The fragility of contemporary capitalism

OSalvation the world remains concerned about the geopolitical and humanitarian fallout of the Russian invasion of Ukraine, its economic consequences are increasingly worrying. Although the two warring countries represent barely 2.5% of the world’s population, it appears that the attacks on production within their borders and the suspension of their commercial relations with the rest of the world threaten to create a crisis in multiple markets, particularly in the food and oil markets where shortages abound and prices are rising. It is a typical illustration of the fate of nations entangled in a globalized world economy.

But there is more than the war in Ukraine that is manifesting itself. Events in remote corners of the global economic system illustrate how centralized and financialized markets for goods and services have increased the fragility of contemporary capitalism. A telling example is the market for nickel and nickel futures. Nickel is a metal used in the production of stainless steel and has grown in importance as a crucial input in the batteries that power the booming global electric vehicle industry. It is not normally the center of attention in economic discussions. But things changed on March 8, 2022, when the London Metal Exchange (LME), which describes itself as “the global center for pricing, hedging and trading industrial metals”, suspended nickel trading.

Some may say the move shouldn’t be too much of a concern. But the suspension was a rare and almost unprecedented event in the history of the LME’s nickel market, which provides the metal’s benchmark price for all those exposed to it along global value chains. The suspension was triggered by extraordinary price trends. In a single day, nickel prices doubled to over $100,000 a ton, and nickel futures prices rose 175% over a two-day period. The trigger for the price explosion was the war in Ukraine and the sanctions that threatened to exclude Russia, which accounts for about 11% of the world’s nickel production, from world markets. But, as noted earlier, Russia and Ukraine appear to be important in multiple markets, such as wheat, oil and fertilizers. All have seen price increases, but none (so far) have resulted in a decision to stop trading the commodity. A lot more had to happen in the nickel market for things to get to this level. And indeed, he had.

Tsingshan’s role in the price explosion

It appears that an actor’s extraordinary exposure to nickel, through his agents, turned what should have been a price spike into a price explosion. That player is China’s Tsingshan Holding Group, the world’s largest producer of nickel and stainless steel, headed by Xiang Guangda, another Chinese tycoon with a rags-to-riches history. The group controls significant nickel production capacities in Indonesia which supply the metal to its stainless steel factories or to Chinese producers of electric vehicle batteries.

Xiang, being a metal tycoon, was obviously exposed to the metal futures market, especially nickel futures. Futures contracts are considered to be smart hedging instruments that help protect those exposed to commodity markets from loss if prices move in unexpected directions. For example, if production decisions are made assuming that the price of nickel would be $40,000 per ton, but the price drops to $35,000 per ton by the time the product hits the market, the supplier would suffer significant losses.

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Thus, paying a premium for a futures market in which some buyers are willing to pre-commit to $40,000 a ton is one way to insure against losses. If the price does not drop, you only lose the premium. If so, you’re cutting your losses and protecting your profits.

But the futures markets are populated not only by hedgers engaged in production, but also by speculators who, convinced of their expectations of market developments, place bets to reap profits from trading. A typical example of such a bet is a “short”. Traders who are convinced that prices for a product will go down borrow that product to sell it at today’s high price, with the plan to buy back at a lower price at a later date to return the product to the lender and close. the case. The difference between the selling and buying prices, after taking into account the costs, generates a profit. Even if you’re not a nickel producer, it’s a legitimate and potentially lucrative business.

Xiang’s case was of course different. His group is a major producer of nickel and steel. This may have convinced him that he had more knowledge and a better idea than most of how the markets would evolve. He thought nickel prices would fall significantly, given likely trends in demand and supply. It encouraged him to go beyond the cover. He opted to accumulate large debt-funded short positions, placing bets that would allow him to benefit from this expected price drop and reap huge profits. Some of those bets were not even on exchange-traded futures, but on OTC derivatives partially issued by banks.

But the Russian invasion of Ukraine tripped him up. Prices rose and, caught in a “short squeeze”, he was losing massively on these trades. Estimated losses totaled over $8 billion in an extremely short period of time.

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When something of this magnitude happens, brokers and creditors demand more “margin” money to cover those losses. If forced to make these payments, the speculator could face a cash crunch and run out of cash to pay. Xiang should also consider buying the commodity – in this case nickel – before prices rise further, in order to deliver the physical metal against futures contracts and reduce losses when closing deals. It also requires money. However, it also increases demand for the physical raw material, both from the short seller and from other steel and battery producers using the raw material, leading to further price increases, as the raw material is in short supply.

This explains the explosion in nickel prices and nickel futures prices. It didn’t help that Tsingshan’s own nickel production was not of the Class 1 type (99.8% purity) needed for delivery under an LME contract. Thus, the group could not divert its own production to make the deals it had made.

LME stops trading

An event like this also shakes the financial markets. In this case, the LME had to halt trading and find ways to liquidate a large portion of the short positions to stabilize the markets. However, some fund managers were unhappy that the exchange, realizing that some brokers would default on the margin calls that the price spike entailed, canceled around 5,000 trades that had been made when the price had risen but before the suspension of trading. transactions. It was clearly a decision that penalized those who would have taken advantage of the trade to save the brokers who entered into these transactions voluntarily. These brokers were members acting on behalf of buyers who wanted the physical commodity for production, while the winning speculators were largely electronic traders making speculative bets.

The action may have prevented many defaults, but it was a violation of market principles. But an LME spokesperson reportedly justified the action by saying: “In the interests of systemic stability and market integrity, we suspended the market as soon as we could and canceled trades from the time where the LME no longer believed that prices reflected the underlying physical market. This position is unlikely to go unchallenged.

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Banks supporting Tsingshan speculation were also affected. If they close the group’s positions or insist on margin calls, Tsingshan and Xiang could default. To avoid this, they had to postpone or extend more credit. Tsingshan owes billions of dollars to companies like JPMorgan Chase, Standard Chartered and BNP Paribas, which had to negotiate a deal allowing the group to defer repayments and offered him more credit.

The China Construction Bank has also signed on with new credit lines and the Chinese government has reportedly advised banks to lend a hand. But uncertainty still haunts the market and those exposed to it.

These ripple effects of the invasion of Ukraine on the global economy and financial system show how fragile the transformation of capitalism over the past three decades and more has made it. A shock can damage the global economic and financial system in multiple ways. Not only will the war in Ukraine have catastrophic military and humanitarian consequences if no solution is found, but its effects on inflation and on unexpected segments of a financialized global economy mired in speculation could precipitate another global economic crisis. .

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