Time to Curb Volatile Markets

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The Year 2012 and 2013 may see the volatile global commodity markets in full play with food grains joining the 3 primary objects of investor attraction. Oil, Gold and the US dollar are the three pivot points of global speculation today. There are many more minor interests like Copper which is hot this year, or new metals like Palladium or agricultural produce like sugar or corporate stocks, the Treasury bonds of different nations. US Treasury bonds which used to be an all time favorite before 2008 has once again regained its following after a mild setback after the sub prime mortgage crisis. Gold has now replaced the long time favorite the US Treasury bond, with big traditional buyers like China and Saudi Arabia, shifting preferences. No wonder it gained in over 50% in value in the last 3 years being quoted over Rs 30,000 or 1/2 K for 10 gms. 

The History Of Speculative Markets/ 

After the year 2000 it was the commodity markets, not the currency or the stock markets that witnessed the maximum volatility.  One could say that since this is a futures market based on the anticipation of traders, of future prices, it is bound to be both volatile and speculative as sources of commodities are finite and demand is growing. The truth however is that the futures market that were originally devised to reduce risk for the producers, the users and the physical traders of stock,  has increased risk due to its unpredictable volatility and speculative tendencies, as it is totally deregulated.

Speculation in Oil at the futures market has hurt both physical retailers and big users like Airlines as per documented evidence.  Dan Gilligan, the President of the  Petroleum Marketing Association in the US, the largest body of retailers with over 8000 members confirmed last year, that despite surplus supply positions and waning demand worldwide  oil prices shot through the roof during September 2008. The Air Transport Association of America has also condemned the destructive volatility of markets at a CFTC hearing last July. The shipping industry too has been hurt as lease rates of oil tankers have been hammered to give a boost to contango trades 

So why does no one address the issue. The possible reason is that there are powerful forces like the big banks and hedge funds who profit from the volatility and spread the booty around to the regulators, the politicians, the media and the judiciary creating an impenetrable barrier which initially stalls any action on reform and finally subverts it. Since most US bills passed are negotiated they lack the teeth to be decisive and lets the offender get away easily with a minor rap on the knuckles or a token fine, if booked.

 Besides with the major violation occurring at ICE Commodity Exchange in London which is outside American jurisdiction, the market makers are relatively certain that they will be able to ward of any intrusive questioning by American Senators with the help of the lax British regulators at FSA and British laws that are not restrictive towards volatility based on speculation. The energy traders who shifted base from the US to the UK in the year 2000 to set up the ICE exchange at London after American regulators clamped down on Enron had done their homework well.    

When the US Congress deregulated energy markets in 2000 and permitted operation in privatised exchanges at the behest of Enron, it created a perennial problem for both the producers and the users of energy. It issued a licence for the trader middleman to take over, from the secretive electronic privatised commodity exchanges without leaving an provision for audit supervision. The California energy crisis showed subsequently to an extent how deregulated markets could be counter-productive, but after Enron was booked under various offences and went bankrupt, the basic issues that had enabled Enron to manipulate its books were left unaddressed, despite attempts by Senator Levin and a few others, to plug the loop holes.

The majority of energy traders at Enron, who had smelt the scent of blood, then moved to London to avoid US regulatory measures. Here Jeffrey C Sprecher of Continental Power Exchange set up the deregulated privatised fully automatic, high speed ICE Exchange for electronic trading of commodities that Enron had dreamt of but could not build. It was here that Big Banks and Big Oil set up the trading cartel that spiked oil in 2008 to take it up to $147 a barrel before crashing it to below $50 creating an unprecedented volatility band of $115 and raking in mammoth profits for the cartel. This market volatility, many believe added to the losses of other big funds like Lehman Brothers, AIG  an during the 2008 market crash, and ultimately led to major bankruptcies in the Wall Street.

However even $500 billion of investor funds is too small an amount to create the massive volatility that has been witnessed in the commodity markets. What has caused this volatility is high speed round trip trading (banned in the US after the Enron saga) of the investor funds   at the ICE commodity exchange at London that churned out a mind blowing turnover of $7 Trillion in the last quarter. Each barrel of oil was cross swapped 20 to 30 times by the traders at the ICE Exchange operating from behind the counters of the Big Banks and Hedge operators, before it hit the retail markets at substantially higher prices.      

Morgan Stanley the Wall Street Bank and one of the biggest in the oil trading business operates through a mindboggling 450,000 subsidiary companies, to effectively control its market share in the oil business. Its trading operation at ICE Exchange is handled not by its employees but by scores of licensed brokers who are the third party operators who can take of debt off its balance sheets or enter into any other off the balance sheet transactions without any questions asked, as the privatised exchange does not leave any audit trail for the regulators.

Whereas taxing the big banks for excessive profiteering is meaningless, a nominal transaction tax of 0.01 percent on individual transactions will be both restrictive as well as create a audit trail for regulators to follow the chain of investments at the commodity exchanges. As a matter of fact this transaction tax should be levied on all financial transactions across the board, be it at the stock exchanges or bond markets, the currency or the commodity exchanges. For if manufacturing and trading operations can bear the VAT worldwide without complaints there is no reason why monetary transactions all over cannot be subject to a Financial Transaction Tax (FATT). Apart from curbing the flow of hot money and reducing market volatility, it will help bring back order to the chaotic financial markets that govern the world today.