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Wheat: The Great Chicago Fire

 

1872

The Great Chicago Fire of October 1871 leads to massive destruction in the city and leaves more than 100,000 residents homeless. The storage capacities for wheat are also significantly reduced. Trader John Lyon sees this as an opportunity to earn a fortune.

“Being a firefighter is not something you do; it’s something you are.”

—the TV show Chicago Fire

The sun burned hot in the American Midwest during the summer of 1871. In and around Chicago, only 3 centimeters of rain fell between July and October. Water resources were nearing depletion, and small fires sprang up regularly. On October 8, a fire broke out in a barn, initiating a disaster that became known as the “Great Chicago Fire.”

Winds from the southwest fanned the flames and set neighboring houses on fire. Traveling quickly, the fire spread toward the city center and crossed the Chicago River. It took two days to get the conflagration under control, and by then an area of more than 8 square kilometers and 17,000 buildings had been destroyed. Every third inhabitant of the city lost his home. The damage has been estimated at more than 200 million USD. In addition to large parts of the city, the fire destroyed 6 out of the 17 warehouses approved by the Chicago Board of Trade (CBOT). The city’s total storage capacity decreased from about 8 to 5.5 million bushels. John Lyon, a large-scale wheat trader, saw the opportunity to make a profit. He joined with another trader, Hugh Maher, and CBOT broker P. J. Diamond, to manipulate the wheat market.

What’s What with Wheat

Different types of wheat are traded on futures exchanges. In the United States, wheat is traded on the Chicago Board of Trade (CBOT) and the Kansas City Board of Trade (KCBT), with the volume of Chicago Soft Red Winter Wheat (soft wheat) outweighing Kansas Hard Red Winter Wheat (hard wheat). Chicago wheat is mainly grown in an area that extends from Central Texas to the Great Lakes and the Atlantic Ocean. Kansas wheat grows primarily in Kansas, Nebraska, Oklahoma, and parts of Texas.

At CBOT, wheat is traded in US cents per bushel and designated with the abbreviation W plus a letter and number that stands for the current contract month (e.g., W Z9 for wheat delivered in December 2019). A contract refers to 5,000 bushels of wheat, with one bushel corresponding to 27.2 kilograms. Therefore, one contract refers to around 136 metric tons of wheat.

In the spring of 1872, the group began to buy wheat in the spot and futures market. Wheat prices rose continuously through early July, and contracts specifying delivery in August traded between 1.16 and 1.18 USD per bushel. At the beginning of July an average of just 14,000 bushels of wheat a day reached the city; by the end of the month, prices had climbed to 1.35 USD. In response, however, wheat deliveries to Chicago increased.

By the beginning of August, 27,000 bushels a day were coming in. But luck was still with Lyon. Another warehouse burned to the ground, and the city’s already stretched storage capacity was reduced by another 300,000 bushels. Rumors about a below-average harvest due to bad weather pushed up prices even more. On August 10 these two factors combined to push wheat contracts for August up to 1.50 USD. On August 15 prices climbed to above 1.60 USD. But then the wheel of fortune started to turn.

As more and more wheat reached the city of Chicago, Lyon was forced to give up.

The high prices incentivized farmers to speed up their harvest: Crops were picked into the night. In the second week of August, about 75,000 bushels of wheat reached Chicago each day; a week later that figure had risen to 172,000 bushels. For the rest of the month, daily deliveries increased to nearly 200,000 bushels.

Wheat that had already been shipped from Chicago to Buffalo returned to the Windy City, because of the high local prices. Newly opened warehouses also added to the storage capacity in the city, bringing it to more than 10 million bushels—two million bushels more than before the Great Fire!

To secure their profits and stabilize prices, Lyon and his partners had to buy all the wheat coming into Chicago. But they were already leveraged by local banks, and the additional funds they needed soon exceeded the group’s financial options.

On Monday, August 19, Lyon had to admit defeat. He could no longer afford to buy wheat in the spot market. The price of wheat with delivery in August fell by 25 US cents. The following day prices dropped another 17 US cents. The crash ruined John Lyon, who was unable to meet his margin calls. His attempt at market manipulation ended in financial disaster and bankruptcy.

Key Takeaways

•The Great Chicago Fire of 1871 led to massive destruction and left more than 100,000 people homeless.

•With the number of grain warehouses drastically reduced, a group of speculators around John Lyon saw a big opportunity in the wheat market. Together they tried to corner the wheat market, but rises in price also resulted in increased shipments of wheat to the city. After initially increasing to 1.60 USD, the price of wheat crashed.

•Lyon and his friends were unable to meet their margin calls. Their attempt at cornering the market ended in bankruptcy and financial disaster.