for the first time, Germany became a market space country. It became pervasive in the United States in 2000.  

The birth of blockchain

RS: So the birth of electronic trading and its ultimate distribution was a 20 to 40-year history. The blockchain was not invented by Satoshi Nakamoto in 2007-2008. There’s a guy by the name of Stuart Haber who developed the blockchain. He is an academic at Princeton. He did the first work on the blockchain in 1990. If that time period is right, the world will change 20 to 40 years later, which means by 2025 to 2030, crypto, blockchain, etc., if we use electronic trading or other financial innovations, the messages, the blockchain is already here. It’s not as new as people think. Power steering was invented in the 1930s and didn’t get used until the 1950s. The blockchain has been invented a long time ago and cryptos came along but the innovation is far enough along and you’re going to wake up one day and it’s all digital. And it’s happening quicker. I didn’t know it, but COVID-19 accelerated the entire trend that existed before. 

ED: Does blockchain change anything that you’ve created in markets? In the way in which information is packaged that’s shared between different people and in a trusted form? Does that change? 

RS: Yes. I think the only exchange in the world that is on the blockchain is this little thing, the American Financial Exchange. And every time a trade occurs, we print a private coin, Ethereum, that says every exchange we’ll publish the price of a good or a stock, the quantity that changed hands and the time. We record where the money originated – in Lexington, Kentucky – where it was consumed – in Chicago, Illinois. We tell you the borrower’s characteristic, what their tier one capital was, what their loss ratio was, what their net interest margin. So every time you create a trade, we can instantaneously track the cash flows across the 50 states and the four million square miles. We can tell you the city and state that the money came from and where it went. That’s a market in itself, those coins. 

ED: So you’re well into the future. So you’re not done yet.  

RS: Don’t be fooled by the fact that I’m 700 years young.

ED: Doc, this is a great conversation even on that point alone, blockchain. That’s another two hours’ worth of drilling down to how it’s going to come together for you and for markets as a whole. 

RS: Well, listen, I have to say coming from you, it means a lot because you are a creator yourself. And while I’m the focus of this interview, you have an equally rich story. You built an organisation that’s world renowned. You’ve been a leader. The very fact that you could create a market for 30,000 people to listen to a conversation, forget who is on it, is an incredible achievement in itself. So I’m honoured to be the subject of your inquiry.

ED: Thanks, Doc. Thank you very much but the honour belongs to me. You’re the man who’s created so much of what the market infrastructure in a country which is ruthless. You have to make it happen. It’s not driven by policy. You have described it, you have to go knocking door by door. You’ve coupled charm, entrepreneurship and intellectual rigour into an amazing story. I don’t say this lightly. When I say it’s my honour to have had this conversation with you, I really mean it. I wish I’ll be able to test with you different topics as we go along. So thank you very much for spending time with me today.

RS: It’s a pleasure. I really look forward to that dinner in Chicago or in Beijing. As you know, I’m a big fan of China as you are. Thank you for having me again.

ED: Thanks, Doc. Thank you very much. 


Keywords: Cop26, Cbot, Dutch East India Company, Kyoto Protocols, LIBOR, Ameribor, Electronic Trading, Blockchain, Covid-19, Ethereum

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