Streetwise Professor

August 30, 2012

There is Little New Under the Sun, Wealth of Nations Edition

Filed under: Commodities,Economics,Politics — The Professor @ 12:00 pm

Glencore’s director of agricultural trading, Chris Mahoney, unleashed a torrent of criticism when he remarked:

“The environment is a good one. High prices, lots of volatility, a lot of dislocation, tightness, a lot of arbitrage opportunities.

“We will be able to provide the world with solutions… and that should also be good for Glencore.”

Let the witch hunt begin!  The UN and Oxfam and other NGOs and the allegedly conservative (though really Conservative-there’s a difference) British government responded to Mahoney’s remarks with sputtering outrage:

With the US experiencing a rerun of the drought “Dust Bowl” days of the 1930s and Russia suffering a similar food crisis that could see Vladimir Putin’s government banning grain exports, the senior economist of the UN’s Food and Agriculture Organisation, Concepcion Calpe, told The Independent: “Private companies like Glencore are playing a game that will make them enormous profits.”

Ms Calpe said leading international politicians and banks expecting Glencore to back away from trading in potential starvation and hunger in developing nations for “ethical reasons” would be disappointed.

“This won’t happen,” she said. “So now is the time to change the rules and regulations about how Glencore and other multinationals such as ADM and Monsanto operate. They know this and have been lobbying heavily around the world to water down and halt any reform.

. . . .

Oxfam was scathing about Glencore’s exploitation of volatile world food prices. Jodie Thorpe, from the aid agency’s Grow Campaign, said: “Glencore’s comment that ‘high prices and lots of volatility and dislocation’ was ‘good’ gives us a rare glimpse into the little-known world of companies that dominate the global food system.”

Oxfam said companies like Glencore were “profiting from the misery and suffering of poor people who are worst hit by high and volatile food prices”, adding: “If we are going to fix the ailing food system then traders must be part of the cure.”

Stephen O’Brien, Parliamentary Under Secretary of State for International Development, said: “We know that food-price spikes hit the poorest hardest. Ensuring the poor can still access enough food is vital in times of food-price rises, which is why the UK is investing in safety nets that deliver food and cash to the poorest.”

All of which raises the age old question: Is profit the problem, or the solution?

For economic nitwits like the UN, Oxfam, etc., it is definitely the problem.  And such economic nitwittery has been with us long hence, as Adam Smith noted in his Digression Concerning the Corn Trade and the Corn Laws, Book V of WON (bonus ironic link!-seems appropriate):

In years of scarcity the inferior ranks of people impute their distress to the avarice of the corn merchant, who becomes the object of their hatred and indignation.

Smith goes into detail about how government policies derived from this outrage are destructive, rather than constructive, turning shortages into famines by restricting the efficient flow of grain from places where it is relatively abundant to where it is desperately short-an efficient flow that is best achieved by allowing avaricious grain merchants to profit front the price disparities that these uneven endowments create:

The ancient policy of Europe, instead of discountenancing this popular odium against a trade so beneficial to the public, seems, on the contrary, to have authorized and encouraged it.

By the 5th and 6th of Edward VI, c. 14, it was enacted that whoever should buy any corn or grain with intent to sell it again, should be reputed an unlawful engrosser, and should, for the first fault, suffer two months’ imprisonment, and forfeit the value of the corn; for the second, suffer six months’ imprisonment, and forfeit double the value; and for the third, be set in the pillory, suffer imprisonment during the king’s pleasure, and forfeit all his goods and chattels. The ancient policy of most other parts of Europe was no better than that of England.

Our ancestors seem to have imagined that the people would buy their corn cheaper of the farmer than of the corn merchant, who, they were afraid, would require, over and above the price which he paid to the farmer, an exorbitant profit to himself. They endeavoured, therefore, to annihilate his trade altogether. They even endeavoured to hinder as much as possible any middle man of any kind from coming in between the grower and the consumer; and this was the meaning of the many restraints which they imposed upon the trade of those whom they called kidders or carriers of corn, a trade which nobody was allowed to exercise without a licence ascertaining his qualifications as a man of probity and fair dealing.

. . . .

Whoever examines with attention the history of the dearths and famines which have afflicted any part of Europe, during either the course of the present or that of the two preceding centuries, of several of which we have pretty exact accounts, will find, I believe, that a dearth never has arisen from any combination among the inland dealers in corn, nor from any other cause but a real scarcity, occasioned sometimes perhaps, and in some particular places, by the waste of war, but in by far the greatest number of cases by the fault of the seasons; and that a famine has never arisen from any other cause but the violence of government attempting, by improper means, to remedy the inconveniences of a dearth.

. . . .

The unlimited, unrestrained freedom of the corn trade, as it is the only effectual preventative of the miseries of a famine, so it is the best palliative of the inconveniences of a dearth; for the inconveniences of a real scarcity cannot be remedied, they can only be palliated. No trade deserves more the full protection of the law, and no trade requires it so much, because no trade is so much exposed to popular odium.

Grain traders like Glencore are the visible manifestation of the invisible hand.  The prospect of earning a profit is what drives them to find who is willing to sell grain and who is desperate to buy it.  It is the extreme shock to relative availability that results from regional and localized droughts (or other weather extremes) that makes trade particularly valuable-and profitable.  It is in such conditions that trade-and trading firms-are most valuable.  And as Smith noted, it is precisely then that they make their biggest profits: deprive them of the ability to profit then, and they won’t be there precisely when they are most necessary.  They won’t invest in the physical and human capital needed to facilitate trade.  They won’t generate the dense network of facilities scattered through the world, that are not only the conduits for physical flows, but are also the conduits through which vital information about supply and demand flow: information that permits them to find out where the grain is available and where it is most needed.

To put it bluntly: if you don’t like seeing pictures of starving African babies,  like the one in the Independent story, ignore those sanctimonious moral poseurs like Oxfam and Ms. Calpe who feed what Smith likened to the “popular terrors and suspicions of witchcraft” far more effectively than they feed actual people.  Remember that prices and profits signal scarcity, giving an incentive to conserve and an incentive to move grain where it is most needed.

And as in Smith’s time, governments are the greatest impediment to this process.  For instance, in 2010 Russia embargoed wheat exports, and there is widespread discussion (including by Glencore’s Mr. Mahoney) of whether it will do it again:

But the smart money is betting that Moscow will indeed force overseas sales down by November or December.

Any export restriction is likely to be far different from the ban imposed in 2010, when Moscow introduced what many traders labelled a “brutal” outright export embargo. Instead, the Kremlin is likely to be subtler this time, combining administrative measures that would slow the flow of grain overseas to a trickle. [Again-nothing new under the sun, i.e., Russian “administrative measures.”]

. . . .

Moscow has a large arsenal of tools at its disposal. Export tariffs and quotas are the most obvious; but executives deeply involved in Russian trading say Moscow could use informal and less obvious tools, including its tight control over the railway, to reduce exports without triggering the ire of its trade partners. [Welcome to the WTO!]

. . . .

Christopher Mahoney, the head of agriculture at Glencore and one of the most influential traders of Russian grains, last week warned about possible restrictions. He said that Russia was likely to exhaust its exportable surplus in the next three months, forcing Moscow to “rethink” its current opposition to restrictions.

There were also extremely counterproductive export restrictions (in rice, particularly) during the 2008 price spike.  These are eminently understandable policies from a political economy perspective, but they shouldn’t be confused with enlightened efforts to minimize the impact of shortages of vital foodstuffs.

Do not read this as a blanket endorsement of commodity trading firms and all they do.  That is far from my view: I know that they can, and have, undertaken inefficient and anti-competitive actions that harm commodity producers and consumers.  I will say-and have said-that under oath.  I know they are anything but moral avatars.

But that’s exactly Smith’s point: “It is not from the benevolence of the butcher, the brewer, or the baker , that we can expect our dinner, but from their regard to their own interest.” And a lucky thing, that, because if we did we’d often starve.  And far fewer people starve, or go hungry, because there are avaricious types who do themselves some good by mitigating the impacts of scarcity.  Meaning that if you want to criticize the Glencores or Dreyfuses or Cargills of the world, castigate them for actual sins-manipulation, for instance-that reduce welfare, and applaud their efforts to profit from droughts by mitigating the effects of supply dislocations even though both the vicious and virtuous actions stem from the very same avarice.

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