The various loopholes in futures markets

I came across this interesting speech by CFTC Commissioner, Bart Chillton.

In this speech he gives three loopholes exploited by future market traders – Enron loophole, London loophole and Swaps loophole. Basically all have a similar theme- one market is regulated and other is not and both have near similar products. The regulators can only watch the former and the traders switch and build volumes in the latter.

This is actually problematic as because of innovation, one can create similar instruments in another exchange and build up positions (he explains that is what Amaranth traders did). Now what should a regulator do? He says we need more cooperation between regulators.

His take on whether speculation is driving prices:

The issue comes as speculators have increased their participation in the futures markets, primarily through swaps dealers, in an unprecedented fashion. In fact, at least $250 billion dollars has come into these markets in the last several years and the question that many people are asking is whether or not that influx of capitol is having an influence on the prices of oil and other commodities.

I’ve had the opportunity to discuss this issue with a lot of really smart people and I can tell you that a lot of them disagree.

Personally, I don’t see how $250 billion dollars doesn’t have a thumb-on-the-scale effect on prices. That’s an astronomical amount of money invested in commodities as an asset class—a new type of investment strategy in the futures markets and different approach applied to commodities trading. But, again, a lot of smart people disagree about the impact.

 

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Growth and kitchen recipes

What drives growth has been a often asked question on this blog. The various posts are here. The answers are numerous and as I have argued in this article, it depends on whom you ask the question. Acemoglu would say institutions, Solow would say technology, Levine would say finance etc. So much so , Avinash Dixit has called all these as recpies for growth. The question still remains: What drives growth?

I came across this excellent explanation from Paul Romer, a growth theory expert. He actually explains it using kitchen recipes 🙂

Economic growth occurs whenever people take resources and rearrange them in ways that are more valuable. A useful metaphor for production in an economy comes from the kitchen. To create valuable final products, we mix inexpensive ingredients together according to a recipe. Human history teaches us, however, that economic growth springs from better recipes, not just from more cooking.

What matters is the ability to use the same ingredients (inputs) to generate a better quality food (output). Check this superb example as well:

In most coffee shops, you can now use the same size lid for small, medium, and large cups of coffee. That wasn’t true as recently as 1995. That small change in the geometry of the cups means that a coffee shop can serve customers at lower cost. Store owners need to manage the inventory for only one type of lid. Employees can replenish supplies more quickly throughout the day. Customers can get their coffee just a bit faster. Such big discoveries as the transistor, antibiotics, and the electric motor attract most of the attention, but it takes millions of little discoveries like the new design for the cup and lid to double average income in a nation.

This is classic economics. We study economics to utilise scarce resources efficiently. The nations who do this better, are the ones who achieve higher growth. Read the entire thing.

House prices in Mumbai refuse to decline

Niranjan Rajadhyaksha in his superb blog Awkward Corner had pointed the stock market gave more returns than Mumbai real estate during 1979 and 2008. This was an amazing piece of statistic.

However, unlike the equity markets, house prices just refuse to decline. Though, there have been reports over decline in housing prices, it is somehow only on paper. A recent Newsweek story said it is cheaper to buy a flat in Manhattan than Mumbai.

The stock prices of most real estate companies have slumped, but not the prices of the goods they manufacture. If interest rates are rising, we should see a fall in house prices. But there is nothing like that happening.

Talking to various brokers in the city, the prices are still very strong and infact continue to rise. Why should this continue? I had pointed to the presence of endowment effect being present in the housing market. This is just getting stronger as sellers have really high holding capability.

I was reading in one of the papers that Builders actually expect prices to rise further hoping demand increases in festivals. Well, what can you really say?

Assorted Links

1. WSJ Blog points Gustav could wreck economic landscape. I now need to understand developments in climatic conditions as well

2. ASB has suggestions for RBI.

3. ACB provides nice stats for Singur. Also read Pakistan’s stick market culture

4. NB points to futuristic traffic lights

5. Mankiw points to a reading list to understand these volatile times

6. DB has tips on where to invest in 2009