By Simon Grey, on July 19th, 2011
ASI:
One example he used was of Jonathan’s Coffeehouse, a private club that preceded the London Stock Exchange. In the 18th century, the government refused to enforce stock exchange contracts, seeing them as a form of gambling. Nevertheless, the Coffeehouse became a centre of commerce and contracts were usually upheld voluntarily. If you were a trader, you could rip somebody off once, but would be barred from the club. For people whose livelihoods were based on stock trading, it wasn’t worth it.
The same phenomenon exists today in a whole range of exchanges. When I go to a restaurant and get a bland meal, it’s practically certain that I won’t sue. Does this mean that profit-maximising restaurants will constantly give out bland meals? No – if it serves bad food, I’ll stop going and tell my friends not to go either. Reputational capital, so to speak, is enormously valuable, and losing it can be worse than just losing a court case. As a side-point, the reason that restaurants in touristy areas are usually so bad is down to this fact as well. Tourists typically don’t know anything about the restaurants they go to – could things like TripAdvisor bring an end to tasteless, expensive tourist food?
One complaint about the unfettered free market is that there is no way to “make sure” that people behave ethically and fairly in their business dealings. The unspoken assumption is that only government can provide the final guarantee against fraud, presumably through the use of force. What’s neglected in this fairly shallow analysis is that most people expect to participate in the market over the long term, the market can exert plenty of force, and the government is far from perfect anyway.
Since most people expect to participate in the market over the long term, it would be foolish for them to do things that would cause consumers to distrust them. As was already noted, if someone were to even sell a shoddy product, they would presumably suffer negative consequences. And if they intentionally defrauded customers, they would find that they would go out of business quite quickly.
The reason for this is due to the effect of social pressure, which exists outside of the state. Most people with decent faculties will find that it is in their best interest to “play by the rules” because doing so ensures that will have social acceptance, which in turn ensures that there is some degree of implicit trust which then enables trade. This social pressure ensures that most people conform to social norms, and this is itself a form of force.
Unlike the state, though, the market does not have coercive power, in the sense that conformity can be forced. Anyone can opt out of the society in which they live, if they so choose. Incidentally, if one were to opt out of a given society, the market in that society would improve because those who opted out would no longer participate in that market.
Finally, the coercive force of the government is not always used for good. Even if the market cannot ensure that no one ever gets hurt when engaging in market transactions, it does not follow that the government will. As such, the argument that the government needs to regulate the market for the good of consumers is simply specious.
By Bron Suchecki, on July 19th, 2011
I recently listened to an interview between Eric Sprott and Chris Martenson. Eric has a very good line in spin playing to the themes beloved by the ‘bugs. Deconstructing them requires more time than I have at the moment, but this comment I can’t leave:
“… I think all the paper markets are a joke. As you are probably aware, we trade a billion ounces of silver a day. A billion ounces. The world produces 900 million a year.”
There are many falsehoods in the precious metal commentary “market” but I’m surprised Eric is supporting the idea that large turnover figures are suspicious, which I debunked in this post. He should be careful supporting this meme as it can just as easily apply to his own funds, particularly his silver fund as he seems not interested in doing any secondaries (in contrast to his gold fund).
The suspicious turnover meme is often confused with fractional bullion banking, an example being this comment by The Burning Platform:
“Several competent analysts have worked the numbers (including Bill Murphy and Chris Powell of GATA), and have come to the conclusion that for every ounce of silver in known inventories there are approximately 100 paper contracts trading (a fractional bullion system, if you will) on various exchanges across the globe.”
My response below:
1) My understanding is that the 100:1 figure did not come from “analysis” but from a statement made by CPM Group’s Mr Christian. See here. I would be very interested in independent analysis coming to the 100:1 figure that did not rely on Mr Christian’s comment, please provide links.
2) Mr Christian’s comments were confused by many as a statement about the ratio of fractional bullion banking instead of paper to physical trading ratio, which are two completely different things. GATA’s Adrian Douglas did an analysis that concluded the fractional ratio was 4:1. That analysis had serious flaws in my opinion (see here but in the end it was too conservative, with Mr Christian confirming it is generally 10:1 (40:1 in the case of AIG). 
By Bron Suchecki, on May 26th, 2011
I left this comment on the FOFOA blog:
Your point about bullion banks having the best intel is important. Bullion banks are like spiders in the center of a web. They can feel the twitching of the flies in the web and determine the mood of the market better than anyone else and often in advance of others.
For example, if Mints are starting to see an increase in demand and begin running down stocks, they will start to take delivery ex-bullion banks, who as a result now have intel that retail demand is picking up before anyone else sees it in reported coin sales.
London Banker has expressed this idea much better than me in this post:
Over the past 25 years the financial markets of the world have become highly concentrated in the intermediation of a handful of firms, and regulation has been harmonised in the interests of these few firms. …
Sadly, these few global firms have been for some time in “a conspiracy against the public”, and have subverted the organs of public governance and the infrastructure of the financial markets to their purposes. …
Four global banks are intermediaries in 85 percent of OTC derivatives transactions. The same banks dominate prime brokerage. The same banks own large equity interests in the now demutualised exchanges, clearinghouses and even warehouses of the global markets. Naturally, the same banks dominated underwriting of securitised assets. The implications have scarcely been grasped of what this portends in terms of the information asymmetries and the opportunity to manipulate markets without risk.
Each of these roles gives these few banks a view into the positions of market investors. They know who owns what, using what leverage, under what terms, and trading in which markets. Knowing that, the manipulation of prices to impoverish investors and enrich the ruling banks is child’s play with a bit of ill-transparent HFT through proprietary dealing desks and connected hedge funds aligned with the firms. …
The only resilient solution is local, transparent markets with disintermediation of the controlling banks. Eliminating the information asymetries which allow them to see everyone’s positions, leverage and trading activity – and trade and ration liquidity accordingly – would go a long way to preventing further concentration. 
By Winton Bates, on March 16th, 2011
I had thought about writing something about gift giving before Christmas, but it might have looked as though I was complaining about how difficult it can be to buy gifts for people who seem to have just about everything they need already. (Perhaps I might even now be wandering into dangerous territory.)
In the past, economists have had some difficulty in understanding why people exchange gifts. The reason is that since the satisfaction that a person obtains from consumption spending is determined by her or his personal preferences it is difficult for anyone else to know what she or he would like. (I hope this is getting me out of trouble rather than digging a deeper hole.) Thus, some people end up with gifts they don’t want. (Fortunately, this rarely happens to me!) The remedy some economists have proposed is predictably crass: give money not goods. Neerav Bhatt has provided an entertaining discussion of this view here, including a clip from an episode of Seinfeld showing Elaine’s reaction to Jerry’s gift of cash for her birthday.
Greg Mankiw provides a good economic explanation of gift-giving in terms of signaling theory. If a person is able to provide a thoughtful gift – despite the difficulty of discovering what the receiver would really like – this sends a signal of the feelings that the giver has toward the receiver.
I suppose that is how gift giving helps to strengthen bonds. It can be wonderful when that happens. (In my experience it is most likely to happen when the potential receiver of the gift is willing to send some signals by dropping a hint or two about what she might like.)
The exchanges of gifts among members of social and business organizations at Christmas functions etc. is presumably also intended to promote bonding. One approach, which is probably fairly common, is for everyone attending such functions to buy and wrap an inexpensive gift, with all gifts being distributed randomly at the function. A member of a club that I belong to recently proposed a different approach: the names of all members would be put in a hat and each person would draw out a name and buy a gift anonymously for that person. This might have resulted in more people being given things that they might appreciate and might have helped to bond individual members of the club to all other members. It seems likely that if you know that the person who has given you a gift that you appreciate is a member of the club, but you don’t know who it is, you might have good feelings towards all other members. (As it happened, the club decided to continue with the practice established a couple of years earlier of donating gifts for children to a local charity rather than exchanging gifts between members. It would be interesting to know if the proposed method of gift exchange has been used elsewhere and what the effects have been.)
 While bonding helps explain exchanges of gifts between close friends and members of some organizations, does it is also explain exchanges of gifts between people who don’t know each other well? Exchanges of gifts between people in different organizations in the modern business world can be viewed as gestures of goodwill (albeit often tax deductible). Some anthropologists and archaeologists have encouraged the view that such exchanges of gifts to establish goodwill were much more common in tribal societies. According to this view, people in pre-industrial economies exchanged gifts to cement relationships, but people in modern economies trade with each other to make profits. Matt Ridley  suggests that is ‘patronising bunk’ (‘The Rational Optimist’, p. 133-4). As Ridley suggests, there is no reason to suppose that traders in all cultures have not always been acutely aware of the desirability of getting a good bargain for the valuable items that they are exchanging. There is some evidence that money can change the way that people perceive exchanges, but this seems to me to be based on misconceptions about money. An exchange of goods with strict reciprocity (barter) might appear more like an exchange of gifts than a commercial transaction, but people are fooling themselves if they think it is different in important respects (other than possible tax avoidance) from an identical exchange facilitated with the use of money.
By Ajay Shah, on March 14th, 2011
If you are in India, and hear news about the earthquake, tsunami and nuclear reactors in Japan, you might want to trade on this. Either because you are hedging Japan exposure that’s embedded in your Indian equity holdings, or because you think you are an informed speculator who has a better and faster judgment about what these events mean for Japan.
Sadly, the Indian capital controls don’t let you trade on the Nikkei 225, which is the Nifty of Japan. But there is something you can do: Trade on the JPY/INR futures trading on NSE.
Quite a few people seem to have thought like this. Here’s a graph of the turnover:
Now let’s pause to think about the story playing out on this market. On one hand, it’s the purely domestic speculators or hedgers, who are buying and selling from each other. This is fine, but where are the linkages to the global financial system?
The most important arbitrage which should be at work is in the currency triplet INR/USD, USD/JPY and JPY/INR. But unfortunately, currency futures trading in India does not include the USD/JPY contract, so one crucial leg of the arbitrage is not readily available. With turnover like $100 million in a day, I’m sure some people are doing such arbitrage in some painful ways.  
By Ajay Shah, on February 25th, 2011
Today, on NSE, derivatives trading showed the following numbers:
| Product class |
Turnover (Billion rupees) |
| Index futures |
353 |
| Index options |
1981 |
| Stock futures |
391 |
| Stock options |
48 |
| Currency futures |
178 |
| Currency options |
30 |
| Total |
2981 |
This is really something: Rs.2.98 trillion notional rupees in a day. It’s starting to sound like a real market.
This data shows an incredible domination of Nifty futures and options. It also shows the massive success of Nifty options.
One element of the options to futures ratio with equities lies in the securities transactions tax, which has distorted the market in favour of options. In the case of currencies, this distortion is absent. Hence, the ratio of options to futures that we see there should reflect the undistorted applications of the products by the market.
Now that the NSE trading community has skills on options, the question arises: Do these skills readily port over into currency options? I believe they should: every good Nifty options trader is a good INRUSD options trader. The same options knowledge should pretty much carry over from equity stock or equity index options to currency options. In fact, with small modifications, the algorithmic trading that is being done on the equity options should readily deploy into the currency options.
So what does the evidence show? Currency options trading (INR/USD only, says the RBI) started on 29 October 2010. I have 117 trading days of data for the open interest of INRUSD options. Let’s compare the rise of open interest starting from contract launch:
The early days of currency futures trading was hard work: the open interest got up to $0.2 billion and stopped growing. In contrast, open interest with currency options has grown very fast in these 117 days. At each contract expiration, it has been much bigger than the previous one.
As a consequence, INRUSD options open interest is now bigger than INRUSD futures open interest, even though the latter has been a market that has been around for much longer:
This is consistent with the story that the Nifty options brainpower would yield a rapid establishment of the currency options market. This also tells us that not all of the domination of equity options is a distortion caused by the differential securities transaction tax.
This rise of the options and futures open interest has done a great deal for the viability of enterprise-scale economic risk management using the currency futures and options, given that the position limit is linked to the overall open interest. The limit is now looking big enough to be of interest to even the biggest Indian companies.
Some older materials that you might like to see:
 
By Ajay Shah, on October 12th, 2010
Akbar’s transport of ice
In the ferocious height of the Delhi summer, Akbar setup a mechanism whereby horses started out with ice in Kashmir and rode south. The ice was handed from one horse to another, keeping it constantly on the move. In the end, what reached him was a few kilos of ice.
(I’m unable to recollect where I read this, and google doesn’t seem to have heard about it. Please do tell me if you know something about this.)
The Indian ice trade
In 1833, merchants figured out that it was profitable to transport ice from the US to India. The existing technical skills enabled the production of low-grade ice in Calcutta for six weeks of the year at a price of 4p per pound. Transport by sea made possible perfect Boston ice, available round the year, at a price of 3p per pound. Ships would start out with 150 tons of ice and reach Calcutta with 2 tons of ice.
`Ice houses’ were built to store ice. The ice houses in Bombay and Calcutta no longer exist, but the ice house in Madras, built in 1841, still exists [location].
In 1878, manufacturing of ice began with the formation of the Bengal Ice Company, and this transport of ice from America dwindled away. By 1882 — a short four years later — it had ended. In 1904, there was an ice plant in Peshawar.
Sources: Better than Hooghly slush by Jayakrishnan Nair, in Pragati, June 2010.
The world’s largest refinery on the coast of Jamnagar
India’s biggest company, Reliance Industries, runs the world’s largest refinery off the coast of Jamnagar. Crude oil is imported here, products are made, and re-exported. Here’s my interpretation of what’s going on. The natural place to put a refinery is in the Persian Gulf, but the political risk in that region is too great, given that the fixed assets in question amount to Rs.2.3 trillion.
What’s the most efficient way out? To transport crude oil on the shortest possible hop from the Middle East to a place with political stability. That takes you to the coast of Gujarat.
A new trade: Alaskan water
I just read a story by Sambit Saha in the Telegraph about a new frontier in trade. A firm named True Alaska Bottling has obtained rights to transport 11.34 billion litres of water (i.e. 11.34 million tonnes) out of a lake in Sitka, Alaska. This will be transported to a plant near Bombay, which will be run by a firm named S2C Global, thus yielding bottled water to be sold in India and in the Middle East.
This seems to me to reflect an extension of the themes above. If you want to deliver product into the Middle East, it is better to build a factory in India given political stability and low labour cost. In this sense, it’s a bit like Reliance. And, it reminds me of the old ice trade; except that this time we’re transporting water.
By Bron Suchecki, on June 18th, 2010
There has been a lot of speculation recently about how much gold is held in London against unallocated accounts, see some examples below:
Bix Weir: “… stay away from COMEX/LME good delivery gold and silver bars …”
Arnold Bock: “… there is little bullion in storage at the London Metals Exchange or New York’s COMEX …”
Bob Chapman: “… Do you really think that the COMEX and LME would deliver the gold even if they had it …”
John Dizard: “Many of them apparently prefer to have their gold in vaults near where they are, Mr Smith’s “middle of nowhere”, rather than in LME or COMEX warehouse receipts.”
Jim Willie: “A clearinghouse held a Letter of Intent to supply the London metals exchange with 250 metric tonnes of gold bullion.”
I am now prepared to finally reveal the truth – there is actually NO gold in the vaults of the LME (London Metals Exchange). Now I know this is an explosive claim and I’m sure you’ll want to know if I can back it up with proof. Well, go to the LME website and tell me where you see gold mentioned?
That’s right, gold isn’t mentioned. The LME is a base metals exchange and does not trade precious metals. Problem is this makes the commentators quoted above, who talk about gold on the LME, look foolish. In my opinion, if you do see a commentator make the mistake of thinking gold trades on the LME it is an indication that they don’t know what they are talking about with regards to precious metals and you should treat their analysis with caution.
Gold is traded in London over-the-counter, in other words in direct deals between counterparties. There is no gold exchange in London. There is the London Bullion Market Association (LBMA), but that is just a trade association and it does not operate an exchange or have any vaults.
You may think I’m being a bit hard on those who confuse the LME and LBMA. You might argue that it is a reasonable mistake, since they are both in London and both deal in “metals”.
To that I would say what sort of credence would you give a commentary by a stockbroker who talked about Pepsi trading on NASDAQ, or Microsoft trading on the NYSE? Would you feel comfortable following stock advice from someone who did not know which exchange a stock traded on?
Confusing LME and LBMA is actually worse than that because the LME is a base metal exchange whereas the LBMA is just a precious metals trade association – a basic Google search would reveal that.
Sorry, I don’t think there is any valid excuse. Getting LME, LBMA and gold mixed up is a sure indicator that one has no actual precious metals market experience, an example of ultracrepidarianism. In which case, how can you trust them to know what is really going on, how can you know they haven’t made other mistakes in their analysis of the gold market? 
By Ajay Shah, on April 23rd, 2010
Exchange-traded derivatives originally only did commodity underlyings. The world’s first financial underlying was : currencies. On 16 May 1972, the Chicago Mercantile Exchange started trading in currency futures. To any finance person, nothing is simpler than a currency futures, but unfortunately in India a mixture of ignorance, ideology and turf considerations has hindered progress.
In 1996, when NSE had just got started talking about equity derivatives, I happened to be session chairman in a conference organised by Invest India titled The future of India’s stock exchanges and I remember asking Ravi Narain something like “Have you thought about other underlyings? Would you trade currency futures?”. Ravi leaned into the mic and said “We’d love to.”.
Most people in India were blinded by the notion of `RBI turf’ and did not think seriously about this problem. When I look in my media archive I see a bit on currency futures in Extracting information from finance, August 2006, and in a few pieces before that, but this was not seriously on the policy radar. When any discussion about this took place, various RBI personnel would claim that futures trading would somehow make Mother India unsafe.
In the Indian discourse, the committee report on Mumbai as an International Financial Centre, chaired by Percy Mistry (April 2007), had the first clear text on currency derivatives.
In April 2007, a column titled Currency futures now, emphasised the links between a well functioning currency derivatives market and the ability of the economy to absorb exchange rate fluctuations. (This remains the best response to Shankar Acharya’s column in Business Standard today, where he bemoans the shift away from administered exchange rates. The price of steel and crude oil and the dollar fluctuates: get used to it and get the right derivatives going).
It took 36 years from the date of the innovation (currency futures at CME) to get started with trading in India. On 2 September 2008, I was complaining about a crash in productivity. On 3 September 2008, I got a first detailed look at the liquidity of the currency futures market.
In a year, on 23 September 2009, one could cautiously suggest that currency futures liquidity was ahead of that on the OTC market. This was clearly visible in the article by Gurnain Kaur Pasricha on 25 November 2009. Here, we were on new terrain: nobody else in the world had done this other than Brazil. The global first-mover, the CME, envies the NSE currency futures contract.
And finally, on 21 April and 22 April of this year, we see signs that the currency futures are more liquid than the Nifty futures.
There is nothing innovative about launching currency futures. There is nothing more commoditised and better understood than an exchange-traded clearing-corporation-settled cash-settled contract on a currency. But the mixture of ignorance, ideology and turf battles that impedes progress in India is alive and well. Currency forwards (and the NDF market) are the only choice for FIIs, who are banned from using the exchange-traded currency derivatives.
RBI believes that with interest rate underlyings, cash settlement is somehow dangerous and that derivatives trading on short-dated interest rates will interfere with the conduct of monetary policy. I wonder how that is reconciled with OTC interest rate swaps involving MIBOR, and with the fact that all good central banks in the world are doing monetary policy without banning either cash-settled interest rate underlyings or short-maturity underlyings.
In short, this is a good story and a bad story. It is a good story in that in the end, we are one of the best countries of the world in terms of getting exchange-traded currency derivatives to work. It’s a bad story in that it took a lot longer than it should have, and the problems that impeded progress continue to be with us.
By Ajay Shah, on April 21st, 2010
India is the second country of the world, after Brazil, where the currency futures are more liquid than the currency forwards. Today when I glanced at the order book of the near month rupee-dollar futures, I was struck by the big numbers that are visible:
The tick size of this market is 0.25 paisa, so the top five prices cover 1.25 paisa on each side. So there’s nothing interesting about the prices: I focus on the quantities. I’m used to generally seeing quantities at each prices running all the way to 1000 to 2000 contracts which is $1m to $2m. Today I was surprised to see two quantities with much bigger values: $6m and $11.3m. This is huge. [NSE currency futures page; the order book for this (April) contract] I was also impressed at the fact that $32.6m and $42.4m of orders are sitting on this order book. These are big numbers.
For a comparison, I popped over to look at the April expiration Nifty futures contract, which is the biggest financial product in India. This order book shows:
This contract is five times bigger than the currency futures contract, so in your mind you have to multiply the quantities by five to make them comparable. So the big two quantities here are around 2000 contracts which corresponds to 10000 contracts of the currency futures contract. The total orders present on the book here are staggeringly large when compared with the currency.
Theory tells us that liquidity should vary with asymmetric information and volatility. Both Nifty and the currency are macroeconomic underlyings with relatively little asymmetric information. But Nifty is more volatile. So if both markets worked well, we would expect Nifty to be less liquid. We are not yet there – the currency futures market is not yet more liquid than the Nifty futures market. Some key differences are obviously visible: foreigners trade on the Nifty futures but are banned from the currency futures, and Nifty options are available while currency options are not yet available (though without foreigners).
A paper idea: When a central bank shifts to a more transparent framework on currency trading, or when a central bank steps away from currency trading altogether, asymmetric information on the currency market goes down so currency impact cost should go down. I wonder if one can find some natural experiment of this fashion. Matters are complicated because the date on which a float commences if often not the date on which the float is announced. This can be dealt with by identifying the date on which the exchange rate regime actually changed, as opposed to what is claimed by the central bank.
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