Inventing the Future: How the Civil War Inspired the Commodities Market
In the Washington, DC, of 1862, Peter H. Watson’s powerful, hefty frame and red Amish-style beard made him instantly recognizable around the Department of War. Before being named assistant secretary of war, Watson had been a high-profile corporate patent lawyer. In 1854 he was employed as chief counsel for Rockford, Illinois-based J. H. Manny & Company, a maker of wheat-harvesting equipment. When rival Cyrus McCormick sued the Manny company over a patent on a reaper, Watson hired attorney and politician Edwin M. Stanton as his assistant. For additional support, Stanton contracted with an Illinois lawyer named Abraham Lincoln. Watson initially found Lincoln grating but came to admire the lanky fellow’s skills. Watson advised Stanton to keep the tall attorney on retainer. These associations had repercussions. The connections linking railway barons, grain dealers, and the lawyers who represented them coalesced into the Republican Party. From California to Chicago, New York to Pennsylvania, many of the new party’s wealthiest supporters were merchants, railway men, and lawyers. Their collective power was undeniable.
Watson was ruthless. So that a client’s machine design would appear older than it actually was, he artificially aged a mechanical reaper’s wooden components. He was arrogant. Meeting Abraham Lincoln in 1855, Watson derided the other man as a “railsplitter from the Wild West” before coming to recognize Lincoln’s gifts. Within a few years Lincoln was a president at war; to help prosecute that war, he recruited Watson to remove the taint of scandal from the War Department. Results of that hiring included a great expansion of the nation’s railroad systems, establishment of reliable supply lines to support Union general Ulysses Grant’s critical campaign in the west, and Watson’s most enduring legacy: creation of what became the futures market.
The War Department’s drafty offices crawled with spies working for either the Confederacy or some military contractor. All wanted to learn the size, disposition, and direction of Union forces—the enemy, to stop those forces; contractors, to gouge the army. To foil these agents, Watson often operated out of a railway car. He communicated most of his orders to his lieutenants via hand-delivered message or telegraphed in code. He had his own secret police force. Watson’s remarkable success at security has kept him nearly unknown to historians, along with his world-changing feat of transforming trade in grain and other agricultural commodities.
Peter Watson was born in Whidby Yorkshire, England, in 1819. Around 1830 his family emigrated to Toronto, Canada. His father’s participation in a failed 1837 rebellion precipitated his banishment from Britain and its holdings, propelling the family to Rochester, New York. Peter and brother William, both mechanically minded, wound up in Rockford, Illinois, running a foundry and machine shop. Peter eventually studied law, specializing in patents. In the 1840s he worked for such clients as Samuel F.B. Morse and Goodyear. His skills brought him to Manny & Co. and elevation into the ranks of Republican power brokers. He joined the Lincoln administration following a scandal that engulfed Lincoln’s first Secretary of War, Simon Cameron. When the Confederacy shut down North-South transport of goods on the Mississippi River, that blockade at first forced most of the grain trade to the Great Lakes, so that between 1859 and 1862 the amount of grain received in Buffalo, New York, tripled, benefiting a monopoly held by a single line, the Northern Central Railroad. Just before the war started, that railway, connecting Maryland to Pennsylvania, had been acquired by Cameron, then a Senator representing Pennsylvania. When named secretary of war by President Lincoln, Cameron placed the Northern Central under the control of the Pennsylvania Railroad, which by then was running from Washington, DC, to Lake Michigan. Cameron chose as his assistant secretary the company’s vice president, Thomas A. Scott—Watson’s predecessor. As assistant secretary of war, Scott set rates for shuttling troops and supplies; as vice president of the Pennsylvania Railroad, he collected those fares and fees. Under the newly reorganized Pennsylvania Railroad, a single railway trunk line soon stretched from Alexandria, Virginia, to wheat fields in Ohio, Indiana, and Illinois.
A congressional investigation reported numerous cases of outright fraud by Scott, including the disappearance of millions of dollars.
Charges were brought in Congress as well as in the Pennsylvania legislature. Lincoln cashiered Cameron. To replace him, Lincoln tried to recruit former legal client Peter H. Watson. Watson refused the ill-paid position, suggesting Lincoln instead hire Edwin Stanton, who was Watson’s right-hand man. Watson told Stanton that becoming war secretary was his patriotic duty. Stanton acceded. A few months later, Stanton demanded that Watson replace the corrupt Scott as his assistant. Watson grudgingly stepped up.
Stanton persuaded Congress to authorize the president to seize railroads as needed for war purposes. Meeting with rail executives in February 1862, Stanton laid out a plan to strengthen and consolidate competing railways between the Midwest and the East. The arrangement included a discount for the military. Watson almost certainly established the terms that would join the railways to the Union war effort.
The president’s wartime authority included both stick and carrot. Railways would give the government a 50 percent discount on published rates or risk seizure by executive order.
In return, the War Department authorized railroads to consolidate management, regularize track gauges, and share cars. System builders could ignore state and local laws that for 25 years had been hindering interstate consolidation of rail lines between the Midwest and the Atlantic Ocean. By 1863, four extended lines had expanded under consolidated management: the Erie, the Penn, the New York Central, and the Baltimore and Ohio (B&O). All soon were connecting the midwestern grain states to eastern ports, though until 1873 most traffic still came by way of lakes and canals to New York City.
The New York Central’s Cornelius Vanderbilt, the Pennsylvania Railroad’s Edgar Thomson, and the B&O’s John Garrett have been credited with building interstate railroads after the Civil War. But the moving force was Peter Watson. Watson and Stanton would establish the complicated public-private partnership under which army engineer Herman Haupt and Major General Henry Halleck were to perform brilliantly.
Watson’s consolidation of the Union Army’s supply chain in the North synched with the operations of the Quartermaster Corps and establishment of military railway corridors through the South. By the middle of 1863, as Watson’s east-west railroad corridors from Chicago were beginning to emerge, the army had begun standardizing its provisioning and its personnel structure. The army reorganized each squad of eight men into a “flying column” able to move quickly. Historically American soldiers had carried necessities in a haversack—a flapped pouch dangling from a single strap, which could be cumbersome. Now the Union army adopted the knapsack, which snugged onto a man’s back using two shoulder straps. Into and onto the knapsack went 60 rounds of ammunition, eight days’ rations of salted meat, crackers, rice, and water, and either a blanket or an overcoat. Most also carried cooking utensils. Individual provisioning meant fewer wagons per regiment. With commodities like wheat and corn arriving at Louisville, Kentucky, and Alexandria, Virginia, from which they were shipped into the field to complement packaged vegetables and meats, quartermasters could assemble and pack rations such that a federal soldier could sustain himself for eight days before needing to be resupplied.
And this was just the beginning. By September 14, 1863, the Union railroad operation had assumed control of all railways in federal possession and all rail construction and reconstruction in the Confederacy. These undertakings were aided by the cheap labor of tens of thousands of formerly enslaved Black men who had escaped into Union territory. By war’s end the Union controlled and had regraded 2,105 miles of track through the Confederate states.
In October 1863, New York newspaperman L.A. Hendricks characterized the army’s virtual annexation of the railway corridor as an “unwritten chapter” of the Civil War. “The railroad is the bowels of the army,” Hendricks wrote. “The railroad is the channel through which the army is fed, nourished and kept alive; by means of the railroad the army lives and moves, and has its being. Cut off the railroad and the army dies.” The Alexandria, Virginia, depot, the reporter noted, covered 200 acres. Depots at Nashville, Tennessee, and Jeffersonville, Indiana, were of comparable size. By 1863 the Nashville depot was warehousing five million rations and delivering 300,000 rations a day to Union soldiers, refugees, and freed people who worked on its grounds and in its corridors. Western commissary-general Henry Clay Symonds declared that, from Nashville, he was also “running a cracker bakery with 400 barrels of flour a day; a bread bakery with 150 barrels of flour a day; a soldier’s rest, with from one to five thousand meals a day (on one occasion [it] furnished 15,000 meals); three pork houses, each packing about one thousand hogs a day; a pickle factory, putting up six thousand gallons of pickles a day, and was receiving about one thousand head of cattle a day,” in addition to “provid[ing] for twenty-one hospitals, with 20,000 patients.”
Logistical solutions, however, work only if there are supplies to be moved, and in late 1863, Watson’s most pressing problem was lack of feed for starving horses. To keep in good flesh, one warhorse needs approximately 22 pounds of oats or forage a day. The War Department owned more than 200,000 horses, a gigantic herd that each month consumed 2.5 million bushels of oats. The animals were scattered from Texas to New York to Florida. Most were clustered at Alexandria, Virginia; at a cavalry outpost in Gettysburg, Pennsylvania; and at the leading edge of the Union Army, now attempting to invade the South but besieged in Chattanooga, Tennessee. The Union supply lines that fed these herds and the soldiers who used them stretched from the main eastern depot in Alexandria and the main western depot at Jeffersonville through Confederate territory to hundreds of camps all over the country.
In late 1863 Watson’s security operatives smashed a scheme in which crooked Union quartermasters had been bilking the government out of a fortune by manipulating stocks of horse feed. The defendants and their civilian accomplices were court-martialed.
In the course of the investigation, word got out that the War Department lacked contracts to deliver the 2.5 million bushels of oats Union Army horses needed every month to stay alive. In response, contractors holding oats more than doubled their rates over the previous year’s. Crisis loomed.
For over a century, nations at war had been issuing paper currency and rationing goods. As of February 1862, the War Office paid for supplies with U.S. Treasury notes called “greenbacks” for the ink used to print them. Unlike prewar currency, greenbacks were not backed by government gold or silver reserves. Unstable in value, they might trade for as little as 35 cents to the gold dollar. This variability led to two-tiered pricing: one amount for goods bought with gold and a higher sum paid by customers proffering greenbacks.
Overlapping and competing state-supervised supply systems compounded the problem. Although Watson was designated to clean up the mess, in June 1863 Congress imposed its own solution: a centralized national purchasing system. The Alexandria depot would serve the eastern armies; the depots at Louisville and Jeffersonville would serve troops in the west. Contractors were to file sworn bids, signed in quintuplicate and enforced by the threat of court-martial. Centralization sharply narrowed the field of bidders. Only about a dozen merchants in the United States had the wherewithal to bid on supplying the 10,000 bushels of oats standard in an army contract. “A large combination of men and money,” assistant quartermaster general Captain Samuel L. Brown said, was “controlling the supply of oats and corn then acceptable for supply of the Army.” The big 12 “demanded increased (and constantly increasing) prices for grain.” By December 1863, the price for oats had more than tripled, exceeding $1 per bushel, and army horses still needed 2.5 million bushels of oats per month, never mind feeding the soldiers using those animals.
To ease the big 12’s Stranglehold and feed the army and its mounts at a reasonable cost, Watson proposed an innovation. Instead of signing large contracts, he was going to use the Chicago Board of Trade to fracture Union purchases into hundreds of tiny contracts, each for 1,000 bushels. Watson ordered assistant quartermaster general Brown to be at a telegraph office at 113 Broadway, near the New York Produce Exchange, on December 20, 1863. Once Brown had ensconced himself, grain trader David Dows helped him send a series of coded telegrams to the Chicago Board. Brown and the Board negotiated over 100 contracts for oats, with months of delivery for each fixed. A week later the War Department sent Brown $500,000 to make good on those contracts. Dows had a trusted agent in Chicago arrange to pack the contracted lots of oats onto ships at the Chicago wharves for shipment across the Great Lakes, then by water to the Alexandria supply depot and to the forward depot at Fort Monroe, Virginia. Other shipments made their way to Jeffersonville, Indiana. At Jeffersonville the commissary-general was authorized to write as many ad hoc contracts as needed to feed the horses and mules in Chattanooga and across the entire western theater of the war. In small lots bought by intermediaries on behalf of the government, affordable grain flowed to soldiers and their mounts. The power of the 12 to act as a cartel and dictate high prices was broken. Instead of depending on contractors to deliver grain to the seat of war, goods purchased in peacetime Chicago could be packed and then delivered over multiple railway routes to supply depots hundreds of miles away.
Fracturing the union’s buys into tiny deals stipulating delivery to central locations pulverized the big 12’s grip on the grain market.
This arrangement fit with Congressional requirements, interpreted broadly. Congress had authorized suspension of army contracting rules “when required by the public exigency” for an “open purchase or contract.” Watson and the acting commissary-general invoked half-starved horses and monopoly power as exigencies. Brown saw the arrangement’s sneakiness for what it was. He declared in his report that Watson had ordered him to “forestall” the market for oats. “Forestalling,” a medieval term, means buying goods for resale. In the 18th century forestallers had joined cutpurses, forgers, prostitutes, and other criminals in the pillory, but times had changed. In forestalling on behalf of the army that day, Brown had entered into more than 100 of what now are called futures contracts.
Such contracts were nothing new; elements of them went back centuries. Since the early 1800s parties had been writing “forward contracts” for goods stipulating delivery at a fixed price and in a fixed quantity, based on examination of a small sample. But the army’s version of this contract incorporated innovative features: a fixed month of delivery; a fixed percentage paid by each party to guarantee the transaction (the “margin”); a standardized quality based on third-party inspection; and a standardized —and smaller-—quantity of 100 or 1,000 bushels, that came to be known as the “contract.” A third-party arbiter, the Chicago Board of Trade, collected the margins. The arbiter possessed legal authority to punish buyer or seller for non-performance. An Illinois state charter ensured that the board’s arbitration committee had authority over these contracts. The harshest sanction for mischief was expulsion from the Board of Trade.
The entire innovative package—which the Chicago Board of Trade called “time contracts”—required new rules that were written between 1864 and 1865. For Watson, who relied on secrecy to camouflage the army’s vulnerability to price gouging, a key advantage of this system was that both buyer and seller could be anonymous. The Chicago Board took margins from buyer and seller and graded grain by its own standards.
A futures contract is thought of as “self-enforcing,” though it was properly enforced by the Chicago Board. The board’s enforcement of the contract erased the need to judge individual trading partners’ trustworthiness. The only variables were date and price.
Reorganized in this way, the market came to operate as a kind of bank for grain or any other commodity. In the grain trade, a futures contract provided a “convenience yield,” comparable to a bank account balance, because, unlike previous contracts, this contract was instantly salable. On any business day one simply brought contracts to a broker with a seat on the Chicago board and had him sell them at the market price.
The futures market also guarded against price swings: a farmer needing credit could contract with a local broker, selling a thousand bushels for future delivery. Selling a portion of his crop this way also protected the farmer from price drops that might come at harvest; flour millers could buy these futures contracts to guard against price jumps. Relatively small incremental “contracts” of 100 bushels allowed speculators with fewer assets to bet on rises and falls based on analyzing information that might affect prices.
Entry of more buyers and sellers increased flexibility in the market, which, according to neoclassical economic theory, protected against wild price swings, improving everyone’s life.
In December 1863, however, only one entity was doing business in this way: the U.S. Army. But eventually what began as a series of ad hoc secret telegrams intended to relieve a desperate military attempting to maintain 1,000-mile wartime supply lines became an opportunity to speculate on supply of and demand for grain.
The most radical feature of the futures market, signaled by its origin in telegraphic communication, was the extent to which the new approach squeezed delivery costs. Until the 1850s, information and goods moved at roughly the same speed. With telegraphy, buyers and sellers could negotiated prices before goods arrived, often reducing uncertainties and streamlining expenses.
Watson seemed to have thwarted the dozen merchants who had been driving up the army price for oats, but opportunities for market influence still existed. Controlling a large warehouse of grain mattered, of course. A sharp operator could issue more futures contracts than he had grain in his warehouse when prices were high and quietly buy contracts to fill those orders when prices dropped. A “combination of men and money” had impelled Watson to persuade the Chicago Board to generate a bunch of identical, standardized contracts. Now any shopkeeper or small-time buyer who held enough warehouse receipts had a silo in his pocket whose contents he might sell when the price rose slightly. The dozen merchants’ power over a market might be more easily broken, but a single large buyer or seller, such as the federal government, might be invisible to everyone else in the market. A government’s desperation, carefully hidden by anonymous purchases on a distant futures market, could crack the cartel’s monopoly.
The futures contract, a uniquely American instrument, fascinated merchants abroad who in time came to embrace it.
Feeding the Union Army’s half-starved horses required a confluence of circumstances: a plugged Mississippi, a group of railway barons, and a new model of military logistics. These factors interleaved to allow Watson to deliver mountains of oats to the horses and then an ocean of wheat and other grains to the soldiers in Chattanooga. This, more than anything, made a Union victory possible. A futures market with a centralized depot system had unified command in the Union’s eastern and western theaters. The futures market also allowed Sherman in the west and Grant in the east to surround, cut off, and finally engulf the Confederate army. A waterborne east-west route in the American North, a futures market for supply, and railroad corridors extending into the southern interior allowed the Union Army to feed soldiers and horses both, dramatically increasing military units’ mobility. Watson resigned from the War Department in July 1864. He went into the mining business.
Immediately after the Civil War, merchants in Montreal, Liverpool, New York, and London began to take note of the Chicago futures contract. That distinct and puzzling entity, a uniquely American form of banking, attracted capitalists to invest in long-distance food trading. Merchants in those cities required more than a decade to rethink and abandon “forward” contracts—and embrace Chicago’s rigid method of futures contracts. Eventually the New York Produce Exchange (1874) and the Liverpool Corn Exchange (1883) adopted Chicago’s rules for grain. In 1884 the British Empire designed futures contracts for Bengal, Madras, and Bombay, India, that were letterpress copies of the Chicago contract. New trading methods emerged from the distinct features of the futures contract, including what is now referred to as pillaring, strangling, and collaring.
These methods allowed multiplying the profit on a price rise, betting on volatility, or betting on a moderate rise while protecting against a drop. Once peace returned to the United States, the construction of a civil logistics pathway to furnish goods to the world became a political priority for the merchants and railroad directors who stood to inherit the Union Army’s wartime infrastructure. Nitroglycerin was already being tested in California and Virginia as a means of blasting tunnels through mountains and extending railways toward deep-water ports. By then, Peter H. Watson had become president of the Erie Railroad, which he had helped bring into being. He was 66 when he died in New York City in 1885.
This article appeared in the Autumn 2022 issue of American History magazine.
GET HISTORY’S GREATEST TALES—RIGHT IN YOUR INBOX
Subscribe to our Historynet Now! newsletter for the best of the past, delivered every Wednesday.
Scott Reynolds Nelson September 27, 2022 at 07:01PM
Comments & Reviews