Streetwise Professor

September 18, 2013

There is Nothing New Under the Sun, Warehouse Games Edition

Filed under: Civil War,Commodities,Economics,Exchanges,History,Politics,Regulation — The Professor @ 7:12 pm

I am working on a project about the economics of commodity trading firms.  One of the interesting questions is what physical assets commodity trading firms own.  In my research on this question, in an attempt to get some historical context, I turned to the excellent Federal Trade Commission Report on the Grain Trade, a five volume study released in the early-20s.  (There is reputedly a sixth volume on manipulation which I and others-Jerry Markham, for one-have feverishly searched for without luck.)   This is truly an excellent piece of work.  Many of the analyses are off, but as a detailed portrait of the grain trade in the 1900-1920 period, it cannot be beat.  Unfortunately, there is nothing comparable for other time periods.

In perusing Volume I, on country grain marketing, I came across this choice quote from the president of the CBOT in 1887:

The alliance between railroads and elevators has resulted in reaching out after millions of bushels not naturally tributary [to Chicago] and when gathered here preventing it by such tricks of the trade as you are familiar with from ever getting away again as long as storage can be collected on it.

. . . .

The grain bought elsewhere by warehouse proprietors is promptly sold to you here on future delivery, which, however, you can only get on payment of such premiums as the urgency of demand may enable them to exact.

. . . .

While the elevator proprietors are willing to pay 1 cent per bushel more for grain to “go into store” in their own warehouses than the market price of the same grain in store . . . is conclusive that the first storage charge is not legitimate, and also that the subsequent terms of storage are unduly profitable.

Replace “grain” with “aluminum”, and you could run this as a news story in 2013.  Goldman’s operations at Metro are almost identical to the operations of the warehousemen in Chicago that President Wright fulminated about 126 years ago.

The FTC study also notes that shuttling grain between warehouses was a part of the game more than a century ago.  It quotes Taylor’s magesterial history of the CBOT, describing an event from 1896:

The Armour Elevator Co. was charged with having transferred 1,200,000 bushels of wheat from one part of the north side system to another, without inspection, on such dates that the receipts resulting therefrom were just regular on the delivery day, May 1.

And not a bankster in sight.  (It is an interesting coincidence that 1896 was the year Goldman-Sachs was invited to join the NYSE.)

The morals of the story.  First, the ability to play warehouse games is inherent to the business of public warehousing of commodities. Second, banks are not uniquely susceptible to playing those games: when conditions are right, whoever owns the warehouses can play the games.  Third, systems of self-regulation are often incapable of addressing these problems.

On the last point, it is important to remember that the seminal case in the history of regulation in the United States, Munn v. Illinois, grew out of the warehousing battles in Chicago during the Civil War and its immediate aftermath.  The Supreme Court decided that the State of Illinois had the power to regulate grain warehouses, and this decision provided the basis for subsequent exercise of regulatory powers by states and the Federal government.

In other words, what is old is new again.  Journalists and regulators and legislators act as if the kinds of games played today are somehow new and unique.  They aren’t.  The commodities business hasn’t changed that much in a century and a half.  The things that were good, bad, and ugly in 1869 are around today, and will be around in 2069 and 2169.

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  1. You have to laugh at the way things like an American civil war, a U-boat campaign against American merchant shipping, the collapse of Tsarist Russia, the capture of the Ukraine, war between Russia and Poland, and the defeat and fall of imperial Germany were considered to be of no account or value in explaining grain price volatility between 1860 and 1925.

    No, what lay behind it all was speculators, obviously.

    Comment by Green as Grass — September 19, 2013 @ 7:36 am

  2. I’ve seen some USDA studies from the ’20s and ’30s and they are. for the most part, extremely well done expositions of the reality on the ground: They sent folks out to observe what was going on, asked questions, and applied economic theory to the problem at hand to explain things in concise and crisp narratives. Some of the best stuff we have comes out of that period (think Holbrook Working).

    We need to send some folks over to the banks to do the same thing, and figure out how commercial banks and used-to-be investment banks that now enjoy the full-faith-and-credit backstop of USG support add anything to the warehouse market than what existed prior to their becoming wards of the state.

    Comment by markets.aurelius — September 19, 2013 @ 4:14 pm

  3. “…the reality on the ground”

    which sadly has never burdened politicians much.

    Bart, for example, can’t tell the difference between a wash-, a cross- and a self-trade.

    The regulators themselves have usually been a lot more thoughtful.

    Comment by Green as Grass — September 20, 2013 @ 4:53 am

  4. they did this in pork bellies too. there was a line in the warehouse, and the USDA couldn’t count bellies on one side of the line (they weren’t ready for market yet). Of course, if the owner of the warehouse was short, as soon as the USDA was done counting he’d move them to the other side of the line.

    Comment by Jeff — September 20, 2013 @ 5:31 am

  5. Hey, Prof. I came across a great article re the history of econometrics, and its debt to the ag economists of the period you’re looking at:

    From the article: “Frisch’s scientific work attracted a number of visitors, not least the econometric laboratory work that Frisch conducted. The first long-term visitor at the new Institute was Frederick V. Waugh who stayed in Oslo most of the academic year 1932/33, working closely together with Frisch. Waugh belonged to the U.S. agricultural economists, whom Karl Fox, serving as the historian of this tradition, has characterized as “world leaders in applied econometrics during
    1917-33”, with Waugh and M. Ezekiel as the foremost representatives. Waugh was impressed by Frisch’s approach to estimating the marginal utility of money and that was the main reason for his visit. In Oslo Frisch absorbed him in econometric work, especially the use of “bunch maps”. Frisch’s work with Waugh continued with the Australian Maurice Belz in the autumn of 1933. The results from the work with Waugh and Belz figures prominently in the Confluence Analysis.” (p. 8)

    Frisch was the first recipient of the Nobel prize in econ (1969); the above article is about his assistant, Haavelmo, who got the prize in 1989.

    Pretty cool stuff. The background on how some of the greatest thinkers of the time used to hang out together is fascinating. Big UofC connection, to boot …

    Comment by markets.aurelius — September 20, 2013 @ 10:51 am

  6. Thanks, @markets. Very interesting. The Cowles Commission was an amazing thing during the Chicago years.

    I conjecture that ag economics was at the cutting edge of econometrics for three reasons, that are somewhat related. First, since agriculture was a bigger part of the economy in those days, it was more attractive as a field of study to leading economists than is the case today. Second, because of its economic importance, studies of agricultural economics attracted more government support (especially at land grant institutions). Third, the data on agricultural quantities and prices was far superior to that for other economic sectors during that period. Some of the data was from private sources: the CBoT produced price data (obviously) but also disseminated a lot of other data in its statistical annuals. Much of the data was produced by the government, again due to the importance of agriculture in the economy, and the political power of farm legislators. (On the data point, one of the main contributions of the Cowles Commission was to collect data on economic activity that the government routinely collects and disseminates today.)

    By the way . . . this post has led to the discovery of the phantom volumes of the FTC study. More on that later. I have seen the tables of contents, and they look fascinating. I expect to receive scans of the full volumes in a week or two.

    And yes, these are well done expositions of ground truth. They were genuinely motivated by a desire to collect facts, and interpret them objectively.

    The ProfessorComment by The Professor — September 20, 2013 @ 6:37 pm

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