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Archive for July, 2010

In a front page story on Sunday, the New York Times suggests that commodity investor Anthony Ward may be trying to corner the cocoa market.  Ward–known as Choc Finger–reportedly purchased 241,000 tons of cocoa, about 7% of the world’s annual crop. The price tag? A cool $1 billion.

The NYT suggests that Ward is doing this to profit from future price increases, either natural or created by his new market power:

His play has some people up in arms. While some see it as a simple bet that cocoa prices will rise on falling supply, others say Mr. Ward has created a shortage of cocoa simply to drive up the price himself. … The fear is that Mr. Ward will become the go-to source until the annual cocoa harvest, which starts in October. With candy makers starting to stock up for the holiday season, they may be forced to pay him ever-higher prices — and cocoa has already jumped 150 percent since 2008.

“The squeeze was really timed perfectly,” said Eugen Weinberg, an analyst at Commerzbank in Frankfurt.

The corner theory is plausible, but I think the NYT committed journalistic malpractice by not reporting another salient fact: cocoa prices are now about 15% lower than when Choc Finger made his play. Ward allegedly bought at a price around 2,700 British pounds per ton of cocoa, but according to the FT the futures contract for September closed on Friday at only 2,300 pounds:

If Choc Finger’s game is to profit from future price increases, he’s sitting on $150 million in unrealized losses. Not a sweet outcome.

Of course, that arithmetic applies only if Choc Finger is playing buy-and-hold with his cocoa stash. There are many other ways he might be trying to profit from his purchase. Perhaps he owned July futures that paid off handsomely from the run-up in price (as you can see in the FT chart, July was the front-month contract until July 15th, after which the September contract, at a much lower price, took over). Or maybe he locked in higher prices from pre-arranged sales? As Craig Pirrong notes, pre-negotiated sales make good sense if you are trying to execute a corner (Paul Krugman offers another simple model). Those details matter, but you wouldn’t know it from the NYT story. (My guess, by the way, is that he’s not down $150 million, although the logic of the NYT story would suggest that. But only time will tell.)

Whatever Ward’s motivation, keep in mind that big purchases don’t always pay off. Sometimes you win, sometimes you lose. As Choc Finger knows first hand, according to Amsterdam Trader:

Press is reporting the “biggest cocoa trade in fourteen years”, but it’s not that special. Back 2002 the same cacao king Anthony Ward bought 202.000 tons, just a little less compared to the current 241.000. At the time his purchase represented 5% of the world market. He made 40 million in 2002 on the trade. Three years ago Ward was quoted as the chocolate guru : “The world’s not going to run out of cocoa, but they’ll have to pay more to get the right beans”. Most press reports refer to the biggest cocoa trade in fourteen years, but haven’t done any more research. The large cocoa trade in 1996 was done by the firm Phibro, amounting 300.000 tons. In charge of the cocoa desk at the time at Phibro, was nobody else than the same Anthony Ward. Phibro lost money on this cocoa trade by the way, and was forced to unwind their positions.

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What’s the Best Voting System?

Last February I highlighted a New Yorker piece about instant runoff voting (IRV) in awarding the Oscar for Best Picture. (Kudos to author Hendrik Hertzberg for correctly predicting the winner: The Hurt Locker.)

As I said at the time, I think elections to public office would benefit from IRV as well:

Why? Because it eliminates the downside of voting for a third-party candidate. In a race between D and R, you may worry that voting for third-party candidate I is “throwing your vote away.” That worry disappears with IRV. You can give I your number one vote and either D or R your number 2 vote. If I loses in the first round, you’ll be disappointed. But you won’t have wasted your vote since your second-place vote now becomes operative.

I think that would be a substantial improvement over the winner-take-all vote tallying that dominates the American political system today. But would it be the best of all possible voting systems?

In this week’s New Yorker, Anthony Gottlieb answers no, pointing to a potential flaw in IRV:

Such transferrable-vote elections can behave in topsy-turvy ways: they are what mathematicians call “non-monotonic,” which means that something can go up when it should go down, or vice versa. Whether a candidate who gets through the first round of counting will ultimately be elected may depend on which of his rivals he has to face in subsequent rounds, and some votes for a weaker challenger may do a candidate more good than a vote for that candidate himself. In short, a candidate may lose if certain voters back him, and would have won if they hadn’t.

The practical importance of this theoretical concern is a matter of heated debate, much of which has focused on a 2009 mayoral election in which Burlington, Vermont used IRV (as it had in 2006). According to IRV detractors Burlington ran right into the “non-mononicity” issue, with the “wrong” candidate winning (at least by some voting metrics). IRV supporters reject that view. (Sorry, I haven’t had time to sort this through; if you are interested, just Google “Burlington 2009 election” and have fun.)

As best I can tell, however, both sides agree that the current system is flawed. For example, many of the IRV detractors believe we should adopt a different system: range voting, which allows voters to express how much they like or dislike a candidate. Rather than just ranking Oscar movies, for example, voters would award scores: (e.g., Hurt Locker 10 points, Up in the Air 9 points, Avatar 2 points). The movie with the highest score would win.

That would also solve my primary concern about not discouraging votes for third-party candidates. But perhaps range voting has other hidden problems as well? As Gottlieb notes there is a limit to how far theorizing can take us in this debate:

Mathematics can suggest what approaches are worth trying, but it can’t reveal what will suit a particular place, and best deliver what we want from a democratic voting system: to create a government that feels legitimate to people—to reconcile people to being governed, and give them reason to feel that, win or lose (especially lose), the game is fair. The novelty of range and approval voting in modern politics is so great that we can’t know how they’ll work out without running experiments.

Let me second that recommendation: more experiments with IRV, range voting, approval voting, and other innovations would be well worth the effort.

But I think we can take a pass on the voting system of old Venice, which Gottlieb describes as follows:

Thirty electors were chosen by lot, and then a second lottery reduced them to nine, who nominated forty candidates in all, each of whom had to be approved by at least seven electors in order to pass to the next stage. The forty were pruned by lot to twelve, who nominated a total of twenty-five, who needed at least nine nominations each. The twenty-five were culled to nine, who picked an electoral college of forty-five, each with at least seven nominations. The forty-five became eleven, who chose a final college of forty-one. Each member proposed one candidate, all of whom were discussed and, if necessary, examined in person, whereupon each elector cast a vote for every candidate of whom he approved. The candidate with the most approvals was the winner, provided he had been endorsed by at least twenty-five of the forty-one.

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Yesterday’s housing data were suitably glum, with single-family starts and permits both down (0.7% and 3.4%, respectively).

And what about my favorite metric, the number of houses under construction? It fell a hefty 5.3%. Which puts the number of single-family homes under construction at its lowest level in decades:

After the expiration of the new home buyer tax credit, only 286,000 single-family homes were under construction at the end of June. That’s down modestly from the 298,000 to 318,000 levels of the past year, when it looked construction was trying to put in a bottom. Just one more sign of continued weakness in housing markets.

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… in Tennessee, that is. But he’s singing about Greek debt:

Given all the recent discussion about inflation and deflation, let me also recommend Merle’s earlier hit, which includes my favorite lyric: “… will we be Zimbabwe or will we be Japan?” (So far, I think Japan is much more likely.)

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The Economist asked several experts to recommend options for resolving Fannie Mae and Freddie Mac, the two failed mortgage giants.

In addition to comments, the magazine’s web site allows users to recommend responses they like. It’s hardly scientific, but since the rankings (as of 9:15pm eastern time) work to my favor, let me rank them in declining order of recommendations:

My co-author Phill Swagel (a whopping 13 recommendations) describes our joint proposal for fully private GSEs that purchase an explicit backstop from the government for their mortgage-backed securities. Pros: The relationship is explicit and transparent, taxpayers are compensated for bearing risk, the portfolios are eliminated, the government backstop will soften severe mortgage meltdowns, and competition can discipline the Fannie and Freddie duopoly. Cons: There are still risks from the remaining government role.

Larry Kotlikoff (11 recs) outlines another proposal to restructure the companies into more sensible private entities. His model: mortgage mutual fund companies.

John Makin (7 recs) wins the award for brevity, arguing that they should be liquidated over 5 years.

Mark Thoma (4 recs) suggests a continued role for the firms, as long as they face much tighter regulation.

Tom Gallagher (4 recs) proposes putting them back on the federal budget as real agencies. This avoids some potential pitfalls of having them run as private companies.

P.S. As an anonymous commenter helpfully points out, the entries over at the Economist have these newfangled things called “dates” associated with them. Not sure how I missed that. The two highest scorers are also the oldest. Also, I must confess that I clicked the recommend button on Phill’s piece, lifting it to 14 votes. Because of some weird interaction between Safari and the Economist site, however, that resulted in it believing that I recommended all five pieces. Ah the perils of technology.

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As you may have heard, the tax cuts that were originally enacted back in 2001 and 2003 are scheduled to expire at the end of the year.

In the good old pre-crisis days, many members of the budget community (myself included) used to say things like “maybe the looming expiration of the tax cuts will finally provide enough pressure to get Congress to enact fundamental tax reform.”

That notion seems rather quaint today. Congress can’t even figure out what to do with the tax code for 2010, which is already more than half over.

For example, we still don’t know whether millions of Americans will be newly subject to the alternative minimum tax. We don’t know what will happen to all the “tax extenders.” And we don’t know whether Congress will really allow all estates of people who die in 2010–including George Steinbrenner–to completely avoid the estate tax (which will then return in full force at midnight on New Year’s morning).

Given that record, most hope for fundamental tax reform is now focused on the President’s fiscal commission. Congress, meanwhile, is now gearing up to figure out what to do about the expiring tax cuts. On Wednesday the Senate Finance Committee held a hearing to discuss the distributional and economic growth effects of extending the tax cuts. I appeared as a witness.

You can read my written testimony here.

You can find the opening statements of Chairman Baucus and Ranking Member Grassley and testimony of the other witnesses here.

You can see video of the hearing here.

As you might imagine, the five witnesses didn’t always agree. There was a strong consensus, however, that our tax system needs fundamental reform. The challenge is figuring out how to do it … and do it well. During the Q&A, Doug Holtz-Eakin had one suggestion: lock the business community out of the discussion entirely. Why? Because a basic principle of tax reform will be eliminating special interest provisions and that will be easiest if business interests aren’t in the mix protecting their favorite provisions.

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No, not for carbon. For sulfur dioxide.

As noted by Mark Peters at the Wall Street Journal:

The original U.S. cap-and-trade market, which succeeded in slashing the power-plant emissions that cause acid rain, is in disarray following the issuance of new federal pollution rules.

The collapse in the pioneering market where power producers trade permits that allow them to emit sulfur dioxide and other pollutants that cause acid rain comes as policy makers seek to establish a similar market to curb the emissions of carbon, a cause of climate change.

The SO2 market has been one of the great successes of economic engineering, using market forces to drive down the cost of cleaning the environment. After almost twenty years of trading, however, the market ran into what may be an insurmountable hurdle: increased regulatory concern about the location of SO2 emissions.

The SO2 marketplace is national in scope, which has been great for establishing liquid trading and allowing emitters to find the cheapest way of reducing emissions. But it also meant that some SO2 emissions would end up in particularly unwelcome spots, e.g., upwind of cities, states, or entire regions that are having trouble meeting air quality standards.

Over the past couple of years, court rulings and new regulatory efforts by the Environmental Protection Agency have increased the emphasis of the location of emissions. And that means that the national market may be coming to an end.

That’s certainly what it looks like in the allowance marketplace, where prices have fallen from more than $600 per ton in mid-2007 to $5 or less today:

The price decline has been particularly sharp because utilities had been polluting less than allowed in recent years. That allowed them to build up an inventory of allowances to use in the future. With prices so low today, however, utilities have essentially no incentive to avoid sulfur emissions and no incentive to hold allowance inventories. As Gabriel Nelson puts it over at the New York Times:

With SO2 allowances trading at about $5 per ton, and little prospect of carrying over the permits into the new program, utilities have little incentive to bank allowances or add emissions controls for the time being, traders say. Because those controls have upkeep costs beyond the original investment, some plants might even find it more cost-effective to use allowances than to turn on scrubbers that have already been installed, traders said.

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