Beyond these two fundamental and interrelated roles of futures trading, another service is provided; namely, the bringing of prices into the open for all to see. It is an integral part of the information role whose nature and importance is only now receiving wider appreciation and understanding.

The problem of liquidation in the delivery month-as suggested above, a unique feature of organized futures trading in seasonally produced commodities as a financial institution is the difficulty of achieving an orderly liquidation when deliverable supplies are particularly short.

It can result in a type of distortion that is a strong form of the delivery month squeeze. The nature of the problem and possible remedies were examined at length in a recent department publication entitled "Treatment of Hedging in Commodity Market Regulation." This is the document that I brought; here are a few copies. USDA Technical Bulletin No. 1538, Economic Research Service, April 1976. Senator HUDDLESTON. Thank you. We will receive that for the committee's use.'

*

Dr. PAUL. The study was made at the request of the administrator of the Commodity Exchange Authority and it has been made available to the successor agency-the Commodity Futures Trading Commission. I will summarize parts of this report that seem pertinent for the analysis of May potato futures in eight brief points:

One: All commodity futures contracts have a squeeze potential because there are positive costs of making and taking delivery. These costs may or may not present serious problems, depending on the nature of the commodity stored and on the availability of stocks, storage, and transport services in relation to the number of contracts outstanding.

Large delivery costs tend to create a large squeeze potential. The problem becomes magnified when the costs are incurred for searching out, transporting and otherwise diverting supplies to satisfy futures delivery.

Two: The fewer the available supplies for delivery on a particular contract, or the more costly it is to make or take delivery of existing supplies, the more susceptible the contract is to distortion, i.e., futures prices get out of line with competitive values in cash trading.

Three: There are two routes to lessen the potential for distortion; namely, (a) modify contract terms to increase deliverability of supplies and/or (b) limit the size of positions that may be carried into the delivery month geared to the available supplies.

Four: Modification of contract terms is the most constructive direction to move. The better the design of futures contract terms, the larger the positions that can be sustained without distorting prices. However, the problem of specifying par types, grates and location for delivery, substitutions, and equitable premiums or discounts thereto, is among the most complex of economic problems-requiring reliable insight into the consequences of each suggested change. There is no substitute for studies of basic economic relations in form, place and time as applied to the commodity under study.

Five: The potentials for improving contracts may be limited by the underlying structural features of commodity markets. Markets differ widely in what structural improvements might be achieved.

Retained in committee files.

Six: Speculative limits have been applied by both the exchanges and by the CFTC, formerly CEA, in order to achieve more orderly markets but bona fide hedges have generally been excluded from any such controls. It has become clear that it is often hard to distinguish between the two.

In any case, the need for orderly liquidation of contracts applies to all market participants, which fact argues for imposing a general constraint on positions carried into delivery month irrespective of their classification.

Seven: One way to mitigate distortion is to have a general constraint on total open positions of all traders in a contract during the delivery month, geared to the economically deliverable supply of commodity. Reasonably accurate estimates of deliverable supplies might allow positions limits to be adjusted in time to avoid difficulties. Eight: In principle there is no particular need for any limits on size of positions before the delivery period. However, to achieve an orderly reduction in size of positions carried into the delivery month would require a positive means for reducing the size of individual positions as the delivery month approaches. One way to do this is with tapering limits applied to each contract. The taper would increase with increased distance to its delivery date.

Focus on Potatoes.-Maine-grown potatoes are stored in volume and fed into fresh and processing markets mostly in the East during the winter and early spring. Typically shipments during May are about as large as shipments during February and March, all peak periods.

This is shown in the accompanying figure, charting monthly potato unloads in New York City from all sources in the 1972-74 period. from "Vegetable Situation, Economic Research Service, February 1976."

Now, looking at the chart a moment, the lower line, the horizontal stripe, are unloads in New York during each month from the State of Maine. As you can see, beginning about October, Maine potatoe unloads start to rise and build up in November and December and continue into January and February-but the biggest shipments are March, April, and May. So that May is a substantial month for the cash movement of Maine potatoes into this large eastern market.

Another large source of potatoes-the diagonal line is harvested a little earlier. I am not a potato expert; I should defer to Mr. Fahey; but New York State potatoes supply the New York market earlier than Maine. The vertical line indicates the Idaho-Washington potatoes, which come a long distance into the New York market. They are in the market at about all times that the Maine potatoes are in the market. The upper line, represents potatoes from all other sources; these are largely new potatoes and come in from the South and from various other parts of the country.

However, 1976 was an unusual year. Maine storage stocks of potatoes on April 1-the last date from which stock reports are issuedwere reported as only 7.4 million hundredweight, as compared to 13.0 million hundredweight in 1975, 9.3 million hundredweight in 1974, and 10.8 million hundredweight in 1973.

Hence, it seems likely that deliverable supplies to satisfy May futures contracts in 1976 were also significantly lower than usual. Each 1 million hundredweight shortfall is equivalent to 2,000 futures contracts, at 50,000 pounds per contract.

The above suggests that there is an economic rationale for trading in May potato futures. It is to facilitate carrying Maine potatoes into May and enable the various markets to be supplied in the interval before new crop potatoes arrive in volume in June or July.

However, there is also a potential problem of achieving orderly liquidation of the contract because of short supplies. Squeezes with noticeable price distortion are one result; defaults are another.

The 1976 episode was, of course, dramatic, but a 600-car default occurred in the May 1955, Maine potato contract, when one firm and its subsidiaries held a dominant position. This was over 20 years ago. It is a similar type of thing; it was rather dramatic too.

A constructive resolution to this problem would require a research effort. As noted, the change in contract terms to broaden the deliverable supply should be considered in terms of economic consequences of the various feasible adjustments. For example, should potatoes other than Maine grown be deliverable on May futures and if so, then at what premium or discount?

Constraints to limit size of positions in the May contract also merits examination. Both the New York Mercantile Exchange and the CFTC (CEA) placed limits on speculative positions. The Government's limit for the May contract is 150 contracts-cars of 50,000 pounds-net long or short.

The limit for November is 300. This amounts to a rough gearing of size of all positions except hedges to the distance of the delivery into the storage season.

Should this taper remain fixed, or should it be varied (a) with the distance of the month in which the trading takes place to the delivery month, and (b) with the outlook for remaining deliverable stocks as the season progresses?

Should hedges be allowed to exceed such limits? If so, should all potatoes held in store qualify as hedgeable cash positions in the Maine potato contract or should only those that, in principle, are deliverable on the contract be counted?

I wish to thank you gentlemen for the opportunity to present these few observations based on my general knowledge of futures trading. I will be glad to answer any questions you may have.

Senator HUDDLESTON. I think even though our time is extremely limited, we would like to get your opinion on specific transactions that we are talking about here.

First of all the last day of trading was May 7 for the May Maine potatoes contract. Is that an arbitrary date? How is it arrived at? Dr. PAUL. I do not know, except that I believe in 1955, referring to the investigation that I read, the date was not that early. It was quite a bit later, but it changed.

Senator HUDDLESTON. Is that a date that is in the contract itself? Dr. PAUL. Well, it is part of the rules which are in the by-laws governing the contract. They are written.

Senator HUDDLESTON. You heard this morning the indication by both Mr. Levine and Mr. Bagley, about their thinking about a new contract.

Did they seem reasonable to you?

Dr. PAUL. They certainly ought to be explored. If truck movement is a predominant movement, or even a substantial movement, it ought to be allowed. Other States produce round white potatoes, which are the same kind of potatoes as Maine produces. If they have some period of substantial stocks they ought to be allowed to make— Senator HUDDLESTON. This flexibility would, in your judgment, reduce the probability of an incident like the current situation? Dr. PAUL. Right.

Senator HUDDLESTON. How prevalent is the practice of roller cars in the potato industry?

Dr. PAUL. I would have to defer to Mr. Fahey.

Mr. FAHEY. Mr. Chairman, it is prevalent in the year of heavy supply, surplus supplies, when the shippers in the Far East will start a car roll and he hopes to sell it en route.

In a position of fairly tight supply, such as in the past spring. the transaction is usually consummated in the shipping points. Senator HUDDLESTON. What about other perishable commodities? Mr. FAHEY. It is across the board in produce, particularly California lettuce, if the market goes down to $2.25 a carton. They will move it across the country.

Senator HUDDLESTON. Looking for better prices?

Mr. FAHEY. Right. But in recent years our supplies have tended to be better with demand. I think over the time the problem is diminishing.

Senator HUDDLESTON. Is it utilized in grain or mostly in perishables?

Mr. FAHEY. I would suggest it is mostly in perishables, where you have short-term supply.

Senator HUDDLESTON. Do you have any comment on the fact that was developed by our two earlier witnesses, that while both were seeking information about the available supply, they apparently

either received different information or interpreted it differently with the Commission coming to the conclusion that there was indeed a shortage of supply while on the other hand, the exchange was assured that there were adequate supplies to meet the need.

Mr. FAHEY. I think the basic supply of Maine potatoes was on the type and size but it would be surprising to most of us that the supply was so tight that a person wishing to consummate a contract could not find any.

Senator HUDDLESTON. If he had been willing to pay the price?

Mr. FAHEY. Yes. But the Maine production in 1975 was a small symptom of the 1940's, and by April 1, the last official date we have supplies reported, Maine potato supplies were 50 percent of the year earlier.

I would like to point out here that there were certain paradoxes this past winter which we had the extreme shortage on a per-capita basis of Maine potatoes. But we had a record supply in the Far West.

Admittedly, the supply in the East is the round white, which is not exactly a substitute for that grown in the Far West. But we did have that paradox. It was difficult, a difficult market for those of us.

who followed it.

What does it mean in terms of price?

At the same time we have the unusual export business from Eastern Europe, very unusual, because they say we have a quarantine; we do not need your potatoes. This year, they did.

At one time our potatoes left our Eastern shore and as they proceeded to their destination to Europe, they said, no, you cannot land your potatoes here. I am merely bringing the point up to point out if you have sold a whole boatload of potatoes to a foreign outlet and those potatoes do not find a home, it has an impact on domestic prices.

While we have a shortage in Maine, the heavy supply in the Far West, our new crop, such as in California, will prefer a large crop. That crop is now being marketed and potato supplies today are fairly heavy. So we have this

Senator HUDDLESTON. That increased production out West would not help because of the delivery restrictions in the contract. Mr. FAHEY. It would have some impact on price.

Senator HUDDLESTON. But the shortfall in production in Maine should have alerted nearly anybody observing the market to potential problems.

Mr. FAHEY. It should, anybody that followed the statistics.

I might point out that normally, after May 1-and I can go to the record for the exact date-approximately 15 percent of your crop was marketable, 100 percent moving.

Starting May 1, your supply thins out in May.

Senator HUDDLESTON. So there again, anyone who is maintaining their short positions beyond May 1, should be on notice that he is risking possibilities of not being able to find potatoes even in normal. times.

Normally the liquidation rate really accelerates in those first few days of May. Mr. FANEY. It normally does.