Global Significance of Chinese Investments. My Deliberations in Mumbai (04/03/2018)

Legends:

What are fitted values in statistics?

The values for an output variable that have been predicted by a model fitted to a set of data. a statistical is generally an equation, the graph of which includes or approximates a majority of data points in a given data set. Fitted values are generated by extending the model of past known data points in order to predict unknown values. These are also called predicted values.

What are outliers in statistics?

These are observation points that are distant from other observations and may arise due to variability in the measurement  or it may indicate experimental errors. These may also arise due to heavy tailed distribution.

What is LBS (Locational Banking statistics)?

The locational banking statistics gather quarterly data on international financial claims and liabilities of bank offices in the reporting countries. Total positions are broken down by currency, by sector (bank and non-bank), by country of residence of the counterparty, and by nationality of reporting banks. Both domestically-owned and foreign-owned banking offices in the reporting countries record their positions on a gross (unconsolidated) basis, including those vis-à-vis own affiliates in other countries. This is consistent with the residency principle of national accounts, balance of payments and external debt statistics.

What is CEIC?

Census and Economic Information Centre

What are spillover effects?

These refer to the impact that seemingly unrelated events in one nation can have on the economies of other nations. since 2009, China has emerged a major source of spillover effects. This is because Chinese manufacturers have driven much of the global commodity demand growth since 2000. With China now being the second largest economy in the world, the number of countries that experience spillover effects from a Chinese slowdown is significant. China slowing down has a palpable impact on worldwide trade in metals, energy, grains and other commodities.

How does China deal with its Non-Performing Assets?

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China adopted a four-point strategy to address the problems. The first was to reduce risks by strengthening banks and spearheading reforms of the state-owned enterprises (SOEs) by reducing their level of debt. The Chinese ensured that the nationalized banks were strengthened by raising disclosure standards across the board.

The second important measure was enacting laws that allowed the creation of asset management companies, equity participation and most importantly, asset-based securitization. The “securitization” approach is being taken by the Chinese to handle even their current NPA issue and is reportedly being piloted by a handful of large banks with specific emphasis on domestic investors. According to the International Monetary Fund (IMF), this is a prudent and preferred strategy since it gets assets off the balance sheets quickly and allows banks to receive cash which could be used for lending.

The third key measure that the Chinese took was to ensure that the government had the financial loss of debt “discounted” and debt equity swaps were allowed in case a growth opportunity existed. The term “debt-equity swap” (or “debt-equity conversion”) means the conversion of a heavily indebted or financially distressed company’s debt into equity or the acquisition by a company’s creditors of shares in that company paid for by the value of their loans to the company. Or, to put it more simply, debt-equity swaps transfer bank loans from the liabilities section of company balance sheets to common stock or additional paid-in capital in the shareholders’ equity section.

Let us imagine a company, as on the left-hand side of the below figure, with assets of 500, bank loans of 300, miscellaneous debt of 200, common stock of 50 and a carry-forward loss of 50. By converting 100 of its debt into equity (transferring 50 to common stock and 50 to additional paid-in capital), thereby improving the balance sheet position and depleting additional paid-in capital (or using the net income from the following year), as on the right-hand side of the figure, the company escapes insolvency. The former creditors become shareholders, suddenly acquiring 50% of the voting shares and control of the company.

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The first benefit that results from this is the improvement in the company’s finances produced by the reduction in debt. The second benefit (from the change in control) is that the creditors become committed to reorganizing the company, and the scope for moral hazard by the management is limited. Another benefit is one peculiar to equity: a return (i.e., repayment) in the form of an increase in enterprise value in the future. In other words, the fact that the creditors stand to make a return on their original investment if the reorganization is successful and the value of the business rises means that, like the debtor company, they have more to gain from this than from simply writing off their loans. If the reorganization is not successful, the equity may, of course, prove worthless.

The fourth measure they took was producing incentives like tax breaks, exemption from administrative fees and transparent evaluations norms. These strategic measures ensured the Chinese were on top of the NPA issue in the early 2000s, when it was far larger than it is today. The noteworthy thing is that they were indeed successful in reducing NPAs. How is this relevant to India and how can we address the NPA issue more effectively?

For now, capital controls and the paying down of foreign currency loans imply that there are few channels through which a foreign-induced debt sell-off could trigger a collapse in asset prices. Despite concerns in 2016 over capital outflow, China’s foreign exchange reserves have stabilised.

But there is a long-term cost. China is now more vulnerable to capital outflow. Errors and omissions on its national accounts remain large, suggesting persistent unrecorded capital outflows. This loss of capital should act as a salutary reminder to those who believe that China can take the lead on globalisation or provide the investment or currency business to fuel things like a post-Brexit economy.

The Chinese government’s focus on debt management will mean tighter controls on speculative international investments. It will also provide a stern test of China’s centrally planned financial system for the foreseeable future.

Global Significance of Chinese investments

Conjuncted: Financialization of Natural Resources – Financial Analysis of the Blue Economy: Sagarmala’s Case in Point.

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The financialization of natural resources is the process of replacing environmental regulation with markets. In order to bring nature under the control of markets, the planet’s natural resources need to be made into commodities that can be bought or sold for a profit. It is a means of transferring the stewardship of our common resources to private business interests. The financialization of nature is not about protecting the environment, rather it is about creating ways for the financial sector to continue to earn high profits. Although the sector has begun to rebound from the financial crisis, it is still below its pre-crisis levels of profit. By pushing into new areas, promoting the creation of new commodities, and exploiting the real threat of climate change for their own ends, financial companies and actors are placing the whole world at the risk of precarity.

A systemic increase in financial speculation on commodities mainly driven by deregulation of derivative markets, increasing involvement of investment banks, hedge funds and other institutional investor in commodity speculation and the emergence of new instruments such as index funds and exchange-traded funds. Financial deregulation over the last one decade has for the first time transformed commodities into financial assets. what we might call ‘financialization’, is thus penetrating all commodity markets and their functioning. Contrary to common sense and what civil society assumes, financial markets are going deeper and deeper into the real economy as a response to the financial crisis, so that speculative capital is structurally being intertwined with productive capital – in this case commodities and natural resources.

Marine ecology as a natural resource isn’t immune to commodification, and an array of financial agents are making it their indispensable destination, thrashing out new types of alliances converging around specific ideas about how maritime and coastal resources should be organized, and to whose benefit, under which terms and to what end? The commodification of marine ecology is what is referred to as Blue Economy, which is converging on the necessity of implementing policies across scales that are conducive to, what in the corridors of those promulgating it, a win-win-win situation in pursuit of ‘sustainable development’, entailing pro-poor, conservation-sensitive blue growth. What one cannot fail to notice here is that Blue Economy is close on heels to what Karl Marx called the necessary prerequisite to capitalism, primitive accumulation. If in the days of industrial revolution and at a time when Marx was writing, natural resources like lands were converted into commercial commodities, then today under the rubric of neoliberalism, the attack is on the natural resources in the form of converting them into speculative capital. But as commercial history has undergone a change, so has the notion of accumulation. Today’s accumulation is through the process of dispossession. In the green-grabbing frame, conservation initiatives have become a key force driving primitive accumulation, although, the form that primitive accumulation through conservation takes is very different from that initially described by Marx, as conservation initiatives involve taking nature out of production – as opposed to bringing them in through the initial enclosures described by Marx. Under such unfoldings, even the notional appropriation undergoes an unfolding, in that, it implies the transfer of ownership, use rights and control over resources that were once publicly or privately owned – or not even the subject of ownership – from the poor (or everyone including the poor) in to the hands of the powerful.

Moreover, for David Harvey, states under neoliberalism become increasingly oriented toward attracting foreign direct investment, i.e. specifically actors with the capital to invest whereas all others are overlooked and/or lose out. Central in all of these dimensions is the assumption in market-based neoliberal conservation that “once property rights are established and transaction costs are minimized, voluntary trade in environmental goods and bads will produce optimal, least-cost outcomes with little or no need for state involvement.”. This implies that win-win- win outcomes with benefits on all fronts spanning corporate investors, the local communities, biodiversity, national economies etc., are possible if only the right technocratic policies are put in place. By extension this also means side-stepping intrinsically political questions with reference to effective management through economic rationality informed by cutting-edge ecological science, in turn making the transition to the ‘green economy’ conflict-free as long as the “invisible hand of the market is guided by [neutral] scientific expertise”. While marine and coastal resources may have been largely overlooked in the discussions on green grabbing and neoliberal conservation, a robust, but small, critical literature has been devoted to looking specifically into the political economy of fisheries systems. Focusing on one sector in the outlined ‘blue economy’, this literature uncovers “how capitalist relations and dynamics (in their diverse and varying forms) shape and/or constitute fisheries systems.”

The question then is, how far viable or sustainable are these financial interventions? Financialization produces effects which can create long-term trends (such as those on functional income distribution) but can also change across different periods of economic growth, slowdown and recession. Interpreting the implications of financialization for sustainability, therefore, requires a methodological diverse and empirical dual-track approach which combines different methods of investigations. Even times of prosperity, despite their fragile and vulnerable nature, can endure for several years before collapsing due to high levels of indebtedness, which in turn amplify the real effects of a financial crisis and hinder the economic growth. Things begin to get a bit more complicated when financialization interferes with environment and natural resources, for then the losses are not just merely on a financial platform alone. Financialization has played a significant role in the recent price shocks in food and energy markets, while the wave of speculative investment in natural resources has and is likely to produce perverse environmental and social impact. Moreover, the so-called financialization of environmental conservation tends to enhance the financial value of environmental resources but it is selective: not all stakeholders have the same opportunities and not all uses and values of natural resources and services are accounted for. This mechanism brings new risks and challenges for environmental services and their users that are excluded by official systems of natural capital monetization and accounting. This is exactly the precarity one is staring at when dealing with Blue Economy.

Synthetic Structured Financial Instruments. Note Quote.

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An option is common form of a derivative. It’s a contract, or a provision of a contract, that gives one party (the option holder) the right, but not the obligation to perform a specified transaction with another party (the option issuer or option writer) according to specified terms. Options can be embedded into many kinds of contracts. For example, a corporation might issue a bond with an option that will allow the company to buy the bonds back in ten years at a set price. Standalone options trade on exchanges or Over The Counter (OTC). They are linked to a variety of underlying assets. Most exchange-traded options have stocks as their underlying asset but OTC-traded options have a huge variety of underlying assets (bonds, currencies, commodities, swaps, or baskets of assets). There are two main types of options: calls and puts:

  • Call options provide the holder the right (but not the obligation) to purchase an underlying asset at a specified price (the strike price), for a certain period of time. If the stock fails to meet the strike price before the expiration date, the option expires and becomes worthless. Investors buy calls when they think the share price of the underlying security will rise or sell a call if they think it will fall. Selling an option is also referred to as ”writing” an option.
  • Put options give the holder the right to sell an underlying asset at a specified price (the strike price). The seller (or writer) of the put option is obligated to buy the stock at the strike price. Put options can be exercised at any time before the option expires. Investors buy puts if they think the share price of the underlying stock will fall, or sell one if they think it will rise. Put buyers – those who hold a “long” – put are either speculative buyers looking for leverage or “insurance” buyers who want to protect their long positions in a stock for the period of time covered by the option. Put sellers hold a “short” expecting the market to move upward (or at least stay stable) A worst-case scenario for a put seller is a downward market turn. The maximum profit is limited to the put premium received and is achieved when the price of the underlyer is at or above the option’s strike price at expiration. The maximum loss is unlimited for an uncovered put writer.

Coupon is the annual interest rate paid on a bond, expressed as percentage of the face value.

Coupon rate or nominal yield = annual payments ÷ face value of the bond

Current yield = annual payments ÷ market value of the bond

The reason for these terms to be briefed here through their definitions from investopedia lies in the fact that these happen to be pillars of synthetic financial instruments, to which we now take a detour.

According to the International Financial Reporting Standards (IFRS), a synthetic instrument is a financial product designed, acquired, and held to emulate the characteristics of another instrument. For example, such is the case of a floating-rate long-term debt combined with an interest rate swap. This involves

  • Receiving floating payments
  • Making fixed payments, thereby synthesizing a fixed-rate long-term debt

Another example of a synthetic is the output of an option strategy followed by dealers who are selling synthetic futures for a commodity that they hold by using a combination of put and call options. By simultaneously buying a put option in a given commodity, say, gold, and selling the corresponding call option, a trader can construct a position analogous to a short sale in the commodity’s futures market.

Because the synthetic short sale seeks to take advantage of price disparities between call and put options, it tends to be more profitable when call premiums are greater than comparable put premiums. For example, the holder of a synthetic short future will profit if gold prices decrease and incur losses if gold prices increase.

By analogy, a long position in a given commodity’s call option combined with a short sale of the same commodity’s futures creates price protection that is similar to that gained through purchasing put options. A synthetic put seeks to capitalize on disparities between call and put premiums.

Basically, synthetic products are covered options and certificates characterized by identical or similar profit and loss structures when compared with traditional financial instruments, such as equities or bonds. Basket certificates in equities are based on a specific number of selected stocks.

A covered option involves the purchase of an underlying asset, such as equity, bond, currency, or other commodity, and the writing of a call option on that same asset. The writer is paid a premium, which limits his or her loss in the event of a fall in the market value of the underlying. However, his or her potential return from any increase in the asset’s market value is conditioned by gains limited by the option’s strike price.

The concept underpinning synthetic covered options is that of duplicating traditional covered options, which can be achieved by both purchase of the underlying asset and writing of the call option. The purchase price of such a product is that of the underlying, less the premium received for the sale of the call option.

Moreover, synthetic covered options do not contain a hedge against losses in market value of the underlying. A hedge might be emulated by writing a call option or by calculating the return from the sale of a call option into the product price. The option premium, however, tends to limit possible losses in the market value of the underlying.

Alternatively, a synthetic financial instrument is done through a certificate that accords a right, based on either a number of underlyings or on having a value derived from several indicators. This presents a sense of diversification over a range of risk factors. The main types are

  • Index certificates
  • Region certificates
  • Basket certificates

By being based on an official index, index certificates reflect a given market’s behavior. Region certificates are derived from a number of indexes or companies from a given region, usually involving developing countries. Basket certificates are derived from a selection of companies active in a certain industry sector.

An investment in index, region, or basket certificates fundamentally involves the same level of potential loss as a direct investment in the corresponding assets themselves. Their relative advantage is diversification within a given specified range; but risk is not eliminated. Moreover, certificates also carry credit risk associated to the issuer.

Also available in the market are compound financial instruments, a frequently encountered form being that of a debt product with an embedded conversion option. An example of a compound financial instrument is a bond that is convertible into ordinary shares of the issuer. As an accounting standard, the IFRS requires the issuer of such a financial instrument to present separately on the balance sheet the

  • Equity component
  • Liability component

On initial recognition, the fair value of the liability component is the present value of the contractually determined stream of future cash flows, discounted at the rate of interest applied at that time by the market to substantially similar cash flows. These should be characterized by practically the same terms, albeit without a conversion option. The fair value of the option comprises its

  • Time value
  • Intrinsic value (if any)

The IFRS requires that on conversion of a convertible instrument at maturity, the reporting company derecognizes the liability component and recognizes it as equity. Embedded derivatives are an interesting issue inasmuch as some contracts that themselves are not financial instruments may have financial instruments embedded in them. This is the case of a contract to purchase a commodity at a fixed price for delivery at a future date.

Contracts of this type have embedded in them a derivative that is indexed to the price of the commodity, which is essentially a derivative feature within a contract that is not a financial derivative. International Accounting Standard 39 (IAS 39) of the IFRS requires that under certain conditions an embedded derivative is separated from its host contract and treated as a derivative instrument. For instance, the IFRS specifies that each of the individual derivative instruments that together constitute a synthetic financial product represents a contractual right or obligation with its own terms and conditions. Under this perspective,

  • Each is exposed to risks that may differ from the risks to which other financial products are exposed.
  • Each may be transferred or settled separately.

Therefore, when one financial product in a synthetic instrument is an asset and another is a liability, these two do not offset each other. Consequently, they should be presented on an entity’s balance sheet on a net basis, unless they meet specific criteria outlined by the aforementioned accounting standards.

Like synthetics, structured financial products are derivatives. Many are custom-designed bonds, some of which (over the years) have presented a number of problems to their buyers and holders. This is particularly true for those investors who are not so versatile in modern complex instruments and their further-out impact.

Typically, instead of receiving a fixed coupon or principal, a person or company holding a structured note will receive an amount adjusted according to a fairly sophisticated formula. Structured instruments lack transparency; the market, however, seems to like them, the proof being that the amount of money invested in structured notes continues to increase. One of many examples of structured products is the principal exchange-rate-linked security (PERLS). These derivative instruments target changes in currency rates. They are disguised to look like bonds, by structuring them as if they were debt instruments, making it feasible for investors who are not permitted to play in currencies to place bets on the direction of exchange rates.

For instance, instead of just repaying principal, a PERLS may multiply such principal by the change in the value of the dollar against the euro; or twice the change in the value of the dollar against the Swiss franc or the British pound. The fact that this repayment is linked to the foreign exchange rate of different currencies sees to it that the investor might be receiving a lot more than an interest rate on the principal alone – but also a lot less, all the way to capital attrition. (Even capital protection notes involve capital attrition since, in certain cases, no interest is paid over their, say, five-year life cycle.)

Structured note trading is a concept that has been subject to several interpretations, depending on the time frame within which the product has been brought to the market. Many traders tend to distinguish between three different generations of structured notes. The elder, or first generation, usually consists of structured instruments based on just one index, including

  • Bull market vehicles, such as inverse floaters and cap floaters
  • Bear market instruments, which are characteristically more leveraged, an example being the superfloaters

Bear market products became popular in 1993 and 1994. A typical superfloater might pay twice the London Interbank Offered Rate (LIBOR) minus 7 percent for two years. At currently prevailing rates, this means that the superfloater has a small coupon at the beginning that improves only if the LIBOR rises. Theoretically, a coupon that is below current market levels until the LIBOR goes higher is much harder to sell than a big coupon that gets bigger every time rates drop. Still, bear plays find customers.

Second-generation structured notes are different types of exotic options; or, more precisely, they are yet more exotic than superfloaters, which are exotic enough in themselves. There exist serious risks embedded in these instruments, as such risks have never been fully appreciated. Second-generation examples are

  • Range notes, with embedded binary or digital options
  • Quanto notes, which allow investors to take a bet on, say, sterling London Interbank Offered Rates, but get paid in dollar.

There are different versions of such instruments, like you-choose range notes for a bear market. Every quarter the investor has to choose the “range,” a job that requires considerable market knowledge and skill. For instance, if the range width is set to 100 basis points, the investor has to determine at the start of the period the high and low limits within that range, which is far from being a straight job.

Surprisingly enough, there are investors who like this because sometimes they are given an option to change their mind; and they also figure their risk period is really only one quarter. In this, they are badly mistaken. In reality even for banks you-choose notes are much more difficult to hedge than regular range notes because, as very few people appreciate, the hedges are both

  • Dynamic
  • Imperfect

There are as well third-generation notes offering investors exposure to commodity or equity prices in a cross-category sense. Such notes usually appeal to a different class than fixed-income investors. For instance, third-generation notes are sometimes purchased by fund managers who are in the fixed-income market but want to diversify their exposure. In spite of the fact that the increasing sophistication and lack of transparency of structured financial instruments sees to it that they are too often misunderstood, and they are highly risky, a horde of equity-linked and commodity-linked notes are being structured and sold to investors. Examples are LIBOR floaters designed so that the coupon is “LIBOR plus”:

The pros say that flexibly structured options can be useful to sophisticated investors seeking to manage particular portfolio and trading risks. However, as a result of exposure being assumed, and also because of the likelihood that there is no secondary market, transactions in flexibly structured options are not suitable for investors who are not

  • In a position to understand the behavior of their intrinsic value
  • Financially able to bear the risks embedded in them when worst comes to worst

It is the price of novelty, customization, and flexibility offered by synthetic and structured financial instruments that can be expressed in one four-letter word: risk. Risk taking is welcome when we know how to manage our exposure, but it can be a disaster when we don’t – hence, the wisdom of learning ahead of investing the challenges posed by derivatives and how to be in charge of risk control.

Velocity of Money

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The most basic difference between the demand theory of money and exchange theory of money lies in the understanding of quantity equation

M . v = P . Y —– (1)

Here M is money supply, P is price and Y is real output; in addition, v is constant velocity of money. The demand theory understands that (1) reflects the needs of the economic individual for money, not only the meaning of exchange. Under the assumption of liquidity preference, the demand theory introduces nominal interest rate into demand function of money, thus exhibiting more economic pictures than traditional quantity theory does. Let us, however concentrate on the economic movement through linearization of exchange theory emphasizing exchange medium function of money.

Let us assume that the central bank provides a very small supply M of money, which implies that the value PY of products manufactured by the producer will be unable to be realized only through one transaction. The producer has to suspend the transaction until the purchasers possess money at hand again, which will elevate the transaction costs and even result in the bankruptcy of the producer. Then, will the producer do nothing and wait for the bankruptcy?

In reality, producers would rather adjust sales value through raising or lowering the price or amount of product to attempt the realization of a maximal sales value M than reserve the stock of products to subject the sale to the limit of velocity of money. In other words, producer would adjust price or real output to control the velocity of money, since the velocity of money can influence the realization of the product value.

Every time money changes hands, a transaction is completed; thus numerous turnovers of money for an individual during a given period of time constitute a macroeconomic exchange ∑ipiYi if the prices pi can be replaced by an average price P, then we can rewrite the value of exchange as ∑ipiYi = P . Y. In a real economy, the producer will manage to make P . Y close the money supply M as much as possible through adjusting the real output or its price.

For example, when a retailer comes to a strange community to sell her commodities, she always prefers to make a price through trial and error. If she finds that higher price can still promote the sales amount, then she will choose to continue raising the price until the sales amount less changes; on the other hand, if she confirms that lower price can create the more sales amount, then she will decrease the price of the commodity. Her strategy of pricing depends on price elasticity of demand for the commodity. However, the maximal value of the sales amount is determined by how much money the community can supply, thus the pricing of the retailer will make her sales close this maximal sale value, namely money for consumption of the community. This explains why the same commodity can always be sold at a higher price in the rich area.

Equation (1) is not an identical equation but an equilibrium state of exchange process in an economic system. Evidently, the difference M –  P . Y  between the supply of money and present sales value provides a vacancy for elevating sales value, in other words, the supply of money acts as the role of a carrying capacity for sales value. We assume that the vacancy is in direct proportion to velocity of increase of the sales value, and then derive a dynamical quantity equation

M(t) - P(t) . Y(t)  =  k . d[P(t) . Y(t)]/d(t) —– (2)

Here k is a positive constant and expresses a characteristic time with which the vacancy is filled. This is a speculated basic dynamical quantity equation of exchange by money. In reality, the money supply M(t) can usually be given; (2) is actually an evolution equation of sales value P(t)Y(t) , which can uniquely determine an evolving path of the price.

The role of money in (2) can be seen that money is only a medium of commodity exchange, just like the chopsticks for eating and the soap for washing. All needs for money are or will be order to carry out the commodity exchange. The behavior of holding money of the economic individuals implies a potential exchange in the future, whether for speculation or for the preservation of wealth, but it cannot directly determine the present price because every realistic price always comes from the commodity exchange, and no exchange and no price. In other words, what we are concerned with is not the reason of money generation, but form of money generation, namely we are concerned about money generation as a function of time rather than it as a function of income or interest rate. The potential needs for money which you can use various reasons to explain cannot contribute to price as long as the money does not participate in the exchange, thus the money supply not used to exchange will not occur in (2).

On the other hand, the change in money supply would result in a temporary vacancy of sales value, although sales value will also be achieved through exchanging with the new money supply at the next moment, since the price or sales volume may change. For example, a group of residents spend M(t) to buy houses of P(t)Y(t) through the loan at time t, evidently M(t) = P(t)Y(t). At time t+1, another group of residents spend M(t+1) to buy houses of P(t+1)Y(t+1) through the loan, and M(t+1) = P(t+1)Y(t+1). Thus, we can consider M(t+1) – M(t) as increase in money supply, and this increase can cause a temporary vacancy of sales value M(t+1) – P(t)Y(t). It is this vacancy that encourages sellers to try to maximize sales through adjusting the price by trial and error and also real estate developers to increase or decrease their housing production. Ultimately, new prices and production are produced and the exchange is completed at the level of M(t+1) = P(t+1)Y(t+1). In reality, the gap between M(t+1) and M(t) is often much smaller than the vacancy M(t+1) – P(t)Y(t), therefore we can approximately consider M(t+1) as M(t) if the money supply function M(t) is continuous and smooth.

However, it is necessary to emphasize that (2) is not a generation equation of demand function P(Y), which means (2) is a unique equation of determination of price (path), since, from the perspective of monetary exchange theory, the evolution of price depends only on money supply and production and arises from commodity exchange rather than relationship between supply and demand of products in the traditional economics where the meaning of the exchange is not obvious. In addition, velocity of money is not contained in this dynamical quantity equation, but its significance PY/M will be endogenously exhibited by the system.

Welfare Economics, or Social Psychic Wellbeing. Note Quote.

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The economic system is a social system in which commodities are exchanged. Sets of these commodities can be represented by vectors x within a metric space X contained within the non-negative orthant of an Euclidean space RNx+ of dimensionality N equal to the number of such commodities.

An allocation {xi}i∈N ⊂ X ⊂ RNx+ of commodities in society is a set of vectors xi representing the commodities allocated within the economic system to each individual i ∈ N.

In questions of welfare economics at least in all practical policy matters, the state of society is equated with this allocation, that is, s = {xi}i∈N, and the set of all possible information concerning the economic state of society is S = X. It is typically taken to be the case that the individual’s preference-information is simply their allocation xi, si = xi. The concept of Pareto efficiency is thus narrowed to “neoclassical Pareto efficiency” for the school of economic thought in which originates, and to distinguish it from the weaker criterion.

An allocation {xi}i∈N is said to be neoclassical Pareto efficient iff ∄{xi}i∈N ⊂ X & i ∈ N : x′i ≻ xi & x′j ≽ xj ∀ j ≠ i ∈ N.

A movement between two allocations, {xi}i∈N → {x′i}i∈N is called a neoclassical Pareto improvement iff ∃i∈N : x′i ≻ xi & x′j ≽ xj ∀ j ≠ i ∈ N.

For technical reasons it is almost always in practice assumed for simplicity that individual preference relations are monotonically increasing across the space of commodities.

If individual preferences are monotonically increasing then x′ii xi ⇐⇒ x′i ≥ xi, and x′ ≻ xi ⇐⇒ xi > x′i2.

This is problematic, because a normative economics guided by the principle of implementing a decision if it yields a neoclassical Pareto improvement where individuals have such preference relations above leads to the following situation.

Suppose that individual’s preference-information is their own allocation of commodities, and that their preferences are monotonically increasing. Take one individual j ∈ N and an initial allocation {xi}i∈N.

– A series of movements between allocations {{xi}ti∈N → {x′i}ti∈N}Tt=1 such that xi≠j = x′i≠j ∀ t and x′j > xj ∀ t and therefore that xj − xi → ∞∀i≠j ∈ N, are neoclassical Pareto improvements. Furthermore, if these movements are made possible only by the discovery of new commodities, each individual state in the movement is neoclassical Pareto efficient prior to the next discovery if the first allocation was neoclassical Pareto efficient.

Admittedly perhaps not to the economic theorist, but to most this seems a rather dubious out- come. It means that if we are guided by neoclassical Pareto efficiency it is acceptable, indeed de- sirable, that one individual within society be made increasingly “richer” without end and without increasing the wealth of others. Provided only the wealth of others does not decrease. The same result would hold if instead of an individual, we made a whole group, or indeed the whole of society “better off”, without making anyone else “worse off”.

Even the most devoted disciple of Ayn Rand would find this situation dubious, for there is no requirement that the individual in question be in some sense “deserving” of their riches. But it is perfectly logically consistent with Pareto optimality if individual preferences concern only to their allocation and are monotonically increasing. So what is it that is strange here? What generates this odd condonation? It is the narrowing of that which the polity care about to each individual allocation, alone, independent of others. The fact that neoclassical Pareto improvements are distribution-invariant because the polity is supposed to care only about their own individual allocation xi ∈ {xi}ti∈N alone rather than broader states of society si ⊂ s as they see it.

To avoid such awkward results, the economist may move from the preference-axiomatic concept of Pareto efficiency to embrace utilitarianism. The policy criterion (actually not immediately representative of Bentham’s surprisingly subtle statement) being the maximisation of some combination W(x) = W {ui(xi)}i∈N of individual utilities ui(xi) over allocations. The “social psychic wellbeing” metric known as the Social Welfare Function.

In theory, the maximisation of W(x) would, given the “right” assumptions on the combination method W (·) (sum, multiplication, maximin etc.) and utilities (concavity, montonocity, independence etc.) fail to condone a distribution of commodities x extreme as that discussed above. By dint of its failure to maximise social welfare W(x). But to obtain this egalitarian sensitivity to the distribution of income, three properties of Social Welfare Functions are introduced. Which prove fatal to the a-politicality of the economist’s policy advice, and introduce presuppositions which must lay naked upon the political passions of the economist, so much more indecently for their hazy concealment under the technicalistic canopy of functional mathematics.

Firstly, it is so famous a result as to be called the “third theorem of welfare economics” that any such function W(·) as has certain “uncontroversially” desirable technical properties will impose upon the polity N the preferences of a dictator i ∈ N within it. The preference of one individual i ∈ N will serve to determine the preference indicated between by society between different states by W(x). In practice, the preferences of the economist, who decides upon the form of W(·) and thus imposes their particular political passions (be they egalitarian or otherwise) upon policy, deeming what is “socially optimal” by the different weightings assigned to individual utilities ui(·) within the polity. But the political presuppositions imported by the economist go deeper in fact than this. Utilitari-anism which allows for inter-personal comparisons of utility in the construction of W(x) requires utility functions be “cardinal” – representing “how much” utility one derives from commodities over and above the bare preference between different sets thereof. Utility is an extremely vague concept, because it was constructed to represent a common hedonistic experiential metric where the very existence of such is uncertain in the first place. In practice, the economist decides upon, extrapolates, assigns to i ∈ N a particular utility function which imports yet further assumptions about how any one individual values their commodity allocation, and thus contributes to social psychic wellbeing.

And finally, utilitarianism not only makes political statements about who in the polity is to be assigned a disimproved situation. It makes statements so outlandish and outrageous to the common sensibility as to have provided the impetus for two of the great systems of philosophy of justice in modernity – those of John Rawls and Amartya Sen. Under almost any combination method W(·), the maximization of W(·) demands allocation to those most able to realize utility from their allocation. It would demand, for instance, redistribution of commodities from sick children to the hedonistic libertine, for the latter can obtain greater “utility” there from. A problem so severe in its political implications it provided the basic impetus for Rawls’ and Sen’s systems. A Theory of Justice is, of course, a direct response to the problematic political content of utilitarianism.

So Pareto optimality stands as the best hope for the economist to make a-political statements about policy, refraining from making statements therein concerning the assignation of dis-improvements in the situation of any individual. Yet if applied to preferences over individual allocations alone it condones some extreme situations of dubious political desirability across the spectrum of political theory and philosophy. But how robust a guide is it when we allow the polity to be concerned with states of society in general? Not only their own individual allocation of commodities. As they must be in the process of public reasoning in every political philosophy from Plato to Popper and beyond.

History and Historicity in the Political Philosophy of Thomas Hobbes

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Hobbes’ early moral and political views may be traced back to the Aristotelian tradition. If this is the case, then it can be said that these views are definitely the materials for his political philosophy but not the seeds for his political philosophy. But his later views are in direct contrast to Aristotelianism. If it may be contended that Hobbes’ taking of considerable elements from Aristotle paved the way for a later break with Aristotle, then a sense of fundamental defect with the Aristotelian philosophy was a must for this break. Hobbes later elaborated these modifications and presented them as systematic objections. This deep dissatisfaction with traditional philosophy must have forced Hobbes for turning to history and thus citing his case in his humanist period. His turning to history is revealed in his revolutionary early thought. His turning to history was definitely intentional with philosophical contentions.

According to Hobbes, philosophy and history are fundamentally different. Philosophy lays down precepts for the right behaviour of men, but then again precepts don’t prove their practical aspects efficaciously. History, not philosophy, gives man prudence.

‘…the principal and proper work of history (is) to instruct and enable men, by the knowledge of actions past, to bear themselves prudently in the present and providently towards the future…’ ‘…the nature of history is merely narrative…look how much a man of understanding might have added to his experience, if he had then lived a beholder of their proceedings, and familiar with the men and business of the time: so much almost may he profit now, by attentive reading of the same here written. He may from the narrations draw out lessons to himself’.

History widens men’s experiences by making men capable of applying the precepts in the individual cases. Hobbes takes it for granted that this philosophy rightly lays down the norms for human actions. He asserts that practical wisdom is at least the sine qua non for moral virtue and this wisdom is gained only through experience. The study of history widens the experience from service to the acquisition of wisdom and thus from service to moral education. Aristotle believes in rational precepts having no influence on most men. But according to Aristotle’s view, what is true of most men is not by any means true of free and noble minded characters who love honour; they obey precepts. As Hobbes doubts the effects of precepts altogether, does he not assert the impotence of reason with reference to all men; can we not say that the dicta of impotence of reason was thoroughly established in his mind, before his engagement with natural science?

The question, by which history originally breaks with philosophy, is the question of effectiveness of rational precept. It purely becomes a matter of application of precepts. These precepts were handed down by Aristotelian ethics. Since Aristotle satisfactorily explicated these precepts, the fundamental problem of philosophy was solved; this gave Hobbes the leisure and ample opportunity to give thought to the secondary problem of the application of precepts. In reference to this application the assertion is made that the precepts are not effective in themselves that they are not followed for their own sake, but under all circumstances it may be made plausible by making use of other measures to ensure their being followed. Hobbes of course does not question the necessity and effectiveness of laws. But now the teachings to be drawn from history slip in as it were midway between the precepts of philosophy and the laws.

‘…(history) doth things with more grace and modestie then the civill lawes and ordinances do: because it is more grace for a man to teach and instruct, then to chastise or punish’.

The teaching to be drawn from history has from now on to fulfill the function for noble natures which, according to Aristotle, was the task of philosophical precepts. The teachings of history replace the precepts of philosophy in the education of the aristocracy.

The opposition of philosophical precept and the historical example based on the doubt of the efficacy of the precept is punctuated in the literature of the sixteenth century. It need only mean, we must attribute to a regrettable shortcoming on the part of the majority of men that they do not obey the precepts of philosophy, that they do not love virtue for itself, but for all its reward, which is praise. This doubt also means that the true motive of virtue is honour and glory. It essentially implies aristocratic virtue. As a result of the close connection between history and honour or glory, the more virtue is envisaged as aristocratic virtue, the keener will be the interest in history. Hobbes often quotes Lipsius as an authority for his views on history. Through Lipsius’ political philosophy, Hobbes successfully accomplished turning to history. What is felt as a lack is not so much the scientific writing of history; it is recognized that from all time histories have been written which are adequate for every possible demand; not even directions for the writing of history, but above all methodical readings of the histories already in existence. With a view to the teaching of history by methodically reading it is to be gained for the right ordering of human actions. The only clear knowledge of the application of the norms, which obtain for human actions, which have taken place in the past. History seeks the application and realization of precepts, the conditions and results of that realization. Unlike poetry, whose main objective is to give pleasure, history and philosophy derives its objectivity in seriousness. Hobbes names history and philosophy as the two fundamental branches of human knowledge.

If the main emphasis of history is to instruct and enable men, to bear themselves prudently in the present and providently in the future, undertaking a methodic utilization of history implies that a methodic education for prudence is aimed at. This education of prudence is to be sought by placing the whole available experience of mankind at our disposal, there has to be no room for any elements of chance. To the question, ‘How is one to behave in an individual case?’, one is no longer to receive the Aristotelian answer of how a sensible man would behave, but one receives for the particular case concrete maxims gained from the study of history. In this education, words and actions are important only in reference to aims. It is only through history that the reader is to be taught which kinds of aims are salutary and destructive. The systematic transformation to history, finds its most complete expression in Bacon’s philosophy.

According to Bacon, moral philosophy as the study of virtue and duty has been perfectly worked out in classical philosophy. But he opines that the fundamental shortcoming of ancient philosophy is the limiting factor that imposes itself on the description of nature of good versus the heroical descriptions of virtue, duty and felicity. As Bacon expressly says of a particular desideratum; a doctrine of the vices peculiar to the individual vocations; but as he thinks in all cases, they will seek what men sought to do, but what men really do. Traditional philosophy is blind to these materials; but the real solace comes about in the study of history. So if the neglect of history is surmounted, one of the weightiest reasons for the inadequacy and uselessness of scholasticism is given way to. Bacon makes a plea for history of literature; which he thinks has been neglected and going into this study makes him sure of making men wise.

‘History is natural, civil, ecclesiastical, and literary; whereof the first three I allow as extant, the fourth I note as deficient. For no man hath propounded to himself the general state of learning to be described and represented from age to age…without which the history of the world seemeth to me to be as the statua of Polyphemus with his eyes out; that part being wanting which doth most shew the spirit and life of the person…The use and end of which work I do not so much design for curiosity and satisfaction of those that are the lovers of learning, but chiefly for a more serious and grave purpose; which is this in few words, that it will make learned men wise in the use and administration of learning. For it is not St. Augustine’s not St. Ambrose’s works that will make so wise a divine, as ecclesiastical history, thoroughly read and observed; and the same reason is of learning’.

Bacon’s interest in history is its applicative tendencies. Bacon vehemently advocated the philosophy’s turning to history. But why? is the question? The primary reason for such a turn augments the most important material for philosophy because philosophic intent is shifting from physics and metaphysics to morals and politics.

According to Aristotle’s assertion, this change of interest takes place as soon as man becomes the consideration of being the highest being in the world. If, however, one looks back to Plato, to whom moral and political problems are of incomparably greater importance than to Aristotle, and who yet no less than Aristotle raised his gaze away from man to the eternal order, one must hold that it is not the conviction man’s superiority to all existing creatures but the conviction of the transcendence of good over all being, which is the reason why philosophic investigation begins with the ethical and political problems, with the question of the right life and the right society. This turn is caused not by the enhanced interest in the question of the good and the best form of State; but by the enhanced interest in man. The division of philosophy into natural philosophy and human philosophy is based on the systematic distinction between man and the world, which Bacon makes in express controversy against ancient philosophy.

‘…the works of God…show the omnipotency and the wisdom of the Maker, but not his image: and therefore therein the heathen opinion differeth from the sacred truth; for they supposed the world to be the image of God, and man to be exact or compendious image of the world, but the Scriptures never vouchsafe to attribute to the world that honour, as to be the image of God, but only the work of His hands; neither do they speak of any other image of God, but man…’

When the man is considered as the most excellent work of nature; then man instead of eternal order which transcends man becomes the central theme of philosophy. The ideal of contemplative life when substituted with moral virtues still ends up in a fiasco for explaining of the turn of philosophy to history. It is not the substitution of the contemplative ideal by moral virtue, in particular by the Biblical demands for justice and charity, but the systematic doubt of the efficacy of precept, which is added to this substitution, is the reason why philosophy turns to history. Bacon doubts the efficacy of rational precepts. The ancient philosophers, he says, ‘fortified and entrenched virtue and duty, as much as discourse can do, against popular and corrupt opinions’.

The reason for the turning of philosophy to history is thus the conviction of the impotence of reason, added to the enhanced interest in man. The impotence of reason is not the incapacity to establish or justify norms. It is not the way in which precepts are given to men, whether by reason or by revelation, the difficulty, which leads to the study of history, would still remain. The fact is that man does not obey the transcendent norm, whether it be rational or revealed, which is the reason of the study of history. History is studied to remedy man’s disobedience. In the sixteenth century, the reason why philosophy turned to history is the repression of the morality of obedience. As long as the distinction between philosophic knowledge on the one hand and the applicative techniques on the other hand is retained; there is at least implicitly and in principle a recognition of the pre-eminence of obedience over every other motive for action. Induction from history teaches one to distinguish between aims which justify themselves and lead to success, and aims which come to grief. The receipts to be gained from history bear only on success and failure. According to Bodin, he says in his Works, history is the easiest and the most obscure of sciences and is independent of every other science. Its subject is the study of aims and projects. By the distinction between good and bad aims, it makes possible knowledge of the norms for human actions.

Hobbes’ political philosophy, which from this time was gradually maturing precisely, had the function of replacing history, as history was understood in Bodin’s words. Hobbes’ political philosophy in its fundamental parts aimed at distinguishing between the good and the bad and thus leading to the discovery of the norms. Thus from the time of the formation of the new political philosophy, history sinks back into its philosophic insignificance; with the important difference being; in the new political philosophy, in contrast to the traditional, history is taken up and conserved. From this point of view one can appreciate the fact that Hobbes, who was particularly preoccupied with history up to the time of his return to philosophy, gives less and less thought to history as his political philosophy develops. As late as the Elements of Law, it is emphasized in a special paragraph that

‘belief…in many cases is no less free from doubt, than perfect and manifest knowledge…there be many things which we receive from report of others, of which it is impossible to imagine any cause of doubt: for what can be opposed against the consent of all men, in things they can know, and have no cause to report otherwise than they are, unless a man would say that all the world had conspired to deceive him’.

The more Hobbes learns to distinguish sharply between what is and what should be, the more the ideal character of the Leviathan becomes clear in his mind, the less significance has history for him. As a result, the distinctions between history, which is serious and seeks truth, and poetry, and the superiority of history over poetry, lose their former justification. History is thrust into the background in the measure that the new political philosophy gains clarity. For the new political philosophy fulfils the function, which had to be fulfilled by history, as, long as traditional political philosophy was acknowledged as valid. The necessity of political philosophy is shown because most men do not obey precepts. And the same presupposition, which caused the turn to history, is the basis of Hobbes’ political philosophy: the replacement of the morality of obedience by the morality of prudence.

‘All that is required, both in faith and manners, for man’s salvation, is, I confess, set down in Scriptures as plainly as can be. “Children, obey your parents in all things…Let all men be subject to the higher powers…” are words of the Scripture, which are well enough understood; but neither children, nor the greatest part of men, do understand why it is their duty to do so. They see not that the safety of the commonwealth, and consequently their own, depends upon their doing it. Every man by nature, without discipline, does in all his actions look upon, as far as he can see, the benefit that shall redound to himself from his obedience….the Scripture says one thing, and they think another, weighing the commodities or incommodities of this present life only, which are in their sight, never putting into the scales the good and evil of the life to come, which they see not’.

Bacon’s criticism of the Aristotelian morals that it does not teach the realization of virtues therefore becomes an element also in Hobbes’ criticism of Aristotle. For the turn to history had taken place precisely because traditional philosophy showed no way to the application of norms. This failure is remedied by the new political philosophy, whose boast it is, that it, in contrast to traditional philosophy, teaches an applicable morality. Hobbes allows the validity of the aristocratic virtue, completing it by a morality, which is systematically applicable and which appeals to the greatest part of men. Hobbes acknowledges the binding force of the Ten Commandments and only denies that they are applicable without more detailed interpretation by the secular power. In the same way, Hobbes admits the natural inequality, and only contests that this inequality is of any practical importance. Hobbes also concedes that the Civil Government be ordained as a means to bring us to a spiritual felicity, and thus that all earthly things are means to eternal bliss. But he denies that from this hierarchy of things earthly and things eternal, anything can be deduced as to the relative position of the holder of secular power and the holder of spiritual power. With this, Hobbes lets us see that even if there were an eternal order, he would take into consideration only the actual behaviour of men, and that his whole interest is centered on man, on application, on the use of means.

The shifting of interest from the eternal order to man found its expression in turning of philosophy to history. Hobbes doesn’t have the intention justifying the traditional norms in a way more practicable for application than was the way of traditional philosophy; he altogether denies the applicability of traditional morals; whether of ancient philosophy or of Biblical Christianity.  He not only showed that Aristotle did not show the way to a way of realization of the norms, but also that he did not even rightly define the norms. Hobbes wishes to play the passions one against the other, in order to show the way for the realization of already established norms, he wishes to draw up a political philosophy which will be in harmony with the passions from the outset. And after Hobbes found in the fear of the violent death, a truly applicable principle of political philosophy, it is again in accordance with the interest in the application that he progresses from this foundation to the establishment of the law of nature. The right to defend life, which man has from nature by the reason of the inescapable fear of death, becomes a right to all things and all actions; since a right to the end is invalid without a right to the necessary means. In order to avoid the arbitrariness, the uncertainty of what a wise man would decide under unforeseen circumstances, he rules that each man has a right to all things and all actions, since anyone under some circumstances may consider that anything or action is a necessary means for the defence of his life. The express premise of this finding is the equality of all men. Since there is no natural order, the difference between the wise minority and the unwise majority loses the fundamental importance it had for traditional political philosophy. Hobbes’ political philosophy first pushes history back into its old insignificance for philosophy. To this extent, it is true to say that Hobbes’ political philosophy is unhistorical. To make this judgment cognizant is however, not so much that Hobbes took no interest in history as that he made incorrect assertions as to history being the basis of his political philosophy. Hobbes’ fundamental error was his assumption that man’s primitive condition was the war of everyone against everyone. Hobbes cannot rest content with findings as to the historical origin States, for they give no answer to the only important question, which concerns the right order of society. So in the criticism that Hobbes’ political philosophy is ‘unhistorical’, the only statement that is justified is that Hobbes considered the philosophic grounding of the principles of all judgment on political subjects more fundamental, incomparably more important than the most thoroughly founded historical knowledge.

Hobbes considers the State of nature not as an historical fact, but a necessary construction. It is essential to his political philosophy that it should begin with the description of the State of nature, and that it should let the State emerge from the State of nature.  But he acknowledges that the subject of his political philosophy, is a history, a genesis, and not an order, which is static and perfect. To clarify this point, one has to compare Hobbes’ ‘compositive’ method with Aristotle’s ‘genetic’ method. When Aristotle depicts the genesis of the city as the perfect community out of primitive communities, the understanding of perfect organism is the main presupposition for the understanding of its constituent parts, the more primitive communities. For Hobbes, the imperfection of the primitive condition, or the State of nature, is perceived not by looking to the already, even if only cursorily clarified, idea of the State as the perfect community, but by fully understanding the experience of the State of nature. As for Hobbes the primitive condition is irrational, so for Hegel

‘knowing as it is found at the start, mind in its immediate and primitive stages, is without the essential nature of mind, is sense-conciousness’.

Hobbes has no intention of measuring the imperfect by a standard that transcends it, but as they simply look on, while the imperfect by its own movement annuls itself, tests itself. This is the meaning of Hobbes’ argument that the man who wishes to remain in the State of nature contradicts himself, that the mutual fear that characterizes the State of nature is the motive for abolishing the State of nature. The premise for an immanent testing, which necessarily finds its expression within the framework of a typical history is for Hobbes, the rejection for the morality of obedience. For Hobbes, at all events, history finally becomes superfluous, because for him political philosophy itself becomes a typical history. His political philosophy becomes historical because for him order is not immutable, eternal, in existence from the beginning, but is produced only at the end of a process; because for him order is not independent of human volition, but is borne up by a human volition alone. For this, political philosophy no longer has the function, as it had in classical antiquity, of reminding political life of the eternally immutable prototype of the perfect State, but the peculiarly modern task of delineating for the first time the programme of the essentially future perfect State. The repression of history in favour of philosophy means in reality the repression of the past; of the ancient, which is an image of the eternal; in favour of the future.

If the order of man’s world springs from man’s will alone, there is no philosophical or theological security for that order. Man then can convince himself of his capacity to order his world only by the fact of his ordering activity. Therefore according to Hobbes’ assumptions, one must turn to real history. Thus, the State of nature, which at first was intended as merely typical, again takes on an historical significance; not, indeed, as a condition of absolute lack of order, but as a condition of extremely defective order. The real history has as its function to vouch for the possibility of further progress by perception of progress already made. After that; historically, perhaps even earlier; its function is to free man from the might of the past, from the authority of antiquity, from prejudices. Authority loses its prestige when its historical origin and evolution are traced; as a result of historical criticism man’s limitations show themselves as limits set by himself, and therefore to be over passed. It is by the doubt of the transcendent eternal order by which man’s reason was assumed to be guided and hence by the conviction of the impotence of reason, that first of all the turning of philosophy to history is caused, and then the process of historicizing philosophy itself.

Kōjin Karatani versus Moishe Postone. Architectonics of Capitalism.

Kōjin Karatani’s theory of different modes of intercourse criticizes architectonic metaphor thinking that the logic of mods of production in terms of base and superstructure without ceding grounds on the centrality of the critique of political economy. the obvious question is what remains of theory when there is a departure not from the objective towards the subjective, but rather the simultaneous constitution of the subjective and the objective dimensions of the social under capitalism. One way of addressing the dilemma is to take recourse to the lesson of commodity form, where capitalism begets a uniform mode of mediation rather than disparate. The language of modes of production according to Moishe Postone happens to be a transhistorical language allowing for a transhistorical epistemology to sneak in through the backdoor thus outlining the necessity of critical theory’s existence only in so far as the object of critique stays in existence. Karatani’s first critique concerns a crude base-superstructure concept, in which nation and nationalism are viewed merely as phenomena of the ideological superstructure, which could be overcome by reason (enlightenment) or would disappear together with the state. But the nation functions autonomously, independent of the state, and as the imaginative return of community or reciprocal mode of exchange A, it is egalitarian in nature. As is the case with universal religions, the nation thus holds a moment of protest, of opposition, of emancipatory imagination. The second critique concerns the conception of the proletariat, which Marxism reduced to the process of production, in which its labor force is turned into a commodity. Production (i.e., consumption of labor power) as a fundamental basis to gain and to increase surplus value remains unchanged. Nonetheless, according to Karatani surplus value is only achieved by selling commodities, in the process of circulation, which does not generate surplus value itself, but without which there cannot be any surplus value. Understanding the proletariat as producer-consumer opens up new possibilities for resistance against the system. In late capitalism, in which capital and company are often separated, workers (in the broadest sense of wage and salary earners) are usually not able to resist their dependency and inferiority in the production process. By contrast, however, in the site of consumption, capital is dependent on the worker as consumer. Whereas capital can thus control the proletariat in the production process and force them to work, it loses its power over them in the process of circulation. If, says Karatani, we would view consumers as workers in the site of circulation, consumer movements could be seen as proletariat movements. They can, for example, resort to the legal means of boycott, which capital is unable to resist directly. Karatani bases his critique of capitalism not on the perspectives of globalization, but rather on what he terms neo-imperialism meaning state-based attempt of capital to subject the entire world to its logic of exploitation, and thus any logic to overcoming the modern world system of capital-nation-state by means of a world revolution and its sublation in a system is to be possible by justice based on exchange. For Postone Capital generates a system characteristically by the opposition of abstract universality, the value form, and particularistic specificity, the use value dimension. It seems to me that rather than viewing a socialist or an emancipatory movement as the heirs to the Enlightenment, as the classic working class movement did, critical movements today should be striving for a new form of universalism that encompasses the particular, rather than existing in opposition to the particular. This will not be easy, because a good part of the Left today has swung to particularity rather than trying to and a new form of universalism. I think this is a fatal mistake.

The Differentiated Hyperreality of Baudrillard

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A sense of meaning for Baudrillard connotes a totality that is called knowledge and it is here that he differs significantly from someone like Foucault. For the latter, knowledge is a product of relations employing power, whereas for the former, any attempt to reach a finality or totality as he calls fit is always a flirtation with delusion. A delusion, since the human subject would always aim at understanding the human or non-human object, and, in the process the object would always be elusive since, it being based on signifiers would be vulnerable to a shift in significations. The two key ideas of Baudrillard are simulation and hyperreality. Simulation accords to representation of things such that they become the things represented, or in other words, representations gain priority over the “real” things. There are certain orders that define simulations viz. signs get to represent objective reality, signs veil reality, signs masking the absence of reality and signs turning into simulacra, since they have relation to reality thus ending up simulating a simulation. In Hegarty‘s reading of Baudrillard, there happen to be three types of simulacra each with a distinct historical epoch. The first is the pre-modern period, where the image marks the place for an item and hence the uniqueness of objects and situations marks them as irreproducibly real. The second is the modern period characterized by industrial revolution signifying the breaking down of distinctions between images and reality because of mass reproduction of copies or proliferation of commodities thus risking the essential existence of the original. The third is the post-modern period, where simulacra precedes the original and the distinction between reality and representation vanishes implying only the existence of simulacra and relegating reality as a vacuous concept. Hyperreality defines a condition wherein “reality” as known gets substituted by simulacra. This notion of Baudrillard is influenced by Canadian communication theorist and rhetorician Marshall McLuhan. Hyperreality with its insistence of signs and simulations fit perfectly in the post-modern era and therefore highlights the inability or shortcomings of consciousness to demarcate between reality and the phantasmatic space. In a quite remarkable analysis of Disneyland, Baudrillard (166-184) clarifies the notion of hyperreality, when he says,

The Disneyland imaginary is neither true nor false: it is a deterrence machine set in order to rejuvenate in reverse the fiction of the real. Whence the debility, the infantile degeneration of this imaginary. It’s meant to be an infantile world, in order to make us believe that adults are everywhere, in the “real” world and to conceal the fact that real childishness is everywhere, particularly among those adults who go there to act the child in order to foster illusion of their real childishness.

Although his initial ideas were affiliated with those of Marxism, he differed from Marx in his epitomizing consumption as the driving force of capitalism as compared to latter’s production. Another issue that was worked out remarkably in Baudrillard was historicity. Agreeing largely with Fukuyama’s notion of the end of history after the collapse of the communist block, Baudrillard only differed by placing importance on the idea of historical progress to have ended and not history necessarily. He forcefully makes the point of ending of history as also the ending of dustbins of history. His post-modern stand differed significantly with that of Lyotard’s in one major respect, despite finding common grounds elsewhere. Despite showing growing aversion to the theory of meta-narratives, Baudrillard, unlike Lyotard, reached a point of pragmatic reality within the confines of an excuse laden notion of universality that happened to be in vogue.

Baudrillard has been at the receiving end with some very extreme, acerbic criticisms directed at him. His writings are not just obscure, but also fail in many respects like defining certain concepts he employs, totalizing insights that have no substantial claim to conjectures, and often hinting strongly at apodicticity without paying due attention to the rival positions. This extremity reaches a culmination point when he is cited as a purveyor of reality-denying irrationalism. But not everything is to be looked at critically in his case and he does enjoy an established status as a transdisciplinary theorist, who, with his provocations have put traditional issues regarding modernity and philosophy in general at stake by providing insights into a better comprehensibility of cultural studies, sociology and philosophy. Most importantly, Baudrillard provides for autonomous and differentiated spaces in cultural, socio-economic and political domains by an implosive theory that cuts across boundaries of various disciplines paving the way for a new era in philosophical and social theory at large.

{Securities Transaction Tax + Commodities Transaction Tax + Revenue Foregone} = A Recipe for Illusionary Scam

Are Transaction Tax and Securities Transaction Tax synchronous? If by chance these are used interchangeably, then the rate is not 0.5%, but in accordance to a slab where sale/purchase, or transaction effects on options or futures, where it is valued in premium in the case of options and actual trade price in the case of futures. Moreover, Securities Transaction Tax differs from intra-day to inter-day transactions. Two crucial factors are the distinguishing parameters here: buying securities and selling securities would attract different STT, and is often resorted to avail exemption in case of long-term capital gain. The rate of taxation is determined by the Government. All stock market transactions that involve equity or equity derivatives like futures and options are liable to be taxed under the STT. Now this last sentence is redundant, but points out to commodities and currencies that stand out exempted from STT. If one talks of stocks, bonds and commodities in the same breath, albeit preliminarily, as different from what the governmental figures exhibit – the latter dips the figures, while it should have been higher according to those in the opposition, then clearly commodities and currency trades should have different taxation structure in the stock exchanges. But, that isn’t the case, for commodities are never traded on the stock exchanges, but on the commodity exchanges, and regulated by Forward Markets Commission and not by SEBI. Further, commodity derivatives can be settled by delivery, unlike security derivatives, which could only be settled by payment or receipt of differences. So bearing this differentiation in mind, where does one see commodities vis-à-vis securities under the rubric of revenue receipt?

I understand it has no truck with revenue foregone (it actually has, and I won’t dismiss it so simplistically!! but for brevity I am presuming it merely). Revenue Foregone is more of a myth in regards to the common misunderstanding surrounding the same. Section 5A (1) of the Central Excise Act 1944 empowers the Union Government to lower tariff rates below levels prescribed in the schedules, and are specifically applicable to mass consumable goods and more often than not are not tax sops to corporations. On the other side, Customs duty concessions are mostly for imported goods and used as inputs for exports as defined under Section 25 (1) of the Customs Act, and thus many a times run the risk of being included on the revenue foregone side, while it is mainly to boost India’s exports more competitively on the global market scene. Taken these two, the myth of Revenue Foregone only proliferates either as giveaways to corporations, or as political decisions taken on behalf of corporations, while the real demand from these corporations seldom make such warrants.

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Taxation on the money made via share market trading depends largely on the purpose for which share transactions are done. An individual can trade shares for business purposes or as an investment activity. In both these cases, the STT that is levied by the Government, varies. Why this obsession with STT is the obvious question? Because: STT is fast, transparent and effective. Since tax is levied as soon as the transaction arises, instances of non-payment, wrong payment etc. are reduced to a minimum. The net result of this is, however, it pushes up the cost of transactions. Now, while calculating the estimated potential of revenues from such taxes, the possibility of migration of trade volume is generally not taken into account. Hence, actual revenue mobilized in most cases does not correspond with the estimated potential, because the revenue potential is a function of the elasticity of trading volume with respect to transaction cost/STT spread. On the issue of volatility, things settle down to an ambiguity, and as far as stock exchanges are concerned, one cannot overlook it. The impact of transaction tax on volatility is a function of market microstructures. If market fundamentalists out-number noise traders, then STT will not only affect the latter, but also have a disproportionate effects on the former, leading to a fall in the trade volume and liquidity and inversely rising volatility. This inconclusively questions the veracity of transaction tax and STT, and the two are synchronous with STT and others being merely under different headings of taxation.

Let us leave behind CTT for the time being, as that would complicate matters since we are talking stock exchanges here and not commodity exchanges. Only thing, I’d like to point out then is not using commodities for revenue receipts, if such receipts are generated from stock exchanges as there is a categorical error in bringing them on a similar platform. If one goes into different heads and nomenclatures, what good does it bring about looking at transaction tax stripped off its components is something I find difficult to fathom? Would it not defeat the purpose if one is looking at volume or volumes of trade and revenue receipts under these? Looking now briefly at CTT. First proposed in 2008, it was met with extreme opposition, and CTT was proposed again in the Budget in 2013, but only on Non-Agricultural Commodities such as Gold, Silver, Aluminium, Crude Oil among others. This time the Bill was passed & CTT was levied on Trades in Commodity Futures on & after 1 July 2013. With the introduction of CTT in commodity trading, trading volumes on the MCX and other commodity exchanges in India have seen a dip as high as 50% – 60%. It has also driven away smaller segments of the volume contributors away from the segments since scalping, jobbing, etc have become an unviable and expensive proposition.

 

COMMODITY TRADING FIRMS: MORE DARKER AND SINISTER THAN CORPORATIONS

Part 1
 
WAC or any other mutation of it sounds soap and it largely depends on TRPs, or takers/viewers. So far, so good, so what? Assuming deregulation from the governments and many of the giant corporations could be pushed down the hill, a homicide that would bring smiles to millions. Right? Yes, partly, but there is a dark trajectory, an obscured world that is omnipresent and omniscient touching everyone of us in more malignant ways than could be even remotely imagined. Where am I heading here? Maybe into oblivion as thats already designated. But, pause I will and ask this. Have you heard of Vitol, Archer Daniels, Mercuria, Noble and Wilmar? What about Glencore? Well, probably not. These are not gamers, or porno-pharmacopeia of sorts swarming the Internetwork and looking for hosts and nodes to sneak into the surveillance bazaars, or even tiers in heaviness of metal sounding junk. These are “commodity firms”, trading into commodities and fixing prices of the most basic commodities from food to energy sources to pharmaceuticals, and what have you. So, what I pay is linked with mathematical calculations wrought by often young, arrogant and brilliant number crunchers. 
Let us explore, with a view to comprehend a world of finance as dark as the world of Internetwork, the Darknet, where one could not just make hay while the sun shines, but merry when the moon phases in and out. This is particularly ugly and compels me to put forth the argument that major financiers from IFIs, NFIs, and Investment Bankers are much too benign in comparison.
Rolling Stone magazine once said this for Goldman, “a great vampire squid wrapped around the face of humanity.” Such a qualification could fit any of the commodity traders, and especially Glencore, who operate out of a wealthy Swiss village, and has annual revenues of $214 billion, that is 60x FB’s or 5x what Google manages to pull in. And, this is not small tributary that swells economies, but maybe, in the most extreme analogical manner an underground tributary with a shadowy existence, since outside the stocks that trade on it, a lot of what it does is not liquid and done off the balance sheets. There goes the challenge of mapping, transparency and accountability. With an IPO of $11 billion, this price fixer has the potential to spark off riots, destabilise economies, and still manage to stay stealthy, for who would take them on radars?
With a truly frightening knowledge of the flow of commodities around the world, incredible performance culture, the firm hefts a fear factor of 3x investment banking, to say the least. With a clientele that is a roll call of world’s largest corporations viz. BP, Exxon Mobil, Chevron, ArcelorMittal, Sony and the national oil companies of Iran, Mexico and Brazil, and public utilities in France, China, Japan and Spain, to name a few, the ideal philosophy they bank on is simple: make money by finding customers for raw materials and selling them at a mark-up by concocting complex hedge funds, market swings, piracy and regime change. Oh!, this is simple huh! In other words, the simplicity lies in one word: CONTROL. They want it and they get it in high-risk environments, reproducing an ugly baby with a parentage of meshed-up financial engineering and old-fashioned conservative/orthodox/traditional commodity trading. With just two designated classes of employees: “thinkers” – who massacre numbers and “soldiers” – who seal the deal/negotiations, the quiet cognitariats release a juggernaut of extreme arrogant efficiency.
The firm was started by Marc Rich, who escaped the Nazis, set shop for spot market for crude oil, evaded taxes, sold oil to Iran during the hostage crisis in the dying 70s and growing 80s, apartheid SA, assisted Mossad and the icing on the cake: engineering a deal for a secret pipeline through which Iran could pump oil to Israel during Shah’s rule. The rule of notoriety ended when he smashed hard to ground in a valiant attempt to control Zinc market by splurging $1 billion. The reins were handed over to a German metal trader, Willy Strothotte, who translated the majority stake into $600 million, making it close to $100 billion in worth today. Glencore, often referred to as an acronym of Global Energy Commodities and Resources (though, this could be some linguist’s word play exercise) often found itself implicated in controversial dealings, but never lost sight of prowling for opportunities.
 
Part 2
Moving on from part 1, which painted a historical notoriety for commodity trading firms, this part deals borders on some operational aspects and a view of dashing financial moves in a stealthy manner.
Way back in 1993, I picked up from the flea market in Poona, Kerrang!, world’s largest read rock and metal magazine. I still remember the words then: From the Quaint Swamps of Milwaukee, comes a force that can be described in one word: Viogression, redefining music and speed spiced up with aggression. This was a death metal band from Wisconsin, and the advertisement was for Milwaukee Death Fest, a converging point for Death Metal fans. Obviously, the speed has been surpassed exponentially ever since. But, why this? As an analogy, Glencore comes brutalizing financial sways and swings, upsides and downsides from a quaint village of Baar in Switzerland, unleashing its ferocity on the London-stock exchange listing and a registered office in Saint Helier, Jersey. As brutal as the band could get on the Milwaukee music scene then, the commodity traders have unleashed their fury on the financial stage and continuing to accelerate its spawn. 
The contingency of operations make for a smart move, for in contingency is the scent of an opportunity rather than the stench of risk. This ain’t the twisted version, but rather a crude philosophical one for the commodity trading firms (CTFs hereafter). The opportunity is built over offtake deals, where other financial institutions fear to tread for uncertainty lying over repayment for whatever gets invested. This is as much a part of the risk investment. Such deals materialise, mostly in natural resources, when with significant capital costs involved in extraction of the resources forces the company to have a guarantee that its product will be sold, that there shall be a secure market. Such a situation is promised, and if the company were to slide into a financial quandary, a likely debt-burden gets slashed by bringing in swapping loans-for-rights/ownership issues, thus offloading the equity for uploading it to the CTFs. In financial parlance, such a move is termed prosaically: right to convert debt into equity in the tail. ‘In the Tail’ connotes tail risks, which are low probability events that have an outsized impacts on prices, more than often inordinately large. In present times, the nightmarish tail risk is the perennial China hard-landing, which, if it were to occur would exponentially rise costs of basic commodities, diverge them due to supply disruptions rather than demand overflow, thus churning faster the global economy and sickening consumption in course as a result of shrinking supply.
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When Merrill Lynch conducted a survey in the beginning of this year asking about the biggest tail risk for the global economy, fund managers answered China hard-landing/collapse in commodity prices. And yet, technically the commodity index is breaking out on the upside. Interestingly, only about 5% of fund managers really worried about inflation risks. 
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Merrill Lynch observed that a net 23% of investors are currently underweight commodities, which is only a slight improvement from net 31% underweight in December 2013. Current readings in exposure are extremely under-owned at 1.7 standard deviations below its decade long average. The situation as it stands today resembles 2008, when just about every fund manager and policy maker was pessimistic on commodities and inflation right before the prices bottomed out and rallied powerfully in coming quarters. But, if inflation was to surprise the markets to the upside, then stocks could get oblivious, since history has time and again proved that commodities have always been the best hedge against inflation. Sigh!, Huh!
Moving on, CTF’s operational key lies in flotation, listing its shares on the stock market, albeit in a split manner as was talked off in part 1. The issue of safeguards and adherence to strict guidelines is robust here, for potential investors are not to be misled. Once new shares are issued on the primary market, trading sets off in the secondary market, in that trading transactions occur between investors without any involvement of the CTF. This still is procedurally under check, but CTFs invent a twist, for they list with the clause for a permanent capital base. Rationale is simple here: In private partnerships, payouts to departing partners shrink the capital base, while public companies’ equity remains intact even if the shares change hands at dizzying speeds. Most cardinally, such a move injects reassurance in credit agencies that not only shy from keeping at bay any relegation of CTFs to junk on the one hand, but allows the CTFs enough manipulability with flexible capital structures going in for the kill, meaty acquisitions on the other. Getting back to Glencore, this example for once sets up a sneak peek into what the CTF is capable of, and how it is well-nigh difficult to locate movements in such financial transactions. Transactions that make possible coming out clean and acquit being cornered to a dock. When speculations were rife in 2010 of a possible merger between Glencore and London-listed Xstrata, shareholders of the latter opposed it, arguing that the valuation of the former be dictated by market forces and not dealt with behind closed doors. To force things to a head, Glencore set the clock ticking on a change in its set-up by issuing a convertible bond. These types of bonds not only can be converted into a predetermined amount of the company’s equity at certain times during its lifespan, but also helps facilitate the CTFs to alleviate any negative investor interpretations of its corporate actions. From investors’ point of view, the bond has a hidden stock option, and helps her with a lower rate of return in exchange for the value of the option to trade the bond into stock. The package was set thusly: convertibles pay a staid interest rate of 5% every year till their maturity in 2014, but are laden with incentives for Glencore to transform itself. In other words, the package contains this: If by December 2012, Glencore does not float or merge with another company, bondholders can sell their bonds back to Glencore at a price which would give investors an annualised return of 20%, in line with the sorts of returns one might expect from equities. By this, the CTF will not be penalised if markets turn lower and if the IPO turns to be unattractive. A smirk invades faces!!! 
CSOs can take up the archaeologist’s role, and dig they will in order to turn opacity into at least translucency, if not outright transparency, for CTFs deal with a chain that is particularly vulnerable to mismanagement, and therefore scrutiny becomes the sine qua non to bring these onto the radar screens. There is an actionaid page on Glencore’s tax dodge in Zambia here and the cover up this tax probe here by none other than European Investment Bank. These wolves make their money at the margins, and profits by working in the global margins, margins of what is legal, erecting walls of shell corporations, weaving complex webs of partners, offshoring accounts in order to obscure transactions, and working with shady intermediaries (Financial Intermediaries in the case of IFIs could be coaxed into differential calculus of presenting themselves into the developing world, but as it holds true invest far and between into repressive political regimes: safeguards and recourse mechanisms at least on paper guarantee this) to obfuscate what is legally corrupt and what is not. No wonder, titularly, the post makes sense: what does one do these? 
Part 3
I apologize for the length of this concluding part and the series thats been flooding your inboxes for the last three days. The idea behind the series emanated after a twitter discussion with a couple of friends, where we wanted to understand the dark movements of commodity trading financing and its ramifications for a political habitat where notions of post-industrial capitalism could be brought to light in at least comprehensibility, if nothing more. Thanks for the patience.
Leveraging information in times of wild commodity-economic swings is cashed on. Trading and hedging all the way, it is akin to a casino, where the ‘house’ always wins, a spot of volatility, where eagles dare, nah, where the wolves dare. In one of the most interesting euphemisms ever from Deutsche Bank on Glencore, the German Bank said, “Key drivers of growth: copper in the Democratic Republic of the Congo, coal in Colombia, and Gold in Kazakhstan. All are places with a heady, dangerous mix of extraordinary wealth and various degrees of instability, violence and strongman leaders. But, these guys need to adapt as well, and adapt they do undermining transparency. In a pretty hubristic manner, Marc Rich said, “Discretion is an important factor of success in the commodity business. They probably don’t have a choice. Transparency is requested today. It limits your activity, to be sure, but it’s just a new strategy to which they have to adapt.” (Italics/emphasis mine). 
Hedge: an investment position intended to offset losses/gains that may be incurred by a companion investment. Hedging is the practice of taking a position in one market to offset and balance agains the risk adopted by assuming a position in a contrary or opposing market or investment.
Derivatives: special contracts that derives its value from the performance of an underlying entity, which could be an asset, index, or interest rate. Derivatives as used here are used in insuring against price movements/fluctuations (hedging), increasing exposure to price movements for speculation or getting access to otherwise hard to trade assets or markets. Thanks Wiki.
Moving on backwards for a time, CTFs chiefly perform arbitrages, while facing a wide array of risks, which are often times managed by hedging, insurance and/or diversification. Probably taking a leaf from Richard Morgan, a force in himself on the science-fiction space, I’d have no second thoughts in underlining that these guys are adept in transferring risks to the financial markets using instruments of hedging in derivatives or purchasing insurance. The principal funding comes through mixing debt and debt maturities, to which we shall turn shortly. Upon emaciating my bitterness as exhibiting in parts 1 and 2, the suggestion that CTFs are potentially the sources of systematic risks like the banks, and hence be open to regulations, the faltering point comes with the fact that these are not too big to fail, and at most of the times keep themselves in check from engaging in kinds of maturity transformations that make banks highly susceptible to run. Moreover, these are not major sources of credits like the  IFIs and their ilk, and thus are not very leveraging entities, and if at all these encounter any financial distress, these simply transfer the distress to others.
In the penultimate section, let us deliberate on risk factors, before concluding with modes of financing. I’d try to keep mathematics to the bare minimum, and would circle on attempts at popularising. Risks have numerous paths of departure from the way IFIs and their ilk define, negotiate and deal with. Traditionally, CTFs deal with Flat Price Risks, where flat price is the absolute price level of the commodity to be traded. The firm transacts a commodity, and hedges the relative commodity position through derivatives transaction, by for e.g. selling future contracts to hedge inventory in transit. This is carried out with the intention of transforming the exposure to commodity’s flat price into an exposure to the basis between the price of commodity and the price of the hedging instrument. Flat Price Risks do not always materialise into distress, for hedging sees to it that an exchange of Flat Price Risk for a Basis Risk transpires, i.e. the risk of changes in the difference of the price between the commodity being hedged and the hedging instrument. Such a price differential is possible because the characteristics of the hedging instrument are seldom identical to the characteristics of the physical commodity being hedged. The differential is, moreover built on a positive feedback mechanism that creates a virtuous cycle, standardising hedging instruments for commodities and inducing market participants to trade these standardised contracts with less of a basis risk, but more of a transaction cost. In short, Basis Risk is commodity-contextual and opportunistic for the firms to accept, and pregnant with what in financial jargon is termed ‘a corner or a squeeze’, by which is meant an exercise of the market power in a derivative market, a tendency to cause distortion in the basis that can possibly inflict harm on hedgers. Certain rogue traders can cause ruptures by either spreading risks across margins between the sale and purchase prices depending on volumes of transactions, or even cause ruptures in operations. Well, it is not very difficult to realise that this is part of a contractual risk, when the other party defaults. This could be quite detrimental for the CTFs for the sellers of commodities to consumers have an incentive to default when prices rise subsequent to their contracting clause, and the CTFs are left to lurk for finding the necessary supplies. To escape the trap of such situations, CTFs devise ways to enter and exit positions to negotiate Market Liquidity Risks, where liquidity as a node of causal chain in market flip-flops can cause huge distress. But, if caught in such scenarios, funding this liquidity risk becomes the imperative. Both, funding liquidity and market liquidity are in a relationship of correlation, of interaction, in that stressed conditions in financial markets result in decline of both market liquidity and funding liquidity, compounded through large price fluctuations and movements leading to greater variation margin payments and thus increasing financing. Lastly, appreciation and depreciation of local currencies tied with political economy of the geographies and vulnerability to legal transgressions often face the CTFs in the face of legal reputation getting hit and imposition of legal sanctions looming large. At present times, when commodity manipulation is subjected to considerably intense political and regulatory attention and scrutiny, CTFs bank on difficulties in legal proceedings on the one hand, and on the other, their expertise regarding the economic frictions in transformation processes that make their activities profitable and their financial size big enough and thus almost lending them a position to do so through a term mentioned in the beginning of this sentence, manipulation.
Turning to financing now. As is well known that debt and equity issued by CTFs link them to a broad financial ecology, and therefore any capital structure envisaged by CTFs opens them up to vulnerabilities of market swings. CTFs traverse from gearing/leverage, forms of leverage these employ and rights/ownership of equities. Pure trading firms that own relatively few fixed assets tend to be more highly leveraged than firms that also engage in processing and refining transformations that require investments in fixed assets. At the same time, firms engaged in more fixed asset intensive transformations have a greater proportion of long-term liabilities. CTFs do not always engage in maturity transformations as do the banks, and when they do, it is the reverse of the borrow short-lend long transformation that makes bank balance sheets fragile, and exposes banks and financial intermediaries (FIs) to runover risks. Additionally, since CTFs’ primarily hedged inventories and trade receivables tend to be highly liquid and of high credit quality, these firms run less liquidity risks than FIs and banks. CTFs rely on bank borrowings to finance these transformation activities, by either through short-term borrowings that could also be routed through unsecured credit lines via an arrangement that is syndicated. A typical case involves bilateral credit lines, and are secured by saleable commodities in liquid markets that are marked to market and hedged, and thereby benefiting these exposures to short maturities, which in turn present less credit risks as compared to a credit secured by less liquid collateral. Other than these, non-bank financial vehicles like shadow-bank transactions are often used to securitise inventories and receivables. Glencore specialises in this format, the format that dals with FIs through the issuance of debt outside the insured banking system. The financing mechanisms get complex when tied with ownership rights, where if inefficient risk bearing is the major cost incurred in private ownership, it is the idiosyncratic risks of commodity that get diversified, thanks to shareholders when the firm is publicly listed. But, private firms have a way out inked in financial contracts whereby risks outside the gamut of management control can be transferred to others. This structure built into the contract not only incentivises benefits to the private CTFs, but also score mighty in comparison to public-listed firms, where risk bearing capability is modest at best. But, there is a catch here that swings the pendulum in favour of publicly-listed firms and was possibly one of the chief reasons for Glencore going public. In large-scale investments where equity investments can shoot the budget of private players and expose them to humungous risks, a transference of risks by means of non-equity financial contracts to others is not feasible, and thus a recourse to businesses that can be hedged in derivatives, credit and insurance markets is undertaken. In short, with increasing asset intensity and accumulation of sorts, a movement away from private ownership to going public is indispensable. The obvious question in many minds at the moment would naturally be: what about disclosure then? Who scores and who wins here? The private firms are obligated to keep accounts and records to be kept in accordance with accepted accounting principles and standards, but the laws regarding what information must be disclosed is discretionary upon jurisdiction. In the case of US, private firms have to provide information to their lenders and derivatives counterparts, and at any time with their discretion can provide their financial information in ways similar to those employed by their public counterparts. Importantly, with respect to disclosures to government regulators, CTF positions in listed derivatives are available to exchange staff and government regulators.
What about their relation with FIs? CTFs supply financial intermediation servies to their customers through trade credits, structured transactions that bundle financing, risk management and marketing services. A CTF selling a commodity to a customer has better information about the buyer than would a bank, thus giving the option to the CTF to have a better preparedness on evaluating creditworthiness as compared to a bank. As is a well known fact that cash is more fungible than a commodity, any diversion with cash input is more likely than with a commodity, and thereby more risky. One way to reduce this risk susceptibility is through an off-take agreement, where a CTF agrees to purchase a contractually specified quantity of a commodity from a producer usually at a floating price. the process starts off with refinancing involving three parties: the borrower, CTF and the bank. Borrower and the CTF enter into a prepay arrangement with the bank providing the necessary funds to the borrower. When the commodity is delivered to the CTF, the CTF pays the amount it owes under the off-take agreement to the bank to repay the loan. Wow!, the bank has no recourse to the CTF, and bears all the credit risk associated with the loan to the borrower. What, then is prepay? Two variants emanate in this regard: in the 1st, the bank provides limited recourse financing to the CTF, and the trader assigns the rights under the off-take arrangement to the bank as a security; the CTF provides funds to the producer, but the bank absorbs the credit risk on the loan (there could be instances when the CTF may keep a risk participation), in the 2nd, the bank provides full recourse financing to the CTF, which then makes a loan to the borrower. Thus in the 2nd variation, the CTF bears the risk that the borrower will not repay the prepaid amount. The CTF, in turn, can offload all or some of this credit risk by entering into an insurance policy, and depending on the terms of the financing provided by the bank to the CTF, the bank may be the loss payee on this insurance policy. A CTF can also engage in a Tolling arrangement, where the CTF supplies a commodity processor with an input and takes ownership of the processed commodity. The CTF pays a fixed fee to the processor, pays the market price to acquire the input, and receives the market price for the refined products. This type of an arrangement is common with oil as the main input. Thee structures bundle together multiple goods and services. For e.g. in a simple off-take agreement, the CTF provides marketing services and hedging. A prepay incorporates these elements and a financing component as well. The seller receives cash upfront, in exchange for a lower stream of payments in the future with the discount on the sales price being effectively the interest on the prep amount. A Tolling arrangement bundles input sourcing, output marketing, price risk management, and working capital financing. The working capital element exists because the CTF has to finance the input from the time it is purchased until it can realise revenue from the sale of the refined goods after processing is complete. The benefits of Tolling entail a need for working capital to finance the timing gap between cash outflows and inflows. But, there is an ethical dilemma here: providing financing for working capital is a traditional activity banks have hitherto engaged in. When the lender lends to an entity, it leaves the entity to acquire input and market outputs, and bear and perhaps manage the price and operational risks associated with those activities. This leaves the lender exposed to risks where any adverse movements in prices could leave the entity into a financial distress and cause default. The lender could require the borrower to hedge, and if it does not, or does not do it effectively, the lender bears the risk. This undermines the incentive of the borrower to hedge, and hedge well. The lender can monitor, but this is costly and often times imperfect. The ethical dilemma is addressed by passing the risk to the lender. A prepay or Tolling does this well. These implicitly provide the funding to bridge the outflow-inflow gap, and pass on the price risks back to the lender. The lender can manage these risks and the agency costs in this arrangement is on the lower side, and since the lender bears the price risk, there is no ethical dilemma anymore. Most crucially, it takes on the incentive to manage the risks, thus quashing any need for monitoring it. the implication is that bundling price risk management and financing can reduce the cost of funding working capital needs. Furthermore, the lender may have a comparative advantage in managing risks due to specialisation and expertise in this function: CTFs and banks have a comparative advantage in risk management. CTFs with their specialisation in logistics and marketing smoothly navigate scale and scope economies. For instance, it may be cheaper for a CTF to provide marketing and logistical services thereby eliminating any associated overheads with these activities. Less sophisticated firms, on the other hand benefit hugely by delegating marketing, logistics and risk management services to specialist firms that can exploit the scale and scope economies. Thus, bundling financing and FIs make for a complementarity.
In conclusion, CTFs are here to stay, but need serious attention of regulators, for there is a scare that traders’ ownership of infrastructure allows these firms to manipulate local prices, even if they do not have the heft to rig global markets. Mochas Kituyi, secretary-general of the United Nations Conference on Trade and Development accuses the industry of corruption and illicit flows and large-scale trade mispricing in the developing world. And this is where their potential hazardous nature surfaces. Importantly, activists need the necessary instruments to dig deep in transactions that more than likely result in CTFs ride out with profit when cornered and/or investigated. In this era of black swans, the sharpening of teeth eating into the flesh of CTFs should generally commence from the knowledge economy/ecology with no truck for the dichotomy.