THE ECONOMICJOURNAL

MARCH 1988 ' "

The Economic Journal, 98 (March 1988), 1-15

Printed in Great Britian

\]

COMMODITY AGREEMEM'T«S:.'6^
MARKETS: LESSONS FROM
Ronald W. Anderson and Christopher L. Cilbert

There have been International Tin Agreements (ITAs) since 1956, which is the
longest continuous period of operation of any of the post-war commodity
agreements.^ The International Tin Council (ITC) supported the tin price
through the use of export controls and through a buffer stock operation
conducted largely on the London Metal Exchange (the LME). On October
24th 1985, the tin support operation collapsed leaving outstanding com-
mitments with banks and brokers over j(^3oom. When the ITC member
governments declined either to inject fresh cash or to acknowledge responsibility
for the ITC's debts, the tin market was thrown into a major crisis which was
to have implications for metals trading and commodity agreements generally.
The default placed LME dealers on the brink of bankruptcy and threatened
the existence of the LME. Ultimately, the LME tin market was closed and
trading practices in other metals were substantially changed. The free market
price of tin fell to 40% of the price prior to the collapse. And the so-called New
International Economic Order which contemplated agreements for most major
traded primary commodities was left in disarray without a single clear example
of success.^
In what follows we study the history of the tin market over the period
1982-5. Important questions this exercise will help to answer are: Was the
collapse of the tin market a failure of the buffer stock operation and was it
inevitable? Was the activity of the buffer stock a commodity market
manipulation? Was there a deficiency in the drafting of the tin agreement?
Was there a failure of commodity market regulation? More generally, while it
has long been recognised that stabilisation schemes are vulnerable to
speculative attacks, the interconection between buffer stock managements and
futures markets has not been explored. In this sense, our historical analysis will
also raise questions for future theoretical research.
The plan of the paper is as follows: Section I reviews and extends the
conceptual framework which we employ; Section II describes the ITC and the
• We have benefitted from comments from Peter Kettle, Rhonna O'Connell and seminar participants at
Newcastle, Oxford and the World Bank, and in addition, from a referee and an editor. However, we remain
responsible for all views expressed and for any errors.
' For discussion, see Fox (1974), Smith and Schink (1976), Gilbert (1977), Robertson, (1982), Gordon-
Ashworth (1984) and Gilbert (1987).
^ The New International Economic Order is the term of UNCTAD (1976).
1 [ I ] ECS 98
2 THE ECONOMIC JOURNAL [MARCH

markets on which it operated; Section III examines the evolution of the tin
crisis; and, in Section IV, we ask what lessons can be drawn from this
episode.
I. THE CONCEPTUAL FRAMEWORK
The academic literature on commodity agreements is mainly concerned with
issues of feasibility and desirability.^ In this paper our particular concern is the
interaction of commodity market intervention and organised futures trading.
Here the existing academic literature is limited. McKinnon (1967) argued that
intervention agencies should stabilise distant futures prices rather than the cash
price. Subsequently, Gemmill (1985 a) and Cilbert (1985) have contrasted
price stabilisation through intervention with earnings stabilisation through
futures hedging. However, none of the previous literature has thoroughly
integrated futures trading into an account of an intervention scheme. One of
our principal purposes is to show how the two institutions were linked in the tin
market.
It is useful to recall the basic logic of buffer stock price stabilisation. A
programme of buying at a price floor and selling at a price ceiling is subject to
a non-negativity constraint on the buffer stock holding and to a financial
constraint. Past studies of buffer stock feasibility have focused entirely on the
former constraint. Townsend (1977) shows that in a perpetual programme
with a fixed price ceiling eventual stockout will occur with unit probability.*
The problem of maintaining a price ceiling is exacerbated by the actions of
private speculators. Salant (1983) shows within a rational expectations (RE)
framework, the time at which stockout takes place is advanced by speculative
attack in which the authority's buffer stock is purchased by private speculators
who then sell to consumers at prices above the established ceiling.
To see how a Salant-type attack works in a simple context, consider the case
in which an authority is aiming for complete stabilisation at a fixed price p*.
At date t the authority has strictly positive stock 5^. Net demand (consumption
less production) in period /-f i is given by the random variable x^J^^{p^J^^). If the
authority maintains stabilisation at/)*, its demand for stock at /-|-i will be
h~^t+\iP*)- Define •^^ = 'Pv{s^ — x^^^{p*)^o). If the authority exhausts its
stock, the market clearing price p^^.^^ solves.
h-Xi^iiPt-^i) = 0.
This implies that, under RE, speculators have current price expectation^

Salant's analysis shows a raid will take place whenever.

where r, is the rate of interest.

Consider the symmetic argument (not made by Salant) with respect to the
' See in particular Newbery and Stiglitz (1981) and Kanbur (1985).
* However, it is also true that the expected time to stockout is infinite (Ghosh et al. 1987).
' This assumes that speculators look only one period ahead. Salant solves the full dynamic programming
problem.
1988] LESSONS FROM TIN 3
financial constraint. Let b^ be the authority's balance (net worth) in period t.
If it maintains p* its balance at l-\-i will be b^-\-p*Xf^i{p*). Define TT^ =
Pr[/>(+/>**'j+i(/>*) ^ o]. If the authority exhausts its resources, the market
clearing price solves
*t+A+i^(+i(^t+i) = 0 -

The expected price for period t-\-1 is given by (i) as previously. There
would be an incentive for a speculative raid if,

E<A+i<(i+O/'*. (3)

In the standard speculative raid, triggered by (2), speculators wish to be long

in the physical commodity and will therefore purchase from the stabilisation
authority. In the symmetric case (3), t^ey wish to go short by selling to the
authority. The problem with this is that, as in much of financial economics, it
is often not feasible to go short in the spot market. It is precisely in this regard
that futures trading could become important since it typically facilitates short-
selling.* However, the availability of futures represents a significant mod-
ification of the model since generally all agents, including the stabilisation
authority, will incorporate futures into their strategy. A complete theoretical
account of this has not been worked out and it is not appropriate that we
attempt to do this here. However, our historical account of the tin collapse of
1985 will highlight important elements which should be included in an
eventual theoretical model.

II. INSTITUTIONS
(A) The International Tin Agreements
The most important objective of the sixth ITA, which came into force in 1982,
was that the price should be kept within a band defined by floor and ceiling
prices. The International Tin Council (ITC), which administers the
agreements, is empowered to intervene in the tin market to contain the price
within this band both through the use of export controls and through the
operation of a buffer stock. Until its collapse, the ITC was successful at
maintaining the price above the floor,' but was less successful at containing it
under the ceiling.
The function of the buffer stock manager (BSM) was to deal in tin so as to
maintain the price of (Malaysian) tin within the desired band. If the price was
at, or below, the floor price the BSM would buy, subject to availability of funds,
until the price returned to the floor.* At the ceiling price he would sell, subject
to availability of stock. Between the floor and the ceiling he would generally be
inactive. The first five ITAs contained no explicit limit on the size of the ITC
buffer stock. The sixth ITA placed an explicit formal limit on both the size of
the buffer stock and on total borrowing.
' For example, this appears to account for the great success of stock index futures.
' Prior to 1985, the price fell beneath the floor on only two brief occasions - see Gilbert (1987).
' This requirement was relaxed in March 1985.
1-2
 4 THE ECONOMIC JOURNAL [MARCH

(B). Markets
Traditionally the London Metal Exchange (LME) has been the principal
marketplace for free market trade in non-ferrous base metals outside the United
States. Fabricators and other users obtain substantial amounts of metal
through LME contracts; even more importandy, the LME price serves as the
basis for cash market transactions. As of 1985 the LME traded seven metals:
aluminium, copper, lead, nickel, silver, tin and zinc. Trading at the LME is
strongly rooted in the practices of the market of physical metal. This makes for
a number of differences between the LME and formal futures markets. For our
purposes the follov^ing are the most important: First, on any day active trading
takes place for two delivery dates - spot and three months forward. Thus LME
contracts are maturing virtually continuously and long-dated forwards are not
traded. Secondly, LME contracts are principals' contracts. Thus when a party
wishes to close out a commitment prior to dehvery, it is necessary to arrange
an offsetting trade (i.e. a trade for the same prompt date in which the original
seller now buys from the original buyer). Finally, at the time of the tin episode
LME contracts were not assured by any clearing association guarantees.*
Tin has long been traded in Malaysia. In 1984 the old auction market in
Penang was superceded by the Kuala Lumpur Tin Market (KLTM), which is
organised along the lines of an American futures market. Until 1986, only tin
from Malaysian smelters could be delivered on either Penang or the KLTM.
An important feature of the ITA was that the price range was denominated in
terms of the Malaysian ringgit (MS). The BSM was permitted to trade on
either the LME or Penang-KLTM.
(C). Traders
Metals trading revolves around the problem of economically holding
substantial stocks of metal. In light of considerable uncertainty about price,
futures trading is a crucial part of many metals markets. Indeed, one of the
most common forms of trading consists of buying metal on the spot market and
simultaneously selling futures contracts to hedge against adverse price changes.
'Borrowing metal', as this practice is known on the LME, is profitable if the
gain from the two transactions covers the costs of financing the initial purchase,
warehousing, and insurance. As a conseqence the futures price normally
exceeds the spot price by an amount that reflects the rate of interest and other
costs. This premium (futures minus spot) is called the contango.^"
In a backwardation the opposite occurs, that is, the spot price exceeds the
forward price. Backwardations occur when there is a relative scarcity of the
category of the good that meets the precise delivery terms of the futures
° In this paper we follow the LME's tradition in using the terms 'forward' and 'futures' interchangeably.
In part because of the tin collapse and in part because of changes in British regulations, trading on the LME
is in the process of changing. In particular, a clearing system will in future apply to LME contracts.
'" Because the LME remains largely a physicals market, metals consumers may choose to hold working
stocks on the market. They can do this by buying spot and selling forward, keeping the metal purchased in
any of the LME warehouses located throughout Europe. These stocks will generate a positive convenience
yield. Consequently, the contango may be less than the interest rate.
1988] LESSONS FROM TIN 5
contract. This results in high prices for near-term fiatures and for spot
transactions of deliverable metal. Since deliverable supply can be increased
over time through extraction or through transformation of currently
nondeliverable metal, the price for later deliveries will be largely unaffected.
While backwardations may result from seasonal production or unforeseen
events, they may also arise by design. An agent who is able to establish a
relative monopoly in the deliverable good surreptitiously and also has large
long positions in a maturing futures contract is able to 'squeeze the shorts', that
is sell to agents with existing short positions at extraordinarily high prices. This
is a typical futures market manipulation.^^
(D) Market Regulators.
While world trade in tin has been largely unregulated, the London market did
receive limited oversight from the Bank of England and the (UK) Department
of Trade and Industry (the DTI). The Bank of England (the Bank) has no
legislated, formal responsibility for regulating the tin market at the LME.
Nevertheless, it has for some time assumed an informal surveillance
responsibility in all the London commodity markets. In particular, the Bank
was concerned that corners and squeezes be avoided, a concern which led it to
follow with considerable interest the potential delivery disturbances in the
LME tin market.
The DTI was concerned with the tin market on three counts. First, it
represented the United Kingdom at the ITC and, in particular, sat on the ITC
Buffer Finance Committee. Second, it was responsible for the welfare of British
industry and, thus, for the British tin mining industry. Third, it was concerned
with the viability of British financial markets.^^

III. HISTORY
(A). Supply and Demand during the Eifth and Sixth Agreements
The consumption of primary tin has been on a downward trend throughout the
11 year period of the fifth and sixth ITAs. Indeed, over the five year period
1981-5, consumption^' averaged 14% lower than over the previous five year
period. This downward trend reflects both substitution effects and the lack of
growth in industrial production in the world economy. Over much of this
period production was increased, initially in ITC member countries but later
elsewhere (Brazil and China).
The net effect of these flows is summarised in the metal balance in Table i.
Non-socialist consumption or primary tin has generally been lower than
production. This excess supply has been met by imports into the socialist bloc
" See Kyle (1984) for a model of rational futures market manipulations and Anderson {1984A) for a
survey.
'* This last responsibility was relatively recent and was due to the Financial Services Act (FSA) which was
being drafted at the time of the tin disruption. Under this act, the DTI's powers in this area will be
transferred to the Securities and Investments Board (SIB). For discussion of the FSA and the SIB and
comparison with American futures market regulation see Anderson (1985).
" Production and consumption figures relate to total market economies and exclude socialist bloc
 THE ECONOMIC JOURNAL [MARCH

Table i
Demand and Supply

GSA Socialist Metal

Year Production Consumption disposals imports balance

1976 1824 1797 5-> 19-5 -11-7

1977 181-5 I7I-5 2-7 193 -6-6
'978 192-7 i7'-3 O-3 24-2 -25
1979 203-2 173-2 0-0 23-8 6-2
1980 201-5 i6i-6 0-0 25-6 14-3
1981 201-1 152-0 5-9 24-6 30-4
1982 184-2 140-4 2-7 24-1 22-4
•983 162-5 140-6 2-9 245 0-3
1984 164-7 1523 37 245 -8-4
•985 160-3 151-1 38 9-4 3-6

Source: I T C and Tin International.

Notes: All figures are in thousand tonnes (i tonne = 2204-6 lbs);' GSA disposals' include stock contributed
to (1976) and returned by the fifth ITA; 'Socialist imports' are net; 'Metal balance' = Production-
Consumption + GSA disposals — Socialist imports.

countries although this has been offset by continuing small disposals from the
US General Services Administration (GSA) strategic stockpile. The sixth ITA
started in mid 1982, towards the end ofa period of acute excess supply of tin.
Export controls had been introduced in April 1982 (under the fifth ITA) and
remained in force throughout the sixth ITA. By the end of 1982, supply and
demand were again in balance but with a cumulated excess supply of 73,000
tonnes. This overhang remained nearly constant throughout the sixth ITA.

(B) ITC Objectives, Constraints and Resources

The ITC had two objectives and two instruments. Continuing tight export
controls maintained balance between production and consumption, while the
buffer stock facility was required to hold the cumulated excess supply off the
market. The BSM could do this either by outright purchase of this quantity of
metal, or by inducing market agents to hold it.
The resources of the ITC at the outset of the sixth ITA consisted of the
49,000 tonnes of tin it owned at the end of the fifth agreement plus new cash
contributions mainly from consuming countries. However, because several
former members of the fifth ITA (notably the United States) declined to join
the sixth ITA, cash contributions committed at the start of the agreement
amounted to only £4S'5^^^ equivalent to about 6,000 tonnes of tin. The
consequence was that the ITC entered the sixth agreement with a large
quantity of metal but with very little cash.
The ITC faced three constraints: (i) The overall level of buffer stock
'holdings', defined as stock plus forward purchases less forward sales, was
restricted to 61,285 tonnes.^* (2) The ITC could borrow to finance stocks, but
'* 39,666 tonnes permitted under the sixth ITA, plus 21,619 tonnes carried over from the fifth agreement.
A device was subsequently found which enabled 2,538 tonnes to be transferred from the sixth ITA to the fifth
ITA. This raised the maximum stockholding to 63,823 tonnes.
1988] LESSONS FROM TIN 7
borrowings were restricted by the availability of stock as collateral. (3) The
ITC needed to ensure that it maintained sufficient cash to meet interest
payments and other expenses. The support operation broke down when it was
no longer possible to simultaneously meet all three constraints.

(C) ITC Trading Strategy

The simplest method of price support would have been to buy on the cash
market and to warehouse the tin purchased. In part, the BSM did this, but the
cumulated excess supply of tin which he needed to control exceeded both the
stipulated maximum buffer stock size and also the extent of his collateral. He
was therefore obliged to seek other means of holding the stock off the
market.
The futures market played an important role in bringing about this result.
Since LME brokers required very little collateral against futures purchases, the
ITC was able to increase its leverage through futures trading. However,
forward purchases added to the ITC's holdings, as interpreted in the ITA, in
the same way as cash purchases, with the implication that the holdings
constraint would be violated. The BSM responded by devising trades which
allowed him to control stock without adding to his holdings.
One major device was the 'special borrow'. In this transaction a physical tin
dealer would borrow tin from the market (i.e. buy cash and sell forward) on
behalf of the ITC. The ITC would pay only interest and commission. The tin
would be removed from the market but since the dealer, not the ITC, was the
owner the tin would not appear as part of the ITC holdings. Furthermore, the
special borrows had the advantage of not using up the ITC's lines of credit.
ITC accounts show that around 20,000 tonnes of tin was held for the ITC
through special borrows. Together with the (approximately) 55,000 tonnes
owned outright, this was sufficient to hold the required stock of metal off the
market.
Stock holding and forward purchases, in the amount permitted as official
holdings, combined with special borrows were not fully adequate for the ITC's
purposes. The reason is that the forward market gave speculators the means of
mounting a speculative attack on the ITC price floor. Since the ITC owned or
controlled almost the entire stock of physical tin, speculators were unable to
attack the floor by selling on the cash market. However, as noted in Section I,
they could in principle go short on the forward market. This would risk little
if, upon maturity, the price floor had held but would profit considerably if the
price floor were broken.
Large numbers of such short sales could have been disastrous for the ITC.
First, such sales would tend to depress the forward price, with the implication
that dealers would require greater compensation to undertake special borrows.
Furthermore, if the sales were sufficiently large and the depression of the
forward price sufficiently deep, the ITC's entire operation could lose credibility
and the short speculation would then become overwhelming.
In the face of this, the ITC found further large futures purchases essential.
This met the speculative pressure and allowed the forward price to be
8 THE ECONOMIC JOURNAL [MARCH

maintained at levels consistent with the price floor. Moreover, by amassing

y
l f d ii h TC
long forward positions the ITC was able to threaten and at times
squeezes, penalising the speculators and earning profits in the process. If in an
attempted speculative attack, speculators held short forward positions in excess
of deliverable supply, the ITC could force the price up to very high levels before
agreeing to offsetting sales. The knowledge that the ITC could act in this way
acted as a severe deterrent against speculation.
These forward purchases by themselves would have led the ITC to be in
violation of its total holdings constraint. A final trading ploy circumvented this
problem. Specifically, the BSM engaged in large numbers of'unpriced forward
sales', that is, sales in which the date and amounts are fixed but the prices are
left to be determined at a later time. Since the realised price is based on the later
spot market price, unpriced forward sales clearly did not counter-balance the
price exposure in the ITC's conventional forward purchases. Nevertheless, the
ITC included these in holdings and, therefore, was able to satisfy that
constraint while making large forward purchases.
Table 2
Position of the ITC, 30/6/84 and 24/10/85
30th June 1984 24th October •985

ITC Price Controlled ITC Price Controlled

holdings exposure stock holdings exposure stock

ITC physical stocks 49.831 49,831 49.831 52.540 52,540 52.540

Stocks held against special — — 26,000 26,845
lends and borrows
Delivered unpriced — — — 6,810 6,810 —
Forward purchases 71.245 71.245 — 63.504 63.504 —
Special lends 2nd leg* i3.3>9 '3.319 — 6,815 6.815 —
Forward sales priced -15,760 -15.760 — -8,850 -8,850 —
Forward sales unpriced — 60,000 — — — 57,060 — —

58.635 118,635 75.B31 63.759 120,819 79.385

Source: ITC Quarterly Statistical Bulletins; House of Commons (1986), pp. 104, 194-9.
Notes: Quantities in tonnes. For 30/6/84 the ITC holdings are as reported in ITC, Statistical Bulletin, (Sept.
1986 p. 42). The figures given for special borrows and for unpriced forward sales are order of magnitude
estimates. The ITC accounts recorded total purchases of 97,245 and forward sales of 101,760. Combining
all these we find the implied outright forward purchases and priced forward sales. It is also assumed that
there was no metal delivered unpriced on that date.
* 'Special lends' were transactions in which the ITC lent tin to a third party through the intermediary
of an LME ring-dealer at off-market prices which would ensure a favourable return to the borrower. The
advantage to the ITC was that these transactions offered significantly higher leverage than was obtainable
in borrowing from banks. The 'second leg' of a special lend is the commitment to repurchase.

Table 2 gives estimates of the ITC positions on two dates based on

information released after the collapse of operations. It is clear that the ITC
position was roughly similar at these two points of time. The ITC held large
positions in physical tin and even larger forward purchases. These positions
" In April 1985 a significant backwardation developed which was widely attributed to actions of the
ITC.
1988] LESSONS FROM TIN 9
were disguised principally through large unpriced forward sales which resulted
in ITC holdings below the maximum permitted by the sixth ITA. When these
unpriced positions are excluded, one sees that the ITC took on price risk nearly
equal to one year's non-socialist world tin consumption. The net effect was that
the ITC was able to withdraw either directly or through dealers nearly 80,000
tons of tin stocks from normal commercial channels.

(E) ITC Income

Using this strategy the ITC defended the tin price floor until, in October 1985,
it was caught with insufficient resources to meet its obligations. To see why the
suspension of buffer stock operations came when it did, we need to examine the
ITC cashflow over the period 1982-5; this breaks down as follows:
(i) Member contributions: The ITC had available initial cash contributions
of ;C43'5"i later augmented by producer contributions of ^2^m.
(ii) Metal purchase: After the end of 1982 the market was in overall balance
so that this item was not important.
(iii) Price differences between the LME and the Penang (subsequently
KLTM) market: LME tin was frequently at a discount to Malaysian tin and
so losses were incurred to the extent Malaysian tin was shipped to Europe.
(iv) Interest costs: The cost of finance on credit extended by banks and
brokers was the largest regular drain on ITC cash. This cost comprised the
direct cost of borrowing on the collateral of warehouse receipts, together with
the interest cost of special borrows.
(v) Capital gains or losses on uncovered forward market positions: The
BSM continually closed out his prior forward purchases with spot sales at
maturity. He made money on a rising market but lost on a falling market.
(vi) Brokers' commission and administrative costs which were small in
relation to the scale of the support operation.
The combined effect of these influences is shown in a simulation of ITC
cashflow using weekly data^* and summarised in Table 3, which supposes
constant physical and forward market positions corresponding to the values
reported in Table 2 for 24/10/85." Until 1985, the interest costs of the support
operation were typically more than offset by capital gains made on the IT'C's
exposed forward position. These gains were the result of fortuitous exchange
rate movements. The ITC stabilisation range is denominated in terms of the
Malaysian ringgit, and, over the period 1982-5, the ringgit moved closely with
the US dollar. Consequently, the appreciation of the dollar from mid-1982

" The simulation used end-week data on LME spot and three month prices, the Penang/KLTM price,
the M S / £ exchange rate and the three month LIBOR, and weekly figures for the Penang/KLTM
turnover.
" Unpriced forward sales: 57,000 tonnes; priced forward sales 8,800 tonnes; special borrows 20,000 tonnes;
special lends 6,800 tonnes. Borrowing rate LIBOR+ | % ; lending rate L I B O R - 2 % ; administrative and
other costs £^m per annum. Interest payments on bank loans are inferred from estimates of the ITC asset
position given in Anderson and Gilbert (1986). Information on late payment of contributions is derived from
House of Commons (1986), p. 194. ITC purchases on Penang/KLTM are taken as equal to Penang/KLTM
turnover whenever the LME was at a discount to Penang/KLTM, and zero otherwise. In this circumstance,
the ITC is modelled as buying cash on Penang/KLTM and selling forward on the LME, with the stock
financed by a bank or brokers' loan. See Anderson and Gilbert {1986) for further details.
10 THE ECONOMIC JOURNAL [MARCH

Table 3
Simulated ITC Cashflow {£m)

Market Trading Activites

Forwarc sales Net

Special - interest Cash
Year.qtr Contributions Expenses Penang borrows Unpriced Priced paid flow

1982 3 77 -13 -3-8 00 00 0-0 — I i-i -8-4

4 83 -'•3 -17 —o-i 21-0 O'l 17-2
1983 I 7-1 -1-3 -17 o-i 55-4 — O'l -7-0 527
2 77 -13 01 0-5 233 O'O -6-3 24-1
3 10 -13 o'3 1-6 -127 03 -8-1 -19-1
4 0'9 -13 —o-o i-o 2-9 07 -7-I -3-0
1984 I o'9 ->3 -0-4 23 -7-3 04 -90 -14-4
2 0-9 -1-3 -07 -05 18-6 ro -9-5 8-6
3 257 -1-3 -18 — 10 26'I — 0-2 -97 37-9
4 17 -••3 -2-5 -O-4 18-8 -0-4 -87 7-2
1985 I '7 -i'3 -42 0-2 10-3 — 0'2 -85 -19
2 17 ->3 0-0 — i-i -18-4 01 -5 4 -24-3
3 17 -•3 — 0'2 -0-9 -23-5 -0-4 -6-0 — 30-6
4 0-4 — o'3 0-0 -0-3 -84 — 0-2 -17 —10-6
Totals 67-5 — 167 -.67 •5 1059 II — 107-2 35-4

until February 1985 meant the floor price in sterling terms rose from £
tonne at the start of the agreement to ^{^ 10,400/tonne by February 1985. It was
these sterling capital gains that kept the ITC afloat until 1985.
When the dollar started to fall after February 1985, the ITC's cashflow
immediately deteriorated forcing it to increase its borrowings. By the summer
of 1985 the financial position was rapidly degenerating and the BSM sought
and obtained a promise of an additional j{^6om from producer countries. By
late October, the ITC had completely exhausted its collateral.^* When, on
October 24th, it became clear that the promised contributions were not
imminent the BSM revealed his situation and buffer stock operations were
suspended. Tin trading stopped on the LME. The price of tin, which had been
trading at j{^8,33o/tonne on October 23 fell to around ^6,000/tonne on the
unofficial free market within weeks and, eventually, to under ^4,000/tonne.
These price falls resulted in enormous losses to the ITC on its long uncovered
forward market position. It was estimated that the ITC would need an
additional ;(^263m in order to meet its debts and continue support at a price
of ;(^6,ooo/tonne." The member countries of the ITC refused to meet ITC
debts holding that their liability was limited under the sixth ITA. This
effectively ended the 29 year history of the tin market 'stabilisation'.
" House of Commons (1986, piO2) shows 49,831 tonnes of the ITC's physical stock of 52,540 tonnes as
committed either to brokers or banks. In Anderson and Gilbert (1986) we report a simulation of the ITC's
asset position which shows the percentage coUateralisation of the ITC stock following a shallow U from the
inception of the agreement, when the stock was 100% committed, to achieve this level again in October
1985. During 1983 and 1984 the coUateralisation of the ITC stock Wcis between 8 0 % and 8 5 % .
" Financial Times, 12/5/85.
1988] LESSONS FROM TIN II

IV. LESSONS
(A) Commodity Markets and Stabilisation
Although the declared objective of the sixth ITA was the maintenance of a
band for competitive tin prices, it degenerated into an arrangement for the
defence of a non-competitive price floor. As a result the ITC had a near-
monopoly in holding tin stock. This gave it enormous power to influence the
price of tin, a fact that was only superficially appreciated by most market
participants and by the regulatory bodies. The ITC exercised that power
within the context of the institutions which the private market had developed
to manage price-risk and to facilitate storage. Chief among these was futures
trading.
In the first instance, the availability of futures made the defence of the price
floor more diflicult. The reason was that in the tin futures market, as in futures
generally, one could go long or short with equal ease. Consequently, the price
floor was made susceptible to speculative attack whenever it appeared likely
that the financial resources of the ITC might be exhausted. The effect of such
short speculation is to depress the forward price relative to the spot price.
Indeed, the evidence that the ITC was under pressure from short speculation
was that during much of the sixth ITA the tin contango gave inadequate
compensation to carry tin. For this reason, very little tin was held outside the
ITC unless indirectly subsidised by the ITC (e.g. through special borrows).
However, futures trading also enhanced the ITC's ability to defend the
'stabilisation' floor. First, by going long futures, the ITC was able to make its
resolve to defend the price floor convincing. If it matched every speculator's
forward sale with a corresponding forward purchase, the forward price was
maintained at higher levels. This gave private stockholders a greater
inducement to carry metal. Furthermore, large futures purchases gave the
speculators reason to doubt the sucess of short-side attacks. Simply put, the fact
that the buffer stock authority stood to lose so much on its large forward
purchases if the price fell made it appear likely that the ITC would take the
steps necessary to continue the defence of the floor.^" Futures purchases gave a
means of making a credible commitment to maintain prices at high levels.
The ITC was also able to use the futures market to punish speculators. The
ITC strategy was to be heavily long both cash and futures. This is the classic
profile for executing a futures market corner. The ITC repeatedly exploited
this position adding much need trading profit to its cash account and
intimidating the market speculators in the process.
Since tin warrants entered as assets in the ITC balance sheet, by raising the
tin price futures purchases also improved the appearance of the ITC's financial
position permitting additional futures purchases. In this regard the operations
of the ITC were similar to a futures market bubble.^^ For a time, the fortuitous
''° It was reasoned by some that the member governments were liable for purchases made by the ITC and
would therefore come forward with additional resources to defend the floor. While possibly reasonable ex ante,
events have shown such a view to have been imprudent.
'* The parallels to the silver bubble of 1979-80 are clear. The dynamics of a bubble have been analysed
by Tirole (1982) among others.
12 THE ECONOMIC JOURNAL [MARCH
appreciation of the dollar allowed the ITC to use its dominant position in tin
stock holding to pyramid up the support operation. Furthermore, high leverage
allowed it to support the price of tin longer than would have been possible
otherwise. It implied correspondingly high price risk so that, when the collapse
eventually came, the sixth ITA was transformed from apparent financial
health to substantial negative net worth in a very short time.

(B) Information
The suspension of tin support came as an almost total surprise. The reason was
that LME dealers, the market users, the Bank of England, and, possibly, the
member countries of the ITC had no clear knowledge of the size of the ITC's
liabilities. The ITC's position was concealed so successfully partially because of
ITC practices and partially because of the normal channels of information in
a commodity market.
The only information that the ITC released in relation to its buffer stock
activities were quarterly statistics on 'holdings'. Since these omitted special
borrows but included unpriced forward sales (which implied no price
commitment), the ITC could accumulate large price exposure and still be
within the overall constraint imposed by the agreement. The figures of holdings
were completely uninformative; however, this was not generally appreciated
outside the ITC.
Futures market practices afford traders anonymity. By trading with a large
number of LME dealers, the ITC was able to avoid revealing too much of its
overall position to private market participants. The Bank of England had more
information than did a single LME member since it received periodic reports
covering the overall market. However, these reports would not have provided
information on beneficial ownership of positions. It would therefore not have
been possible to infer the ITC's position from these reports. In some ways the
DTI was in the best position to perceive the ITC strategy. However, the DTI
has maintained that, in spite of the fact that they represented Britain on the
ITC, their requests for greater information were rebuffed.'*^ Furthermore, its
responsibilities as representative on the ITC made it difficult for the DTI to act
on such information they did receive.
In competitive commodity markets maintaining private information about
trader positions does not prevent agents from determining whether margins or
other protections against default are adequate for the positions. Tin was
different because knowledge of the overall ITC position was of great importance
in evaluating the riskiness in transactions dealers had with the ITC. Had such
information been publicly known, agents would probably have sought greater
protection. By making the ITC's financial constraints more stringent, the end
of stabilisation may have occurred earlier and with less dislocation.
" House of Commons (1986), pp. 191-2. In June 1985 DTI officials did ask the LME to warn its members
not to advance additional credit to the ITC. The LME felt unable to transmit this advice to its members (ibid,
pp. 226-8).
1988] LESSONS FROM TIN I3

(C) Alternative Analyses and Remedies

It is sometimes suggested that the collapse of the ITC was inevitable. Many
economists may be encouraged to adopt this view on the basis of the theoretical
analysis reviewed in Section I above. However, in the light of the successful
operation of stabilisation schemes during the first five ITA's spanning twenty-
five years, the participants in the tin market could hardly have taken the
collapse of the sixth as inevitable. Furthermore, our analysis suggests that if the
dollar had continued to appreciate against sterling, the price floor might have
been maintained until the end of the sixth ITA.
In the aftermath of the tin collapse the inference was drawn that commodity
agreements should be prohibited from using futures markets (Gemmill, 1985^).
In our view the question is not so straightforward. Futures trading helped
traders speculating against the maintenance of a price floor but at the same
time gave the ITC some means of countering this. Were futures trading to be
effectively prohibited to the buffer stock while still available to other traders,
price stabilisation even within a reasonable band might have been very
difficult.
Finally, it has been suggested that the absence of a clearing association for
LME contracts was an important contributing factor in the tin collapse
(Gemmill, 19856), and indeed, under pressure from the British authorities, the
LME has now accepted clearing. A futures market clearing association is a
particular method for dealing with default risk (Edwards, 1984). Serving as a
party to every trade, the clearing association provides a form of default
insurance. Individual risks are pooled so that if defaults are statistically
independent, the costs of bearing the risk are low. Exposure is also limited
through the margin system in which additional collateral is posted on positions
that suffer adverse price movements.
The problem on the LME in October 1985 did not fit this pattern because
the defaulting party was effectively the entire long side of the forward market.
Risk-pooling is of little help if all the parties at risk suffer the same catastrophe
simultaneously. If the LME had been cleared but nothing else had changed,
the risk of the ITC's default simply would have been shifted from individuals
with short positions onto the LME membership generally.
Clearing could have had an indirect effect on the ITC. First, a clearing
association would have a greater incentive than would a single dealer to collect
information which would allow detection of a large, concentrated position.
However, while a clearing association can readily know the positions of all
clearing members it does not directly know beneficial ownership which would
have been necessary to infer the ITC position. Second, if as a consequence of
clearing, the ITC had been routinely required to post margin, its futures
purchases would have imposed an unavoidable claim on its financial resources,
and this would have significantly reduced leverage. In this sense clearing might
have been a practical deterrent to the distortion of the tin market. However,
it is important to recognise that this results from the discipline imposed through
margins, and that margins do not require clearing.
14 THE ECONOMIC JOURNAL [MARCH

(D) Summary
The combination of accumulated production-consumption imbalances with
exogenous movements of foreign exchange rates resulted in the deformation of
the sixth ITA into the defence of a monopolistic price floor. This programme
was threatened by the speculative short-selling of tin futures. The history of the
tin market over three years 1982-5 was that of the ITC's exploitation of
institutions of the tin marketplace and the loose drafting of the ITA to forestall
the effects of this speculation. The main components of this defence were: the
use of large futures purchases to maintain the credibility of the ITC so that the
resulting price bubble appeared rational; the disguise of the ITC aggregate
position behind the veil provided by the market's usual safeguards of private
information; and the aggressive interpretation of the sixth ITA so that the ITC
position could be construed as conforming to total exposure limit imposed by
that agreement.
Graduate Center of the City University of New York

Institute of Economics and Statistics, Oxford

Date of receipt of final typescript: July ig8j

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