Here again the government spenders have the better of the argument with all those who cannot see beyond the immediate range of their physical eyes. They can see the bridge. But if they have taught themselves to look for indirect as well as direct consequences they can once more see in the eye of imagination the possibilities that have never been allowed to come into existence. They can see the unbuilt homes, the unmade cars and radios, the unmade dresses and coats, perhaps the unsold and ungrown foodstuffs. To see these uncreated things requires a kind of imagination that not many people have. We can think of these non-existent objects once, perhaps, hut we cannot keep them before our minds as we can the bridge that we pass every working day. What has happened is merely that one thing has been created instead of others.
Henry Hazlitt, Economics in One Lesson, 1948
On November 3, 2010, while the FOMC chaired by Benjamin Bernanke was putting the finishing touches on its latest money printing scheme in Washington DC, fifty global financial regulators met at the OTC Derivatives Regulators Forum, hosted by no less than the
New York Fed. Front and center among the group were representatives of the US Commodity Futures Trading Commission (CFTC), fresh off the Fr
ank-Dodd coup that gave them authority to regulate derivatives, the world's largest market in notional amounts. While many have lauded the coming "reforms" as a necessary step to reigning in financial fraud, what is being created is simply a massive new
power center from which those at the top will vainly attempt to manipulate market prices and entrench favored institutions within the new framework. Inasmuch as the central banks'
precious metals suppression schemes have become
increasingly ineffective, a new venue is opening through which a last ditch effort may be mounted to beat back the commodity safe havens of purchasing power, as the central banks continue to wage their competitive currency devaluation arms race.
Will the CFTC, at the direction of ex-Goldman Sachs Managing Director, Gary Gensler, use its newly minted authority to cause massive price dislocations in the commodities and other markets through position limit changes and the regulation of swaps used by exchange traded funds (ETFs)? Whether or not Chairman Gensler will aid his banker cronies in this fashion remains to be seen, but history reveals that such absolute power is seldom left untapped.
The Dodd-Frank financial overhaul, which became law in July, gave the Commodity Futures Trading Commission a year to establish rules governing the $615 trillion over-the-counter derivatives market, including which companies will be categorized as swap dealers or major swap participants. Those are designations that entail higher capital requirements and increased scrutiny.
With numbers that big, the regulators are salivating. Indeed, Chairman Gensler
said as much:
"This is like the 1930s for the Securities and Exchange Commission. I mean, I am just tickled pink," he said.
...
He proudly displays a dog-earned copy of the Dodd-Frank law on his desk, its cover signed by a who's who of U.S. regulation: Ben Bernanke, Paul Volcker, Tim Geithner, Sheila Bair, Mary Schapiro and Elizabeth Warren, among others.
"It's like my high school yearbook!" Gensler exclaimed.
And he's not shy about asking for money, as the Reuters article continues:
The problem is getting the $261 million annual budget he needs from Congress where sceptical Republicans are expected to gain power in the Nov. 2 elections, and may even win control of the House of Representatives.
"I'm still hopeful," Gensler said.
He warned of delays in registering 300 new swaps dealers, trading venues, and data facilities.
"We've got ... to do something more than just 'robo-sign' them," Gensler said.
Cute. However, whatever the size of the new budget, it will be a drop in the bucket compared to the profits that will be reaped by those who already have inside access to the new rules and their timing.
Speculative Position Limits
A major issue that will soon be decided regards speculative position limits, or how much of the open interest of a given market one entity and its affiliates may control. Generally, speculators are limited in the futures positions they are allowed to maintain, while bona fide hedgers are not. There are various loopholes used to get around these limits, and they generally involve swaps. If an institutional investor wants to establish a large futures positions, it can enter a swap agreement with another entity (think JP Morgan and the silver ETF, SLV), wherein they agree to make payments depending upon the price movements of an underlying instrument, such as a commodity. The very existence of this swap then allows the entities to consider any futures positions as hedges, and voila--they are bona fide hedgers with no position limits.
Some of these loopholes have been closed, but most remain. With the CFTC's newly mandated purview over the OTC derivatives market, which includes swaps, it will have unprecedented influence over commodities prices on short to intermediate term horizons. This is not to say that long term fundamentals do not matter, or that speculators are the sole reason (or to blame) for large price movements. However, a large shift in speculative interest can and has snowballed into large price movements.
How to Kill an Energy Rally
A prime example is the rebalancing of the Goldman Sachs Commodity Index (GSCI) that took place in the summer of 2006. At the time, about $60 billion tracked the index, including some large pension funds, which would allocate a portion of their assets to purchasing commodity futures contracts in the exact weightings prescribed by the index. A change in the index composition would trigger buying or selling in the days and weeks that followed. There are several such commodity indexes, and they are periodically rebalanced pursuant to announced schedules, usually annually. However, according to the
New York Times, on August 9, 2006, Goldman announced it would not roll over certain gasoline futures contracts into newly reformulated contracts. The result:
Unleaded gasoline made up 8.72 percent of Goldman’s commodity index as of June 30, but it is just 2.3 percent now, representing a sell-off of more than $6 billion in futures contract weighting.
...
Wholesale prices for New York Harbor unleaded gasoline, the major gasoline contract traded on the New York Mercantile Exchange, dropped 18 cents a gallon on Aug. 10, to $1.9889 a gallon, a decline of more than 8 percent, and they have dropped further since then.
Goldman's changes probably induced arbs, commercial hedgers, and other traders to sell September and October unleaded gasoline future contracts to avoid possible (settlement, delivery, etc.) problems.
September futures expired in August; October contracts expire September 29. So unleaded gasoline prices collapsed in August and September.
For the conspiracy minded, note that ex-Goldman Sachs CEO Hank Paulson was sworn in as Treasury Secretary just a month prior in July, 2006, and that rising gas prices were becoming an issue for the approaching mid-term elections. The fall in the energy complex not only led to relief at the pump, but a pretty drastic (but short-lived) selloff in commodities overall.
The Role of the Speculator
Speculators are convenient scapegoats, and they make especially good targets for corrupt and incompetent states when speculators profit while others suffer. Short sellers, CDS traders and commodities traders alike have recently received the vocal and regulatory wrath of the state. The infantile blatherings of the Greek prime minister come to mind:
“We will be taking actions to see how we can regulate this world market so speculation won’t be hitting otherwise healthy economies,” Papandreou told NPR’s Robert Siegel.
...
In a speech Monday at the Brookings Institution in Washington, Papandreou spoke of “malicious rumors, endlessly repeated and tactically amplified” that have driven up Greece’s cost of borrowing money.
Papandreou acknowledged, however, that much of the country’s economic troubles can be traced to Greece’s failure to balance its books, saying the country “fully take[s] responsibility” for its problems.
No it didn't. The ECB became the new market for Greek debt and bought considerable quantities from large European banks, many of which would have been insolvent had Greece defaulted. Greece was able to auction more debt with the implicit backstop, and the big banks got redeemed at par. Price fixing by the ECB papered over the problem for the time being, but prices cannot be suppressed forever. And, what the ECB has done, the Fed has done on steroids.
Through its so-called quantitative easing, the Federal Reserve is attempting to keep the Ponzi debt scheme alive and paper over the incredible wastefulness and fraud at all levels. And, not just the literal fraud related to phony mortgage securitizations that came about from the free money it handed out, but the fraudulent price signals it sent that caused what is probably the
greatest misallocation of resources in the history of civilization.
A Nation of Zombies
The US is mired in record unemployment with rising consumer prices not dissimilar from the 1970's stagflation era, and will remain in such a state because the ruling class hands out money to buy votes, both to individuals and corporations. Government subsidies create these zombies that are necessarily inefficient and increasingly parasitic.
Two of the three big US auto makers required government bailouts to survive the 2008 panic. Even with favorable accounting rule changes, cash for clunkers, and other subsidies, they are still barely hanging on, notwithstanding the recent
popular media spin (that $20.1 billion IPO is equal to the amount of new QE2 funny money that's been printed through November 16, as
Robert Wenzel points out). Most of the airline industry has been in a perpetual zombie state for decades. The signals have been clear--what is needed is more productive (which is probably to say fewer) workers in these industries.
The price signals that the Fed attempted to suppress from the dot com bust only created more false signals that were magnified. After the Fed reversed its money printing binge in 2008, the signals became crystal clear. We did not need as many houses, they did not need to be as big, the commute was too wasteful in time and energy. There are entire zip codes that would not exist were it not for the Fed's free lunch. Unfortunately, the lunch was not free and some of these zip codes will become ghost towns.
There are also entire industries that would not have existed or been but a shadow of their size. Many related specifically to mortgages and housing have already gone through the painful adjustment. However, many have not.
Prices Matter
It's easy to look at the manager at the GM plant, thankful to have his job, and say, "See, the government made that happen. He gets his paycheck for helping to produce a tangible product that people use, and he turns around and spends that paycheck in the economy." However, it takes imagination to see the possibilities that have not happened. Let's consider him the marginal employee who is ambivalent about his job and who, under different circumstances, would have chosen a different career path.
Perhaps he had once dreamed of working in another industry. Perhaps he dreamed of owning his own business. However, when the state enacted laws favorable to unions a century ago, it sanctioned wage price fixing. Perhaps high promised wages enticed him to stay in his hometown as a teenager. When the state bailed out his employer, perhaps it enticed him not to retrain to learn to utilize his talents elsewhere.
The state cannot support all its pet zombies for perpetuity, so there will be a reckoning, and it is already underway. Instead of our manager making an easy decision in his late teens, or a difficult adjustment in his twenties while single, he now finds himself in his thirties with a family to support, with nearly two decades wasted developing skills that are not needed or enjoyed by him. Through price fixing, the state has similarly robbed its subjects of aggregated eons. Our manager is thankful, however, that the state takes from productive industries to support his employer, and rewards his rulers with his vote, not realizing the alternative life that could have been.
The fact is, prices matter because they send signals to people about what to do with their money. When prices are suppressed, people tend to make incorrect economic decisions that only magnify the underlying problems the price fixing was intended to "correct". Further, these suppression schemes are only temporary. Below is the same chart of the Goldman Sachs Commodities Index, but extended two years.
Clearly, the Fed's previous money printing binge was enough to quickly reverse the trend upward in commodities in early 2007, which persisted until the Fed changed course to outright tightening in early to mid 2008.
It is easy to look at the 2008 run-up in crude oil to $150, to look at the unprecedented open interest by commodity index funds and ETFs, and to conclude that the speculators were the cause. It is easy to look at bond spreads in captive EU states that cannot print their own currency and conclude similarly. To be sure, the speculators did exacerbate these price movements; however, the signals they were sending were important messages themselves about state profligacy.
It was the flood of
new money created by the Fed out of thin air that heightened the demand for new investment products, including the very mortgage securities that triggered the panic. The expectation of money losing its purchasing power created an urgency that encouraged lax standards and outright fraud. The Fed's price fixing of the cost of money led not only to costly malinvestments that would later be revealed, but also led to the entire spectrum of the stages of production simultaneously bidding up the same resources. Throw in the recognition of commodities as an asset class to preserve purchasing power, and there could not have been anything other than a bubble.
The CFTC's Top Concern: Price Fixing
A Reuters article
explains (brackets and bolding ours):
Position limits for futures and swaps mandated by the Dodd-Frank financial reform law are a top concern for commodity traders who say the plan could limit fund participation in markets.
Industry groups including CME Group Inc (CME.O) and Morgan Stanley (MS.N), and the Futures Industry Association have told the CFTC it risks harming commodity markets with overly restrictive speculative trading limits, and have urged the agency to move cautiously.
COALITION URGES TOUGH APPROACH
But a coalition including farmers, petroleum marketers and convenience store operators told the CFTC it must quickly implement position limits to bring stability and confidence to the market.
"It is not enough to deal just with manipulation, excessive speculation will require a stricter approach," the Commodity Markets Oversight Coalition said in a letter posted on the CFTC's web site on Wednesday.
r.reuters.com/vaw63q
The group said the CFTC should not wait to phase in the limits, and should consider setting more aggressive limits on positions held by exchange-traded funds and index funds.
The CFTC is unlikely to unveil its new position limits proposal in November, and would more likely wait until Dec. 1 or later to discuss the plan, [CFTC Commissioner] Sommers said.
Position limits are only the beginning. In the past few years, swaps and similar derivatives have quickly become the preferred method for price balancing by ETF and index fund managers, and are common to nearly every leveraged and inverse ETF. As we recently saw in the silver futures market, a simple
margin increase was enough to temporarily halt a parabolic rally in the thinly traded commodity, and the effects were realized globally.
The Fed is less than one short week into its new, near-trillion dollar money printing scheme, which will expand its balance sheet by a net $600 billion. It's goal is to
inflate away the world's problems--those of its kleptocrat patrons, anyway. If it fails over the next few months, it will simply
try harder, as
de facto debt monetization becomes institutionalized. Meanwhile, commodities will continue to be repriced in increasingly devalued currencies, with the flagship precious metals of gold and silver being recognized as festering sores on the interventionists' faces.
Gold Price Suppression
Nothing scares a central banker more than a gold rally, so one can surmise that the few stops that remain will be pulled. The easiest way is to stoke a broadly based risk market selloff, but that is contrary to the intention of QE2 itself. It also risks completely shutting down the US municipal bond market, already on the verge of imploding, as well as triggering another sovereign debt crisis in Europe. An already shell shocked public is increasingly suspicious of the prior bailouts, and is too much of an unknown risk to those who depend on the perception of state legitimacy (
gold audit, anyone?).
No, the Fed can have its cake and eat it too if most of the risk markets keep rising or at least go sideways while the commodities complex takes a hit as a result of position limit changes. The CFTC has announced its intention to do just this as early as December 1, so short and intermediate term traders take head. After these stop-gap measures eventually fail and the commodities bull rears its head again, we will need to be on alert for stealth attacks via swaps regulation. Ron Paul should have no shortage of questions for Chairman Gensler if he is ever called before the
US House Subcommittee for Domestic Monetary Policy. Inasmuch as the CFTC now regulates all currency derivatives, an appearance or three would be in order.
The war on personal wealth that the US state began nearly a century ago with the creation of the Federal Reserve and the Constitutionalization of income confiscation is in its final stages. Prices can no longer be effectively suppressed because of the advanced stage of the Ponzi, and other forms of information cannot be suppressed (
yet) because of the internet. Though it's possible we will eventually transition to a new Ponzi (which is in the works), the case for optimism can be made that a better informed public with no prospects for a future bailout will rebuild a system in which prices are given the respect they deserve.
