Wheat and Oil
In the 1870s a Tuscan nobleman, Leopoldo Franchetti, travelled round Sicily and wrote a book about it that is still counted among the best descriptions of the Mafia. Gambetta retells a story from it about the millers of Palermo.
The millers formed an association. Today you’d call it a cartel. Each one paid dues. And each promised not to compete with the rest. They held the price of flour by controlling how much got milled: they took turns cutting production, and whoever’s turn it was to mill less got compensation from the others. The millers could hire only men from another association—carters and apprentices who also served as muscle for the local Mafia capo. Both associations, Franchetti writes, were under the protection of powerful mafiosi.
Franchetti doesn’t go into detail. But Gambetta draws a conclusion I find brilliant. To collude like that, the millers had to trust each other an awful lot. Every one of them stood to gain if the others milled less while he milled more and sold dear. And it was the capo who made sure everyone paid their dues, that whoever’s turn it was to underproduce didn’t cheat, and that he himself wasn’t cheated out of his compensation. The Mafia sold the cartel the thing it was shortest of: the certainty that nobody would cheat.
The Oil Cartel
More than eighty years after Franchetti wrote his book, in 1960, several of the biggest oil-exporting countries set up an organisation that went on to become the most famous cartel in the world. Its members agree on quotas: how much crude each country will pump so the price stays where they want it. In 1973, during the war in the Middle East, the Arab exporters declared an embargo on the countries that had backed Israel. Within a few months crude cost several times more.
And from there it goes exactly the way Gambetta described it with the millers. Every country gains if the others stick to their quotas while it pumps more and sells dear. So the quotas get broken all the time. The cartel holds only as long as it has its own “capo”—the biggest producer, ready to cut its own output to save the price or, the other way round, to crash the price to punish the cheats. The analogy limps, of course. Countries have no capo with muscle, only interests. But they collude by the same logic.
The Fair Price
What happens when someone tries to set the price of bread instead of finding it?
In October 1943, with the Allies already landed in Sicily, the whole stock of ration cards in Palermo was stolen, Dickie writes. The whole lot. At least twenty-five thousand went into illegal circulation. The Allies made farmers hand over grain at fixed prices, but small farmers and big landowners alike dodged the deliveries. And so, Dickie remarks drily, black-market traders were enormously popular.
Set a price below what people are willing to pay, and the goods go where the price is more honest. First into the back alley. Then onto the black market. And then to the people who run the black market. You can’t set a “fair” price for grain by decree. You can only find it. On an exchange, where all the buyers meet all the sellers. Or in a back alley, where only the ones who aren’t afraid meet.
That’s what commodity exchanges are for. Nobody hands down the Chicago price of wheat from on high. Every day it is haggled out by thousands of farmers, millers, traders and speculators voting with their money on what grain will be worth in a month, in six months, in a year. Nobody guesses it better. And still the exchange gets it wrong all the time.
The Middleman Between Grain and Flour
Gambetta gives another story—from a Sicilian village at the end of the nineteenth century that researchers called Camporano. The roads were dangerous, and the peasants were afraid to take their wheat to the distant mill. A local man by the name of Mariano Ardena put together an armed escort that, for a fee, accompanied the peasants and their grain. Business took off. By 1900 it had turned into an exchange: for a modest fee, the peasants handed over their wheat in the village and got flour back without going anywhere.
Ardena made his money on the difference between grain here and flour there—on carrying it, storing it and guarding it. That’s the middleman’s margin. Every middleman lives on it, from the village shopkeeper to the global trading house. He doesn’t grow the wheat and he doesn’t mill the flour. He feeds on the danger that lies in wait for the grain between the field and the mill.
Grain traders have a similar-sounding word, but it means something else. The basis is how much cheaper or dearer wheat is here and now, at your elevator, than the futures contract on the same wheat for the matching month. The farmer has sold a future in advance—and no longer fears a fall in the exchange price. But he still fears the basis. If wheat in his district falls further than in Chicago, he pays the difference himself. That’s what they call basis risk. The exchange insures you against the sea, but not against your own bay.
Nobody Knows the Future
Now for why only the brave take up guessing commodity prices.
In the summer of 1972 the Soviet Union quietly, through several American trading companies, contracted for around four hundred and forty million bushels of American wheat, worth roughly seven hundred million dollars. They used a credit the American government had granted for three years, and drew it down in about a month. On top of that, the American government was paying subsidies to the exporters. The market didn’t know how much had been bought in total. It found out when it was too late. In 1973 food prices around the world went up by at least a third. The Americans called the affair “the Great Grain Robbery”. The buyer learned about his own bad harvest before the market did. And beat the whole world.
Then on 20 April 2020 something happened that everyone thought impossible. American crude in contracts for May delivery closed the day at minus thirty-seven dollars sixty-three cents a barrel. Minus. Sellers were paying buyers to take the oil off their hands. The pandemic had stopped the world, and nobody needed crude. The storage tanks in the town where the contract said delivery had to be taken were nearly full. Whoever held a contract and had nowhere to put the oil was ready to pay just to be rid of it.
The Don and the Price of Oil
In forty years Don Vincenzo never once tried to guess what olive oil would cost a year ahead. Once I brought him a calculation showing prices would rise and suggested we buy in more. The Don read it and asked: “And if the Spanish have a record harvest and Spanish oil gets cheaper?” I didn’t know. “Neither do I,” he said. “That’s why I don’t guess. I keep three weeks’ stock, a five-year contract and money in an envelope. Let the people who are paid for it do the guessing.”
The Bottom Line
You can’t set a price by decree, and you can’t guess it; all you can do is get ready. But even the exchange gets you only partly ready: you’re insured against the Chicago price, not against the gap between it and your own village.