Matt Levine had a pretty entertaining explanation of a different incident earlier this year, involving futures contracts:
> JPMorgan, which does not make batteries or cars, bought bags of abstract nickel years ago. It took delivery of that nickel, not in the sense that a truck full of nickel showed up on Park Avenue but in the sense that an entry was made, on the ledger of the warehouse, saying that the bags of nickel in Row X, Shelf Y now belonged to JPMorgan.
> JPMorgan then used that nickel for its intended purposes for years. Those purposes were to write financial contracts referencing that nickel. The nickel worked perfectly well for those purposes — JPMorgan’s derivative contracts traded and paid off normally — for years, even though the nickel was not in fact nickel, just bags of rocks.
> And then one day a warehouse worker, like, stubbed his toe against JPMorgan’s nickel and was like “hmm that’s not the sound nickel makes when you kick it” and opened the bags and found rocks. And then the [London Metal Exchange] dutifully reported that some nickel was not nickel, and JPMorgan’s nickel warrants were transformed into rocks warrants. But it’s all just a random accident? The purpose of JPMorgan’s nickel was not to be turned into batteries or cars, but to sit in a warehouse. It was doing a great job of that, until someone noticed!
Also one of my favorites, futures derivative contracts are like second derivative meta on reality :-). The invention of money[1] was an example we used with our kids to explain the difference between "money" and "wealth"[2]. Because once you can internalize that distinction, you can ask yourself "is this expensive or is it valuable?" and get a reasoned answer to that.
[2] While many people associate "wealth" with "being rich" it actually has a economic definition unrelated to whether or not one possesses more or less of it than their neighbors for friends. From Investopedia, "Wealth measures the value of all the assets of worth owned by a person." which you can give an example of that owning a bicycle is "wealth" that is an asset, and you can use that asset to get to and from a job that is further than you can walk, so that asset (wealth) enhances your ability to generate capitol (money) to fund your daily needs and to acquire more assets (wealth).
The future itself is the first derivative, it's a bet on the rate of change in terms of availability and/or consumption of a resource (hence the slope of the production curve), the second derivative is rate of change in the interest in the rate of change of the availability :-).
> [2] To be clear, I’m making this up, I have no idea how the fraud was discovered and never want to find out, unless the real story is funnier than this one.
> [3] I don’t know if they were? Is JPMorgan entitled to take out the rocks? Is it required to take out the rocks? “Hey JPMorgan you have 10 days to come pick up your rocks; if you don’t we’re gonna throw them through Jamie Dimon’s window”? If someone cracks open one of the rocks and there’s a diamond inside, does JPMorgan get the diamond?
In a previous job, I did some stock taking. Quarterly, without trained people nor procedures instead of a proper cycle coint, done double blind, by a dedictaed team of people (I didn't stay long at that job). Some of the inventory we had to account for, and funny enough most of it was almost correct accounting / revenue shennenigans nothwothstanding, was stored in a huge warehouse that held aerospace grade aluminium and titanium ingots. Thousands of tons of those. All being traded on some exchanges, hardly ever leaving said warehouse.
Propably nobody would ever nice what it was until, if ever, the ingots were to be used to produce bars and other raw materials for production. And even if it wasn't aluminium or titanium by then, propably enough money was earned to just replace it with the real stuff and not worry.
I've read this four times and it feels like I'm having a stroke trying to understand it.
Edit: I think they're saying that they audited a metals warehouse and that nobody actually checked that the ingots were what they claimed to be.
That's probably because the ingots came from trusted sources and/or were checked via things like mass and x-ray spectrography machines before being admitted into the system.
My main takeaway is that ownership of those metals isn't translated into them being used for manufacturing, and since they generally aren't used for manufacturing and they aren't being moved when ownership transfers, there is very little reason to audit them.
So if they eventually DO end up being purchased for manufacturing but upon inspection are found to be short stocked or it's the wrong material entirely, the commenter was speculating that replacing the fake material with the real thing would be covered somehow either by the warehouse collecting storage fees or insurance.
It was avfun experience, we audited other stuff stored at the same warehouse (the reasons for that are good case study on how not to run logistics and warehouses). And I did raw material procurement, bars, plates and such, for aerospace before, so seeing the ingots sitting in a warehouse being bought and sold without being moved at all was interesting see. And we litterally thousands and thousands of ton of that stuff in a warehouse in one of the most expensive warehouse locations you can think of.
I heard a bunch of conspiracy theories about Comex warehouses and gold repositories not actually holding the precious metals that they claim.
But AFAICT, the theories were coming from political extremist influencers. (Buy these silver rounds at large premiums, so that, when the dollar collapses, and people find the warehouses are empty, and Canadian tanks roll into Washington, you'll be the alpha male.)
Would be funny if someday we learned that the demagogues were accidentally correct about the warehouse shenanigans.
Consider that the stated gold reserves in Fort Knox haven't been audited since the 1950s. Then-Treasury Secretary Mnuchin during the Trump administration, supposedly visited and in lieu of an actual audit, reported that 'yup it's there' ... Very reassuring!
Germany's central bank in 2013 was forced by those rumors to re-patriate a lot of gold formerly held in Paris and by the Federal Reserve in New York. So called conservatives seeded stories that the Fed had emptied the vaults and only paper remained. Of course that was all hogwash and the stuff has now partly been transferred to Frankfurt.
I wonder what fraction of nickel or other precious metals is effectively never used. With oil or grain, those will expire, so physical delivery is taken often.
That's like putting up a dummy fire extinghuisher to make people feel safe. It works. But if one day there is a crisis, that's when you will want the real thing.
It’s bad because it can’t be settled. If Chase is to assume the clawback from a default settlement, then they are essentially non secured contracts and could have been traded so without the extra cost of the rocks.
But in general you want the people responsible of delivery to be responsible and actually deliver even if 99% of the time the underlying is just exchanged electronically.
For the net impact to the economy it depends on few things.
What did suppliers do in response? If suppliers believed there was a nickel reserve that could potentially enter the market, they would be less likely to choose strategies such as constraining supply in order to increase prices which helps consumers of nickel. However, they also would be less motivated to store up surplus nickel of their own that would help alleviate natural shortages.
The other thing to consider is that we think the nickel did exist at some point in time, so in this case crime did pay. Therefore the thieves' ill-gotten gains will have increased their capacity to carry out future scams.
It's similar to if you provided insurance to someone and happily accepted payments knowing you could never actually pay out their insurance claim. The person making payments is a victim even if he never realizes it.
Are you though? You never had a claim that couldn't be paid out. If you needed that insurance in order to do or buy something, you were able to do or buy that thing. You have no damages. You absolutely could have, but you didn't.
If someone points a loaded gun to your baby's head but you never notice, is your baby really a victim of assault? In both situations it's irrelevant if you never knew, you were still exposed to a massive amount of risk, making you a victim.
A war starts tomorrow and you need need X to produce the stuff to protect your country. Not a problem right, you have plenty of X. Ooops, not really, it's lies and corruption all the way down.
The same JPMorgan that financed Epstein, failed to keep mandatory records, "lost" 47 million emails and were fined nearly a billion dollars for spoofing metals markets? The JPMorgan that taxpayers "gave" a $12 billion bailout to?
... Probably not your friend, unless your 'net worth' is in the 8 figures range.
> JPMorgan, which does not make batteries or cars, bought bags of abstract nickel years ago. It took delivery of that nickel, not in the sense that a truck full of nickel showed up on Park Avenue but in the sense that an entry was made, on the ledger of the warehouse, saying that the bags of nickel in Row X, Shelf Y now belonged to JPMorgan.
> JPMorgan then used that nickel for its intended purposes for years. Those purposes were to write financial contracts referencing that nickel. The nickel worked perfectly well for those purposes — JPMorgan’s derivative contracts traded and paid off normally — for years, even though the nickel was not in fact nickel, just bags of rocks.
> And then one day a warehouse worker, like, stubbed his toe against JPMorgan’s nickel and was like “hmm that’s not the sound nickel makes when you kick it” and opened the bags and found rocks. And then the [London Metal Exchange] dutifully reported that some nickel was not nickel, and JPMorgan’s nickel warrants were transformed into rocks warrants. But it’s all just a random accident? The purpose of JPMorgan’s nickel was not to be turned into batteries or cars, but to sit in a warehouse. It was doing a great job of that, until someone noticed!
https://www.bloomberg.com/opinion/articles/2023-03-21/jpmorg...