How Copper Came a Cropper
Last year, the world was
astonished to hear that a young employee of the ancient British firm Barings
had lost more than a billion dollars in speculative trading, quite literally
breaking the bank. But when an even bigger financial disaster was revealed last
month--the loss of at least $1.8 billion (the true number is rumored to be $4
billion or more) in the copper market by an employee of Sumitomo Corp.--the
story quickly faded from the front pages. "Oh well, just another rogue trader,"
was the general reaction.
Thanks largely to
investigative reporting by the Financial Times , however, it has become
clear that Yasuo Hamanaka, unlike Nick Leeson of Barings, was not a poorly
supervised employee using his company's money to gamble on unpredictable
markets. On the contrary, there is little question that he was, in fact,
implementing a deliberate corporate strategy of "cornering" the world copper
market--a strategy that worked, yielding huge profits, for a number of years.
Hubris brought him down in the end; but it is his initial success, not his
eventual failure, that is the really disturbing part of the tale.
To
understand what Sumitomo was up to, you don't need to know many details about
the copper market. The essential facts about copper (and many other
commodities) are 1) It is subject to wide fluctuations in the balance between
supply and demand, and 2) It can be stored, so that production need not be
consumed at once. These two facts mean that a certain amount of speculation is
a normal and necessary part of the way the market works: It is inevitable and
desirable that people should try to buy low and sell high, building up
inventories when the price is perceived to be unusually low and running those
inventories down when the price seems to be especially high.
So far so good. But a long time ago somebody--I wouldn't be
surprised if it were a Phoenician tin merchant in the first millennium
B.C.--realized that a clever man with sufficiently deep pockets could basically
hold such a market up for ransom. The details are often mind-numbingly complex,
but the principle is simple. Buy up a large part of the supply of whatever
commodity you are trying to corner--it doesn't really matter whether you
actually take claim to the stuff itself or buy up "futures," which are nothing
but promises to deliver the stuff on a specified date--then deliberately keep
some--not all--of what you have bought off the market, to sell later. What you
have now done, if you have pulled it off, is created an artificial shortage
that sends prices soaring, allowing you to make big profits on the stuff you do
sell. You may be obliged to take some loss on the supplies you have withheld
from the market, selling them later at lower prices, but if you do it right,
this loss will be far smaller than your gain from higher current prices.
It's nice
work if you can get it; there are only three important hitches. First, you must
be able to operate on a sufficiently large scale. Second, the strategy only
works if not too many people realize what is going on--otherwise nobody will
sell to you in the first place unless you offer a price so high that the game
no longer pays. Third, this kind of thing is, for obvious reasons, quite
illegal. (The first Phoenician who tried it probably got very rich; the second
got sacrificed to Moloch.)
The amazing thing is that Sumitomo managed to
overcome all these hitches. The world copper market is immense; nonetheless, a
single trader, apparently, was able and willing to dominate that market. You
might have thought that the kind of secrecy required for such a massive market
manipulation was impossible in the modern information age--but Hamanaka pulled
it off, partly by working through British intermediaries, but mainly through a
covert alliance with Chinese firms (some of them state-owned). And as for the
regulators ... well, what about the regulators?
For that
is the disturbing part of the Sumitomo story. If Hamanaka had really been
nothing more than an employee run wild, one could not really fault regulators
for failing to rein him in; that would have been his employer's job. But he
wasn't; he was, in effect, engaged in a price-fixing conspiracy on his
employer's behalf. And while it may not have been obvious what Sumitomo was up
to early in the game, the role of "Mr. Copper" and his company in manipulating
prices has apparently been common knowledge for years among everyone familiar
with the copper market. Indeed, copper futures have been the object of massive
speculative selling by the likes of George Soros, precisely because informed
players believed that Hamanaka was keeping the price at artificially high
levels, and that it would eventually plunge. (Soros, however, gave up a few
months too soon, apparently intimidated by Sumitomo's seemingly limitless
resources.) So why was Hamanaka allowed to continue?
The answer may in part be that the global nature of his
activities made it unclear who had responsibility. Should it have been Japan,
because Sumitomo is based there? Should it have been Britain, home of the
London Metal Exchange? Should it have been the United States, where much of the
copper Sumitomo ended up owning is warehoused? Beyond this confusion over
responsibility, however, one suspects that regulators were inhibited by the
uncritically pro-market ideology of our times. Many people nowadays take it as
an article of faith that free markets always take care of themselves--that
there is no need to police people like Hamanaka, because the market will
automatically punish their presumption.
And Sumitomo's strategy did
indeed eventually come to grief--but only because Hamanaka apparently could not
bring himself to face the fact that even the most successful market manipulator
must accept an occasional down along with the ups. Rather than sell some of his
copper at a loss, he chose to play double or nothing, trying to repeat his
initial success by driving prices ever higher; since a market corner is
necessarily a sometime thing, his unwillingness to let go led to disaster. But
had Hamanaka been a bit more flexible and realistic, Sumitomo could have walked
away from the copper market with modest losses offset by enormous, ill-gotten
gains.
The funny thing about the
Sumitomo affair is that if you ignore the exotic trimmings--the Japanese names,
the Chinese connection--it's a story right out of the robber-baron era, the
days of Jay Gould and Jim Fisk. There has been a worldwide rush to deregulate
financial markets, to bring back the good old days of the 19th century when
investors were free to make money however they saw fit. Maybe the Sumitomo
affair will remind us that not all the profitable things unfettered investors
can do with their money are socially productive; maybe it will even remind us
why we regulated financial markets in the first place.
