Perspective on Risk
We Are Not in Kansas Anymore; Revoking PNTR; Canceling Trades and Deferring Delivery; Geopolitical Financial Blocs; Now This Is Real Risk
A little longer between posts than usual: I was checking off a bucket list item by sitting in on my favorite band, Snarky Puppy, as they recorded their next album, Empire Central.
We Are Not in Kansas Anymore
I’m going to sound like a broken record, but we all need to understand that we can’t project the last 20 or so years into the future. Things have changed.
The US and its allies are moving to revoke Permanent Normal Trade Relations (PNTR) with Russia.
The Bank for International Settlements suspended Russia’s membership.
The LME took an unprecedented step of cancelling completed trades and deferring delivery requirements,
The US has engaged in the crypto Central Bank Digital Currency (CBDC) debate with a vengeance, and in a way designed to continue USD hegemony. An all-of-government approach is being deployed.
The fiscal and monetary stimulus we’ve all become addicted to is going to be withdrawn. We may even be at a secular inflation point for inflation and rates.
Geopolitical alliances are going to be required for financial system access.
Revoking PNTR
Permanent Normal Trade Relations is what used to be called “most favored nation” status. Russia lost its MFN trading status in 1951, and regained PNTR status in 2012.
We should all remember that revoking Russian PNTR is only the latest step in the backlash against globalization. The US failed to join the Trans-Pacific Partnership after leadings its development, and recently renegotiated NAFTA and
Some folks from the Fed days may remember that I used this 1999 Merrill advertisement to help explain the changes we were seeing that were affecting our banks.
There is a nice, simple survey paper titled The Economic Consequences of Globalisation in the United States which will helpfully summarize the effects:
The current era of globalisation began in the 1970s, when the share of trade in world output was around 10% (Figure 1). Globalisation accelerated in the 1980s, when the share of world trade in output surpassed historical records, eventually climbing to about 25% by 2009.
The authors had three principal observations:
Studies on the overall effects of globalisation suggest large gains.
Studies of US labour market data reveal significant adverse trends, which
include extreme cases of very harmful effects. Yet globalisation is only one
of several factors that appear to be at work, including technological progress,
demand shifts, and diverging, unrelated trends in economic activity across
sectors and locations, and
Studies of specific policy changes have findings broadly consistent with those
of the first two areas of research – that the overall effects of increased trade
have been positive. However, these gains coincided with adverse labour
market trends that were most likely attributable to other factors.
How significant were the gains?
The unprecedented rise in global interdependence has been very productive. World GDP growth, which hovered in the 2% per year range in the 1970s and early 1980s, doubled to reach the 4% range before the global financial crisis.
Federico and Tena-Junguito (2016)1 estimated that the increase in the share of world trade in GDP since the 1950s has added about 5 percentage points to world income (Figure 2). Given world GDP of $85 trillion in 2018, the incremental benefits from trade since the 1950s represent about $4.3 trillion of world income
Additional studies suggest that the US has benefited from globalisation even more than the rest of the world. In a multi-study review, Bradford, Grieco, and Hufbauer (2005)2 concluded that advances in globalisation from 1947 to 2003 added $0.8 trillion–$1.5 trillion, or 11%–14%, to the US GDP of $11 trillion in 2003. Extrapolating these estimates to 2018 GDP suggests that changes in economic interdependence since 1947 added $2.2 trillion–$4.0 trillion to US GDP in 2018, or 11%–19% of 2018 GDP of $20.5 trillion.
[T]he US does benefit from globalisation through a different, important channel. Global supply chains enable US producers to concentrate on their most productive tasks while shifting less efficient tasks elsewhere. An early study of US offshoring found that outsourcing service tasks had significantly positive effects on the productivity of US firms, although offshoring of material inputs less so (Amiti and Wei, 2009). With recent data and a broader definition of supply chains, Constantinescu, Mattoo, and Ruta (2019) showed that embedding foreign value added in production generally increases productivity across US sectors, especially in industries producing exports.
The paper goes on to summarize labor market effects; I refer you to the paper for those specifics.
ETH Zurich produces a summary statistic, the KOF Globalization Index, that illustrates the overall slowdown.
Canceling Trades and Deferring Delivery
For those that haven’t been following, the nickel market has skyrocketed.
Reportedly, “‘short squeeze’ sent the price of nickel soaring and left a Chinese metals tycoon facing billions of dollars in potential losses.” Again, initial reports suggested that “a huge (short) position amassed by Xiang Guangda, the billionaire founder of China’s leading stainless steel producer Tsingshan Holding Group” led to the losses.
Tsingshan is China’s largest nickel producer (~$40B in revenues)They reportedly specialize in ‘nickel pig iron’ which is at a lower purity level than the contract specification for LME delivery. Tsingshan would sell its ‘nickel pig iron’ directly to its customers.3
One theory is that Tsingshan was using the liquid LME contracts to lock in a price for future production by establishing a short position at the LME. In essence, Tsingshan may have been running both basis risk (nickel pig iron vs LME contract specification) as well as delivery risk (need to acquire LME quality nickel for delivery).
Now, if you guessed that Russia was a major nickel producer, you win a prize.
With the spike in price, any short positions would face huge variation margin calls. Tsingshan was reportedly facing a $1 billion call.
The LME took the drastic action of cancelling trades and allowing for delivery deferral. The LME canceled 9,000 trades worth $4 billion. How does the LME describe what occurred:
During the early hours of trading on the morning of Tuesday 8 March, Nickel prices moved up significantly in a short period of time. It became clear that pricing in the early hours trading did not reflect the underlying physical market and that the Nickel market had become disorderly.
Given the extreme price moves and thin trading volume during early hours trading, the LME also took the decision (Notice 22/053), in the interests of market stability and integrity, to cancel all trades executed on or after 00:00 UK time on 8 March in the inter-office market and on LMEselect. Cancellations were made retrospectively in order to take the market back to the last point at which the LME could be confident that the market was operating in an orderly fashion and that prices reflected the underlying physical market – i.e. the close of the previous trading session.
This was in part due to the LME's conclusion that the significant price moves during the early hours trading activity had created a systemic risk to the market, including in relation to margin calls, which if LME had not acted would have closed at levels far in excess of those ever experienced in the LME market. The LME and LME Clear had serious concerns about the ability of market participants to meet their resulting margin calls, raising the significant risk of multiple defaults and a consequent reduced ability for market participants to continue to access the market and manage their risk. 4
Now, who is being bailed out here? At first glance, it’s Tsingshan and its broker, the state-owned China Construction bank. Or maybe its JP Morgan, BNP Paribas SA, Standard Chartered Bank Plc, CCB International Holdings, ICBC Standard Bank Plc, United Overseas Bank Ltd., DBS Group Holdings Ltd., BOC International Holdings Ltd. and brokerage Sucden Financial Ltd.5 Bloomberg reports that Tsingshan owed JPMorgan about $1 billion in margin on Monday. The LME itself is probably OK.
Conspiracy theorists suggest its because the LME is now at least partially owned by the Chinese.
Craig Pirrong is generally my go-to read on commodity clearing risk. He has the following observations6:
Now in a Back to the Future moment echoing the 1985 Tin Crisis, the LME is trying to get the longs and shorts to set off their positions. “Can’t we all just get along?” Well likely not, because it obviously requires agreeing on a price. Which is obviously devilish hard, if not impossible given how much money changes hands with every change in price.
[C]learing is supposed to operate under a “loser pays/no credit” model. That’s really something of a misconception, because even though the clearinghouse does not extend credit, intermediaries (brokers/FCMs) routinely do to allow their clients to meet margin calls. But here we evidently have a situation in which the brokers (or Tsingshan’s banks) were unwilling or unable to do so, which led to the failure of the loser to pay.
[B]y closing the market, the LME is effectively extending credit (“you can pay me later”), and giving Tsingshan (and perhaps other shorts) some time to stump up some additional loans. Apparently JPM and the Chinese Construction Bank have agreed in principle to do so, but a deal has been hung up over what collateral Tsingshan will provide.
The creditworthiness of LME Clear is obvious very dodgy, and it is potentially insolvent.
There may also be parallels here to when Yasuo Hamanaka (aka “Mr. Five Precent”) at Japan’s Sumitomo Corporation racked up huge losses in the 1990s trying to corner the copper market, or when the Hunt family attempted to corner the world's silver markets in 1980. (Aside: Tsingshan is run by Xiang Guangda. His moniker is “big shot.”).
My first question as a former examiner is “what happened to position limits on the exchange?”
Cliff Asness has been spot on criticizing the bailout and moral hazard being created here.
Again, it’s early, lot’s more to come here.
Geopolitical Financial Blocs
Further to the globalization thread, this info-graphic caught my eye. It just goes to show that there is considerable pressure to move off the USD to a different currency regime. But it’s important to remember WHY it has not occurred: the RMB is not an open capital account, and the ‘rule of law’ around investments in China has considerable uncertainty. Spain, Germany, the Netherlands, Belgium and Poland already appear to trade more with China than the US. China also dominates in the growing areas of the world: India, Southeast Asia and Sub-Saharan Africa.
I wonder what would be the outcome if China moved towards a pre-Bretton Woods, gold-backed currency regime…haven’t thought this through yet…interested in any of my reader’s ‘perspective.’
Now This Is Real Risk
From my go-to source, The NY Post: Ancient Japanese ‘killing stone’ said to contain evil demon has cracked open
As if the world doesn’t have enough problems, people are now worried that an evil demon locked in a rock for almost 1,000 years is on the loose.
The so-called ‘killing stone’ that kept the malevolent spirit imprisoned all this time has split in two, sending believers into a state of panic.
Japanese legend has it that anyone who comes into contact with the rock will die.
According to mythology, the volanic rock – officially called Sessho-seki – is home to Tamomo-No-Mae, aka the Nine-Tailed Fox.
Now we could stop there, but no. Reseqarching, the Post leaves out important details of her past:
Tamamo no Mae (Japanese: 玉藻前 or たまものまえ, meaning “Lady Duckweed”) was born some 3,500 years ago in what is now China. Her early life is a mystery, but she eventually became a powerful sorceress. After hundreds of more years she became a white faced, golden furred kyūbi no kitsune—a nine-tailed fox with supreme magical power. In addition, she was an expert at manipulation. She used her charms and wit to advance her standing and influence world affairs.
During the Shang Dynasty Tamamo no Mae was known as Daji. She disguised herself as a beautiful woman and became the favorite concubine of King Zhou of Shang. Daji was a model of human depravity. She held orgies in the palace gardens. Her fondness for watching and inventing new forms of torture are legendary. Daji eventually brought about the fall of the entire Shang Dynasty. She managed to escape execution, and fled to the Magadha kingdom in India in 1046 BCE.
In Magadha, she was known as Lady Kayō, and became a consort of King Kalmashapada, known in Japan as Hanzoku. She used her beauty and charms to dominate the king, causing him to devour children, murder priests, and commit other unspeakable horrors. Eventually—whether because she ran out children to eat or because Kalmashapada began to turn away from her and towards Buddhism—she fled back to China.
During the Zhou Dynasty she called herself Bao Si, and was known as one of the most desirable women in all of China. In 779 BCE she became a concubine of King You. Not satisfied as just a mistress, she manipulated the king into deposing his wife Queen Shen and making Bao Si his new queen. In order to please his beautiful new wife, King You committed acts of such evil and atrocity that eventually all of his nobles abandoned and betrayed him.
From Wikipedia:
The fox stayed quiet for some period. Then she appeared in Japan as Tamamo-no-Mae, the most favoured courtesan of Emperor Toba. She was said to be a most beautiful and intelligent woman, being able to answer any question asked. She caused the Emperor to be extremely ill and was eventually exposed as a fox spirit by the astrologer Abe no Yasuchika, who had been called to diagnose the cause of the Emperor's poor health. A few years later, the emperor sent Kazusa-no-suke (上総介) and Miura-no-suke (三浦介) to kill the fox in the plains of Nasu.
In the 1653 Tamamo no sōshi (玉藻の草紙), an addendum was added to the story describing that the spirit of Tamamo-no-mae embedded itself into a stone called the Sessho-seki. The stone continually released poisonous gas, killing everything that touched it. The stone was said to have been destroyed in the Nanboku-chō period by the Buddhist monk Gennō Shinshō (源翁心昭), who exorcised the now-repentant fox spirit. He held a Buddhist memorial service after the deed, allowing the spirit to finally rest in peace.
Google images has several representations
Godchecker ranks Tamano-no-Mae as the 9th most popular Japanese god.
Notes:
Shit’s gonna get real.
Federico, G. and A. Tena-Junguito (2016), ‘A Tale of Two Globalizations: Gains from Trade and Openness 1800–2010’, CEPR Discussion Papers, No. 11128. London: Centre for Economic Policy Research.
Bradford, S.C., P.L.E. Grieco, and G.C. Hufbauer (2005), ‘The Payoff to America from Global Integration’, in C.F. Bergsten (ed.) The United States and the World Economy: Foreign Economic Policy for the Next Decade. Washington, DC: Peterson Institute for International Economics (pp.65–109).