The fragility of contemporary capitalism

The Ukraine situation is having unexpected economic consequences, such as an explosion in nickel prices, and a prolonged war could be catastrophic for a financialised world economy mired in speculation.

While the world remains preoccupied with the geopolitical and humanitarian fallout of the Russian invasion of Ukraine, its economic consequences are increasingly a matter for concern. Although the two countries at war account for barely 2.5 per cent of the world’s population, it emerges that the damage to production within their boundaries and the suspension of their trading relationship with the rest of the world are threatening to create a crisis in multiple markets, not least in the markets for food and oil where shortages abound and prices are rising. This is a typical illustration of the fate of nations entangled in a globalised world economy.

But there is more that the war in Ukraine is showing up. Events in remote corners of the global economic system illustrate how centralised and financialised markets for goods and services have increased the fragility of contemporary capitalism. A telling example is the market for nickel and nickel futures. Nickel is a metal used in the production of stainless steel and has gained in importance because it is a crucial input in batteries that fuel the world’s booming electric vehicle industry. It is not normally the centre of attention in economic discussions. But matters changed on March 8, 2022, when the London Metal Exchange (LME), which describes itself as “the world centre for industrial metals pricing, hedging and trading”, suspended trade in nickel.

Some may say that the move should not be too much cause for concern. But the suspension was a rare and almost unprecedented event in the history of the LME’s nickel market, which provides the reference price for the metal for all those exposed to it along global value chains. The suspension was triggered by extraordinary price trends. In a single day, nickel prices doubled to exceed $100,000 a tonne, and the prices of nickel futures rose by 175 per cent over a two-day period. The trigger for the price explosion was the Ukraine war and sanctions that threatened to shut out Russia—which accounts for around 11 per cent of global nickel output—from world markets. But, as noted earlier, Russia and Ukraine seem to be important in multiple markets, such as wheat, oil and fertilizer. All of them have seen price increases, but none of a kind (as yet) that ended up in a decision to halt trading in the commodity. A lot more must have happened in the nickel market for things to reach such a pass. And indeed, it had.

Tsingshan role in price explosion

It emerges that one player’s extraordinary exposure to nickel, through its agents, was turning what should have been a price spike into a price explosion. That player is China’s Tsingshan Holding Group, the world’s biggest producer of nickel and stainless steel, led by Xiang Guangda, yet another Chinese tycoon with a rags-to-riches story. The group controls large nickel producing capacities in Indonesia that supply the metal to its stainless steel plants or to Chinese producers of electric vehicle batteries.

Xiang, being a metals tycoon, was obviously exposed to the market for metal futures, especially nickel futures. Futures are seen as sensible hedging instruments that help protect those exposed to markets for commodities from suffering losses if prices move in unexpected directions. For example, if production decisions are taken assuming that the price of nickel would rule at $40,000 a tonne, but the price falls to $35,000 a tonne by the time the product reaches the market, the supplier would suffer significant losses.

So, paying a premium for a futures trade wherein some buyers are willing to commit in advance to pay $40,000 a tonne is a way of insuring against losses. If the price does not fall, you lose only the premium. If it does, you cut your losses and protect profits.

But futures markets are not populated only by hedgers engaged in production but also by speculators who, convinced of their expectations of how markets would move, place bets to reap profits from trading. A typical example of such a bet is a “short”. Traders who are convinced that the prices of a commodity will fall borrow that commodity to sell at today’s high price, with the plan to buy back at a lower price at a later date to return the commodity to the lender and close the deal. The spread between the selling and buying prices, after allowing for costs, delivers a profit. Even if you are not a nickel producer, it is a legitimate and potentially lucrative activity to engage in.

Xiang’s case was, of course, different. His group is a major producer of nickel and steel. That possibly convinced him that he had more knowledge and a better idea than most on how the markets would move. He believed that nickel prices would fall significantly, given the likely trends in demand and supply. That encouraged him to go beyond hedging. He chose to accumulate large short positions, financed with debt, placing bets that would allow him to benefit from that expected fall in price and reap huge profits. Some of those bets were not even in exchange-traded futures but in over-the-counter derivatives partly issued by banks.

But the Russian invasion of Ukraine tripped him up. Prices rose and, caught in a “short squeeze”, he was losing massively on those deals. The estimated losses totalled more than $8 billion in an extremely short span.

When something of that magnitude happens, brokers and creditors demand more “margin” money to cover those losses. If forced to make those payments, the speculator could face a liquidity crunch, running short of cash to pay up. Xiang would also have to consider buying the commodity—in this case nickel—before prices rose further, in order to deliver the physical metal against futures contracts and cut losses when closing deals. That also requires money. However, it also increases the demand for the physical commodity, both from the short seller and other steel and battery producers using the raw material, resulting in further price increases, since the commodity is in short supply.

That explains the explosion in nickel and nickel futures prices. It did not help that Tsingshan’s own production of nickel was not of the Class 1 type (99.8 per cent purity) needed for delivery against an LME contract. So, the group could not divert its own production to close the deals it had entered into.

LME halts trading

An event like this roils financial markets as well. In this instance, the LME had to halt trading and find ways of closing out a large proportion of the short positions to stabilise markets. However, some money managers were angry that the exchange, realising that some brokers would default on margin calls that the price spike entailed, cancelled around 5,000 trades that had been concluded when the price had risen but before the suspension of trading. This was clearly a decision that penalised those who would have profited from the trade to save the brokers who had entered into those deals voluntarily. Those brokers were members acting on behalf of buyers who wanted the physical commodity for production, while the speculators who gained were largely electronic traders making speculative bets.

The action may have prevented many defaults but it was a violation of market principles. But a spokesperson for the LME reportedly justified the action, stating: “In the interests of systemic stability and market integrity, we suspended the market as soon as we could and cancelled trades from the point at which the LME no longer believed that prices reflected the underlying physical market.” That position is unlikely to go unchallenged.

The banks supporting Tsingshan’s speculation were hit as well. If they closed the group’s positions or insisted on margin calls, Tsingshan and Xiang could default. To prevent that, they had to roll over or extend more credit. Tsingshan reportedly owes billions of dollars to the likes of JPMorgan Chase, Standard Chartered and BNP Paribas, which had to negotiate a deal that allowed the group to postpone repayments and offered it more credit.

China Construction Bank also obliged with new credit lines and the Chinese government has reportedly advised banks to lend a helping hand. But uncertainty still haunts the market and those exposed to it.

These ripple effects of the invasion of Ukraine across the world’s economy and financial system point to how the transformation of capitalism in the last three decades and more has rendered it fragile. A shock can damage the world’s economic and financial system through multiple routes. Not only will the war in Ukraine have catastrophic military and humanitarian consequences if no resolution is found, its effects on inflation and on unexpected segments of a financialised world economy mired in speculation could precipitate another global economic crisis.