Moral Hazard

18 August 2006



London Metal Exchange Bails out Nickel Traders

The unfettered capitalism of the commodities markets proved to be so much nonsense this week. Like other businessmen, the traders in nickel at the London Metal Exchange are socialists at heart, at least when it comes to their own wallets. If they really believed their own propaganda, they would have turned down the LME’s intervention that saved the shorts from themselves. Instead of letting them go broke, the LME opted for “orderly trade.”

Nickel is a base metal that goes into just about any manufactured good anywhere in the world. Traders buy and sell it by the ton, and the price for delivery in three months reached $29,200 per ton on Wednesday amid a panic among short traders. Shorts, of course, are those who sell a commodity before they buy it, hoping to profit from a drop in prices; it’s quite legal and it can provide a valuable market function when prices go too high for the fundamental situation to bear. Shorts lose money when the price goes up, and at $29,200, they were losing piles of cash; that’s double what the price was a year ago.

“Well, too bad,” say Adam Smith and all the followers of ideological capitalism. “Not so fast,” comes the reply from the LME’s powers that be. Simon Heale, chief executive of the exchange, said, “Nickel stocks are at historically low levels and we now have a genuine material shortage. Our first priority is to ensure that trading remains orderly and to prevent the risk of settlement defaults.” According to the Financial Times, the LME said, “from Friday [August 18, 2006], anyone with a short position who was unable to make physical delivery could postpone delivery at a cost of $300 a tonne per day – equivalent to about 1 per cent of current market prices. The LME imposed a limit in the spread between nickel cash and futures prices of $300 per tonne per day.”

Defaults are messy, and interruption of orderly trade might affect the production of some refrigerators, car parts and screwdrivers. However, that shouldn’t have been the LME’s “first priority.” Nor should the rules have been changed simply because some traders and speculators were losing. Should someone with 100 shares of Dell be allowed out of a long position at no loss because that company’s laptops are being recalled? Of course not.

In economics, it’s called “moral hazard,” letting the big boys out of their bad trades because the effects on the rest of the economy are perceived to be worse if they are not. There are banks that are too big to fail because of this concept, and perhaps, it is destined to be part of an imperfect world. Nonetheless, a few bankruptcies in the nickel market might be a lesson to others – “bulls make money, bears make money, hogs get slaughtered.” Instead, there’s a socialist bailout for people who deserve to be much poorer than they are, while for others the law of the jungle is still in force. The nickel traders will still vote Tory and not bat an eye – Orwell called it “doublethink.”

© Copyright 2006 by The Kensington Review, Jeff Myhre, PhD, Editor. No part of this publication may be reproduced without written consent. Produced using Fedora Linux.


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