Wednesday, April 30, 2008

Making the pool deeper doesn't help people swim...

Our new blogging talent, Tanner Emkhe, sees right through the mess at the commodity exchanges. And he is not shy about explaining it to old cowboys like Steve Cornett.

And his answer is exactly the kind of free-market theory that prompted dismay at the Bear Stearns bailout and various mortgage crisis solutions being proposed. Interestingly, the over-regulated European markets are not seeing the damage we are. Could it be that government interference isn't per se bad?
It is instructive to compare the American financial mess with the economic situation in nations that resisted deregulation. Old Europe tends to get a scornful press in the United States. But Europe is not suffering a financial meltdown today - mainly because Europeans (with the exception of Britain and Switzerland) took only a few sips of the financial Kool-Aid so heavily promoted by US banks.

A few European banks did get into trouble last summer, because they bought some toxic subprime securities made in America. But the European Central Bank, in its first real test since the Euro made its public debut in 2002, has performed well and the crisis has largely passed. Here, the Fed keeps lurching from bailout to bailout. [More]
One odd thing in this debate, however, is the unique focus on agriculture that ignores the larger economic trend. Tanner's solution - "force" banks to lend more - is based on a kind of dollar-for-dollar armaments race. What it ignores are a few tiny obstacles. First, I don't want to be the bearer of bad news, but there seems to be a bit of a GLOBAL CREDIT CRUNCH rumored to be going on. Banks cannot lend because their balance sheets are so impaired. Try selling some municipal bonds, for example. Let me put it simply - there is no money to lend.

So even if throwing "big money" is the right thing to do, the only place to get that kind of cash is from the government. Oh wait, that besmirches the purity of the free market with government interference. So Tanner's suggestion is a bit ingenuous. No government regulation, just government money. Sounds familiar.

Second, even if we could throw money at it, if the numbers are so huge behemoths like Cargill are simply saying "no", maybe we should respect their judgment. I'll bet they have a few finance and economic eggheads shouting "Stop digging the hole deeper!"

Tanner's solutions look good on a term paper, just like letting housing prices deflate 40% strikes many purists as the tough love needed for economic virtue to be reestablished here in the US. But it turns out the enormity of of economic system and the recovery time from such a debacle could be decades. Theoretical economic systemic solutions are crisp, elegant, and utterly oblivious to their collateral damages. Those of us with a horse in this race see it otherwise.

The commodity markets are not sacrosanct institutions ordained by Providence. They are man-made constructs with arcane and less than perfect rules. If we can adjust the rules to compensate for for economic conditions we have never encountered and never imagined, why shouldn't we?

Talking tough is easy, but insisting on arbitrary regulations simply because "rules are rules" while the walls are collapsing is not an optimal solution. That's why the Fed is acting in imaginative new ways, and why I support equal innovation in a market that is clearly laboring to function. Letting the chips fall where they may works for routine economic problems, but crises of this magnitude need to be handled with more attention. Often the chips are bigger and fall in unexpected places.

Steve's position strikes me a guy who has seen and felt a few chips, and watched other friends do so as well. Tanner's answer is politico-economic scripture. There are more choices between them than they might suspect, I think.


Ol James said...

Mr. Ehrnke's point about the government keeping their hands in their pockets and banks digging deeper said a lot. If you want something messed up...let the government into it.
The part about the banks digging deeper...ABOUT TIME!!! The old adage goes.."If you want to make money you have to spend it", should be applied to ALL of the big banks and companies. The banks get money from the Federal Reserve at single digit interest rates, usually figured with "simple" interest. They loan the money to clients at double the rate and figure it on an "APR", which to me is just "legal loan-sharking". All I hear is that companies have a responsibility to their's about time they started to share in the losses with the profits. After all when my truck tears up the "gubber-mint" doesn't send me a comes out of my pocket.

Anonymous said...

If I recall, Tanner does place some weight on money flow from funds but at the same time forgets, or ignores, the loophole which permits index funds to evade position limits.

A front page story article in Barrons brought this up last month so, a few clips:

IT’S NOT EASY TO SIZE UP THE influence of the index funds. But based on their known cash commitments in certain commodities, and the commodity indexes their prospectuses say they track, it is possible to estimate the size of their commitments in all commodities they buy. Using this method, analyst Briese...estimates that the index funds hold about $211 billion worth of bets on the buy side in U.S. markets.

Applying a similar method, but with slightly different assumptions for indexes tracked, Bianco Research analyst Greg Blaha puts that figure at $194 billion. Either figure is enough to turn the index funds into the behemoths of the commodity pits, where total bullish positions now stand at $568 billion.
The speculators, now so bullish, are mainly the index funds. To see how their influence on the market has become outsized, just look at how they operate. Nearly $9 out of every $10 of index-fund money is not traded directly on the commodity exchanges, but instead goes through dealers that belong to the International Swaps and Derivatives Association (ISDA). These swaps dealers lay off their speculative risk on the organized commodity markets, while effectively serving as market makers for the index funds. By using the ISDA as a conduit, the index funds get an exemption from position limits that are normally imposed on any other speculator, including the $1 in every $10 of index-fund money that does not go through the swaps dealers.

The purpose of position limits on speculators, which date back to 1936, is clearly stated in the rules: It’s to protect these relatively small markets from price distortions. An exemption is offered only to "bona fide hedgers" (not to be confused with "hedge funds"), who take offsetting positions in the physical commodity.

The basic argument put forward by the CFTC for exempting swaps dealers is that they, too, are offsetting other positions — those taken with the index funds. ...

Complete article at:

John, what do you think might happen should this exemption be closed?

John Phipps said...


I realized after a few questions like yours I had exceeded my actual knowledge about two posts ago.

Frankly I can see bad things happening from almost any action, because these contracts extend so far into the future and leverage huge amounts of wealth.

As soon as I can get my corn in the ground (or if we get rained out) I'm going to do some serious research and seek some opinions before I spout off any more than I have.

I'm not proud of my superficial knowledge of these matters, but I know if just a few more people had been willing to admit they weren't really sure what a CDS was, there would be a few more trillion $$ in the world than there are now.

I'll get back to you as soon as I can.

Thanks for reading and commenting.

Anonymous said...

In journalism school I think rule #1 is that if you are not right,you are wrong. You might want to check how you are spelling Tanner's last name.

His Mom

John Phipps said...

Tanner's Mom:

My apologies. You bring up a good point, too. What is interesting about watching real trained journalists get into blogging is their frank disdain for the quality of the product.

I have seen grammatical gaffes and awkward writing all over the blogosphere by premier journalists who discovered the premium is on speed and links, not prose.

In fact, one Pulitzer-prize winner I spoke with flatly refuses to write for the web, considering it contemptible communication. As you can imagine, even his career is threatened.

For me, my spell-checker is my only safety net, and I have "Ehmke"now entered. Although I think readers will soon know him as just "Tanner".

Ya gotta admit, I came closer than "ol james". And being hooked on phonics doesn't help much with this name.

Thanks for commenting

Ol James said...

If I misspelled the name, I sak your forgiveness. But...danged I even wrote it down from the article on AgWeb...hmm
Last thing I want to do is have momma or anybody's momma mad at me!! I may be ignorant..but I aint stupid (the jury is still out on that one).