Raphael Stevens

THE WORLD’S supply chains have taken a knock yet again. Russia’s invasion of Ukraine provoked the biggest commodity shock since 1973, and one of the worst disruptions to wheat supplies in a century. Countries from Hungary to Indonesia are banning food exports to ensure supply at home. The West has issued sanctions against Russia, depriving it of all sorts of parts and technologies.The strain on globalisation comes on top of the effects of the financial crisis of 2007-09, Brexit, President Donald Trump and the pandemic. For years measures of global integration have gone south. Between 2008 and 2019 world trade, relative to global GDP, fell by about five percentage points. Tariffs and other barriers to trade are piling up. Global flows of long-term investment fell by half between 2016 and 2019. Immigration is lower too, and not just because of border closures.The war in Ukraine stands to accelerate another profound shift in global trade flows, by pitting large autocracies against liberal democracies. Such confrontation happened during the cold war, too. But this time autocracies are bigger, richer and more technologically sophisticated. Their share in global output, trade and innovation has risen, and they are key links in many supply chains. Attempts to drift apart, therefore, will bring new consequences, and costs, for the world economy.After the second world war democracies ruled the economic roost. In 1960 America, Britain, Canada, France, Italy and Japan accounted for about 40% of global exports. Autocracies, by contrast, were economically unimportant on the world stage. The Soviet Union accounted for 4% of global trade; China barely featured in the statistics. Average GDP per head across the communist bloc was a tenth of America’s. The West was locked in a fierce ideological battle with communist countries, filled with proxy wars and nuclear scares. But in economic terms there was no contest.Their economies were also largely unintegrated. One observer in the late 1950s reckoned that trade between the USSR and America was so small that a big shipment could double the total from one month to another. The exceptions in east-west trade—a bit of Russian gas to Europe; a wheat deal in 1972; a vodka-for-Pepsi swap from 1974—were few. A study published by the IMF days before the Soviet Union fell said that “foreign direct investment in the USSR has been minimal to date”.The communist bloc played by its own rules. Soviet external economic activity largely took place within COMECON, a group of sympathetic countries (China and the USSR barely traded with each other from the late 1950s, having fallen out). Trade in COMECON took place not via money-for-stuff, but in the form of a peculiar system of barter—oil for manufactured goods, say—agreed by governments.From the late 1970s onwards, autocratic regimes began to open up. In part this was the result of an ideological change, first apparent in China. The death of Chairman Mao in 1976 allowed hitherto heretical views to emerge. “Unless it could expand and modernise its economy more rapidly than it had done in previous decades, China would remain poor, weak and vulnerable,” wrote Aaron Friedberg of Princeton University in a paper published in 2018, describing the ideas of Deng Xiaoping, the leader who spearheaded China’s opening up in the 1980s. A focus on class struggle gave way to a desire for modernisation and development. Further momentum for globalisation came from the fall of the Soviet Union in 1991.The West, on the whole, welcomed and encouraged economic liberalisation, believing that it could be a force for good (and for large profits). By bringing countries into the global trading system it would be possible to raise living standards, as well as foster democracy and freedom. A globalised world would also be a more peaceful one, the argument went.In the 1990s globalisation took off. Trade boomed. Annual global flows of foreign direct investment (FDI, including purchases of companies and the construction of new factories) rose by a factor of six. In 1990 Russia’s first McDonald’s opened, in Moscow; KFC set up shop a few years later. Russian oil companies began directing their exports towards the West. Between 1985 and 2015 Chinese goods exports to America rose by a factor of 125.Living standards certainly went up. The number of people living in extreme poverty has fallen by 60% since 1990. Some formerly closed countries have utterly changed. The average Estonian is now only marginally poorer than the average Italian.The other hoped-for benefit of globalisation—political liberalisation—has faltered, however. Our World in Data, a research organisation, puts countries into four groups, ranging from most to least free: “liberal democracies”, such as America and Japan; more flawed “electoral democracies”, such as Poland and Sri Lanka; “electoral autocracies”, such as Turkey and Hungary; and “closed autocracies”, such as China and Vietnam, where citizens have no real choice over their leader.Classifying political regimes is not an exact science, and involves making assumptions and judgments. Our World In Data counts India as an electoral autocracy since 2019, for instance, which some other sources do not agree with. Nonetheless, it helps give an idea of a broader trend: the waning might of liberal democracies.The share of political regimes that were liberal democracies rose from 11% in 1970 to 23% in 2010. But democracy has retrenched since. Most of the 1.9bn people living in closed autocracies now reside in just one country: China. But lesser forms of autocracy are on the rise, such as in Turkey, where President Recep Tayyip Erdogan has consolidated power during his two decades in office (see chart 1).Using data from the World Bank, the IMF and elsewhere, we divide the global economy into two. We estimate that today the autocratic world (ie, closed and electoral autocracies) accounts for over 30% of global GDP, more than double its share at the end of the cold war. Its share of global exports has soared over that period. The combined market value of its listed firms represented just 3% of the global total in 1989. Now it represents 30% (see chart 2).China is by far the biggest non-democracy in economic terms, with a dollar GDP roughly two-thirds of America’s, making up over half of our group of autocracies. But others, such as Turkey, the United Arab Emirates and Vietnam, have also gained in economic clout over the past 30 years.Autocracies are now an especially serious rival to democracies when it comes to investment and innovation. In 2020 their governments and firms invested $9trn in everything from machinery and equipment to the construction of roads and railways. Democracies invested $12trn. Autocracies received more FDI than democracies between 2018 and 2020. And since the mid-1990s their share of patent applications has gone from 5% to over 60%. China dominates patenting, but on almost all our other measures the economic power of autocracies has soared even after China is excluded from our calculations.Many autocracies have remained steadfastly mercantilist. China, for instance, opened its domestic markets where it suited it, but kept whole sectors closed off to allow domestic champions to rise. Nonetheless autocracies have become integrated with democracies to an extent that would have been unthinkable during the cold war. Vietnam, which has been ruled by a single party for decades, for instance, has become a pivotal link in the global manufacturing supply chain. The kingdoms and emirates of the Middle East are vital sources of oil and gas.We estimate that roughly one-third of democracies’ goods imports come from other political regimes. The codependency in some markets is clear. Democracies produce about two-thirds of the oil necessary to meet their daily needs. The rest must come from somewhere else. Half of the coffee that fills Europeans’ cups comes from places where people have weak political rights. And that is before getting to precious metals and rare earths.Integration goes far beyond trade. American multinationals employ 3m people outside democracies, a rise of 90% in the past decade (their total foreign employment has increased by a third). Investors from democracies hold over a third of the autocratic world’s total stock of inward FDI. Autocracies have built up huge foreign reserves, now worth more than $7trn and often denominated in “free” currencies like the dollar and the euro.Broken dreamThis intimacy is now under threat as a third, darker period comes into view. Even before the war in Ukraine, powerful countries were losing interest in a truly global presence. Instead they were seeking to rely more on themselves or to dominate their immediate geographical area. Their new thinking is becoming increasingly enshrined in strategy and policy.The waning appetite for globalisation has a few causes. One relates to greater consumer awareness in the West about human-rights abuses in places such as China and Vietnam. Polls in Western countries regularly find that a high share of respondents support boycotting Chinese goods (whether they would actually do so is another matter). Western companies are being pressed to source goods elsewhere. Concerns over the national-security implications of trade and investment, including industrial espionage, have also risen.Autocracies have their own worries. One is that too much integration can cause Western culture to seep across borders, weakening autocratic rule. Deng himself identified the dilemma: “If you open the window for fresh air, you have to expect some flies to blow in.”Another, bigger worry relates to power. Being part of global supply chains means being vulnerable to sanctions. This was clear from an early stage. In 1989 China faced sanctions after the crackdown in Tiananmen Square. The next year America placed Cuba, El Salvador, Jordan, Kenya, Romania and Yemen under sanctions for various infractions. Several rounds of Western sanctions on Russia, first in 2014 and then again today, bring the message home still more forcefully.Already there is evidence of a crude decoupling. In 2014 America banned Huawei, a Chinese tech firm, from bidding on American government contracts. In 2018 Mr Trump started a trade war with China, with the goal of forcing it to make changes to what America said were “unfair trade practices”, including the theft of intellectual property. FDI flows between China and America are now just $5bn a year, down from nearly $30bn five years ago.Recent policy announcements and trade deals shed some light on the probable direction of globalisation as the world’s most powerful democracies and autocracies turn away from each other. Countries are signing smaller, regional trade deals instead; democracies are banding together, as are autocracies; and many countries are also seeking greater self-reliance.Begin with regional trade deals, the number of which is booming. In 2020 China signed an agreement with 14 other Asian countries, mostly non-democracies. In that year the ASEAN group of South-East Asian countries became China’s biggest trading partner, replacing the EU. In Africa, meanwhile, most countries have ratified the African Continental Free Trade Area.Countries with shared political systems are also coming closer. The CoRe Partnership, an agreement between America and Japan, launched last year and is designed to promote co-operation in new technologies from mobile networks to biotech. The US-EU Trade and Technology Council, the pointed ambition of which is to promote “the spread of democratic, market-oriented values”, is working on climate change and strengthening supply chains.Autocracies are also forming their own blocs. The stock of long-term investment from the autocratic world into China rose by over a fifth in 2020, even as the amount of investment from autocracies into America barely budged. Saudi Arabia is reportedly mulling selling oil to China in yuan, rather than dollars. Long-term investment from autocracies into increasingly illiberal India rose by 29% in 2020.Large countries in particular, meanwhile, are also turning inward. A big focus of President Joe Biden’s administration, for instance, is “supply-chain resilience”, which in part involves efforts to encourage domestic production. China’s turn in 2020 towards a “dual circulation” strategy includes an attempt to rely less on global suppliers. It wants to release its rivals’ grip on “chokehold” industries, such as chipmaking equipment, which it fears could be used to strangle its rise. India, too, has turned towards self-reliance.Many of these efforts could come at a price. Autocracies are notoriously prone to pursuing their own self-interests, rather than banding together. History shows that withdrawing from global trade and investment networks carries huge costs. In 1808 America came close to autarky as a result of a self-imposed embargo on international shipping. Research by Douglas Irwin of Dartmouth College suggests that the ban cost about 8% of America’s gross national product. More recently, many studies have found that it was primarily American firms that paid for Mr Trump’s tariffs. Brexit has slowed growth and investment in Britain.Russia’s attempt at self-reliance, by pursuing import substitution on a large scale, building up foreign-exchange reserves and developing parallel technological networks, shows just how hard it is to cut yourself off from the global economy. Sanctions by the West rendered much of its reserves useless overnight. The economy was struggling even before the war, and has since gone off a cliff. Unemployment is likely to soar as foreign firms leave the country.The risk, though, is that countries draw the opposite lesson from Russia: that less integration, rather than more, is the best way to protect themselves from economic pain. The world would become more fractured and mutually suspicious—not to mention poorer than it could have been. ■For more expert analysis of the biggest stories in economics, business and markets, sign up to Money Talks, our weekly newsletter.This article appeared in the Finance & economics section of the print edition under the headline “Economic freedom v political freedom” More

SIXTY YEARS ago, a dispute over the placement of Soviet missiles in Cuba pushed Washington and Moscow perilously close to all-out war. The crisis provided history’s most extreme example yet of nuclear brinkmanship, situations in which governments repeatedly escalate a very dangerous situation in an attempt to get their way. It also demonstrated the extraordinary value of the work of Thomas Schelling, an economist then at Harvard University, who used the relatively new tools of game theory to analyse the strategy of war. The war in Ukraine has made Schelling’s work, for which he shared the economics Nobel prize in 2005, more relevant than ever.Game theory came into its own in the 1940s and 1950s, thanks to the efforts of scholars like John von Neumann and John Nash, who used mathematics to analyse the strategies available to participants in various sorts of formal interactions. Schelling used game theory as a prism through which to better understand war. He considered conflict as an outcome of a strategic showdown between rational decision-makers who weighed up the costs and benefits of their choices. If a would-be attacker expects to gain more from aggression than any cost his adversary can impose on him, then he is likely to go through with the aggressive act.For a government hoping to deter an aggressor, the effectiveness of its deterrence strategy thus depends in part on the size of the retaliatory costs it can inflict on its attacker. But this is not an exact science. Both sides may have incomplete information about the relative costs they can expect to bear. When Vladimir Putin, Russia’s president, was preparing his invasion of Ukraine, for example, Western democracies threatened to impose stiff sanctions. Just how tough the sanctions could be was not necessarily knowable to either side beforehand, because the details needed to be negotiated with allies.The credibility of retaliatory threats matters, as well; both sides of a potential conflict may issue grave threats, but if they ring hollow they may be ignored. The threat of stiff sanctions by Western democracies—clearly a powerful tool in hindsight—might well have been weakened by doubts that governments were prepared to expose their citizens to soaring oil and gas prices. Governments deploy a range of tools to bolster the credibility of their threats. An American promise to defend an ally may be strengthened by the placement of American troops within the ally’s borders, in harm’s way, for instance; an American president would presumably find it more difficult to back down in the face of an attack that claimed American lives. Schelling, for his part, noted that credibility can sometimes be enhanced by taking costly actions or limiting your own options. A general’s promise to fight to the bitter end if an enemy does not withdraw becomes more credible if he burns the bridges that provide his own avenue of retreat.The problem of credibility becomes far more complicated in a showdown between nuclear-armed powers, which both have sufficient weaponry to retaliate against any first strike with a devastating attack of their own. If the first use of nuclear weapons is all but assured to bring ruin on one’s own country as well, then efforts to use the threat of nuclear attack to extract concessions are likelier to fail. Wars may nonetheless occur. The invasion of Ukraine could be seen as an example of the stability-instability paradox: because the threat of a nuclear war is too terrible to contemplate, smaller or proxy conflicts become “safer”, because rival superpowers feel confident that neither side will allow the fight to escalate too much. Some scholars reckon this helps to account for the many smaller wars that occurred during the cold war.And yet the cold war also threatened to turn hot at times, as in 1962. Schelling helped explain why. He noted that the threat of a nuclear attack could be made credible, even in the context of mutually assured destruction, if some element of that threat was left to chance. As a showdown between nuclear powers becomes more intense, Schelling observed, the risk that unexpected and perhaps undesired developments cause the situation to spiral out of control rises. (When nuclear forces are on high alert, for instance, false alarms become far more dangerous.) The upper hand, in such a situation, is thus maintained by the side that is more willing to tolerate this heightened risk of all-out nuclear war.This is the essence of brinkmanship. It is not merely a matter of ratcheting up the tension in the hope of outbluffing the other side. It is also a test of resolve—where resolve is defined as a willingness to bear the risk of a catastrophe. Mr Putin’s move to increase the readiness of his nuclear forces may represent an attempt to demonstrate such resolve (over and above the message sent by the invasion itself). President Joe Biden’s refusal to escalate in kind could be seen as an acknowledgment of the conspicuous fact that an autocrat embroiled in a pointless war has less to lose than the rich democracy to which Mr Biden is accountable.The only winning moveIt could be, however, that Mr Biden had something else in mind. In his Nobel lecture, Schelling wondered at the fact that nuclear weapons had not been used over the 60 years that had elapsed since the end of the second world war. While he chalked up the absence of nuclear use between superpowers to deterrence, he reckoned that in other wars and confrontations restraint was best understood as resulting from a taboo: a social convention that stayed belligerents’ hands when they might otherwise have deemed it strategically sensible to deploy nuclear weapons.Russia’s aggression has shattered another taboo, against territorial aggrandisement through violence. And though the governments of the West feel compelled to respond to limit the damage that has caused, they are no doubt also keen to restore the old convention—to demonstrate that the world has moved beyond an age where the mighty take by force whatever they want. ■Read more from Free Exchange, our column on economics:How oil shocks have become less shocking (Mar 12th)Vladimir Putin’s Fortress Russia is crumbling (Mar 5th)How to avoid a fatal backlash against globalisation (Feb 26th)For more expert analysis of the biggest stories in economics, business and markets, sign up to Money Talks, our weekly newsletter.This article appeared in the Finance & economics section of the print edition under the headline “War games” More

ON MARCH 8th, the day the price of a barrel of Brent crude oil spiked above $127, the European Commission unveiled its grand plan to fight stratospheric living costs. Claiming that the “crisis situation” warranted exceptional measures, it recommended that member states levy a one-off tax on electricity-generating firms. The revenues raised could then be used to keep households’ bills down. The next day Elizabeth Warren, a senator from Massachusetts, tweeted that she and other legislators were working on a tax on the “war-fuelled profits” accruing to American oil majors. The proposal is now making its way through the House of Representatives.Politicians have reached for such “windfall” taxes before. Bulgaria, Italy, Romania and Spain have imposed them on power generators in recent months, as benchmark energy prices have risen. In 1980 America announced that it would begin taxing oil producers in six years’ time, hoping to cash in on profits that were expected to be made after prices were deregulated. Britain’s new Labour government taxed utilities in 1997, after the Conservative government had sold them off cheaply.The levies are understandably tempting for the taxman. Big windfalls mean big receipts. The usual worry with a tax is that it might change companies’ behaviour, say by encouraging them to lower investment in order to bring down future tax bills. But the event causing the windfall is meant to be a one-off, unconnected to investment. They are “extremely efficient ways to raise revenue”, says Helen Miller of the Institute for Fiscal Studies, a think-tank in London. At least, in theory.Britain’s tax probably fitted the ideal better than most. It had a clear rationale: that excess gains had come from the underpricing of shares when firms were privatised. Post-privatisation profits were multiplied by a price-to-earnings ratio; a 23% tax was levied on what was left over once public proceeds from privatisation were subtracted. Even then, however, the tax failed to target the beneficiaries of excess gains. British Telecom, the first utility to be privatised, had listed in 1984. Many early punters had come and gone, leaving shareholders in 1997 bearing the burden.Levies elsewhere have faced other hurdles. In 2006 Mongolia introduced a 68% charge on profits from copper and gold sales, hoping to cash in on a new mine during a commodity-price boom. Instead, investors withheld funds for the project until regulators agreed to drop the tax. America’s tax did distort firms’ behaviour, by some estimates reducing oil production between 1980 and 1986 by up to 4.8%.The European Commission’s plan has its flaws. It does not explain why the current situation warrants a one-off tax, adding uncertainty about when such levies might be used again. Furthermore, the energy industry buys and sells power using long-term contracts, making the link between today’s prices and tomorrow’s profits fuzzy. And prices can fall as quickly as they rise. By March 16th, for instance, the oil price was back to about $100 a barrel.Recent experiments offer scant grounds for optimism. Romania, Italy and Spain are targeting renewable-power generators, which have not experienced the same increase in costs as generators that use fossil fuels. Richard Howard of Aurora Energy, a consultancy, says that this raises the “risk premium” of investing in renewables—exactly what legislators want to avoid. Peter Styles of the European Federation of Energy Traders, a trade body, notes that Spain’s scheme stops green-energy generators accruing excess profits to begin with, which will distort the way prices are set in the market.Their momentum across Europe also creates a fiscal opening that may be hard to close. The commission recommends that all windfall taxes should be wound down by the end of June. But Spain has already extended its clawbacks once. And Italy’s measures will last until December. ■This article appeared in the Finance & economics section of the print edition under the headline “Power grab” More

TO THEIR CHAMPIONS, cryptocurrencies are supposed to be a libertarian Utopia. Because tokens are created and moved by loose, decentralised networks of individual computers based in dozens of countries, cross-border transactions can be quick and in theory are free from control by intermediaries, such as banks, which can be regulated by national governments. Critics of crypto-finance have long looked askance at the same system. To statists, it represents the tyranny of techno-anarchy.Russia’s invasion of Ukraine and the West’s subsequent sanctions on Russian banks, companies and elites appears to turn on its head the debate about whom crypto helps and hurts. Though politicians and regulators in America and Europe at first feared that people and entities hit with sanctions would use cryptocurrencies to dodge the restrictions, little evidence of such activity has materialised. Instead, crypto institutions appear to be under the thumb of governments, too. And there has been a huge surge in crypto donations to help the government in Ukraine.Crypto’s decentralised network is supposed to be supranational and its users are meant to be anonymous. This makes it seem like a useful tool for sanctions-dodging. Certainly, there is evidence that Russians have been buying more crypto. But this may stem from a desire to hold an asset that is not plunging in value. The rouble has tumbled by about 25% against the dollar since February 23rd, whereas bitcoin has risen against the greenback. For oligarchs looking to dodge sanctions, though, crypto has three main flaws.The first is that the infrastructure, such as large exchanges, does not really exist in Russia. “Had the Russians wanted to use blockchain infrastructure for sanctions evasion, they would have had to have taken a very different regulatory approach,” says Tomicah Tillemann, a former staffer for President Joe Biden, who now advises Katie Haun, a crypto-focused venture capitalist. “Russia, along with a number of other authoritarian societies, has been pretty hostile to digital assets.” Thus Russians’ ability to convert significant amounts of wealth into crypto is limited.The second flaw is that it is not possible to buy most everyday items or financial assets with crypto, which means that a sanctions-dodger must at some point leave the crypto-sphere. “Ultimately what they really need to do is get access to some form of fiat currency, which becomes more challenging,” said Christopher Wray, the head of the FBI, in a US Senate hearing on the Russian invasion on March 10th. That requires interacting with a crypto-exchange.Though early iterations of some exchanges resisted the need to implement “know your customer” (KYC) anti-money-laundering measures, many have acquiesced as they have become regulated institutions. Some are publicly listed. Most have a presence in America and Europe. Binance, the largest exchange, implemented a KYC policy in 2021, requiring those using it to identify themselves to the firm.The message from regulators to exchanges has been unanimous. America’s Treasury has stressed that its sanctions apply “whether a transaction is denominated in traditional fiat currency or virtual currency”, a message reinforced by an executive order on digital currency from Mr Biden on March 9th. The White House has also issued a statement with the leaders of other G7 countries and the EU, vowing to “impose costs on illicit Russian actors using digital assets to enhance and transfer their wealth”. The crypto industry has rushed to accommodate these requests. Coinbase, another large exchange, has frozen 25,000 Russian accounts. Binance has said it will freeze the assets of people who have been targeted with sanctions.The third problem is that moving money around in crypto is not as private as is widely thought. Government sleuths have invested time and energy in trying to link supposedly anonymous wallets with real people, with some success. And as blockchain transactions are public, once identified, it is easy to trace the history of funds. In December the FBI managed to seize $3.6bn-worth of crypto-assets related to a theft from an exchange in 2016.Crypto may turn out to be far more useful to those looking to move in the open, rather than in the shadows. On February 26th the official Ukrainian Twitter account published digital-wallet addresses through which it is accepting bitcoin, ether and other tokens. Donations quickly flooded in. “Crypto really helped during the first few days because we were able to cover some immediate needs,” says Alex Bornyakov, Ukraine’s deputy minister for digital transformation. Nearly $100m-worth of tokens has since been donated to those and other wallets set up by private initiatives.Getting money to war zones is notoriously hard. In 2008 Mr Tillemann visited Tbilisi in Georgia with Mr Biden, then a senator, in the middle of Russia’s invasion of the country. “It became very obvious that we were going to have real challenges getting in resources,” he says. Donors were forced to ship pallets of $100 bills into war zones in Iraq and Afghanistan.Moving money out of war zones to buy supplies can be just as difficult. In the chaos of the war, it became increasingly difficult to pay in dollars or euros, especially abroad. “So we needed a tool to quickly perform those transactions. And crypto was our first choice,” says Mr Bornyakov. Although most suppliers did not operate in crypto, they agreed to accept it, he says. Ukraine has spent some $30m on things like bulletproof vests, night-vision goggles and medicines. Around a fifth of that was spent directly in crypto.The war has made it clear that there are serious uses for crypto. But it is now policed seriously, too. ■For more expert analysis of the biggest stories in economics, business and markets, sign up to Money Talks, our weekly newsletter.Editor’s note (March 16th 2022): This article has been updated since it was first published.Our recent coverage of the Ukraine crisis can be found hereThis article appeared in the Finance & economics section of the print edition under the headline “False promise” More

THE TRADING of commodities is an arcane activity that makes it into the public eye only at times of extreme hubris. That is when names like the Hunt brothers, who tried to corner the silver market in 1980, and Hamanaka Yasuo, or “Mr Copper”, who in 1996 produced huge losses for Sumitomo, a Japanese trading house, became household ones. Xiang Guangda, a Chinese tycoon known as “Big Shot”, vaulted into the news this month by taking a position on nickel that went badly wrong. The result has been one of the biggest tremors in the 145-year history of the London Metal Exchange (LME). It has also brought China, which is keen to exert more power over the trading of commodities, face to face with free markets gone mad.In the cloistered world of the LME, some facts about the affair are clear. One is that nickel prices, already hot before Russia’s invasion of Ukraine, surged after the West imposed sanctions on Russia. Another is that Mr Xiang’s firm, Tsingshan, had exposure to short positions on the LME of about 180,000 tonnes of nickel, which were supposed to benefit if prices went down. They didn’t, as a short-covering scramble for nickel briefly pushed prices above $100,000 a tonne on March 8th, putting Tsingshan’s potential losses into the billions of dollars. At that point the LME suspended nickel trading, cancelling all trades that took place overnight. When the suspension was lifted on March 16th, a sharp drop in nickel prices forced the LME to suspend trading again, adding to the chaos.Three big questions remain. How important is Tsingshan’s role in the debacle? Did its troubles provoke interference from China? And has the LME bungled its response? All will be the subject of scrutiny.In media reports, Tsingshan has the lead role in the drama. There is debate about whether its short-selling represented the normal activity of one of the world’s largest nickel producers hedging its output, or a speculator making a rash bet. What appears clear is that the nickel it produces is not the type of metallic nickel that is traded on the LME, meaning there was a mismatch between its shorts and longs. As its losses increased, its brokers forced it to provide more cash, or “margin”. The size of its position meant that they also faced big margin calls, making it as much their problem as Tsingshan’s. On March 15th Tsingshan said it had reached a standstill agreement with its creditors until it reduces its positions in an orderly way.In the market, rumours abound that China may have influenced the LME’s activities, partly because Hong Kong Exchanges and Clearing (HKEX) owns the exchange, and also because Tsingshan is strategically important to the country, because its nickel goes into electric-vehicle batteries. The LME denies receiving pressure from HKEX. It granted extra time on March 7th to CCBI Global, a Chinese broker for Tsingshan that is a member of the LME, to raise funds from its state-owned parent, China Construction Bank, to cover margin calls. That may have been a prudent thing to do. It knew the wealthy bank could provide the funds. Some traders wonder whether it would have been as tolerant with a non-Chinese entity. In the aftermath, Chinese authorities are said to have fought hard to stop Tsingshan’s nickel assets falling into the hands of non-Chinese speculators.The most intense scrutiny may fall on the LME itself, specifically the timing of its decision to suspend nickel trading and the cancelling of overnight trades that were rumoured to be in the billions of dollars. It said it halted trading in the early hours of March 8th when it reckoned the nickel market had become disorderly. It added that its decision to cancel that day’s trades was because the big price moves had created a systemic risk to the market, raising concerns of multiple defaults by member-brokers struggling to meet margin calls.That latter decision is the biggest bone of contention. Critics say it favoured those with short positions, such as physical producers and their banks, over those with long positions that could be sold at a big profit. They ask why it stepped in to protect brokers when the LME has a default fund that its members can get access to in times of trouble. “The decision to erase the trades…will undermine long-term confidence in the LME,” says Yao Hua Ooi of AQR, an asset manager that had trades cancelled on March 8th. “If you want the AQRs of this world [in the market], you cannot intervene when they make money and it hurts your brokers.” He said the firm was exploring all options against the LME.The LME has since set daily limits on price moves (which were exceeded on March 16th when it briefly reopened nickel trading). That is another sign of intervention by an exchange that used to pride itself on its free-market nature. Its owner in Hong Kong, with China looking over its shoulder, would no doubt approve. ■This article appeared in the Finance & economics section of the print edition under the headline “When China met the free market” More