Month: July 2010

The Cocoa Corner: Is Choc Finger Down $150 Million?

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.

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.

A New Low in Home Construction

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.

What To Do With Fannie and Freddie?

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.

Testimony on the 2001 and 2003 Tax Cuts

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.

The End of Cap and Trade?

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.

The Hot Tentacle

The World Cup started with vuvuzelas and ended with Paul the octopus. The world’s most famous cephalopod grabbed headlines by correctly predicting the winners of eight straight World Cup matches, including today’s victory by Spain over the Netherlands.

I’ve enjoyed Paul’s exploits, but his success got me wondering: just how many animals are out there picking World Cup winners? Could it be that, oh, 256 animals were making predictions when Paul started his run and he’s just the lucky one?

Well, after a little bit of internet snooping, I haven’t found all 256 yet, but I bet they are out there. For starters, there’s Mani the parakeet who called four quarterfinal matches correctly, but then fowled up by picking the Dutch over the Spaniards in the final.

And then there’s this article in the Christian Science Monitor, which recounts failed prognostications by a sloth, a hippo, and a monkey.

So that’s at least four. As for the other 251 failed psychics that I think are out there, my guess is that Google doesn’t know about them. And that, friends, is what’s known as survivorship bias. That bias is a big deal in financial markets. For example, the performance of existing mutual funds is much better than that of mutual funds generally because the laggards get closed and drop out of the data.

And so it is with animal psychics. The lucky ones grab headlines, while the laggards are forgotten. Which doesn’t mean that I begrudge Paul his fame. Indeed, I think his fame should spread right into finance and statistics classes when school starts in the fall.

How to Defeat the Lionfish? Use Your Knife and Fork

As regular readers know, I am intrigued by animals in weird places (voles in the Rose Garden, grey whales in the Mediterranean) and quirky discussions of property rights (guacamole, overhead bins, snow shoveling, office lunches). So imagine my delight when I opened the Food section of the Washington Post to discover an issue that brings them together: the battle against the lionfish.

The beautiful, venomous lionfish is native to the Indo-Pacific, but back in 1985 it started showing up in a weird place: the east coast of the United States. Today you can find the spiny critters along the eastern seaboard, through the Caribbean, down to Belize, and over to the Azores. That’s bad news since the lionfish often crowds out (or consumes) native species.

So what to do? According to Wikipedia, some places have offered bounties for killing them (but, one hopes, not enough to induce breeding and importing) or have established kill-on-sight policies. Another strategy, as the WaPo reports, is to move them down a notch on the food chain:

Federal officials have joined with chefs, spear fishermen and seafood distributors to launch a bold campaign: Eat lionfish until it no longer exists outside its native habitat.

The genius of this approach is that it harnesses a classic economic pathology–the tragedy of the commons–to serve a greater good. No one has any property rights to these interlopers, so all we need to do is create enough market demand for their tasty flesh. Once that reaches critical mass, we can sit back and watch fishermen and -women overfish the Atlantic lionfish into oblivion. Or so goes the theory.

I wish them good luck–and look forward to seeing Atlantic lionfish on the menu soon. I am skeptical, however, that it will actually work. But if it does, maybe the seafood alliance could then turn their attention to the new Potomac snakeheads?

Why Taxes Are Going Up

It’s hard to imagine that spending restraint alone can solve America’s long-run fiscal woes. Facing an aging population and rising health care costs, the federal government will continue to expand even if policymakers take serious steps to trim spending. That’s why policy wonks are working so hard to evaluate ways to raise more revenue. Cutting back on loopholes and other tax expenditures, taxing carbon emissions, introducing a value-added tax – all of these deserve attention in case America decides that it wants to finance a substantially larger federal government.

However, that focus sometimes overshadows a key fact about our tax system: Revenues are already on track to rise substantially in coming years. And not just because of an economic rebound and expiring tax cuts. There are structural reasons why tax revenues will grow faster than the economy.

The Congressional Budget Office estimates that tax revenues will rise from 14.9% of GDP in 2010 to 20.7% in 2020 and 23.3% in 2035 if current law remains in place (the “extended baseline” scenario in pink):

To put those figures in context, note that federal revenues have averaged about 18.2% of GDP over the past forty years. Tax revenues today are thus remarkably low. Indeed, they are the lowest they’ve been since 1950. But that will quickly reverse under existing law. By 2020, revenues would near their all-time record (20.9% of GDP in 1944) and by 2035, revenues would be more than 25% higher than historical levels.

That rapid growth reflects six factors. First, the economy will recover, lifting revenues from currently depressed levels. Second, the 2001 and 2003 tax cuts will expire, as will tax cuts enacted in the 2009 stimulus. Third, the Alternative Minimum Tax, which is not indexed for inflation, will boost taxes for millions more taxpayers. Fourth, the new taxes that helped pay for the recent health legislation will go into effect. Fifth, retiring baby boomers will make more taxable withdrawals from tax-deferred retirement accounts. Finally, in a phenomenon known as bracket creep, growing incomes will push taxpayers into higher brackets and reduce their eligibility for various credits.

Together, those six factors will increase tax revenues by 8.4 percentage points of GDP over the next 25 years, according to CBO. About a third of that increase (2.7 percentage points) comes from expiring individual income tax provisions and the expansion of the AMT. Another third (2.6 percentage points) is due to real bracket creep and reduced credits. And about one-seventh (1.2 percentage points) results from the tax increases in the health legislation. The other factors account for the remainder.

We clearly have sizeable tax increases built into our revenue system. The trillion-dollar question, however, is whether policymakers will allow them to happen. That’s why CBO considers a second scenario in which Congress gives in to the temptation to cut taxes. Under that “alternative fiscal” scenario (blue), Congress would permanently extend most of the 2001 and 2003 tax cuts and would limit the growth of the AMT. That would slow the growth of tax revenues but they would still reach 19.3% of GDP by the end of the decade, well above the forty-year average. CBO assumes that policymakers would then enact a series of unspecified future tax cuts to hold revenues at that level rather than letting structural factors lift them higher.

CBO’s bottom line is thus simple: tax revenues will rise faster than the economy even if Congress does nothing new. Indeed, revenues may rise faster than the economy even if Congress enacts substantial tax cuts. Our long-run fiscal dilemma exists because the scheduled growth in future spending is even larger than the scheduled growth in future revenues.

This post first appeared on TaxVox, the blog of the Urban-Brookings Tax Policy Center.