Mr. Chairman and Members of the Committee, I am pleased to be here this morning and to explore with you the issues raised in connection with Senate bill 2704. In my view, a law of the sort you are considering would have been quite helpful in minimizing the adverse impacts of the recent speculative bubble in the silver market. As is appropriate in collegial deliberative bodies, however, the members of the Commission hold differing opinions concerning the seriousness of the silver bubble and whether remedial legislative action is called for to prevent a recurrence. The perspective I offer is strictly my own rather than that of the Commission as a whole. As I have previously testified before both House and Senate Agriculture subcommittees, my principal conclusion from the events of the last few months is that massive, unchecked and unnecessary speculation in commodities is an unacceptable threat to our nation's tightly interwoven financial structure. Futures markets play an important economic role in commercial enterprise, but when they are perverted from that role into centers of unrestrained speculation they become a burden on commerce and a danger to the economy When strategically placed financial institutions support, as a whole. and indirectly participate in, excessive speculation, the danger is particularly clear. The silver market has been a predominantly speculative market for years now, with commercial hedging activity constituting less than one fifth of the open interest at most points in time. Certain banks and brokers showed themselves all too willing to make loans which promote the speculative volume. The combination was an invitation to trouble. That trouble arrived when the price leadership of a few disproportionately large traders provided the catalyst in 1979 to form a speculative bubble. History has taught us that bubbles burst. And when they do, they all too often trigger economic chain reactions. The collapse of the silver bubble this March threatened damage well beyond the commodities markets. Much attention has been given already to the impact on financial institutions. It was feared that the positions of the Hunt family were too large to be liquidated without triggering a round of panic selling in Price-induced margin calls to other market participants could silver. have forced additional position reductions and increased the panic. A sudden rush to raise margin funds in the silver market could then have caused other markets to experience selling pressure. And, because major banks and brokers had financed the activities of the largest speculators, the effects of any silver margin defaults could have spread rapidly through the securities and banking sectors. During the final week of March, there were signs that each of these threats could become reality. We will never know how close we came to the edge of a general financial panic, but that is an issue which need not be settled. There was no economic benefit in the craze for silver to justify even a small risk of economic collapse. It is important to keep in mind, moreover, that risks to large financial institutions were not the only public costs of the silver bubble. There were adverse implications for employment, for inflation and for the allocation of credit. Costs of production at Kodak, the nation's largest producer of photographic film, are estimated to have risen by 4 million dollars a month for every one dollar rise in the price of silver. Some smaller businesses at first found it difficult to obtain silver and were later unable to pass on its increased costs. These effects should not be The Bureau of Labor Statistics reports that six thousand underestimated. jobs in the jewelry, silverware and plateware manufacturing industry were lost between November and January. The impact on inflation was also documented by the Bureau of Labor Statistics. for intermediate materials, supplies and components rose a seasonally adjusted 2.8 percent from December to January, the largest monthly increase since August, 1974." It attributed about one quarter of this increase to the precious metal cost acceleration. The burden of this inflation, moreover, was by no means confined to luxury items. The price of medical x-ray film, an expense shared by every economic stratum, jumped 93 percent. Photosetting paper used in newspaper printing rose in cost by 75 percent. Credit availability as well has been affected by the silver bubble. The largest silver speculators held their enormous positions with the aid of hundreds of millions of dollars in borrowed money. I doubt that the Hunts were the only silver market participants to borrow money. As the price of silver was driven higher during the winter, the holders of short positions were required to put up substantial unanticipated amounts of variation margin. When the price began to plummet, the longs had to raise variation margin money in a hurry. Somehow, the resources for speculation were found while loans for consumers, farmers and small businesses were being turned down. It is an unfortunate aspect of our political life that it often requires a major catastrophe to change public policy. It would be a shame if the lessons and punishments of 1980 prove insufficient to teach us something about the dangers of excessive speculation in commodities. A short list of corrective measures, taken together, would go far to diminish the likelihood of a recurrence of this year's bubble. One of these measures requires no further grant of legislative authority. The Commission is currently considering the use of its existing powers to impose speculative position limits in all commodities. Position limits would restrain the impact on commodities markets of traders so large that they can only negate the basic assumptions of competitive markets. I hope the Commission will act decisively to establish meaningful limits well before the next threat to rational pricing is perceived. Congressional action, not Commission action, is necessary for the most important of preventive measures: the vesting of margin authority with some agency of the federal government. The full airing of the issues surrounding margin authority before both this Committee and the Agriculture Committee represents an extremely useful activity at this time. Low margins are probably the single strongest inducement to widespread speculative use of futures markets. Traditionally, the exchanges have set margins low in an attempt to draw speculative volume. In the silver market, for example, prior to September of last year, margins were generally lower than 5 percent. Accordingly, when silver was selling at roughly $10 an ounce, the margin required was only 30 cents an ounce. Each time the price rose another 30 cents, the value of the speculator's initial investment was doubled. The margin today for a long speculative position in Treasury Bills can be as low as $1,500 for each one million dollars in open interest. |