Streetwise Professor

December 29, 2015

Spoof Me Once, Shame on You: Spoof Me Twice, Shame on Me

Filed under: Commodities,Derivatives,Economics,Exchanges,Regulation — The Professor @ 6:41 pm

I’ve often written that HFT firms are the best able to detect spoofers, and to take preventative measures (which reduce the profitability of spoofing, and hence its prevalence). The whole business of HFT is extracting signals from orders and order flow, and trading accordingly. Spoofing is based on manipulating the order flow–in essence, injecting noise into it. HFT firms evaluate their executions, and attempt to identify patterns that predict both winning and losing trades. If spoofers systematically impose losses on HFT firms, eventually the latter will figure it out.

This is the first article that I’ve read that supports this contention:

Inside Ken Griffin’s $25 billion empire, Citadel’s cyber investigators had isolated a new enemy: spoofers.

It was late 2013, and at the firm’s Chicago headquarters, a team of researchers discovered that a rival company’s algorithm was outmaneuvering their automated trader. The algo was placing futures orders it had no intention of filling to entice firms like Citadel into the transactions, then canceling them, leaving Citadel with money-losing trades. Citadel’s plan: to pit its computers against the spoofer in a high-stakes duel over market manipulation.

. . . .

Vertex Analytics may have devised a way to make high-frequency trading more transparent and spoofing easier to detect. The Chicago-based technology firm can represent graphically every order and transaction on CME’s markets, obviating the need to go through pounds of paper searching for a telltale sequence of

Vertex’s approach was a revelation for Robert Korajczyk, a finance professor for more than 30 years at Northwestern University, where he’s studied asset pricing and liquidity.

“My first reaction to seeing the graphics capabilities was ‘This can’t be done,’” Korajczyk said. “However, Vertex can do it.”

. . . .

Citadel isn’t the only firm that took measures against spoofers without regulators’ help.

In 2012, Chicago-based HTG Capital Partners detected a pattern of large canceled orders followed by aggressive trades in the opposite direction that left them with losing positions, according to an affidavit released last month. The firm created tools to help identify when spoofing was taking place, the affidavit said.

Transmarket Group has created an “anti-manipulation guide” that tells traders how to spot spoofing, according to a copy seen by Bloomberg News. The Chicago-based firm lists specific examples of spoofing in the natural gas market on CME as part of the guide.

The article spends a lot of time discussing enforcement actions against spoofers, and the difficulties of making a case. Even ignoring my doubts (expressed in earlier posts) whether the social costs of spoofing really warrant expensive enforcement efforts, the fact that sophisticated and knowledgeable players have the incentive to detect this kind of conduct, and take defensive measures (and perhaps offensive–at least that’s what the description of Citadel “pit[ting] its computers” against spoofers suggests) means that the frequency and scale of spoofing activity is likely to decline significantly. It is a pathogen that found a niche, but the hosts’ immune systems are adapting, and it will become less dangerous in short order.

This isn’t true of all forms of manipulation, but the very nature of spoofing–which involves doing things that are intended to be detected–makes it vulnerable to detection and countermeasures. This means that the system tends to be self-correcting, and this mitigates the need for enforcement. Unfortunately, it appears that enforcement officials (both civil and criminal) think otherwise, and have prioritized the prosecution of spoofing. Combined with the outrageous overcharging and over-penalizing that I’ve mentioned before, this is a disturbing development.

Helluva Way to Run a War: The Pentagon & Obama Go to the Mattresses

Filed under: History,Military,Politics — The Professor @ 1:24 pm

I have long hypothesized that an intense war between the White House and the Pentagon has been raging for years.

Exhibit 1 in support of this hypothesis is the simple fact that Obama is on his fourth defense secretary, whereas no other major department has had more than two. The most recently defenestrated SecDef, Chuck “Hapless” Hagel, recently blasted the administration, savaging it for micromanaging, and entrusting the micromanaging to certifiable idiots like Susan Rice, whose major qualification, of course, is her willingness to say anything–anything–in defense of the administration, no matter how ludicrous.

Hagel’s complaints about micromanagement merely echo those of his predecessors, Bob Gates and Leon Panetta. And of course, there are many other stories (some discussed here) that provide further support.

Hagel also claims that the White House tried to “destroy” him with a slanderous leak campaign. The White House no doubt did this pour encourager les autres: no independent thought will be tolerated! This apparently had the desired effect. One candidate,  Michele Flournoy, withdrew her name from consideration precisely because of her concerns about micromanagement by The Incompetent One.

All of this of course should make you look askance at anyone who would take the job.

Today brought another story of the Pentagon-White House War: Reuters reports that the Defense Department has been doing everything in its power, and pulling every bureaucratic trick imaginable, to impede Obama’s obsession with emptying Gitmo.

The most lurid war story came out some days ago, when Seymour Hersh wrote a long piece in the London Review of Books claiming that the Defense Department actively opposed administration policy in Syria. One must always take Hersh stories with a large grain of salt, but this one has a high degree of verisimilitude. The Pentagon was aghast at Obama’s support for jihadi groups fighting Assad, and for its deference to Turkey which was supporting every jihadist in sight–including ISIS.

The strongest piece of evidence in favor of the Hersh claims is the failed Pentagon program to arm allegedly moderate opposition groups. The Pentagon knows how to arm, equip, and train insurgent forces: indeed, this was the original purpose of Special Forces. The only possible reason that the Pentagon could have fucked it up as badly as it did in Syria is that it wanted to fuck it up.

Another piece of evidence in favor of Hersh is that he writes that ex-DIA head Michael Flynn was the most aggressive opponent of Obama’s Syria policy (with Dempsey playing a more devious Yes Minister role). Flynn has been very outspoken recently, including this recent interview.

So there you have it folks. The Defense Department and Obama and his thugs have gone to the mattresses. Helluva way to run a war. Or wars.

December 26, 2015

Is Russia Like the One Hoss Shay?

Filed under: Economics,Politics,Russia — The Professor @ 7:59 pm

This piece in War on the Rocks challenges seven common beliefs about Russia. Two were of particular interest.

The first challenges the view the Russia is brittle. As someone who long ago advanced this hypothesis, I challenge the challenge. The basic problem is that I don’t think author Michael Kofman really understands the concept of brittleness. Here’s what he says:

With each new outbreak in what has become an almost routine series of political, economic, or foreign policy crises, a segment of the Russia-watcher community invariably begins to make predictions of Putin’s imminent demise. Unfortunately, the science of predicting regime change seems to lag significantly behind astrology. We should remember that few predicted the Soviet Union’s rapid demise, the start of the Arab Spring, or anticipated the rapid fall of Victor Yanukovich in Ukraine following the start of the Maidan.

There are two ongoing case studies on the merit of such predictions. The first is Pakistan, a country that by the same theory should have collapsed long ago under the weight of its many problems. The second is North Korea, which soldiers on despite decades of predictions and estimates of the regime’s imminent implosion. As former Secretary of Defense Robert Gates remarked on our ability to predict the nature and location of the next conflict, “our record has been perfect” given that “we’ve never once gotten it right.” The same should be said of our ability to judge regime brittleness. The point is not that neo-Kremlinology or assessments of political stability are a waste of time, but that this is a single layer of analysis that should be taken with a healthy dose of skepticism.

The point about brittleness is exactly that the process is not linear and that collapse occurs suddenly and unpredictably. Brittle systems survive most things, but when they fail, they fail completely and suddenly . . . like the USSR, Arab regimes, and Yanukovych.

Brittleness arises from coordination games in authoritarian regimes. Preference falsification is one mechanism. Coercive mechanisms and social pressures induce people to claim allegiance to an authoritarian regime, or remain silent, even when they don’t like it. This can be self-reinforcing, because people don’t receive contradictory information, and think that their own dissatisfaction is not widely held, and thereby remain silent (or feign support) which convinces others that their dissatisfaction is not widely held, and on and on. This system is stable, until some shock (a military adventure gone wrong, for instance, or an economic calamity, or an incompetent response to a natural disaster) induces enough people to express their opposition to convince the remainder that their dissatisfaction is indeed widely shared. The equilibrium then flips from uniform support or acquiescence to widespread opposition.

Preference falsification is a brittleness mechanism that works through the broad populace. Natural state mechanisms work through the elite. Elite support for the regime is predicated on the beliefs that it commands control over enough resources that can be distributed to the elite, and that this control will endure for some time. When an adverse economic shock reduces the stream of rents that is used to buy elite support, or if the durability of the regime comes into question (due, for instance, to a health crisis at the top of the regime), the elite can suddenly withdraw support or challenge the existing leadership, leading to regime collapse.

Both of these mechanisms are non-linear. Small shocks can lead to large changes. Since the shocks are unpredictable, the shattering of a brittle regime is unpredictable as well.

Highly personalized and institutionally impoverished systems tend to be more brittle, in large part because these systems are more dependent on the vagaries of individual health, personality, and sanity. In this respect, it is interesting to consider the case of Stalin. The Soviet system survived Stalin’s death in part because it did have developed institutions that facilitated succession. Putin, in contrast, has followed the more traditional authoritarian approach of becoming the indispensable person. Such as system is inherently more brittle.

The second point I’d like to challenge is related to the first, namely, whether Putin (and the Russian government generally) is obsessed with regime survival. Kofman argues that this is an empirically empty hypothesis.

This is incorrect. Putin is clearly obsessed with regime change. Look at his rhetoric on color revolutions and the Arab uprisings. He sees dark plots everywhere, most of them emanating from the US. His fears are matched by actions. Putin’s resumption of the presidency, and the relentless campaign to control civil society and eliminate independent media especially in the aftermath of the late-2011 protests are the clearest examples domestically, and the hysterical response to Ukraine, Syria and even backwaters like Montenegro are the foreign policy manifestations of this fear. The obsession with stability at home and abroad is also symptomatic of of concerns about regime survival.

The domestic reactions are classical authoritarian responses to anxieties about brittleness. Controlling information enforces the preference falsification equilibrium. The confident don’t fear open expression of discontent. Those who know that stability depends the shared belief that the regime has near universal support, do.

Obsession with regime survival is an acknowledgement of brittleness: that’s why these concepts are related (though Kofman does not connect them, which is revealing). Michael Kofman may not believe that Russia is brittle, but Putin’s behavior strongly suggests that he does.

Again, the whole point about brittle regimes is that the timing of their demise is almost impossible to predict, as that brittleness is a non-linear process that involves the risk of a large and sudden change in equilibria in response to a modest shock. Non-brittle systems muddle along. Brittle regimes don’t: they sometimes fall to pieces all at once, like the one hoss shay.

December 25, 2015

Four Corners Offense: The Social History of Commodity Corners

I’ve been spending something of a busman’s holiday, reading this and that about commodity market corners in days long past. I started out looking into some of the big cotton corners at the beginning of the last century, namely the Brown-Hayne corner of 1903 and the Patten corner of 1910. These are the subject of a new book, The Cotton Kings: Capitalism and Corruption in Turn-of-the-Century New York and New Orleans. The book is entertaining history, but could use some more economics. It is journalistic in style, rather than analytical.

Reading about Patten’s cotton corner led me to read about his wheat corner of 1909, his corn corner of 1908, and his oats corner of 1902. Mr. Patten was a busy man.

And a reviled one. He was known as “The Wheat King,” whom the The Literary Review accused of  “The Crime of Making Bread Dear.” He was the model for the villain in the very influential D. W. Griffith short film, “A Corner in Wheat.”

This early short was one of the first films, if not the first, to address a serious social subject. Its theme would be very familiar today: the two Americas, rich and poorSergei Eisenstein admired Griffith, and employed his “parallel editing” technique (which he referred to as Griffith’s “montage of collision”): some film historians consider Griffith’s technique more subtle and less heavy-handed than Eisenstein’s.

(Unbeknownst to me when I was growing up in Evanston, Illinois, Patten was a longtime resident of the city, and its former mayor. He built a mansion there, and funded the Patten Gymnasium, where I swam in the summers.)

Patten was a nationally known figure. The Justice Department indicted him under the Sherman Act for his cotton corner, and the case attracted front page attention in national newspapers, including the New York Times, when it went to the Supreme Court. (Patten was fined $4000, or less than .1 percent of what he allegedly made in his corner. Not much deterrence effect there, eh?)

Patten was not alone in being a figure of national renown–and infamy. Commodity speculators were the banksters of their day. The Matt Taibbi of the 1880s, Henry Demarest Lloyd, wrote about cornerers at the Chicago Board of Trade in a famous essay. Frank Norris wrote a famous roman à clef, The Pit, based on the Leiter wheat corner of 1898.

In sum, in the last third of the 19th century and the first quarter of the 20th, commodity markets generally, and commodity market corners in particular, were the subject of intense interest. In some respects, it is not surprising that commodity corners were the subject of close journalistic coverage, serious fiction, social critical literature, and film during this era. Agricultural commodities were much more central to Americans as both consumers and producers. In 1900, 41 percent of the American workforce was employed in agriculture: now it is under 2 percent, and agriculture represents less than .7 of GDP. Half of American consumption spending went to food and textiles in 1900: a century later, that figure was down to 20 percent. Relatively speaking, the commodity derivatives markets (the Chicago Board of Trade, the Minneapolis Chamber of Commerce, Kansas City Board of Trade, the New York and New Orleans cotton exchanges, etc.) were more important and more developed that the capital markets, including the New York Stock Exchange, than is the case today: by the 1990s, when I was researching commodity exchanges and doing work with some, the commodity traders lamented that the explosion of financial futures had led the managements of exchanges to lose touch with the realities of commodities.

That said, one can see many echoes of the distant debates about and social criticism of commodity trading and corners in current controversies over financial markets. Just as outrage over the alleged excesses of the 2000s gave birth to the spate of post-Crisis financial regulation, fury over the Leiters and Pattens and Browns led to the first major regulations of financial markets in the United States: the Cotton Futures Act of 1914, and the Grain Futures Act of 1922 (which morphed into the Commodity Exchange Act, which is still with us, and which was amended by Frankendodd). Both Acts followed major government studies, the Commissioner of Corporations’ Report on Cotton Exchanges, and the Federal Trade Commission’s Report on the Grain Trade. Both of these are very well done, and provide very detailed descriptions of both the cash and futures markets. They are priceless resources. In some respects, because of them, we know more about the operation of commodity markets in the first decades of the 20th century than we do of their operation in the first decades of the 21st.

Maybe someday I’ll write a book about all of this, one that integrates the economics, history, and political economy. It’s of great personal interest, but not highly valued in the economics or finance professions today. I was amused when I came upon the link to an AER article about the Cotton Futures Act: it is beyond imagining that something similar would appear there today. But as I hope the foregoing shows, plus ça change, plus c’est la même chose. Issues of the relationship between financial markets and the real economy, the political economy of financial markets, and the influence of financial titans on political and judicial institutions, are still with us. In 1909, a film like A Corner in Wheat grappled with the social impact of finance in a very provocative and arguably simplistic way: in 2009-2015 movies like Too Big to Fail, Margin Call, and The Big Short do the same.

Don’t hold your breath, but maybe someday you’ll read about this in depth in print, rather than superficially in pixels.

December 23, 2015

The WaPo Caters a Pity Party

Filed under: Politics — The Professor @ 11:41 am

This story in the WaPo is utterly infuriating, on many levels.

In a nutshell: A British “Asian” Muslim family was denied entry into the United States by DHS.

Rather than even acknowledging the possibility that DHS had a legitimate security interest in doing so, in an alleged news story the WaPo leapt into action, blaming Trump:

Ever since Donald Trump called for a “total and complete” ban on Muslims entering the United States, many people have decried the idea of excluding people from the country just because of their religion. Would such a policy, some wondered, be constitutional? Would it be American? Would it be decent?

Now, a British Muslim family headed to Disneyland has been prevented from traveling to the United States by the Department of Homeland Security. The Guardian reported that a family of 11, headed to the California resort from Britain’s Gatwick Airport, was unable “to board the plane even though they had been granted travel authorization online ahead of their planned 15 December flight.”

Trump had zero to do with this. FFS, it was the Obama administration’s DHS that barred them from the flight, and we have had plenty of evidence that the administration, and the DHS in particular, is consumed by political correctness that leads it to avoid anything that can be even remotely called profiling of Muslims. And it’s not as if the Obama administration genuflects to Trump: Obama has in fact sharply criticized Trump’s ban-all-Muslims gambit. If this DHS has issues with you, that’s saying something.

The WaPo raises the issue of whether the family was all UK citizens. As if that should matter.  let’s not forget that the UK has a huge homegrown radical Islam problem, rooted deeply in the Asian community. The UK government acknowledges this.

Another huge red flag is the fact that the family immediately went into full-blown victim mode:

“We were devastated,” Mahmood told the British TV station ITV. “We’d planned this trip for two months — the kids were excited — and all of a sudden some person just comes and says ‘you’re not allowed to board the plane,’ with no explanation.”

“We were alienated,” he added, “the way we were just taken out the room.”

Mahmood said the children were “devastated” and had “tears in their eyes.”

In an interview with the BBC, Mahmood said he was taken aside by a British border control official just before his family was due to board the flight — and that the children knew almost instantly what was happening.

“We were the only family that were Asian, Muslim appearance. It was embarrassing that we were the only family that were taken out,” he said. “When they saw me shaking my head, the younger ones started crying. They knew straight away.”

No American officials told them why they weren’t being allowed to enter the United States, Mahmood told the Guardian, but he said the reason was “obvious.”

“It’s because of the attacks on America — they think every Muslim poses a threat,” he told the newspaper.

All of this is hyperbolic and manipulative, but the last sentence is particularly egregious. Um, Mahmoud’s experience made the news because it is clearly the exception, not the rule. “Every Muslim” is not denied entry: very few are. Mahmood & family were denied entry.

There is another exception reported in the story, a certain Mansoor who was denied entry to the US, and who also played the victim for all it’s worth.

But rather than take a skeptical or merely even-handed approach to Mahmood and Mansoor, the WaPo catered the pity party.

And that does bring Trump into the story: this clueless political correctness in the political class and its media enablers is exactly what drives Trumpism.

December 22, 2015

Embarrassing Silliness on Commodity Market Financialization in the FT

Filed under: Commodities,Derivatives,Economics,Energy — The Professor @ 8:04 pm

Satyajit Das writes some smart things. He also writes some silly things. This article in the FT is definitely in the silly category. Embarrassing is more like it.

Das claims that “increased financialisation” has “exacerbated” the downturn in commodities. What does he mean exactly?

Let’s start with the what Das means by financialization. (I’m ‘Merican and I’ll spell it like a ‘Merican, dammit!) This has become a term of art to mean traditional financial investors (pension funds, hedge funds, retail investors etc.) taking on direct exposure to commodity price risks, usually via derivatives (including ETFs). But Das treats anything touching finance as financialization. His use of the word is so broad as to be meaningless.

Cash flows from future sales were monetised to raise large amounts of debt to finance expansion. The collateral value of commodities secured expansion in borrowing and trading.

Uhm, when has this not been true in commodities? Commodity production tends to be highly capital intensive, which requires, you know, capital, which requires tapping the capital markets to, you know, fund. Since the dawn of capital markets, lenders and equity investors have mobilized savings to supply capital to miners, drillers, etc., to fund the digging of mines and the drilling of wells, based on the expectation of being paid back from cash flows from future sales. That’s exactly what finance is. If that is “financialization,” pretty much everything is “financialized” and the term is so general as to lack all meaning and analytical bite.  Modern markets have always been financialized in this way.

Natural resource firms have long been major users of the capital markets. Indeed, many of the earliest stock and bond markets developed to finance commodity investments, and mining and E&P firms have long been leading names in major stock and bond markets. In that respect, commodities have been financialized a lot more for a lot longer than most sectors of the economy.

In fact, it is the very capital intensity of extractive industries (which made natural resource firms reliant on capital markets from the first) that  explains the boom-bust cycle. Most of the costs of natural resource extraction industries are sunk costs. Literally sunk: very expensive, very long-lived holes in the ground that can’t be undug and used for something else. If demand turns down after these investments are made, it usually makes economic sense to continue operating , because the variable costs of operation tend to be relatively low and can be covered even when prices are low. Since the capacity is long-lived, exit does not occur, meaning that low prices can persist for long periods. But that’s economically efficient when investment is largely irreversible.

Which brings me to Das’s next groaner:

The need to maintain cash flow to service debt requires production levels to be maintained, even if it is below cost. This delays the withdrawal of supply and correction of prices. It also destroys the value of equity, making it difficult for firms to raise new capital to reduce debt.

Producing “below cost” (by which I assume he means continuing to produce when prices are below cost) destroys cash flow, rather than maintains it, if cost is measured properly. It is optimal to operate as long as prices cover avoidable costs (e.g., variable costs, and fixed costs that must be incurred as long as output is positive), even if prices are below some measure of accounting cost which typically embeds sunk costs: you can’t judge economic operation by looking at income statements, which have sunk costs baked in.

This kind of continued operation doesn’t “destroy the value of equity.” To the contrary, it is shutting down when price more than covers avoidable cost that destroys the value of equity. The fact that avoidable costs in natural resource extraction tend to be low relative to total costs means that not exiting even when prices are low is economically efficient.  (Another implication of the cost structure of natural resource production is that it is typically efficient to produce either at capacity or shut down altogether.)

Debt costs reflect the sunk costs of investment. Sometimes–like now–cash flows are insufficient to cover the costs of servicing this debt for many firms. That’s what bankruptcy laws are for. If they work well, the continued operation (or not) of insolvent firms will depend on current and expected future margins between price and avoidable costs, not the Ghost of Sunk Costs Past.

Then there’s this:

For industries like shale gas and oil which were cash flow negative even at high oil prices because of the need to invest in new wells to maintain production, reduction in the supply of capital affects the ability of firms to operate.

Again, Das is apparently utterly confused about the proper cash flow concept to apply. If “maintain production at all costs” was truly the mantra of the E&P industry, the problem would not be financialization, but management retardation. Finance would be implicated only to the extent that financiers are similarly retarded and gladly shovel good money to them to permit continued value destruction. If anything, it is the need to access the capital markets that prevents retarded managements from wreaking havoc: few things are more destructive of value than CEOs with bountiful free cash flows that relieve them of capital market discipline. Cutting off capital from negative NPV projects is a boon, not a burden.

Finally we get to derivatives!:

Hedging ameliorated the effect of declining prices. Derivative gains contributed in excess of 30 per cent of revenues in the US shale industry in 2015

And this is a problem why? This is exactly the way “financialization” is supposed to work. It transfers price risks to those (namely, well-diversified financial investors) who can bear them at a lower cost. Yes, investment probably would have been lower, and prices higher, had this risk transfer mechanism not existed. But this doesn’t mean that the level of investment with an efficient risk transfer mechanism is too high: it means that the level of investment without one is too low.

More bad derivatives stuff:

Margin calls further complicate matters. An airline that has hedged future oil purchases at high prices may face margin calls that make unexpected claims on its cash flow.

Yes, cash flow mismatches on hedges can be a problem. Which is exactly why corporate end users strongly preferred (and prefer) OTC hedges which embedded credit to mitigate these problems.

More financialization evils, according to Das:

Financialisation altered fundamental industrial structures. Traditionally high barriers to entry, such as technology, expertise and access to capital, led to domination by large producers who planned and controlled production.

Now specialised resources service firms provide access to technology and the willingness of capital markets and non-traditional lenders to provide finance allows easier entry resulting in a more fragmented industry.

These are features, not bugs! These are benefits of financialization! Breaking down oligopolistic and monopolistic market structures is good, not bad!

At the same time, trading in financial claims on future commodity cash flows has encouraged institutional investment in the sector as part of diversification into new asset classes. Hedge funds and trading firms now act as quasi banks financing and facilitating risk management by commodity market participants.

So facilitating the flow of capital from savers to investors is a bad thing? Facilitating risk management is bad too? Who knew?

This is just bizarre:

This activity is marked-to-market daily or secured by the value of the commodity. Any change in value can trigger calls for additional collateral complicating cash flow management or force liquidation of holdings. Capital market investors may lack the ability to ride out prolonged corrections. It complicates dealing with financial distress and the necessary restructuring.

Tapping into a deeper pool of capital, which financialization (as defined by Das) allows, spreads the risks and makes it easier to ride out prolonged correction (which, again, are an inherent consequence of the cost structures/operational leverage of natural resource extraction), not harder. And the statement about complicating dealing with financial distress and restructuring is completely conclusory, with no supporting argument or evidence.

Yes, in a world with poorly developed financial markets, large scale investments in industries characterized by irreversibility and large scale (like natural resource extraction) are expensive to fund. “Financialization”–which in Das’s expansive usage, apparently just means lower cost access to bigger pools of investment and risk capital–indeed leads to a bigger natural resources sector. Yes, by its very nature this sector will inevitably go through protracted periods of low prices, which will impose losses on investors. But that’s a risk that they willingly choose to bear, in exchange for an expected return that they consider compensatory.

Das appears to be afflicted with Bastiat Disease, i.e., the inability to distinguish between the seen and the unseen. Das sees the financial carnage that the current natural resources depression has created, but hasn’t considered what would happen if the world was less financialized. What are the unseen consequences of that?

I can tell you: a poorer world.

There are some forms of finance that are wealth-destroying rent seeking. The financing and risk management of the production of minerals and energy are not among them.

December 21, 2015

Adam Smith Goes to Syria: How Bad Government Policies Turned Drought Into Famine

Filed under: Climate Change,Commodities,Economics,Energy,History,Politics,Regulation — The Professor @ 7:39 pm

The myth that global warming caused a drought which caused the civil war in Syria has been flogged repeatedly by the left, especially in the lead-up to the Paris farce: another example of the “elites” letting no good crisis go to (political) waste. As I discussed in March, there was indeed a drought in Syria, but no credible scientific evidence links the drought to climate change.

Droughts happen. What turned the drought into catastrophe in Syria was the depletion of groundwater by previous government-driven efforts to spur production:

Syria was such a successful producer that it became a net exporter of wheat for the better part of two decades — almost unheard-of in a region where most governments imported cheap wheat from abroad. According to ICARDA Director General Mahmoud Solh, the increased productivity netted the Syrian government more than $350 million a year . The country also kept a strategic reserve of wheat — usually about 3 million metric tons, enough to get it through a lean year or a price spike. In this most stable of dictatorships, nobody dreamed of a war.

But all that productivity came at a price. To produce these remarkable gains, Syria’s agricultural sector “mined” groundwater to irrigate farms. Experts predicted that this would lead to severe water Shortages. When a four-year drought struck in 2006, devastating 60 percent of Syria’s agricultural lands, the country’s groundwater was already depleted.

(This sounds a lot like Soviet agricultural malpractice.)

This brings to mind Adam Smith’s argument that bad government policy turns “dearths” caused by nature into famines:

The seasons most unfavourable to the crop are those of excessive drought or excessive rain. But as corn grows equally upon high and low lands, upon grounds that are disposed to be too wet, and upon those that are disposed to be too dry, either the drought or the rain which is hurtful to one part of the country is favourable to another; and though both in the wet and in the dry season the crop is a good deal less than in one more properly tempered, yet in both what is lost in one part of the country is in some measure compensated by what is gained in the other. In rice countries, where the crop not only requires a very moist soil, but where in a certain period of its growing it must be laid under water, the effects of a drought are much more dismal. Even in such countries, however, the drought is, perhaps, scarce ever so universal as necessarily to occasion a famine, if the government would allow a free trade.

It as not just the  Syrian government that contributed to spiraling food prices which created popular unrest in the Middle East that culminated in 2010-2011 (which the Muslim Brotherhood exploited in Egypt and Syria in particularly): US government policy contributed to the problem. In particular, US biofuels mandates that stimulated the production of ethanol drove up the price of corn by an estimated 30 percent, and as Brian Wright has shown, drove up all other grain prices as well (because corn is a substitute for other grains in both consumption and production). (I strongly recommend reading at least the introduction of the Wright paper: I’d quote in detail, but the online versions embed some devious feature that makes it impossible to copy-and-paste.)

It is sickly ironic that policies intended to reduce global warming pushed by the same crowd that falsely blame the Syrian drought and subsequent civil war on global warming (a) do nothing to reduce global warming, and (b) have done far more to exacerbate poverty and create social unrest  in the Middle East than global warming ever has or ever will.  Ethanol is an unmitigated disaster environmentally, economically, and socially. Yet the people Thomas Sowell trenchantly calls “the anointed” colluded with agricultural lobbies in the United States (encompassing both growers and processors) to inflict this monstrosity on the world.

How dare they–how fucking dare they–presume to lecture anyone on their obligations to “save the planet” and help the poor? Through biofuels policies alone they have inflicted huge misery and privation, and yet they have the audacity to try to exploit one of the consequences of these policies in order to ram more of their brilliant ideas down our throats.

Haven’t they done enough? Can they please now just go away?

Alas, we won’t be so lucky. These are our elites, after all, and we are stuck with them, like a case of malaria. And they are actually proud of stupid policies like biofuel mandates. There is no stupid that can equal the stupid of not just not learning from mistakes, but reveling in them.

Do you still wonder why the Trump phenomenon exists? The global reaction against the elites, of which Trump is just the most prominent example, is yet another baleful consequence of the failure of these so called elites. The reaction may be as bad as the disease, but let the blame fall where it should: squarely on the shoulders of those condescending fools whose allegedly good intentions have paved a superhighway to hell.

December 20, 2015

Russia v. Ukraine: Will the Concept of Odious Debt Have Its Day in Court?

Filed under: Economics,History,Politics,Russia — The Professor @ 4:39 pm

Ukraine has announced that it will default on the $3 billion debt to Russia incurred in the waning days of the Yanukovych government–or is it regime? For that distinction could prove to be important.

It is somewhat surprising to me that as of yet Ukraine has not formally invoked the concept of “odious debt,” even though it seems apposite. Although there were earlier legal precedents (notably, US repudiation of Cuban debts incurred by the Spanish government prior to 1898), the concept was formalized in the 1920s by (ironically) a Russian emigre, Alexander Nahum Sack. Sack wrote:

When a despotic regime contracts a debt, not for the needs or in the interests of the state, but rather to strengthen itself, to suppress a popular insurrection, etc, this debt is odious for the people of the entire state. This debt does not bind the nation; it is a debt of the regime, a personal debt contracted by the ruler, and consequently it falls with the demise of the regime. The reason why these odious debts cannot attach to the territory of the state is that they do not fulfil one of the conditions determining the lawfulness of State debts, namely that State debts must be incurred, and the proceeds used, for the needs and in the interests of the State. Odious debts, contracted and utilised for purposes which, to the lenders’ knowledge, are contrary to the needs and the interests of the nation, are not binding on the nation – when it succeeds in overthrowing the government that contracted them – unless the debt is within the limits of real advantages that these debts might have afforded. The lenders have committed a hostile act against the people, they cannot expect a nation which has freed itself of a despotic regime to assume these odious debts, which are the personal debts of the ruler.

The key criteria established by Sack fit in the Ukraine-Russia case quite well. Yanukovych’s regime quite clearly utilized the debt to “strengthen itself” and “to suppress a popular insurrection.” If anything, the debt was used contrary to the interests of the nation. Putin provided the debt in order to make it financially feasible for Yanukovych to reject an EU association agreement, even though this agreement was widely popular in Ukraine. Furthermore, it is quite clear that the lender–Russia/Putin–were knowledgeable of the purposes for which the debts were “contracted and utilised.” Indeed, Putin offered the loan precisely in order to achieve these purposes, which suited Russia.

Russia, of course, argues that Yanukovych’s government was legitimate, and the current government is an illegitimate regime. Given the history, the facts seem to be on Ukraine’s side.

If the case proceeds, I anticipate that Ukraine will eventually invoke this doctrine. At the very least, it would strengthen its negotiating position.

Putin evidently has given up on a wholesale invasion of Ukraine, or even the eastern Ukrainian regions that he once (but no longer) referred to as Novorossiya. Militarily it was likely to be too difficult, and it would likely lead to further western measures that crush the already weakened Russian economy.

Instead, Putin is resorting to measures to prevent the consolidation of the Ukrainian state. The conflict in Donbas is kept on simmer. There is evidence of Russian active measures in the parts of Ukraine under government control. To these military and paramilitary means, Putin is adding economic conflict. Last week he announced that Russia was suspending a free trade agreement with Ukraine. Russia’s rigid negotiating stance on the $3 billion loan is another way of weakening Ukraine, and also creating strains between the Ukrainian government and the west (in the form of the IMF). Rather than striking a death blow, Putin is inflicting multiple ulcers on its recalcitrant neighbor.

Unfortunately, Ukraine is adding self-inflicted wounds to those dealt them by Putin. In particular, it has failed signally in its attempts to get corruption under control. Oligarchs still control the country. Struggles between oligarchic factions are reflected in bitter conflict in the Rada, culminating in the farcical events of last week, when a legislator lifted up Prime Minister Arseniy Yatsenyuk (grabbing him in a very delicate place in the process) while Yatsenyuk was addressing the parliament. Ukraine keeps copious quantities of inflammables piled up, making Vlad the Arsonist’s job very easy. Old Sovok habits die hard, and Putin is exploiting that.

Realpolitik, geopolitics, and western exhaustion and frustration with Ukrainian dysfunction are leaving Ukraine increasingly isolated. This is why Putin is pushing on many fronts, including on the matter of the $3 billion of debt. Ukraine’s best legal option is to declare the debt odious, and fight it out in court. It will at least buy time, and it has a reasonable chance of success given the, well, rather odious history of this loan.

The Crude Export Ban Is Gone, But Don’t Get Your Hopes Up

Filed under: Commodities,Energy,Politics,Regulation — The Professor @ 2:50 pm

Well, ding dong the wicked export ban is dead. The repeal was included in the wretched omnibus deal passed in the dead of the night last week.

As a matter of economic principle, banning the ban is a good thing. Trade restrictions are almost always inefficient, and the oil export ban was no exception to that rule. In the near term, however, the practical impact of the sunsetting of the ban will be limited. At present, Louisiana Light Sweet is trading about par with Brent on a spot basis, and at only a few cents discount on a forward basis. Even given the quality premium for LLS, the differential is too narrow to make it economical to transport oil to Europe. This situation differs dramatically from the conditions that sparked the move to eliminate the ban, namely, a double digit discount of US oil prices from Brent.

The narrowing of the spread was due to many factors, but probably the most important of these was the fact that although oil exports were banned, exports of refined products were not. The low domestic oil prices made refining, including refining for export, to be very profitable. This encouraged investment in refining capacity that increased the demand for US crude, which narrowed the spread.

The repeal of the ban essentially creates an option, and this option is valuable. Although exporting crude is not economic now, it will be in response to some economic shocks. For instance, a disruption of European supplies, a spike in US production, or a big refinery outage in the US would all tend to depress the US price relative to the price in Europe, and if the shock is big enough, this could open the arb.

As for those who think that the lifting of the ban will help US producers in their hour of need, get ready for disappointment. The price difference between the export and no-export worlds is capped by the no-export-world spread: if absent the ban the price difference is greater than transportation costs, lifting the ban raises the domestic price and lowers the foreign price until the spread equals the cost of transport. When the arb channel is closed (as is currently the case), lifting the ban has no effect. Any price effect from lifting in the ban will occur in the future, and will be contingent on future supply and demand conditions. My guess is that the elimination of the ban will periodically give a couple of bucks boost to the US oil price. Not a huge deal.

The lifting of the ban will help traders, to the extent that arbs periodically come into play. It will also periodically benefit infrastructure owners (e.g., pipelines, terminals, and ports) that hand exports. Refiners  will lose when the arbitrage opens: this is why the compromise included a modest tax break for refiners, to secure their support.

Perhaps the biggest losers are those who bet on the continuation of the ban by building condensate splitters: minimally processed crude and condensate could be exported, so the splitters were a way to circumvent the ban. They are now white elephants, as the crude can be exported directly.

All in all, the lifting of the ban is not a big deal. Perhaps the main effect of this development, at least in the short term, is to show that 239 years after the publication of the Wealth of Nations, bad arguments about trade survive and even thrive. But even this didactic effect is overshadowed by circumstances, because the continued success of Trump shows the same thing, and much more forcefully.

In sum, I’m glad to see the ban go, but am underwhelmed by the near-term effects of its demise.

December 16, 2015

Barack “The Bourbon” Obama: Learning Nothing, Forgetting Nothing

Filed under: History,Military,Politics — The Professor @ 9:53 am

The linchpin of Obama’s recalibration of his anti-ISIS campaign (for it is little more than that) is the deployment of US special operations forces in direct actions targeted on ISIS leadership. This represents further proof of Obama’s intellectual rigidity, and his utter inability to learn from experience–or to admit error.

For this is exactly what Obama did in Afghanistan starting in 2009:

Each year during the Afghan “surge” that President Barack Obama initiated in 2009, one declassified document shows, the manhunting task force ran many more missions than the year before–about two per night countrywide in August 2009; six per night a year later, when the Norgrove mission went south; and eleven per night a year after that, at the time of the “Extortion 17” tragedy. By 2011, the JSOC task force numbered more than 3,800 personnel — huge in special operations terms, but still just 2.4 percent of the overall U.S.-led force in Afghanistan, as one briefing slide notes.

Accompanying the overall surge was a “Ranger surge” that put more and more platoons of the elite light infantry regiment into the field alongside the SEALs, allowing more targets to be struck. Operators from the Army’s Delta Force were present as well, some of them providing what a JSOC staff officer calls a “very special capability”: the ability to track a moving convoy of cars or trucks by helicopter and raid it on the go, as depicted in the movie “Black Hawk Down” and numerous YouTube videos. The documents describe one joint Delta-Ranger team specializing in this task as an “expeditionary targeting force”—the same term defense secretary Carter used this week to describe the new JSOC raid force deploying to Iraq.


And this has accomplished what, exactly? The Afghanistan hamster wheel spins and spins and spins, regardless of how many SEAL and Ranger raids are mounted, and how many “high value targets” are killed. The main result of these operations–if “successful”–is to provide promotion opportunities for aspiring guerrillas and terrorists. It certainly has not changed things on the ground.

Actually, the operations have accomplished something: getting highly trained and difficult to replace special operators killed and maimed and just worn out. The details of the operations were only discovered because they were included in FOIA’d reports about two raids that went horribly wrong.

But faced with another difficult situation, this time in Syria and Iraq, rather than contemplating soberly the all pain, no gain lessons of the “Expeditionary Targeting Force” model in Afghanistan, Obama goes to it again.

What Talleyrand said of the Bourbons applies with even greater force to Obama: He has learned nothing, and forgotten nothing.

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