The Dojima Rice Exchange

Dojima Rice Exchange

In the modern world Finance is among the most powerful players in people’s day to day lives. The complex financial instruments of today’s world have their humble origins in history. It’s not something people usually think about or consider as they go about their lives. Everyone uses money and some invest in financial instruments, but often enough, the history of such practices is never discussed or considered. Today’s article is based on the history of Dojima Rice Exchange and the beginnings of commodity futures trading.

**Update: Due to the popularity of this article The Plutarch Project Podcast has done an episode on this topic if you prefer to watch rather than read click here**

What are Futures Commodities?

In today’s world, a futures contract is “a legal agreement to buy or sell something at a predetermined price at a specified time in the future, between parties not known to each other.” Today the futures market is HUGE. Just about anything (especially commodities, bonds, and stocks) can be speculated on. Let’s take a look at a super simple explanation of how commodity futures work.

First, someone writes up a contract for a set amount of some commodity. If the price of a commodity (such as sugar, oil, or gold) goes up the buyer of a contract will make money. He or she purchased the product at a lower-but agreed upon- price and can now sell it at a higher price on the current market. If the price of the commodity goes down the seller makes money. He or she can now buy the commodity at a cheaper price and sell it for the higher-but once again agreed upon-contract price.

The Beginnings of Futures Commodities Trading

The practice of commodity trading began in earnest in the 1700s in Japan. The history leading to a futures market began a century earlier with the creation of the Tokugawan Shogunate in 1600 (The Edo period). At this time the true power of the nation lied with the Shogunate (Chief Military Commander)the emperor was more of a religious figurehead.

The hot commodity of this period of time was rice. It was so important in Japanese society that it was used as a primary form of currency. Rice accounted for about 90% of the government’s revenue and it was used to pay a large portion of the societies’ elite people-the Samurai classes.

The Samurai Classes

In the west the samurai class has often been lumped together but there were several subcategories of Samurai classes that were seperated mostly by wealth. At the top were the Daimyo (Feudal Lords). In order to be in the Daimyo caste you had to produce at least 1.8 million liters of rice annually. It’s important to note that in theory the Shogun owned all the rice. In reality they Shogun would “rent out” 70% to the Daimyo. There were anywhere from 200-300 Daimyo at any given time. In short, they were the top 1% of society. The fat cats rolling around with tons of rice and silver-at least in theory.

Below the Daimyo were the hatamoto (the banner men) class and below them the gokenin. There was no real difference in income between these two classes. The most often cited difference was that the hatamoto class had the authority to have an audience with the Shogun; the gokenin did not. Payment to the Samurai classes could be made in rice to be eaten or sold in the markets, silver at the Shogun’s set rate based upon the price of rice, or a combination of the two. When the price of rice was high the Shogun would use a slightly lower rate and the opposite is true when the price was low- thus helping to enable a stable price for the Samurai classes.

Changing Economic Dynamics:

The rise of the merchant and artisan classes

In total the Samurai classes composed about 7% of the population. During the beginning of the Tokugawan Shogunate in 1600 the population of Japan was about 12 million. In the year 1716 there were roughly 30 million people. The bulk of the population was composed of farmers, mechants, and artisans. With the population more than doubling there was a dire need to feed all of these mouths and rice played an integral role in both economics and appetites.

Half a century into the Tokugawan shogunate’s rise to power, Japan found itself in uncharted economic waters. Much like Europe the rise of urban living and growing merchant and artisan classes (known as the chonin class) began to change how wealth was accumulated and transferred among Japanese society. The merchant and artisan classes began to gain incredible sums of wealth, this posed a threat to the Samurai classes and the traditional land economy.

The Dojiima Rice Exchange was officially established in 1697 to help aid in this process. Clients could hold rice in the warehouses, buy or sell large portions of rice, or gain credit for purchases to be bought with future rice yields. The establishment of this exchange would later lead to other financial innovations including a shift in how currency was distributed from rice to coin and eventually to paper money. Dojima was at the center of all of these innovations for centuries after its establishment.

Financial Obligations of the Samurai

Members of the Daimyo were required to own their own house in their area of rule as well as another house in Edo (modern day Tokyo). The Daimyo’s family would remain in Edo, while the Daimyo would rule in their respective territories. This was an attempt by the Shogunate to their Daimyo with less fear of reprisal. As you can imagine this would raise the costs associated with being a samurai substantially. Along with these essential expenses many of the Samurai class would spend their wealth on lavish lifestyles-using money borrowed from the chonin.

In the early 1700s the price of rice dropped to half of the price it had been worth just a year prior. This put a major damper on the Samurai classes’ ability to live the lavish lifestyles that they had become accustomed to. The chonin merchants developed the theory of nobemai (延べ米) what we now consider a primitive form of futures trading. This financial instrument helped them to gain large sums of wealth for little or no extra work.

As the chonin began to utilize their new financial instruments their power grew to unheard of heights. Their ability to monopolize the rice market lead to a stranglehold over other rice markets across Japan. As their power grew the samurai classes began to fear the economic role these “lower classes” had obtained. Resentment of the chonin class grew and grew until the shogunate was forced to begin confiscating property and wealth of chonin that had grown too wealthy.

Retaliations Against the Chonin Class

In 1712, the shogun created a law that suspended a large portion of legal proceedings involving loans samurai had taken. Again in 1719 the Shogun repeated the action, this time with all samurai debts.

One of the most notable confiscations of the time was from a particularly powerful merchant named Yodoya. He had become too powerful and loved flaunting his wealth. After trying to enforce loans on several powerful Daimyo the shogun confiscated his wealth and erased the debts owed by the Samurai classes. Although more than likely an exaggeration Yodoya was said to have been owed over 100 million ryo or what would be the equivalent of about $17.7 billion USD in today’s money. Even if it was exaggerated it does show that there was an incredible amount of credit in existence during the time. (source 2)

Much like today their were also some very creative accounting schemes at work. The Daimyo would extract taxes from their subjects at a set percentage of expected yield. The set percentage of taxation could be changed on a whim, but this often lead to trouble with the lower echelons of society. Quite often they would maintain the same rate regardless of how much rice was actually produced. This fear of the chonin class coupled with the transfer of economic system from land based to money based set the stage for the development of commodity futures. While the Daimyo were cautious to change the taxation rates they-along with the elites rising from the chonin class- were free to speculate on the price of rice in secret.

Futures trading had been going on in Japan for at least 30 years by the time the Dojima Rice Exchange was founded. It was always done in the shadows. It was the use of Rice-bills which paved the way for future commodities trading.

Rice Bills

Rice bills were tickets for people to buy and sell rice at a set price. In theory these tickets had an expiration date. In reality people would trade them and/or sit on them until they needed the currency or when a lucrative time arose. Sometimes keen businessmen would stash them away for years at a time. These transactions were generally discouraged by the shogunate, fearing that they could make the economic situation even more turbulent.

The Role of Information in Rice Futures Speculation

Today information is essential to making smart trades. The same was true in the 17th century. Scholar Urlike Schaede retold a popular about how information and speculation met in Japan in the following vignette:

“A rice merchant from Nagoya [to the south] frequently met a colleague from Sendai [to the north] on his business trips to Edo and exchanged information on harvest, weather conditions, etc., in their hometowns. One day the Nagoya merchant learned of an impending bad harvest in the northern parts of Japan which would reduce rice shipments to Edo by about 50%. At the same time he knew that the Nagoya area would have a good harvest. Recognizing the potential profit opportunity, the Nagoya merchant bought the future harvest of his region by paying approximately 10% to the farmers and writing drafts for the rest of the negotiated amount. These drafts were not to be presented for payment before the rice was actually sold. When the harvest came in, he stored it and after three or four months sold it with a profit of 30- 40%, as prices had climbed in the meantime.”

Using the financial instruments at their disposal, and the information available through sharing of privileged information led some merchants into great wealth.

Origins of Futures Trading and the Official Establishment of the Dojima Rice Exchange

Tokugawa Yoshimune became Japan’s shogun in 1716 and was under heavy pressure to reform the Japanese economy. The country had been plagued with economic infighting and peasant uprisings resulting from hunger, taxation, and the rising economic power of the chonin.

Yoshimune’s predecessors had created the first official Rice futures market in the rice capital of Japan: Dojima, Osaka. It’s important to note that futures contracts as we now know them were not legal. Wild speculation and other contracts were specifically banned. Futures contracts were being made, but they weren’t legally enforceable. So if you ended up on the wrong side of a trade there was definitely an opportunity to skirt your debt and take a risk that the contract partner wouldn’t try to enforce it themselves. The goal of the shogunate was the level out the market- not to create wealth beyond belief from thin air. The sums of currency speculated on at these early markets were modest and the illegal kinds of contracts were generally kept behind closed doors.

Establishing the Price of Rice:

The Fuse Cord Price and the Bucket Price

The price of rice was set by the practice of “fuse cord price” and “bucket price” which Scholar Urlike Schaede describes in the following passage:

“A wooden box containing a fuse cord was hung at the ridgepole of the exchange building. Exchange officials put fire on the cord and allowed trading to continue as long as the box was on fire. The prevailing price at the moment the fire went out became the day’s official closing price, called the ‘fuse cord price’ (hinawa-nedan).

However, traders were little impressed by the official closing of the market and had to be stopped from continuing their transactions by the ‘watermen’ (mizukata) who splashed water all over the market place in order to disperse the trading crowd. Because splashing was also of limited effectiveness, in their second attempt the watermen would dash whole buckets of water over the crowd, which usually stopped the day’s trading.

The prevailing price at this time, the ‘bucket price’ (okenedan), was the actual daily trading price which was registered in the books and used for mark-to-market or settlement. On the other hand, the official fuse cord price became the opening price of the following day’s session. This price fixing system included a settlement obligation: if no price was found at the time the fire went out, or if the box did not burn down completely by itself for some reason, all transactions of the day were declared void and open positions that had been kept overnight had to be cleared by the fuse cord price of the preceding trading day.”

That sounds a bit more exciting than an opening and closing bell. Perhaps this is something traders should consider making this a thing again.

Fluctuations in the Price of Rice

Increased trading and speculation helped to bolster the low price of rice-for a time. This increased the funds available to the Samurai classes and eased some of the economic woes people of the time were facing. From 1719 to 1721 the price of rice rose out of control. This lead to starvation and other problems for the bulk of society. Yoshimune closed the market and persecuted the merchants who had been selling illegal contracts.

Making the Dojima Rice Exchange Official

In 1724 Yoshimune foresaw the need for the price of rice to rise again and gave a tacit nod to the rice futures market being reopened under a similar model to the one he had abolished a few years prior. In 1728 he gave an official nod to back the rice futures market but maintained some prohibitions in regards to the types of speculation that could be legally done.

By the year 1729 there was increasing pressure put on the Shogunate to open up trade and broaden the range with which it could be conducted. Scholar Dazai Shundai published a book laying out a case for such practices to begin in Japan. He shined a particularly keen light on how influential the price of rice was in Japan. He noted,

“Samurai are jubilant when the price of rice is high, while they are distressed when it is low. They have no aptitude for money-making, nor are they thrifty by habit. When they find themselves in possession of much money, they soon squander it in temporary pleasures and luxury, and the money they spend finds its way into the pockets of artisans and tradesmen. Even when artisans and tradesmen have to buy dear rice, the amount of rice which they need for their daily sustenance is, after all, relatively small, while the profits which they can make are relatively much greater. The high price of rice does not, therefore, affect them seriously. On the other hand, the profits which they can make when the price of rice is low are somewhat meagre, as the samurai then have little money to spend. A sharp decline in the price of rice nowadays, therefore, causes far greater distress to all four classes of people than it used to do in the old days.”

Economic Reforms

The shogunate took the advice of their scholars and placed a higher importance on economics especially in regards to rice. Despite the best intentions of the Shogunate the price of rice dropped dramatically in the early 1730’s. A lot of rice was lost due to abhorrent harvests and poor trade deals. People looking to control the market kept huge amounts of rice in their warehouses keeping the price low- but still not affordable for people who were living off of fresh harvests. The samurai panicked and the hungry lower echelons of society began rioting against the speculators. These riots would occur from time to time over the course of the next century.

In 1735 the shogunate set a price floor for rice-hoping to balance out the market even in the worst of times. People found selling rice below the floor price would be fined a healthy sum of money. These, along with other decrees relating to rice led Yoshimune to be remembered as the Kome Shogun or Rice Shogun.

Reestablishment of the Dojima Rice Exchange Under Government Control

For the next forty years things continued in this same fashion until the Dojima Rice Exchange was re-established under the watchful eye of the government in 1773. The government took over organization, regulation, and sponsorship roles and also their own warehouse to house the rice. This also led to a series of riots and rebellions as the government became aware of the full role of the Dojima exchange. For 3/4’s of a century the Dojima Rice Exchange had been much like a money bank as well as a trading floor. The Daimyo and other citizens would make deposits, withdrawls, take out credit, and speculate. The funds gained from these activities were propping up the entire Japanese economic system.

Despite the government’s lack of financial tact-they did become increasingly aware of the role and power held in financial institutions. It was decided that this kind of power shouldn’t be in the hands of the chonin and the Japanese shogunate and future empire took steps to take it as their own. It was eventually reorganized again during the Meiji period and finally dissolved into the Government Rice Agency in 1939. Futures trading and other types of commodity and agricultural exchange are now held at the Kansai Derivative Exchange.

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Non-linked sources:

https://www.investopedia.com/articles/optioninvestor/10/history-options-futures.asp

https://edisciplinas.usp.br/pluginfile.php/151297/mod_resource/content/2/Dojima_Rice_Market_Case.pdf

https://www.thebalance.com/commodities-futures-and-how-they-work-3305647

https://www.jstor.org/stable/1290356?seq=1#page_scan_tab_contents

https://www.jpx.co.jp/dojima/en/index.html

https://en.wikipedia.org/wiki/Dōjima_Rice_Exchange

http://factsanddetails.com/japan/cat16/sub107/item502.html

https://marketvoice.fia.org/issues/2016-09/japans-derivatives-markets-an-update-on-technology-and-trading-volumes