Modem derivative securities -- financial instruments whose value is linked to or "derived" from some other asset -- are often sophisticated, complex, and subject to a variety of rules and regulations. The same is true of the derivative instruments traded at the world's first organized futures exchange, the Dojima Rice Exchange in Osaka, Japan, where trade flourished for nearly 300 years, from the late seventeenth century until shortly before World War II. This Article analyzes Dojima's organization, efficiency, and amalgam of legal and extralegal rules. In doing so, it contributes to a growing body of literature on commercial self-regulation(1) while shedding new light on three areas of legal and economic theory.
First, unlike participants in many other studied markets, Dojima traders did not opt out of the legal system. Like other parties to discrete transactions in early modern Japan, Dojima traders were forced out by the shogunate government. Although participants operated in the shadow of latent state regulation, the government remained largely hands-off by, most importantly, denying legal enforceability of futures contracts. The distinction between opting out of and being forced from the legal system is more than historical curiosity. In a recent article, for instance, Lynn Stout argued in the context of modern over-the-counter derivative markets that private ordering can be superior when parties "are involuntarily shut out" of the legal system.(2) Thus, she advocates the decriminalization of off-exchange derivative trading, but rejects civil enforceability of such contracts -- the exact approach adopted in Japan three centuries ago. Similarly, in early 2000, the chairman of the Federal Reserve, the Treasury Secretary, and the chairman of the Commodity Futures Trading Commission called on Congress to exempt over-the-counter derivatives from the Commodity Exchange Act.(3) Dojima provides an empirical basis for analyzing these regulatory approaches, as well as more general proposals for exchange self-regulation.(4)
Second, this Article explores claims made by others that legal intervention can improve the welfare of market participants only when participants have poor judgment or face high drafting costs.(5) Absent these circumstances, legal intervention hurts participants. After nearly half a century of forced reliance by Dojima participants on extralegal arrangements, the shogunate in 1773 temporarily made futures contracts enforceable in court. Comparison of pre- and post-1773 Dojima market indicators thus offers a unique opportunity to analyze the market-wide effects of legal intervention.
Third, unlike the bartered exchange transactions (among, for instance, ranchers, whalers, and diamond merchants) that provide the basis of much recent scholarship, derivatives transactions can be quite complex. Because losses from derivative trading are not limited to the amount invested, huge losses may result -- as recent billion-dollar losses at Barings Bank, Metallgesellschaft, Orange County, and Sumitomo Corporation demonstrate. This Article is the first to examine extralegal rules arising from such complex transactions. Because the Exchange data lend themselves to accepted econometric techniques, this Article also attempts to calculate rough measures of market efficiency.
In addition, while I do not claim that this Article supplants the excellent work of Japanese economic historians on Dojima,(6) it is one of the very few works on Dojima available in English,(7) and the first in any language to place Dojima in context using a law-and-economics methodology. Although the study of early modern Japanese institutions can be daunting (in this Article, for instance, I rely heavily on eighteenth-century documents written, unfortunately, in eighteenth-century Japanese), the gap in the literature is remarkable nonetheless. Dojima merits obligatory mention in virtually every popular work, introductory textbook, and law review article on derivatives and markets as "the world's first organized futures market."(8) Moreover, Dojima development bears striking resemblance to that of early Western markets, suggesting that similar private-ordering systems tend to arise in similar institutional environments -- independent of social structures, cultural constraints, and (arguably) Western conceptions of contract, norms, and reputation.
I am the first to acknowledge the sketchiness of some of the 300-year-old evidence from early modern Japan. But the best evidence available, which I have attempted to assemble here, leads to two central claims. First, Exchange participants appear to have developed effective means of discipline, governance, and dispute settlement, with only minimal "shadow-of-regulation" input from the state. Second, the Dojima Rice Exchange appears to have performed well when futures trading was illegal, when it was made legal but contracts were legally unenforceable, and when contracts were legally enforceable. The government's decision to make futures contracts legally enforceable appears not to have dramatically increased -- or for that matter decreased -- several market performance measures.
This Article proceeds as follows. Part I sets forth the history of the Exchange, describes trading mechanics and regulation, and discusses reasons why the world's first organized futures exchange began at Dojima and not elsewhere. Part II discusses the governance and anti-manipulation institutions of the Exchange and analyzes Dojima's relative reliance on formal internal rules rather than informal constraints. Part III attempts to measure the efficiency of the institutions discussed in Parts I and II by using price data gathered from eighteenth- and nineteenth-century Japanese documents. Part IV examines the effect of state-provided dispute resolution at Dojima by comparing dispute resolution and performance measures at Dojima before, during, and after the period in which shogunate courts were open to Dojima suits (1773-1784).
Economic, Social, and Legal Setting
Around 1600, Ieyasu Tokugawa led a coalition of local lords to victory in battle and established a Japanese national dynasty that would last until the Meiji Restoration of 1868. Though Tokugawa Japan is generally characterized as isolationist and peaceful,(9) recent scholarship casts doubt on strong isolationist claims, noting that most Europeans left on their own after losing a trade war to the Dutch, and that Japan was always open to trade with other Asian countries.(10) But peaceful it certainly appears to have been, as the Tokugawa unification marked the end of 100 years of civil war and a prelude to the dramatic changes that would occur in the Western-influenced late-nineteenth century.
With peace came growth in population, cities, and commerce. Edo (modern-day Tokyo) became the country's political center, while Osaka -- the "country's kitchen" -- became the commercial center. Unlike many other feudal societies, Japan enjoyed a flourishing market economy, a development attributable to a combination of restrictions on foreign trade, a fragmented political system of 250 economically interdependent feudal domains, and the need of feudal leaders to fund expensive, centrally mandated trips to Edo every two years under a system of alternate residence.(11) Economic specialization increased, and the port city of Osaka, located near many large rice fields, became a center of agricultural commerce and industry.
The Tokugawa government did not rely on a single currency, but three -- gold coin (mostly used in Eastern Japan), silver currency (by weight, mostly used in Western Japan, including Osaka), and copper coin (used nationwide). But currency demand outpaced production, due at least in part to the Tokugawa government's monopoly over gold and silver mines. Local domains turned to substitutes, often minting their own currency.(12) Sometimes financial instruments such as promissory notes, bills of exchange, and letters of credit also filled the gap.(13)
In part because of its availability and ease of measurement, rice became a substitute currency.(14) Rice, "the most important commodity in Tokugawa society,"(15) was the measure by which the shogunate figured its annual budget.(16) Many feudal lords collected taxes from peasant subjects in rice and financed their governments by converting rice into currency at markets. Domain lords stored their rice in warehouses in Osaka, and, in a preliminary step toward the creation of an organized marketplace, paid Osaka merchants to manage it as their agents.(17)
The relative social status of the feudal lords and warehouse merchants was quite clear. Tokugawa society was divided into four hereditary vocational status groups, in descending order: samurai, farmers, artisans, and merchants. The merchant status group was not monolithic, including both merchant property owners and day laborers. But merchants were clearly at the bottom of the social hierarchy, above only the extremely underprivileged, and were often subject to persecution from above by feudal lords in the form of asset confiscation and from below by peasants in the form of arson and theft.(18)
The Tokugawa legal system was one of fragmented federalism.(19) Tokugawa law applied in principle only in territory controlled directly by the central government, or perhaps more precisely, the Tokugawa feudal lord -- about one-third of Japan, which included Osaka. The remainder of Japan was governed by a hodgepodge of feudal laws, the only guiding principle being a supremacy clause of sorts that mandated (in 1615) local statutes not contravene those of the government.(20) While property rights were not afforded statutory protection, local domains enforced "de facto property rights."(21) Spotted use of legal precedents may have occurred in some regions,(22) but it was not until 1742 that important statutes and precedents were assembled into a...