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06/04/91

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Look to the future to understand the present, economist advises

STANFORD -- The Midwest drought of 1988 brought fears that the greenhouse effect was melting solar icecaps and changing weather patterns forever. However, Jeffrey C. Williams didn't worry too much.

He simply looked to the commodities market. There, traders were pricing soybeans at $10 per bushel for the current year, but back down to the typical $7 for the following harvest.

"Which is the market's way of saying," Williams said, "that contrary to what all the journalists were saying, there was just one bad year of weather."

"Futures markets and storage are by their nature connecting the present to the future," said Williams, an associate professor at Stanford University's Food Research Institute. "If you're storing today as an individual, a society, a country, you're believing something about the future."

Williams became an expert on futures markets somewhat by serendipity. As a first-year graduate student at Yale, he was in a complex economics lecture on why farmers were revolting during the Populist era. The professor suggested it was uncertainty over which crops to plant; Williams raised his hand and asked, Why didn't they just look at the futures prices?

This led to the question of whether there even were futures markets in the 1890s -- indeed, there were -- a subject Williams ultimately explored in his doctoral thesis.

"Futures prices tell a lot about temporary shortages and temporary surpluses," he said. "That's really what the price signals allow, a rational allocation of the commodity over time."

Take oil, for example. When Saddam Hussein invaded Kuwait in August 1990, the price of a barrel of oil for immediate delivery jumped from $16 to $40, reflecting a shortage caused by embargo of Iraqi oil and disruption of delivery of Kuwaiti oil. In the futures market, however, the price for oil to be delivered in a year or so increased much less, from $18 to $24. The market's estimation of the invasion of Kuwait, Williams said, was that, at most, it was a short-term disruption of oil.

When futures markets indicate that a shortage is temporary, he said, the rational response is to cut back on use temporarily. One way to assure a cutback is to raise prices. Thus, he said, the oil companies did us a favor by doing so.

"All kinds of senators were saying, 'these evil oil companies, once again milking the American public,'" Williams said. "If the oil companies had just proceeded as if it was business as usual, the price in two months would have been even higher."

As an economist, Williams is drawn to futures markets partly for their purity. Many people can use them, he said, trading volume is high, and the cost of buying and selling is very low, about .01 percent (compared to 6 percent to buy or sell a house). So "they come the closest of any market in the world to the theoretical abstract that economists like to use," he said.

Williams, who was recently granted tenure at Stanford, has published two books, The Economic Function of Futures Markets (1986) and Storage and Commodity Markets (1991, with Brian D. Wright), which reflect his two parallel interests, the history of commodities markets and computer modeling of economic theory. His new book explores mathematical models of how the capability to store a surplus affects the prices and production of commodities.

Simulating how a market reacts to weather shocks or harvest forecasts are not problems you can just "write down an answer to," he said. "They need to be solved numerically rather than analytically."

Williams earned his bachelor's degree at Williams College, where he graduated magna cum laude in 1975. After completing his doctorate at Yale in 1980, he was a postdoctoral research associate there for a year, then taught at Brandeis until 1987, when he came to Stanford.

He and Food Research Institute professor Anne E. Peck recently completed for the National Grain and Feed Assoc.a report that evaluates the performance of the Chicago Board of Trade wheat, corn and soybean futures contracts over a 25-year period. They are proposing a study with the Commodities Futures Trading Commission, looking at how it monitors the big players in the futures markets.

Williams also is trying to interest a book publisher in an analysis of the Hunt silver case, what he called the most famous commodities case in the last 20 years. The Hunts made large purchases in June 1979, and were accused of manipulating the market. They made billions as silver soared from $9 an ounce in July 1979 to $50 an ounce in January 1980, then lost billions as it dropped back to $11 an ounce by March 1980. The Hunts' trial lasted six months in 1988 and they were ultimately assessed damages of $150 million.

Williams was called as an expert witness on behalf of the Hunts to explain market factors that could have driven the price up, including the fall of the shah of Iran, the hostage crisis and the Soviet invasion of Afghanistan.

"The price of gold went up by a factor of four or five and a lot of the reason the price of silver went up has to do with the same political events," Williams said.

To liven up his undergraduate course on "The Political Economy of Commodity Markets," Williams has his students read Theodore Dreiser's The Financier and Frank Norris' The Octopus. He's quick to admit that commodities don't thrill everyone.

"On an absolute scale, it's not really exciting . . . but we fought a war over oil," Williams said. "There should be a good reason to look at the world's grain markets, all the disruptions that go on there. They're not very exciting for their own sake, but they sure matter a lot to security issues."

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