Streetwise Professor

Cocoa has been on a wild ride for the past year.

So wild that Bloomberg has a separate category for “The Cocoa Crisis.” Contributing to the recent hysteria is news that Hershey has requested “special permission to buy over 90,000 tons of cocoa.” Evidently the chocolate manufacturer has requested a position limit exemption from the CFTC. (Links to the “Cocoa Crisis” coverage are in the article).

Note that exemptions, specifically for hedging, are explicitly recognized in the relevant regulations, and are granted routinely, so this is not really exceptional. Not knowing the exemptions granted to Hershey in the past it is difficult to know whether the magnitude of the exemption is extraordinary.

The article is confusingly written. In commodities subject to limits, there are different kinds of limits. These include single month and all month limits outside the “spot month” and “spot month” limits. Spot month limits kick in sometime prior to expiration. In cocoa, it is my understanding that the spot month limit kicks in on First Notice Day, which for the next ICE Cocoa contract (“CC”), March 2025 (“CCH5”) is 24 February, 2025.

The article implies that the exemption requested is for the spot month:

The maker of Reese’s Peanut Butter Cups wants to take a position that will allow it to purchase more than 90,000 metric tons of cocoa on ICE Futures US, said the people, who asked not to be identified because the information is private. The request to the Commodity Futures Trading Commission equates to about 5,000 20-foot containers and is more than nine times the amount the exchange currently allows.

The spot month limit is 1,000 lots, so 9,000 contracts would be 9x the spot limit. The single month/all month limit is 4,900 contracts, so the requested exemption would be less than 2x the single/all month limit.

I am somewhat skeptical that the exemption request is related to the spot month given that spot exemption requests can occur closer to FND, and the magnitude is so large relative to ICE cocoa certified stocks (currently only 1,604 lots) that granting such an exemption would be problematic. Particularly problematic would be “purchas[ing] more than 90,000 metric tons of cocoa on ICE Futures US” if that means acquiring that much physical cocoa via the delivery process.

But Hershey did that in 2020, and exchange cocoa is supposedly at a discount to the cash market. The cash market discount begs the question: why? Are apples being compared to apples in terms of quality, location, etc.?

Acquiring 90,000 tons–or 25 percent of that amount– would require bringing in large amounts of cocoa to exchange warehouses. That in turn would require acquiring cocoa on the cash market (at a supposed premium), getting it to ICE warehouses, grading it, etc. So it’s hard to believe that cert cocoa is an economical source of supply for Hershey in the quantities mentioned in the Bloomberg article.

The price movement in 2020 sure as hell looks like a squeeze, but neither ICE nor the CFTC took action, so maybe Hershey figures it can do it again.

Unlike 2020, this time the spread didn’t take off:

The March-May 2025 spread did spike in mid-December, but only narrowed slightly after the publication of the Bloomberg article on 8 January. (Perhaps somewhat confusingly, an increase in the spread is referred to as “narrowing”. “Wider” means a bigger carry: “narrower” means less carry or more backwardation).

Here’s 2020 for comparison:

I certainly believe that big commercials can sometimes bamboozle ICE and the CFTC, especially when it comes to telling just so stories about how its economical to take delivery. So it’s not inconceivable that Hershey is trying to do that here, and that they will succeed.

The are other curious things in the article. For example: “A spokesperson for the Pennsylvania-based company said Hershey has a ‘rigorous’ procurement process and that it is ‘well covered’ on its cocoa needs for 2025.” If “well covered” means that Hershey has supply contracts sufficient to meet its anticipated physical needs, why would it need to take delivery? If “well covered” means that they supply contracts are fixed price, Hershey wouldn’t need to hedge using futures. So the company’s statement obfuscates rather than informs if it is intended to ease fears that the company could be hammered by a high and rising cocoa price in 2025.

As I noted before, the epic price rally has put cocoa in the news frequently. Another example is this Reuters article from last month. In brief, the high and volatile cocoa prices have driven speculators from the market, leading to thinner, less liquid markets.

A couple of comments.

First, the exit of hedgies has not caused prices to decline, which implies that they were not the ones that caused the high prices in the first place as has been frequently claimed (as is usually the case when prices move a lot–“round up the usual suspects”).

Second, the reduction in speculative capital makes the price more sensitive to bigfooting by commercials. Like Hershey. Just sayin’.

Third, this demonstrates clearly the effects of clearing and margining. Volatility and high flat prices increase margins and thereby the cash needed to maintain positions. Since cash liquidity can be costly, this raises the cost of providing both long term and short term market liquidity, which leads to the exit of speculative capital that has occurred in cocoa. This in turn increases volatility all things equal. That is, the margining mechanism creates a positive feedback loop that can be detrimental to market performance.

Not to say that the credit risk mitigation benefits of margining don’t outweigh these market liquidity costs. Just pointing out that mitigating credit risk is not cost free.

Given the decline of liquidity and the possibility that a large commercial may lean on the delivery process, the cocoa market is worth keeping an eye on.

As an aside, some years back there were squeezes in cocoa in March. I used to teach my commodity trading course in Geneva in March, and I joked to my students that I should buy CC calendar spreads before heading to Geneva. (I now teach there in April). This March might be particularly interesting.

And of course there was the big Armajaro corner in cocoa in July 2011.

All in all, cocoa can be a source of material for those interested in how er “technical factors” affect pricing. Including me. So I guess you could say I’m coo coo for cocoa:

(A flashback to my youth).

Trump’s Greenland obsession has attracted considerable ridicule (go figure) but increasingly some who cannot be considered reflexive Trumpists are stating that greater US control over the world’s largest island makes good geostrategic sense. In a nutshell, increasing American control over Greenland would enhance America’s strategic position in the Arctic, which is an increasingly important theater of jockeying between world powers. Russia has always been a rival in that region, but now the non-Arctic state of China is making moves there as well. (Come to think of it, Trump’s statements about making Canada the 51st state may reflect the same calculation, especially in light of the collapse of Canada’s military and the globalist, leftist tilt of its government in recent decades).

Note that I wrote “control” above. Ownership is sufficient to obtain control, but it is not always necessary to do so. Control rights can also be obtained by contract, which in an international context would be in the form of a treaty or similar inter-state agreement.

Thus, the real issue is what is the best way for the US to achieve its strategic objectives, via purchase or treaty/contract. That is, this is analogous to a firm deciding whether to vertically integrate to acquire inputs, or instead enter into a contract with a separate firm to do so. (In the IO literature, this is sometimes referred to as the “make or buy” decision).

The major advantage of purchase is that ownership confers exclusivity, and the right to exclude. This is of particular importance in the case of Greenland, where excluding a Chinese presence is essential to achieve US interests. This includes a presence in both facilities/bases and natural resource development.

Now it may be possible to formulate treaty language that would grant exclusivity to the US. However, (a) nations can renege on treaties, and (b) as the case in any contract, there can be ambiguity in treaty language that allows ex post opportunism. Thus, enforcing such exclusivity terms is likely to be costly and the risk of breach is non trivial.

Trump’s rhetoric in another controversial acquisition (re-acquisition, actually) proposal illustrates the issues with enforcing the right to exclude certain uses of an asset. Specifically, the Panama Canal Treaty–actually titled The Treaty Concerning the Permanent Neutrality and Operation of the Panama Canal–required the canal to remain out of the control of any power and granted the US the right to defend the canal against threats to neutral operation and access. This has not prevented the development of massive Chinese port facilities at each end of the canal, facilities that have potential military uses that threaten the US’s access to the canal especially but not only in the event of a Sino-American war.

That is, a case can be made that the US has a right to intervene to eject China from the Canal Zone, or at least would have the right to do so under certain contingencies. The practical enforceability of that right is clearly problematic. It would not be so if the US still controlled the CZ.

Another example of the risks associated with obtaining rights to strategic territory via contract is also in the news, namely the UK’s apparently imminent transfer of control of Diego Garcia to Mauritius–a deal that Starmer is apparently panting to complete before Trump takes office.

Trump’s real estate experience no doubt makes him acutely aware of the trade-offs between leasing a property and owning it. These trade-offs are particularly important when development options are considered, and Greenland would be all about development options–transportation infrastructure, military facilities, and mines (for rare earths, specifically). Writing an even passably complete contract describing and allocating such development rights would be challenging in the extreme, and Trump no doubt understands this clearly.

Ironically, the biggest obstacle to development of a US-owned Greenland would be . . . US law. The entire panoply of environmental law that has throttled development in the US would presumably be applicable to Greenland. Certainly environmental groups (plausibly acting as cat’s paws for China and Russia) would engage in lawfare to restrict development. And a future president could do as Biden just did with respect to offshore energy development, and Biden other presidents have done by proscribing development on some federal land.

In sum, (a) some degree of US control of Greenland would advance American national interests, and national security interests specifically, and (b) obtaining that control via contract (treaty) would likely entail substantial transactions costs in specifying and enforcing those rights. In contrast, ownership would confer control and avoid these transaction costs. Thus, buying Greenland makes economic sense, not in the sense of American investments in Greenland are positive NPV projects, but in the sense that ownership is the most economical way to incentivize and secure those investments. Put differently, transactions cost economics strongly favor achievement of American objectives in Greenland via purchase. It is therefore not surprising that a ruthlessly transactional man who has decades of experience in dealing with the trade-offs involved with purchase and contract is pursuing that course.

The celebrations in some quarters over the cold blooded murder of health insurance company CEO Brian Thompson are beyond sick. Thompson has become dehumanized, and transformed into nothing more than the face of an industry that many despise. The man accused of his murder, Luigi Mangione, a Ted Kaczynski (Unabomber) admirer and radical anti-capitalist evidently believed that his supposedly humanist ideology justifies taking a human life.

That’s wrong regardless of the particulars of the supposed systemic sin he really wants to destroy. It therefore seems somewhat invidious to examine the merits of his motivation. But given that he has received such widespread accolades it is unfortunately necessary.

Take it as given that there are massively dysfunctional elements and intense conflicts in the US healthcare system. But what is the source of those dysfunctions and the resulting dissatisfactions, with respect to insurance in particular?

The fundamental problem inheres in the nature of insurance, and third-party payment for healthcare generally (whether via private insurance or government provision).

Insurance incentivizes moral hazard. In healthcare, part of that moral hazard in due to the insured: they have insufficient incentive to take actions to reduce bad health outcomes. This leads to greater demand for healthcare services. But a big part of the moral hazard problem relates to providers: they have an incentive to overtreat. And facing low marginal cost for additional treatments, the insured have an incentive to overconsume.

Due to moral hazard, risks are not insured completely. One way of limiting insurance coverage is through deductibles–a major source of complaints in our current system. In healthcare particularly, another especially despised way of limiting coverage is to deny some claims–another source of great discontent, and supposedly one of Mangione’s specific grievances (as indicated by his writing “Deny” on at least one of his casings). Especially given the severe information asymmetries between the insurer, the insured, and the provider, in many cases these denials are arbitrary, and would not occur in a Nirvana where information is complete and free. But we don’t live in Nirvana. (And note that denials, and anger about them, are a feature of every type of insurance, be it auto or home or what have you).

That is, there is inherently an adversarial relationship between the insurer and the insured. When the stakes are high–as they are with health–this adversarial relationship is inevitably extremely fraught.

Don’t like denials? Well, if you outlaw them, or even substantially restrict them, you definitely won’t like what insurance costs.

This is not something that moving to a government-run system changes. Medicare and Medicaid also limit coverage and deny coverage for treatments. And look at systems like the UK or Canada where treatments are rationed in large part by waiting, or not getting treated at all.

It is no coincidence, comrades, that Canada and now the UK have implemented “right to die” legislation, which in reality is “right to kill”: offing granny is a very efficacious–and cost effective!–way of denying treatment. Both countries’ systems have proved incapable of providing care at cost that taxpayers can afford, so they are reducing demand through such Orwellian measures, as much as they try to deny that.

So it is not an issue of insurer “greed” or the evils of capitalism. It’s baked into the cake, regardless of the baker.

In countries with socialized medicine, years of government propaganda have helped to diffuse anger at the inadequacies of the health system. In the United States, insurers have been the targets (quite literally in the case of Mr. Thompson), and this has only increased since Obamacare was adopted.

This was effectively a devil’s bargain for the industry. Forcing people to obtain insurance increased the demand for the insurers’ products, but effectively shielded the government from hostility. Given that the insurance industry was a major booster (and in fact author) of Obamacare, it is clear that this was a trade-off that they were quite happy to accept. Although Brian Thompson might beg to differ. If he was alive.

The conflict in healthcare is inherent in the nature of the product, but the conflict has been exacerbated by, and the system hugely distorted by, government policies adopted over the decades.

The original sin is the tying of health insurance to employment, an artifact of labor union lobbying and taxes. The tax-favored nature of paying compensation in the form of benefits rather than wages/salary incentivized employer-provided insurance. This had several malign effects, notably the linkage of insurance with employment, and also the encouragement of excessive coverage (and hence excessive demand for healthcare services) by distorting relative prices.

Other distortions include restricting choice by mandating that insurers provide coverage that individuals don’t want or need. This inflates cost by yet again distorting relative prices. Broader coverage also inevitably leads to more denials, increasing resentment among the insured.

Healthcare insurance is hard. Insurance is hard generally due to information asymmetries, but those generic difficulties are exacerbated by the emotional salience of sickness and health. As a result, insurers will never be loved, and indeed, will almost always be reviled.

Meaning that those whose sickness is a moral rather than physical one who celebrate the death of Brian Thompson are not just moral defectives but mental ones. They attribute the defects of the healthcare and healthcare payment systems to the greed of private enterprises, or the supposed systemic evils of capitalism. The seen vs. the unseen. The things that they hate are inherent in the nature of the service, and can be worse when private enterprise and capitalism don’t deliver it. Don’t believe me? Move to Canada and find out the hard way.

Until I read this post by Nasdaq chief economist Phil Mackintosh I was unaware that the SEC wants stock exchanges to adopt cost-based pricing. Even by regulator standards–and Gensler-era SEC standards in particular–this pegs the Dumb-o-Meter.

It is dumb on many levels. Full spectrum dumb.

For one thing, why would the SEC want cost-based pricing? Presumably because it believes that exchange prices are too high. Why would that be? Market power presumably.

But in the electronic era, and ironically especially in the post-RegNMS era, there is substantial competition between exchanges, and between exchanges and the OTC market. Here’s a chart of trading volume and shares by venue for the last 5 days (found here).

Note that exchanges account for less than half of total volume, with a majority of trading taking place on the OTC market. Even among exchanges, volume is fairly well split, with the NYSE having the biggest share (roughly 1/3 of exchange volumes).

This volume split reflects the competition that resulted from RegNMS in an electronic environment. Given this competition, excessive exchange profits should be the least of the SEC’s worries.

Even if market power was a concern, the idea of cost-based pricing would be inane. Exchanges have fixed and variable costs. Price structures must cover both, but average cost pricing leads to inefficiencies: the price of the marginal trade should equal marginal cost, but marginal cost is virtually impossible to measure. And with fixed costs, it can be efficient to utilize variants of Ramsey Pricing in which prices deviate from marginal costs, and for multi-product firms the deviations between price and marginal cost vary by product. (Exchanges are multi-product firms, offering transaction services, data, listing, and other services). (The SEC might also want to catch up with the economics literature, starting with Coase’s The Marginal Cost Controversy, which is only 78 years old).

Moreover, as Mackintosh notes, exchanges are platforms–though he doesn’t explicitly point out the key fact that they are two sided platforms, as most matching systems are. A crude taxonomy of the two sides in the exchange context is liquidity suppliers and liquidity demanders.

As has been known since two sided platforms became a thing (post-Internet, basically) optimal platform pricing structures can be very complex, and optimal pricing structures are not cost-based. To generate the mix of customers that maximizes platform value it is typically the case that one side pays below cost prices (and may indeed pay a zero price or receive a subsidy). In the exchange context, this is most readily seen in maker-taker or taker-maker pricing structures where the exchange fee differs depending on whether you are the active or the passive side of a transaction.

One aspect of inter-exchange competition is that they compete on price structures in order to optimize platform value. Some exchanges even offer different platforms with different pricing structures. This differentiation accommodates the heterogeneity of traders, some who prefer one structure and others who prefer another. In essence, the platforms are competing for different clienteles.

The idea of imposing a cost-based cookie cutter pricing structure on exchanges is therefore beyond absurd. Not only is it unnecessary to constrain market power, any cost-based structure would be wildly inefficient and completely at odds with the basic economics of exchanges as two-sided platforms.

But I guess that’s what you should expect from an agency dominated by lawyers and accountants.

It is ironic that the SEC apparently doesn’t recognize the benefits of one of its major regulatory initiatives of the past two decades–RegNMS. That regulation led to substantial inter-exchange and inter-platform (exchange-exchange, exchange-OTC) competition. One result of that competition is non-cost-based pricing that reflects the fundamental nature of trading venues as two-sided platforms. Thus, exchange pricing is something that the SEC doesn’t have to worry its pretty little head about.

There is a bigger lesson here, relevant to our DOGE era. Parkinson’s Law says that in a bureaucracy work expands to fill the time available. An agency that has the time to pursue such daft initiatives is obviously over-resourced and over-staffed.

Put differently, idle regulator hands are the Devil’s workshop.

Apropos an earlier post scourging Tyler Cowen’s lament that cutting regulator headcount would harm businesses who rely on regulators’ guidance, there have been numerous articles appearing in the post-election days similarly arguing that regulators are really businesses’ friends. They’re from the government, and there to help you! Really!

But as I noted in that post, much of that “help” is necessary only because regulators create the need for helpers by implementing wasteful, complicated, and intricate rules. Cost-based pricing of exchange services could be a poster child for that. It would be economically unnecessary (because competition constrains pricing) and inherently result in absurdities that would have the regulated running to the regulators for guidance and clarification. Regulators creating jobs for regulators, and justifying their existence thereby.

Angela Merkel is currently on a world tongue bath tour. The occasion is the release of her evidently quite turbid memoir.

A recent stop was in DC, where she was interviewed by Barack Obama. If held at Gitmo, this would be considered a Geneva Convention offense, but people actually stood in line for and paid for the privilege of attending. Of course, they are swamp denizens, and Merkel is a kindred species and Obama is their lord.

In her memoir confesses to not a single error in her long tenure. Zero. Kein!

The lack of self-awareness here is staggering. Germany is currently a basket case. Its economy has been in a prolonged recession. It is in political chaos and social ferment, due in no small part to the mass immigration of recent decades. The phrase “Germany is the sick man of Europe” has considerable currency.

Virtually all of Germany’s current travails can be laid directly at Angela Merkel’s feet. The two biggest problems besetting Germany are energy (which is a major cause of the broader economic malaise) and immigration, both of which are the direct result of Merkel policies. Energiewende (which I have pilloried for over a dozen years) with its renewables obsession and the closing of nuclear plants due to (checks notes) a tsunami in Japan has made German energy among the most expensive in the world. Not a good thing for an energy intensive manufacturing economy! The perversities of the post-Syrian War immigration wave are impossible to ignore–although the German government strives mightily to suppress opposition on the issue.

These were signature Merkel policies. Bad in substance, they were also served up with a huge dollop of supercilious sanctimony. Merkel condemned (and continues to condemn) anyone who opposed them as intellectual and crucially moral inferiors.

In brief, Angela Merkel is the Ms. Magoo of German politics (and world politics, given how she was and is lionized outside of Germany). A blind bumbler who left a trail of chaos and destruction behind her, all the while touting her achievements. “Merkel, you’ve done it again!”

The adulation she is currently receiving suggests she is an exception to Enoch Powell’s dictum that “All political lives, unless they are cut off in midstream at a happy juncture, end in failure, because that is the nature of politics and of human affairs.” And that may be Merkel’s true genius. That she saw what was coming and stepped aside to let others clean up the mess and take the blame. If so, well played!

But that would require a degree of self-awareness that Merkel apparently does not possess. She seems utterly sincere in her belief that she did no wrong, and indeed, did everything right.

But a lack of self-awareness is the most prominent trait of her class. As I’ve written since Trump emerged on the stage in 2015 the establishment/elite/ruling class is completely unaware of the baleful consequences of their overlordship, ignorant of how much they are despised by the hoi polloi, and clueless about their impending doom. Even as it stares them in the face, as evidenced by Trump’s decisive victory and the political chaos in France, Germany, and the UK.

Yet on and on they go, as supercilious and sanctimonious as ever.

We see it in the US in spades, with the Democrats’ complete inability to comprehend or come to grips with the massive repudiation they received a month ago. Obama is the best illustration of this, projecting on Trump and his voters all the horribles (e.g., vote rigging, lawfare) his party has committed, and failing to acknowledge that DEI, wokeness, mass immigration, climate extremism, etc., etc. etc., are widely detested.

These people need to go away. But they never will leave voluntarily. In their narcissistic self-regard they view themselves as God’s gift and their legacies as glorious.

So do to them what they hate most: mock them. Mercilessly. And start with Ms. Magoo.

The structure of financial market regulation has been a source of dissatisfaction since at least the time of the birth of the SEC in the 1930s, and maybe even dating back to the first regulation of futures markets in 1922. Don Wilson of DRW is only the latest of those to express this dissatisfaction.

Since derivatives markets first emerged from their niche in the commodities, and especially agricultural commodities, a lot of the criticism has focused on the bifurcated nature of US regulation, with separate securities and derivatives regulators, the SEC and the CFTC respectively. Why not just have one regulator given the substantial overlaps between securities and derivatives markets? Whereas previous “reform” proposals have been to merge the agencies, Wilson suggests scrapping them both and creating a new unified regulator.

This idea is a hardy perennial and has always struck me as mere org chart shuffling, or furniture rearranging. And that’s the best case. Worse outcomes are very possible.

For one thing, the relevant laws–the Securities and Exchange Acts, and the Commodity Exchange Act–would remain in place, with one commission in charge of implementing both. Many of the conflicts, tensions, and contradictions involving the SEC and the CFTC are rooted in the underlying laws, and would remain post-merger (or replacement with a super agency). The conflicts would become intramural rather than intermural as it were, but would not go away.

For another, I generally favor functional regulation and given the myriad functions of financial markets and institutions subsuming all regulatory oversight to a single agency may well impede functional specialization.

The SEC already represents a good example. In broad strokes the Securities Act relates to securities issuers (e.g., disclosures) and the Exchange Act relates to the trading of securities. Those are two very different functions and only tangentially related. Yet a single regulator oversees both.

The CFTC also has authority over trading per se on some venues.

Both agencies have authority over intermediaries (e.g., broker-dealers, FCMs) and clearing.

Maybe there would be some reasonable rationale for splitting off regulation of issuers from regulation of trading, trading intermediaries, and clearing, and putting these last three in a single silo. But even that is problematic due to path dependence.

We are not starting with a blank slate. The pre-existing statutory division is one historic fact. Another is that derivatives and securities markets have evolved very differently, and that could very much reflect the longstanding regulatory bifurcation.

Is it desirable to move toward uniformity in how derivatives and securities markets are organized and governed, and in essence ignore the historical process that created the current market structures? That’s not immediately obvious given how wrenching and unpredictable the process of achieving uniformity would be–and how rife the unexpected consequences would be.

Moreover, how would the political economy work? There’s no guarantee that the politics of a unified regulator would lead to a more efficient regulatory structure.

Indeed, to me it’s more likely that that rent seeking would rule, and efficiency would be damned. There’s actually a strong argument to be made that competition between regulatory agencies disciplines the rent seeking to some degree. And it can also discipline the ideological fervor of someone like Gary Gensler.

The ongoing drama over crypto regulation is an example. I’m not a crypto evangelist by any means but overall I favor letting market processes determine the outcome. If GiGi was king, or even merely the sole regulator of crypto, that would never happen. Regulatory competition (with the CFTC) constrained Gensler and the SEC, so the market will have the chance to have the final vote.

Indeed, one of Don Wilson’s beefs is very specifically with Gary Gensler. (And oh boy, do I get that!) A regulatory structure with one regulator would make some future GiGi far more dangerous.

Why should regulatory monopoly be looked upon more favorably than private monopoly? Indeed, regulatory monopoly is more dangerous because it cannot be disciplined or undermined by entry. Only the naive who believe in the public interest theory of regulation (and regulators) could believe that a single regulator would act to enhance efficiency rather than exploit its power for often malign reasons.

I have often written that there is a multitude of ways for executing financial transactions that have some common elements because transactors and transactions are heterogeneous. One size does not fit all. (Gensler was something of a one size fits all fanatic at the CFTC). Even though any division will lead to anomalies, conflicts, and regulatory arbitrage, there is enough distinctiveness between say derivatives markets on the one hand and security markets on the other to make separate regulators a better outcome. The division of labor is limited by the extent of the market. The scope of financial markets is so huge that there is considerable division of labor in them, and a division of regulatory labor makes considerable sense too.

Further, although the term “regulatory arbitrage” is typically used as a pejorative, it is not necessarily a bad thing. Indeed, it can be a good thing when market participants use regulatory fragmentation to introduce beneficial innovations that a particular regulator would prevent.

It should also not be forgotten that the SEC and the CFTC are not the only regulatory players in this game. The banking regulators and the Fed are also quite involved, especially on issues relating to intermediaries (who are banks or deeply enmeshed in the banking system) and clearing. Some regulatory fragmentation is inevitable as a result. Just mashing together the SEC and the CFTC will not make the fragmentation disappear.

I say only slightly facetiously that the best effect of regulatory consolidation is that reduced specialization would increase the cost of regulation, leading to less of it. There are no economies of scale, and are in fact diseconomies of scale, at the commissioner level. The bandwidth of the commissioners who are the final arbiters of rules is limited. As a rough estimate, a single commission responsible for double the statutes will have the capacity to produce half the rules as two commissions would. Sounds good to me!

(And no, doubling the number of commissioners would not help. Each commissioner has to weigh in on each proposed rule).

(Less factiously, doubling the workload would empower staff as commissioners would be more reliant on staff to craft rules, and explain them, so rule “output” might not decline that much as the commissioners just end up spending less time on each proposal).

Proposing agency merger or creation of a super agency is almost always a symptom of overall dissatisfaction with regulatory outcomes. But those bad outcomes are usually the result of bad regulators or bad underlying statutes. As noted above, consolidating regulators would increase the power of the bad regulators who will inevitably come along, so be careful what you ask for. And redrawing the regulatory org chart won’t address the statutory problems.

So if you don’t like current regulatory outcomes, don’t focus on the number of agencies and the names on the buildings they occupy: focus on the laws that determine what regulators can do and how they can do it.

Frankendodd was full of bad things, so start with that. Go to a slimmer legal framework that focuses on force and fraud rather than one that attempts to micromanage market macrostructure. Work towards a framework that disempowers would be Gary Genslers rather than the reverse.

Recent Supreme Court decisions, especially Loper, will help by constraining the ability of regulators to go beyond the authority explicitly delegated to regulators by statute. But many of the delegated powers are already too broad, so that needs to be addressed too.

In sum, to fix regulation it is necessary to get to its roots. Its roots are in legislation. Shuffling around who implements the legislative mandates is a superficial response to a deeper problem that originates in the Capitol.

PS. My friend Jeff Carter has a Substack on the same issue. Check it out.

Last week marked the 1000th dreary day of the Russo-Ukrainian War. It also saw a new, and disturbing, phase in the conflict.

Specifically, the Biden Administration (not the non compos mentis Biden, of course, but some shadowy cabal of aides) granted permission to Ukraine to utilize Army Tactical Missile Systems (ATACMs) to attack targets on some Russian territory, specifically Kursk oblast and environs. In response, the Russians launched a nuclear capable experimental intermediate range ballistic missile (IRBM) into Ukraine: the missile was topped with six non-nuclear (and in fact non-explosive) warheads.

In many respects the western response to Russia’s launch was overwrought. It was obviously a signal of escalation dominance that reminded me of Crocodile Dundee and the knife:

“That’s not a missile. That’s a missile.” I see your tactical missile and raise you a ballistic missile. I call.

Regardless of the merits of unleashing the ATACMs (which I will discuss below) it was utterly irresponsible for a lame duck administration to do so. It will not have to deal with the consequences. The incoming Trump administration will. And it can only complicate Trump’s already daunting task in Ukraine. Given how clearly disruptive this move was, it could only have been undertaken with malign intent. An “if we can’t rule, nobody will,” spiteful decision.

Regarding the merits. On the one hand ATACMs do not represent a substantial escalation: Ukraine has for months launched attacks on Russia using drones, and on soil Russia has claimed its own (notably Crimea) using various western-made cruise missiles. However, and ironically, by previously pointedly refusing to permit the use of ATACMs on targets in Russia the administration effectively deferred to Putin’s declaration that doing so would cross a red line. Thus, the volte face can only be interpreted as a deliberate flouting of said line, and therefore a deliberate escalation.

And for what? ATACMs, especially in the limited numbers that the US has supplied to Ukraine, cannot have a decisive effect on the war. (Nor can Storm Shadows, or SCALPs, or Taureses, or JASSMs). At most they can disrupt to some degree Russian logistics (e.g., by blowing up munitions depots) or command and control (by striking headquarters). (The fact that the administration made this argument to justify its previous denial of permission for using ATACMs in Russia demonstrates that it recent reversal was an act of spite rather than a reasoned military judgment).

But Ukraine’s military problems so fundamental that inconveniencing Russian operations in these ways will not be decisive.

Ukraine’s first fundamental problem is manpower. Yes, Russia is suffering far larger casualties, but the bloody minded Putin has shown his willingness to tolerate them, and Russia can absorb them far more readily than Ukraine.

Ukraine’s second fundamental problem is air defense, which has both a tactical and a strategic dimension. Tactically, after almost two years of complete ineffectualness, the Russian air forces finally found a way to influence the battle zone by dropping large numbers of FAB glide bombs (some weighing 3 metric tons) on Ukrainian positions from beyond the range of Ukrainian air defenses. Yes, ATACMs can be used to strike the airfields hosting the SU-34s that drop the bombs, thereby forcing the Russians to base them further away and reducing the number of sorties they can launch, but this effect is at the margins. Strategically, through drones and missiles (like iskander, which is more capable than ATACMs) Russia has devastated Ukraine’s energy infrastructure. Whether Ukraine can survive another winter of concerted attacks on its power grid is debatable.

Zelensky has been screaming for more anti-aircraft missile systems (especially Patriots) and some have been forthcoming, especially from Europe. But the need far outstrips the capacity of the US to provide more.

Ukraine’s third fundamental problem is its military command, starting with Zelensky himself, his military chief Syrski, and his general staff (“GenStabU”). The excellent Sarcastosaurous substack is the go to source on this, but its critique is echoed by Ukrainian troops that bear the consequences of the command’s incompetence.

The problems are myriad. The underlying problem is that old Soviet habits die hard. Most notably, command is overly centralized, leading to slow responses to battlefield crises, and a shocking indifference to information coming from those on the front lines.

The centralization has also led to an extremely defective organizational structure. The Ukrainian army has brigades which control battalions, but it has no divisions that control brigades, or corps that control divisions.

Supposedly because divisions are too expensive. Getting brigades and battalions destroyed due to command and control problems isn’t?

The lack of divisions leads to poor coordination between adjacent brigades, and the Russians have learned to exploit these seams. (Seams between units are always a vulnerability. Multiplying the seams multiplies the vulnerabilities). Moreover, Syrski et al control the brigades and even battalions directly, and shuttle them around willy-nilly in response to the latest front line crisis. This has created numerous opportunities that the Russians have exploited, for example by attacking when a new unit is shuffled into line without adequate preparation, or by putting units with no communication channels next to one another, making coordinated response to Russian attacks almost impossible.

When you see reports of this brigade or that being in some place, it is often not an intact brigade, but just a few battalions (and sometimes only one) from that brigade. Meaning that Ukrainian lines are held by jumbles of units controlled (or pretended to be controlled) by generals in Kyiv with minimal operational awareness. It makes the (often exaggerated) Chateau Generalship of World War I look good by comparison.

The Ukrainian command has also exhibited at times a Hitleresque (or Stalinesque) tendency to demand that units fight to the last and not withdraw when caught in an untenable situation, leading to pointless casualties (including the loss of prisoners who are executed by the Russians). This is particularly disastrous when manpower is in precious short supply–as it is.

Ukraine’s only saving grace is that Russian command is even more incompetent. The difference is that Russia has the material resources to compensate for this incompetence. Ukraine does not.

Ukraine has also made some incomprehensible decisions on how to allocate its scarce resource. Most notably, despite the demonstrated effectiveness of the Russian prepared defenses (and in particular the use of heavy minefields) in stopping the much vaunted but failed Ukrainian counteroffensive of 2023 (the Surovkin Line), time and again Ukraine has failed to fortify obvious targets of Russian offensives.

So as it is, Ukraine is barely hanging on. It’s not losing yet, but it certainly is not winning. And definitely not by Zelensky’s definition of victory: regaining all occupied Ukrainian territory. That is the pipe dream to end all pipe dreams.

Yet he insists on it.

The situation now is that both sides need an end to the fighting, but neither is willing to acknowledge it. Ukraine’s dire circumstances are evident, and although Russia’s aren’t quite so dire, they are bad, and the cost Russia is incurring is certainly not worth the possible gain–adding another string of shitholes to Putin’s collection. Eastern Ukraine was a shithole before Russia invaded: now it is a depopulated shithole buried under rubble.

And the economic consequences for Russia have been baleful. Speaking of rubble, that describes the ruble now: it is now worth less than a penny. Official Russian statistics tout the strength of the Russian economy, but it is a war economy. Shoveling massive resources to the military, to be blown up in Ukraine, props up GDP, but people don’t consume aggregates. The economic circumstances of Russians have degraded substantially in the past 1000 days, and will only degrade more every additional day the war goes on. The Portuguese living standards that Putin once promised are a bad joke now.

Neither side can achieve victory as they have defined it. Heretofore neither side has been willing to acknowledge that.

Trump has boasted that he will end the war. Given the intransigence of the parties, this boast seems unrealistic. But perhaps he can exploit the fact that neither side gains from continuing the war to to cobble together something resembling peace.

The most likely path: another frozen conflict in which Putin will get de facto control of what he has grabbed in the past two plus years.

The biggest obstacle to this outcome is Zelensky. I think he is genuinely dead set (emphasis on the dead) on driving the Russians from Ukrainian territory. But that is a delusion.

Zelensky, apparently not realizing that he who pays the piper calls the tune, has demanded that the west supply the resources to achieve his objective. For one thing, such resources don’t exist, and meeting even a fraction of Zelensky’s demands would denude the US’s already scanty stocks of missiles and shells. The US has more pressing concerns than eastern Europe: eastern Asia in particular. Moreover, the real binding constraint on Zelensky’s ambitions is not hardware but meatware. Ukraine has too few soldiers, a large fraction of its military-age population is unwilling to serve, and it is even more of a demographic basket case than Russia.

In brief, Zelensky played a vital role at the outset of the war, and his conduct then was exemplary. But it has quite clearly gone to his head, and he is now a delusional autocrat who is an existential threat to the people he claims to represent. Not to mention a military incompetent (as discussed above).

The establishments in the United States and Europe inveigh against a settlement that leaves Putin in control of even a sliver of Ukraine. They invoke the ghost of Munich, and claim that Putin will use the respite to rearm and will then set his sights on Nato’s eastern flank.

As if. If this war has shown anything, it has shown that Russia’s ability to project conventional military power beyond its borders is virtually non-existent. Further, the army that went into Ukraine was supposedly the product of serious reforms that addressed the flaws exposed in Georgia in 2008. In the event, it wasn’t. Given the systemic defects of the Russian system (of which corruption in the military is just one symptom) any future “reforms” are almost certain to be as tragicomic as the previous ones.

And how long would they take? Years. The establishments obsess on Putin, who is already 72. He will be well past his sell by date (especially by Russian male standards) by the time his allegedly reformed military will be capable of doing anything. And that is time that the Europeans can use to put on their big boy lederhosen and pantalons and create something other than Potemkin militaries that Putin (or more likely his successor) would be unwilling to confront.

That is, deterrence of Russia is completely in European hands. And if they decide to forego it, that’s their choice and their problem.

So Trump has a chance to realize his boast by negotiating (a la Teddy Roosevelt perhaps) an outcome that satisfies no one. But war is politics by other means, and politics is the art of the possible. The dreams of Putin, Zelensky, and the establishment are impossible. If Trump can get them to accept that, an imperfect peace is possible. And an imperfect peace is far preferable to the current nightmare.

The biggest challenge to achieving this is making it clear to Putin that he cannot prevail. Abandoning Ukraine altogether now would undermine that. So, rhetoric and I think genuine belief notwithstanding, to get his peace Trump will have to hold his nose and continue to fund Ukraine to some extent. The delicate balance to be found is between providing enough support to persuade Putin that continuing the war is futile, but not so much as to refill Zelensky’s pipe of dreams.

The acts of the dying Biden administration are certainly no help. The road to a settlement is torturous enough as it is without its malign actions.

Give Trump a chance. The odds are against him, given the characters involved in the conflict. But the Biden administration seems hell bent on stacking the odds against him and denying him–and hence those dying in Ukraine–that chance.

Donald Trump’s post-election blitzkrieg (see! He is Hitler!) has shocked and awed the ruling class. One of his moves that has attracted the most attention is his announcement of a “Department of Governmental Efficiency” (“DOGE”) to be headed by Elon Musk and Vivek Ramaswamy.

Musk has promised to use the yet-to-be-formally-established non-department department to trim trillions of dollars from federal spending (although it is somewhat unclear if this is an annual number or a cumulative total over some period).

The mechanism by which this laudable goal can be accomplished is unclear, given Congress’ power of the purse, and previous Supreme Court rulings regarding things like impoundment by which the president can thwart Congressional appropriations. Various stratagems have been floated, but these will set up a Constitutional clash, which, ironically, will get bogged down in the political and judicial quagmire that is the source of much inefficiency.

Moreover, it must be recognized that the room for budgetary maneuver is quite limited. Entitlements plus interest (including spending on veterans in entitlements) consume about 53 percent of federal spending. Discretionary spending accounts for “only” $1.6 trillion, half of which is for the Pentagon. Even axing entire departments, like the Department of Education, would only free up modest sums: Department of Education spending accounts for 4 percent of the budget, and no doubt closing down the entire monstrosity would result in a lot of that spending being shuffled elsewhere. (The case for eliminating Education rests–and rests quite firmly–on non-budgetary grounds, namely its destructive effects on American education at all levels).

Looking at trends, the Covid spending spikes (which added appreciably to debt and per the Fiscal Theory of the Price Level were a major contributor to inflation) stand out, but so does the increase in the growth rate of federal spending under Biden.

Notably, Federal spending plateaued during the post-2010 period of divided government, then ticked up under Trump (no budget hawk he), and accelerated markedly under Biden.

Therefore, the best outcome is to try to recapture the (relative) budget discipline that prevailed post-GFC, and post-Republican capture of the House in 2010. This is something that will have to come from Congress, and from Trump. Not from Elon and Vivek.

This is not to say that DOGE is futile. It can–and should–focus on non-spending sources of government inefficiency, but particularly on the inefficiencies that the government inflicts on the private sector through regulation. Especially during the Biden administration, the administrative agencies have run amok in imposing new rules, interpreting existing ones in pernicious ways, and regulating by enforcement. The new administration has considerable–though not untrammeled–power to cut back on this thicket, and pretty much complete discretion at not adding to it.

This is exactly the domain which exercised Musk most, as epitomized by his Parable of the Sharks and Whales:

Gulliver Musk’s SpaceX in particular (but Tesla too) has been attacked by regulatory Lilliputians. And X would clearly have been in a Harris administration’s regulatory cross hairs.

Here DOGE can perform yeoman’s service to propose, but it will still be up to the agencies to dispose. And those efforts will also trigger protracted legal battles. But there are battles that must be waged, and DOGE can perform a vital role of identifying the most egregious problems, the fixing of which would generate the most benefits.

This is also the area where the name-and-shame aspect of DOGE can work best. Lacking any real authority, DOGE can best serve as a bully pulpit (and hopefully a bullying pulpit) to galvanize public support for anti-regulatory efforts. As a strategy guide, I recommend Alinsky’s Rules for Radicals. Virtually all of them could be quite useful to DOGE, including “ridicule is man’s most potent weapon” and “pick the target, freeze it, personalize it, and polarize it.”

Back in the day, Senator William Proxmire had his Golden Fleece Award that ridiculed particularly absurd examples of government spending. DOGE should initiate something like that, perhaps even on a weekly basis. It could echo Proxmire’s focus on spending, but it should especially focus on regulatory outrages and absurdities.

It could also serve as a clearinghouse for complaints about regulatory abuse. You know, sort of like from the days when the doges ruled Venice:

No doubt the most useful information would come from within the agencies themselves, as many of the apparatchiks within said agencies will no doubt be waging guerrilla war against de-regulatory efforts and only their peers will be able to expose them.

There are two ways to rescue the United States from its parlous fiscal circumstances: cut spending, or increase growth. I doubt DOGE can do much regarding the first, but can contribute materially to the second. Attacking regulation-induced economic sclerosis would provide a much needed fillip to the American economy, which would spur federal revenues and help boost primary surpluses. This would also have salutary effects on inflation, again per the Fiscal Theory of the Price Level.

I wish Musk and Ramaswamy and those they attract to DOGE the best. They have set for themselves the Herculean task of cleaning the Augean Stables in DC. The best way to perform it is to prioritize and to optimize the use of the tools at hand. Given the numerous obstacles to tackling spending directly, this dictates a focus on regulation, and the mobilization through transparency of popular awareness of its myriad perversities.

Note. According to Wikipedia, the word “doge” “originally referring to any military leader, becoming in the Late Roman Empire the title for a leader of an expeditionary force formed by detachments (vexillationes) from the frontier army (limitanei), separate from, but subject to, the governor of a province, authorized to conduct operations beyond provincial boundaries.” That actually seems quite appropriate here, especially the authorization to conduct operations beyond boundaries.

There is a bit of a kerfuffle in futures world about the CME winning approval from the Natinoal Futures Association (NFA) to operate its own brokerage firm (futures commission merchant “FCM”). The industry is pretty unified in its opposition to this “vertical integration” by the CME that will put it into competition with some of its customers.

(Once upon a time I worked on the 15th floor of the tower on the left).

I think this will turn out to be much ado about nothing. Yes, CME has the right to open an FCM, but whether it will, or how big it will be if it does, is very much open to doubt.

Recall that the CME launched this initiative in response to FTX’s adoption of this model. (The fact that the CME obtained approval almost exactly 2 years after FTX went kaput tells you a lot about the speed at which regulators work). FTX is no more, and no other exchange, crypto or otherwise, has adopted the model. So there’s no perceived competitive threat from an integrated exchange, which reduces (and perhaps eliminates) the CME’s need to bring the FCM to life. It likely pursued the application after FTX’s demise as a precautionary measure.

If that’s right, the FCM will remain on the shelf.

And I think it will because it’s hard to make a business case for it. Let’s consider the various economic rationales for such integration.

One commonly asserted one is to leverage monopoly power. Commonly asserted, and wrong. The one monopoly rent theorem implies that except under very special (and usually quite contrived) circumstances, a monopolist (which CME arguable is in most of its products, and in clearing) can extract all the rents from its market power by pricing its own product, and cannot increase profit be obtaining market power upstream or downstream.

Regulated monopolists have sometimes integrated to circumvent rate regulation. For example, ATT owned its equipment supplier Western Electric. ATT operated under rate of return regulation, but could circumvent that by purchasing equipment from its subsidiary at inflated prices.

That doesn’t apply to CME. It is a regulated monopolist but not subject to rate of return regulation.

Integration can also be a way of circumventing price controls. That’s also not an issue here.

Vertical integration can mitigate transactions costs when there are bilateral monopolies (at least after the “fundamental transformation” that occurs when the upstream and downstream firms make relationship specific investments). The FCM sector is pretty fragmented and competitive, and does not fit this “scorpions in.a bottle” template.

Another reason for vertical integration is double marginalization. This occurs when both the upstream and downstream firms have some market power. Each charges a price above marginal cost, and in general the all in price exceeds the joint profit maximizing price.

Again, the FCM sector, though more concentrated than it was historically, is still highly competitive. It’s not impossible that FCM prices (commissions and data charges) exceed marginal cost, but not by much.

But it is not outside the realm of possibility that CME believes that the more concentrated FCM industry could use a little price competition. An exec at Interactive Brokers apparently thinks so: “If they’re going to undercut our pricing and offer cheaper market data then that will be a problem.” (It’s quite interesting that market data is mentioned. That’s a big deal in the modern electronic world).

Pro tip: “we don’t like the fact that they may compete with us on price” is not a public spirited rationale for opposing a competitor’s or potential competitor’s action.

I consider this to be the most likely reason for CME to activate an FCM and operate it seriously. And that would not be a bad thing. Although the impact on the ultimate customer is likely to be modest because lower FCM prices would permit CME to jack up its price. But the combined CME+FCM price would be lower if there is indeed double marginalization going on. That would benefit the ultimate customer.

Another reason for integration would be for the CME to secure better information on the costs of supply and the demand for FCM services. This could help it optimize its pricing.

The one potential real concern about CME’s move is that it is a self-regulatory organization that polices FCMs, and that it might favor its own or try to raise its rivals’ costs through exercise of its oversight facilities. But note that the NFA, which granted approval, regulates FCMs (under CFTC auspices).

In sum, absent competition from a new integrated FTX copycat, I don’t see a compelling business case for the CME to turn on the lights to its newly approved FCM, or at least to operate one at a scale that would compete seriously with the bank-owned big boys. (Funny how that form of integration gets little comment or scrutiny, eh?). The reason that it might–to stimulate price competition in the FCM space and mitigate double marginalization–would benefit customers, though perhaps not by much. The self-dealing issue is ameliorated considerably by the fact that the NFA regulates FCMs. (Indeed, political economy considerations, namely pressure from other NFA members, might make the NFA be harder on the CME).

So all in all, nothing to get hot and bothered about.

As a small example of the joys of Californication that would spread to the entire US under a Harris administration, a couple of days ago Gavin Newsom signed legislation that would empower the state’s Clean Air Board to require California refiners to hold certain levels of. inventory. The objective of this legislation is to prevent the price spikes that periodically occur in the state.

Implicit in this legislation is the idea that inventories are too low. Why would that be? What market failure is there that induces such allegedly suboptimal behavior? None has been provided.

And no, the existence of price spikes is not evidence of inefficiency, and in particular inefficiently low inventories. In fact, in an efficient market for a storable commodity, price spikes should occur periodically: their absence would be evidence of excessive inventory holding.

The intuition is straightforward. Spikes occur when there are stockouts–when inventories fall to low levels due to supply and demand shocks. But it is optimal to have stockouts. If you didn’t, that would mean that you have produced something that is never consumed, which is obviously wasteful. So inventories should be drawn down to low levels periodically, and prices should spike then. Therefore, prices should spike periodically.

The cover of my book on commodity price dynamics based on the theory of storage has a graph of a simulated efficient, competitive market price for a storable commodity. It has spikes.

Forcing excessive stockholding is inefficient. Moreover, it tends to raise prices on average even if it reduces the frequency of price spikes. The only way to increase inventories that are consumed in certain periods is by reducing consumption during other periods. That requires higher prices in these other periods.

But spikes are politically salient, whereas higher prices most of the time get treated as the baseline, as being normal. The fact that those baseline prices are higher than they would be absent the mandated stockholding is hidden from most voters. So politicians can claim credit for shaving off some of the highly visible spikes, and aren’t blamed for the hidden cost (i.e., higher everyday prices).

That’s all assuming the legislation has the intended (if inefficient) effect of raising inventories. But it might not. As I understand it, the mandate applies to refiners. But non-refiners–traders in particular–hold stocks too. Indeed, those are most likely to be the “speculative stocks” that are used to smooth out supply and demand fluctuations, thereby reducing price volatility.

Mandating higher refiner stocks is likely to result in a reduction in these speculative stocks, thereby reducing the effect of the regulation. Given that holding excessive inventories is inefficient, this offsetting is a good thing. Indeed, it is possible that the offset will be 100 percent, meaning that every increase in refiner stocks is offset exactly by a decline in non-refiner stocks, thereby vitiating entirely the effect of the law.

So, the possibilities are: (a) the regulation will increase what consumers pay for gasoline, or (b) it will have no effect. Making consumers better off is not one of the possibilities.

Newsom has used the legislation to demonize oil companies, whom he claims make too much money, as evidenced by the high prices Californians pay for fuel, relative to those who live elsewhere.

Riddle me this, Gavin: if being in the refining business in the Golden State is so damned lucrative, why have 7 refineries in the state shut down in the last decade? Indeed, hot on the heels of Newsom’s crowing over the law, Phillips66 announced it is closing its refinery in California.

Note to the slow learners (and no learners): exit is not a sign of excess profits. Quite the contrary.

But this is the type of deep economic thinking that infests progressives, and which they want to inflict on all of us. Oh, if what happens in California were to stay in California, what happiness there would be for the rest of us. But the Democratic party wants to Californicate all of America instead.