Streetwise Professor

January 13, 2015

It’s Deja Vu All Over Again, or the Putin Hamster Wheel, Crisis Edition

Filed under: Commodities,Economics,Energy,Financial crisis,Politics,Russia — The Professor @ 8:12 pm

I was glancing over some posts from the 2008-2009 crisis period, and was struck at the similarities between what happened in Russia then and what is happening now. The imploding ruble. Capital flight. Discussions of whether capital controls were necessary to stem the rout. The heavily stressed banking system. The government’s desperate attempts to support the the banking system and big firms. The attempts of Rosneft and Gazprom to use the crisis as an excuse to feed at the government trough. Putin’s crazed and frequently paranoid ramblings, and a broader national paranoia.

Russia scraped by last time, in part because oil prices rebounded starting in mid-2009, and because the world economy (notably China) also fought its way out of the crisis. The stimulus-driven Chinese rebound was especially important, because it supported commodity prices, which was vital for a commodity producer like Russia.

Will it scrape by this time? Well, there is a lot of ruin in a country, as Adam Smith informed us, so it’s always risky to predict a collapse. And Russia has rebounded from even worse situations (think 1998).

That said, things aren’t nearly so favorable for Russia this time around. First, there is the self-inflicted wound: the invasion of Ukraine and the sanctions that followed. This is harming the banking and extractive sectors in particular. The fundamentals are bad enough for these sectors: sanctions exacerbate the problems. Second, Russia can’t look to a return to rapid Chinese demand growth to save it this time. China’s slowdown (which is have broad based effects, including on Tesla which has seen Chinese sales on which it was counting decline substantially) is at the root of the current commodity downturn, and since it is likely that this growth slowdown will persist Russia can’t look for succor from that quarter. Third, as bad as Russia’s institutional environment and governance were in 2009, they are even worse now. The ossification of Putinism (and Putin himself!) and his deep fear of overthrow are leading to regress, rather than progress in the development of the rule of law, secure property rights, and civil society, and the reduction of corruption, cronyism and rent seeking. The horrible institutions and governance will be a drag on growth. Fourth, the fiscal situation is weaker. Reserves are relatively smaller now, and Putin’s electoral promises to raise social payments and his commitment to increase dramatically armaments expenditures represent a significant departure from the fiscal probity of the Kudrin years.

Russia emerged tenuously from the last crisis, and never regained the pre-crisis rate of growth. Its post-2009 growth performance was lackluster, given the fundamental environment and Russia’s stage of development. In my view, the conditions for a recovery are even less favorable this time. Some-and arguably the lion’s share-of the reasons for that are self-inflicted, or more accurately, inflicted by one Vladimir Vladimirovich Putin, whom the Russian populace has chosen to inflict on itself. Consequently, though Russia will hit bottom and rebound, I think it is likely that this rebound will be even weaker than the last one. The national equivalent of a dead cat bounce.

Not that the current situation is not without its moments of levity. Today, for instance, oligarch Mikhail Prokhorov announced he is putting the Brooklyn Nets up for sale. Prokhorov’s wealth has been running in reverse for the past several years, and in the current circumstances, the Nets are arguably his most salable asset. His Russian holdings, not so much.

In a way this is sad, because although Prokhorov is a jerk like most NBA owners, he is also somewhat amusing. In contrast, other owners are just jerks.

But back to the main show. When looking at Russia today, Yogi Berra comes to mind. It’s deja vu all over again. Only worse.

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January 11, 2015

Twitter Lunacy on Keystone Makes The Bigtime: The Senate Floor. Which Is No Coincidence.

Filed under: Climate Change,Commodities,Economics,Energy,Politics — The Professor @ 1:22 pm

A few weeks ago I ridiculed one of the arguments raised against Keystone XL: Namely, that oil transported on the pipeline will be exported. I pointed out that this is idiocy. The very purpose of the pipeline is to transport it to the very complex refineries at the Gulf of Mexico. These refineries are clearly able to outbid anyone for oil sands crude transported on Keystone XL, and they will. Moreover, export through the Gulf to Asia, is far more costly than export to Asia via Canada’s west coast.

The main targets of my ridicule in that post were various Internet and Twitter economic geniuses. Hardly an august group. But their voices have been heard! For now the Democrats in Congress are making this argument the centerpiece of their opposition to pro-Keystone legislation:

As Republicans revive the Keystone debate in Congress, opponents are trying to shift the focus to where the Canadian pipeline’s oil will end up once it reaches Texas: China or U.S. gas tanks?

Massachusetts Democrat Edward Markey stood on the floor of the Senate this week next to a giant sign reading “Keystone Export Pipeline” as he argued against a bill to approve the project.

Ed Markey. I should have known.

You can just see TransCanada CEO Russ Girling’s frustration at having to deal with such economic inanity:

Russ Girling, head of pipeline builder TransCanada Corp. (TRP) issued a lengthy statement saying it doesn’t make any sense to export the oil once it reaches the U.S. coast of the Gulf of Mexico, home to the world’s biggest concentration of refineries.

But TransCanada has concluded that this argument, inane as it is, is politically effective:

Girling said the company’s internal polling shows the export issue raises the most concern for Americans. In an interview last month with Bloomberg News, Girling acknowledged that critics found a “nerve that resonates” in that argument.

So much for the influence of economic reasoning on political debate.

I mentioned the Twidiots earlier. There’s something interesting here, and clearly illustrates a pattern. Specifically, that there are no coincidences, comrade. Especially in social media. Or to put it differently, there are too many coincidences for them to be coincidences.

The Twitter storm of the Keystone export meme coincided closely in time with Obama making the same point, and led into the Democratic leadership making this argument the center of their anti-Keystone campaign. In combination with other such “coincidences” strongly suggests manipulation of social media to support political strategies, and in particular administration political strategies. The Twitter storm that broke out in support of the (equally inane) administration free community college initiative over the last few days is another example.

Meaning that pushing back on Twitter stupidity may not be a waste of time. For such stupidity is often merely the handmaiden of some asinine political agenda.

 

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January 6, 2015

Whither Chinese Commodity Demand? Your Guess Is As Good As Mine

Filed under: China,Commodities,Economics,Energy,Politics — The Professor @ 8:40 pm

Commodities are down broadly: Oil gets the headlines, but most major commodities-especially industrial commodities-are down, with iron ore leading the pack. The main driver is Chinese demand: perhaps it’s more accurate to say that the main brake is slackening Chinese demand. Forecasting the course of future Chinese demand is challenging, because there is a huge political component to it.

China has long followed a commodity-intensive, investment-focused (including construction and infrastructure), credit-fueled economic model. It has long been recognized that this model is unsustainable because it is fraught with imbalances. There have been signs that China has recognized this, and in particular the new Xi government is attempting to to navigate this transition, signaling a desire to transform to a consumption-based model with growth rates in the 6-7 percent range rather than 10 percent (though analysts like Michael Pettis say that growth rates in the 3-4 percent range are more realistic.)

One sign of that is the central government’s recent attempts to rein in local governments that borrowed heavily through “local government funding vehicles” (“LGFVs”) to support local infrastructure, housing construction, and industry. Clamping down on LGFVs would be one way of steering China’s economy away from the investment-intensive model:

China’s local government bond issuers face judgment day as authorities in the world’s second-largest economy decide which debt they will or won’t support.

Borrowing costs soared by a record amount last month before today’s deadline for classifying liabilities, on speculation some local government financing vehicles will lose government support after the finance ministry starts reviewing regional authorities’ debt reports. Yield premiums on one-year AA notes, the most common ranking for such issuers, jumped a record 98 basis points in December.

Premier Li Keqiang has stepped up curbs on local borrowings just as LGFVs prepare to repay 558.7 billion yuan ($89.8 billion) of bonds this year amid economic growth that’s set for the slowest pace in more than two decades. The yield on the 2018 notes of Xinjiang Shihezi Development Zone Economic Construction Co., a financing arm in a northwestern city with 620,000 people, climbed a record 63 basis points in December.

But there are mixed signals. Today China announced a $1 trillion stimulus:

China is accelerating 300 infrastructure projects valued at 7 trillion yuan ($1.1 trillion) this year as policy makers seek to shore up growth that’s in danger of slipping below 7 percent.

Premier Li Keqiang’s government approved the projects as part of a broader 400-venture, 10 trillion yuan plan to run from late 2014 through 2016, said people familiar with the matter who asked not to be identified as the decision wasn’t public.

. . . .

The projects will be funded by the central and local governments, state-owned firms, loans and the private sector, said the people. The investment will be in seven industries including oil and gas pipelines, health, clean energy, transportation and mining, according to the people. They said the NDRC is also studying projects in other industries in case the government needs to provide more support for growth.

The NDRC’s spokesman, Li Pumin, said last month China would encourage investment in those areas.

So which is it? A transition to a less-investment intensive model, implemented in large part by reducing the use of credit by local governments? Or continuing the old model, to the tune of $1 trillion over the next couple of years?

Commodity traders want to know. But given the opacity of the Chinese decision making process, it’s impossible to know. The signals are very, very mixed. No doubt there is a raging debate going on within the leadership now, and between the center and the periphery, and decisions are zigging and zagging along with that debate.

I see three alternatives, two of which are commodity bearish. First, there is a transition to a more consumption-based model: this would lead to a decline in commodity demand. Second, there is a crash or hard landing as the credit boom implodes due to the underperformance of past investments: definitely bearish for commodities. Third, the Chinese keep pumping the credit, thereby keeping commodity demand alive. The third alternative only delays the inevitable choice between Options One and Two.

In brief, for the foreseeable future, the most important factor in commodity markets will be what goes on in Chinese policymaking circles. And insofar as that goes, your guess is as good as mine.

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January 1, 2015

Will Bomb For Food

Filed under: Economics,Military,Politics,Russia — The Professor @ 2:11 pm

Russia is leasing 12 SU-24 swing wing Fencer fighter-bomber aircraft to Argentina. Argentina is paying with . . . food, specifically beef and wheat. The 1970s-era SU-24 was, um, very similar to the US’s 1960s-era F-111, which the US retired in 1996. (Seriously: look at pictures of the Soviet SU-24 and the American F-111 and it’s hard to tell the difference.)

The UK is unsettled by the transaction, because the jets could threaten the Falklands. And of course Argentina is in such great shape that it can easily afford a few wars of choice. After all, the last one went so, so well.

But look at it this way. If Argentina prevails this time over an emaciated British military, it will conquer islands with 500,000 sheep. Just think of how many weapons the Argentines will be able to lease from Russia in exchange for all that lamb, hogged, mutton and wool. Chile, look out!

I have another suggested trade between the two countries. They should just exchange their currencies. That way, each can obtain more varied wallpaper.

So no, Russia is not isolated. It is a fully paid member of the Drowning Men’s Club, whose desperate members grab onto one another for dear life as they go under once, twice, and yet again. Look at its economic and political allies, such as they are. Argentina, Venezuela, Cuba, North Korea, Syria. Decrepit losers, every one. Hell, even Belarus is looking for ways to escape the embrace of a drowning Russia.

This deal is so revealing. Russia, once the world’s breadbasket, can’t feed itself. But what does it have to trade? Decrepit military equipment from another era, and a derivative design largely lifted from the evil Americans at that. When “Will Bomb For Food” is only a slightly exaggerated characterization of a country’s comparative advantage, it says everything you need to know about Russia’s economy 23 years after the end of the Soviet Union and 15 years after the advent of Putinism.

 

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December 31, 2014

The Oil Price Decline: No Conspiracy Theories Need Apply

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 11:50 pm

2014 is in the books, and fittingly the last day of the year  saw a fall in the price of oil. The nearly 50 percent decline in oil prices from the end of June to today was the biggest commodities story of the year. This decline has spawned numerous conspiracy theories, which like most conspiracy theories, are pure bunk.

Most of the stories focus on Saudi Arabia and shale oil. In some versions, the Saudis decided to crash the price of oil to drive out competition from US shale production. I analyzed, and dismissed, this story some weeks back. In other versions, the Saudis decided to crash the price of oil in order to strike a blow at its arch enemy Iran, or in some variants, at Iran and Russia (either in cahoots with the US, or to punish Russia for its support of Assad).

Well, to crash prices it is necessary to increase output. The Saudis, however, did not increase output over the past 6 months: it has remained relatively static. This couldn’t be more different from what happened during the 1985-1986 price collapse, to which the most recent decline is often compared. In the early-80s, the Saudis cut output from about 10 million barrels per day (mmbpd) to as low as 3.5 mmbpd in order to maintain prices in the face of rampant cheating on output quotas by other OPEC members. Realizing that it was being the chump, the Saudis increased output about 44 percent. Nothing like that has happened in the past six months.

The other purported cause of the price decline is the increase in US output. This increase is indeed remarkable, but its timing and magnitude doesn’t explain the price decline. US output has been rising inexorably for a couple of years, and the rate of increase has exceeded forecasts, but not by nearly enough to explain the post-June price decline. Since June, US output has risen by about 100kbpd per month. Cumulatively, that’s about 600kbpd, or a less than .7 of world output. Even using an elasticity on the high side of 10*, this could account for about a 7 percent decline in the price. What’s more, some of the US increase has been needed to offset the on again, off again production in Libya and declines in production in Mexico.

Meaning that the focus on the supply side has been totally misplaced. This in turn implies that all of the hyperventilating about S&S-Shale and the Saudis-is wrongheaded.

Instead, the most likely explanation for the price decline is a decline in demand. The fall in price parallels quite closely declines in world GDP forecasts. Chinese manufacturing in particular has slowed. This has been reflected in other commodity prices which are driven by Chinese industrial demand, most notably iron ore, which has fallen almost 50 percent over the last year, and copper, which has fallen by about 15 percent since June. And somehow I don’t think the Australians or Chileans are attempting to punish their economic rivals or geopolitical enemies. They are just along for the ride on the demand train.

The biggest price daily oil price decline occurred the day after Thanksgiving, when OPEC announced it would not cut output. Prices have also declined on days when the Saudis or other Gulf states reiterated their intention to maintain output. But maintaining and increasing output are two different things. The Saudis didn’t announce that they were opening the taps, like they did in 1986. They are just saying they won’t shut them. And as I argued in an earlier post, given their market share and the elasticity of demand for oil, that’s a rational thing to do without having to resort to predatory explanations.

Again, although most analysis focused on supply, the post-Thanksgiving price decline was really attributable to demand too. Market participants were predicting that OPEC would cut output to support prices in the face of falling demand, and this expectation helped to prop up prices. When the expectation was contradicted, prices fell.

I was only surprised that people were surprised that OPEC didn’t cut output. I didn’t see that happening, and I was right: The Saudis only cut output very modestly (by about 3 percent) during the price collapse in the aftermath of Lehman. Where I was wrong was not understanding that it appears that it was almost universally believed that OPEC was almost certain to make a large cut: I was right about the Saudis, but wrong about what everybody thought about the Saudis. This is why I am blogging, rather than sipping Mai Tais on a yacht that would make Abramovich green with envy.

So, it’s not exactly a case of move along, there’s nothing to see here: the price decline is certainly worth watching. It’s just that what you are seeing is not the result of some grand scheme engineered by the Saudis or anybody else. If there is any scheming going on, it is China’s attempt to move to a more sustainable growth model that is less dependent on stimulus-driven investment in industry and infrastructure.

It is certainly the case that the decline in commodity prices generally, and the oil price in particular, could have -and is indeed already having-seismic economic and geopolitical consequences. It is definitely the case that Russia and Iran are going to suffer mightily as a result of the price decline. This may in turn force them to dial back their geopolitical ambitions, although particularly in the case of Russia it could lead to the opposite response by a desperate leadership. But just because these outcomes might be desirable to the US or the Saudis doesn’t mean that the price decline was deliberately engineered to produce them. They are just consequences of broad economic developments that were intended by no one. For the Saudis, the unintended geopolitical consequences at best palliate some serious economic pain.

Given that (unlike in 2008-2009) the demand decline isn’t due to weakness in the US economy, on the whole the US will benefit from the lower oil price, though some regions (like here in Texas and in North Dakota) will obviously suffer. Drilling activity in the US will decline, but this shouldn’t warm Saudi hearts, because if demand rebounds and drives up prices, drilling will rebound too. The oil and the technology aren’t going anywhere: they are on tap for when the price is right.

Recent academic research shows that most of the price variations in oil over the past decades have been demand driven, rather than supply driven. This most recent decline is just another example of that.

Conniving oil ticks and outlandish Texas oilmen make colorful copy , but usually the world is much more prosaic. Oil supply is very inelastic in the short run, so when demand declines even modestly, prices can plunge. This is counterintuitive to most: how can small changes in demand have such huge effects on prices? This leads to speculations about conspiracy, especially when the price changes can shake nations like Russia to their cores. But such speculations are idle. The normal operations of commodity markets routinely produce such price movements. Which is precisely why subjecting grandiose ambitions for geopolitical power to the vicissitudes of commodity prices is the strategy of fools.

And yeah. I’m looking at you, VVP.

Putin may not be having a happy New Year, but I close this post by wishing all my readers all the best for 2015. Enjoy the schadenfreud!

*This elasticity of 10 is related to the sensitivity of oil consumption to prices. Speculative storage makes oil demand more elastic. Indeed, in response to the price decline, visible speculative storage (primarily at Cushing) has increased, and the market has moved into a contango, which is associated with greater storage.

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December 29, 2014

Three Card Monte, In New York and Moscow

Filed under: Commodities,Economics,Politics,Russia — The Professor @ 8:31 pm

One of the most vivid memories of my early trips to New York was the three card monte games on virtually every corner. The guys would slide their bent cards on the top of cardboard boxes. The most amusing memory is that when a cop would approach one of the card sharps. The hustler running that table would whistle, and you could see others on nearby corners fold up their boxes in a flash and scurry off onto a side street.

Well, they’re back. And like everything else, their games are more expensive. Now you get the privilege of losing $100 when you play: back in the day, it was merely $20.

Speaking of three card monte, it appears that currency traders have figured out the three card monte game that Elvira Nabiullina of the Central Bank of Russia has been playing. The ruble resumed its plunge, declining more than 9 percent today.

As I noted last week, it looks for all the world that the CBR is trying to fool the suckers and hide the black lady with a lot of sleight of hand. Rather than spend reserves officially to prop up the ruble, the CBR is lending dollars to the big banks (VTB and Sberbank) which is lending them to Russian exporters, and the government is ordering the corporates to sell dollars and buy rubles, thereby supporting the currency. See! Reserves stay the same! The country’s finances are healthy!

But if you watch closely, and follow the money and the risk, and you’ll see that the CBR has effectively spent the reserves, or at least put them at significant risk of loss, by replacing dollar liabilities of the US government with dollar liabilities of soon-to-be-junk corporates whose ability to earn dollars to repay the loans has plunged along with the prices of commodities, especially oil.  If that happens, the CBR will have to eat the losses on the collateral posted by the banks (i.e., the loans the banks make to the Russian corporates).

This con game worked for, oh, a good week or so. Today’s big ruble move suggests that market participants are seeing through the scam. So lookout below, and don’t stand under a falling ruble, lest you end up like Wile E. Coyote looking up at the anvil that’s about to drive him into the pavement.

Come to think if it, it amuses me to imagine Putin in the role of Wile E., watching all of his machinations and dreams of conquest come crashing down upon him.

Me-meep.

PS. In the early-80s, the three card monte wager was a little more than 1/2 of the price of a barrel of oil. Today, the price of a barrel of oil is a little more than 1/2 of a three card monte wager. Food for thought.

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December 25, 2014

Desperate Times Call for Desperate Measures: The CBR Bails Out Russian Exporters & Borrowers

Filed under: Economics,Politics,Russia — The Professor @ 10:51 am

As part of its efforts to address its looming financial crisis, the Central Bank of Russia announced a new program to assist Russian companies needing dollar and euro financing, and in particular, needing dollars and euros to repay maturing loans. The CBR will lend USD and EUR to banks for 28 to 365 days. The banks, in turn, will lend to exporters and foreign currency borrowers: the banks secure the borrowings with the CBR by pledging as collateral the loans extended to exporters.

On 23 December 2014, the Bank of Russia Board of Directors took a decision to introduce a new instrument — FX loans secured by a pledge of claims on FX loans. This decision aims at expanding credit institutions’ possibilities to manage their own FX liquidity, as well as to refinance external FX loans of Russian exporters, which are soon to be redeemed, given a restricted access to international capital markets. The introduction of the said operations will also be conducive for the exchange rate to return to its fundamental values and to the achievement of demand-and-supply balance in the forex market amid lower exchange rate volatility.

The said operations will be effective until 1 January 2018. The earlier set total maximum amount of credit institutions’ debt to the Bank of Russia equivalent to US$ 50 billion applies to FX repos and FX loans secured by a pledge of claims on FX loans and remains intact.

Note that this program will be in place for more than three years. This is compelling evidence that the CBR expects the crisis to last for some time. Whether the CBR’s resources will last that long is another matter.

Through this mechanism, the CBR is using “credit institutions” as cutouts to lend to Russian corporates. Rather than borrowing FX from foreign banks, the “exporters” will borrow from the CBR via the banks. And who would these exporters be? Well, the biggest are energy producers (Rosneft and Gazprom in particular) and other natural resource firms. Given that Rosneft is sanctioned, and hence is most restricted in its access to foreign debt markets; is an extensive foreign borrower; and due to lower oil prices is facing greater difficulties servicing this debt; it is likely the biggest beneficiary of this program.

Through this action, the CBR is weakening its balance sheet. It will replace $50 billion in low credit risk assets (e.g., US Treasuries) with high credit risk assets from companies like Rosneft (BBB-, and almost certain to be junk soon). Moreover, the CBR is taking on wrong way risk: the loans will be most likely to default or require restructuring precisely when the Russian economy is weakest.

I also suspect that this dovetails with the stealth capital controls, in which the government has commanded state enterprises to reduce their dollar holdings. Some of the dollars that they will spend will be obtained from the CBR via this loan program. This combination of programs therefore allows the CBR to use reserve dollar and euro holdings to support the currency without recognizing declines in official reserve holdings.

Desperate times call for desperate measures, and these measures are desperate indeed.

 

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Vova Really Needs to Drink More

Filed under: Economics,Politics,Russia — The Professor @ 10:24 am

Putin, the alleged personification of the Russian nation, is conspicuously un-Russian in at least one important way: he is a teetotaler. But I suggest that he become a true embodiment of the narod and take up heavy drinking. It might improve his understanding of economics.

There is no better illustration of Putin’s economic ignorance than his recent call to cap the price of vodka. His reasoning? If the current economic crisis causes its price to rise, Russians will substitute towards samogon:

“The overshoot of vodka prices leads only to increasing consumption of bootleg [spirits],” said Putin, who is known for promoting a healthy lifestyle. “I think the relevant structures [government bodies] should think of that,” he added.

Actually, price controls on vodka will have the opposite effect. Price controls reduce production, leading to shortages. The true price of vodka will rise above the officially sanctioned price.* The higher prices and shortages of licit liquor encourage the production and consumption of homemade moonshine made out of . . . well, you probably don’t want to know. (But if you do.) Alcohol poisonings will likely actually rise rather than fall.

This is Vova’s way of promoting a healthy lifestyle. His misunderstanding and mismanagement of the vodka market is a very symbolic of his misunderstanding and mismanagement of Russia’s economy generally.

No wonder Russians are such prodigious consumers of alcohol, in whatever form that is at hand.

*The “true” price could be the black market price. Alternatively, it could be the controlled price plus whatever costs are incurred (value of time spent in line, bribes, etc.) to get access to vodka at the controlled price. It can also be paid in the form of lower quality. Lower quality, of course, reduces the difference in value between store bought vodka and samogon, inducing a substitution towards the latter.

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December 21, 2014

Bomb the ISIS Bandwagon

Filed under: History,Military,Politics — The Professor @ 7:30 pm

An operational plan is clearly shaping up in Iraq. From 12/15-12/17, coalition air forces carried out 45 strikes on 50 targets in support of Peshmerga forces in Ninewa Province: this is a large number, by comparison with the rest of the air campaign, and it is significant that they were carried out in support of a ground offensive. With the help of this support, the Kurds cleared Mt. Sinjar, and have taken a large part of the city of Sinjar. This is important because the city lies on the main road between ISIS’s positions in Syria and Mosul. Furthermore, Iraqi counterterrorism units parachuted (!) into the Tal Afar airport. Tal Afar lies to the east of Sinjar, and is also on the road from Syria to Mosul. If the airport can be secured, this would serve as a base to support advances east and west.

These moves are obviously intended to isolate Mosul from support from ISIS forces and logistics in Syria.

In the meantime, Iraqi forces have made a concerted effort to take Baiji on the Tigris, and also Tikrit somewhat further south. Controlling, or at least interdicting, the line of the Tigris would isolate Mosul from Anbar, ISIS’s main stronghold in Iraq. For this reason, ISIS is counterattacking hard in Baiji, and is also attacking in Ramadi and elsewhere in Anbar, most likely in an effort to draw off Iraq forces from their operations along the Tigris.

Some Iraqis have expressed a desire to attack Mosul soon, but the US is holding them back. It is evident that in addition to needing time to train up Iraqi troops to some semblance of a military force, the US is taking a methodical approach of isolating Mosul and squeezing it for a while before giving the go ahead for an assault.

The US can also use the interval to attrit ISIS troops in Mosul, and undermine morale. This last is a realistic possibility, as recent reports indicate serious discontent among ISIS fighters. ISIS is demanding its minions to swear featly, and to report regularly to keep them from slipping away. Moreover, it is carrying out exemplary executions of those of doubtful enthusiasm or loyalty.

This is most pronounced in Syria, where ISIS’s insane persistence in attacking Kobani has led to an estimated 1000 ISIS KIA. ISIS fighters in Raqqa are beginning to rebel at being sent to Kobani to become JDAM magnets, and there are reports that after many foreign fighters attempted to desert ISIS summarily executed 100 of them, pour encourager les autres. I guess a lot of the Ali Gs who thought jihad would be a lark involving beheading the defenseless and the acquisition of sex slaves in this life are less enamored with the prospect of 72 virgins in the next.

The new ISIS motto is apparently “The executions will continue until morale improves.” Hardly the sign of a confident force.

Time to turn up the pressure. I’ve said that ISIS is like a shark that needs to keep moving to survive. Recruits flocked to its banners when it appeared unstoppable, and about to realize jihadist fantasies. If its inevitability is proven chimerical, the sunshine beheaders will fall away, leaving the hard core types. It is just at such a time, when enemy morale begins to show cracks, that it is imperative to ramp up the pressure. The air campaign is still too desultory, but it has shown results. Increasing its tempo and intensity would almost certainly expedite the unraveling of ISIS, the first signs of which are now manifest.

Napoleon said the moral to the physical is three to one. Let’s use our physical superiority to pressure ISIS’s moral center of gravity. Bombing the bandwagon is the best way to consign ISIS to oblivion.

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December 20, 2014

Can a Money Launderer Truly Come Clean?

Filed under: Energy,History,Politics,Russia,Uncategorized — The Professor @ 8:07 pm

During his press conference, Putin made a very arch reply to a question about Khodorkovsky’s ambition to be president: “Of what country?”

Well, Khodorkovsky is making it clear that the answer to that question is “Russia.” He gives voice to his ambitions in an extended interview in the FT, and repeats his forecast that Putin’s main danger comes from within his “entourage”.

In some respects, Khodorkovsky’s re-emergence and frank statements of his political ambitions and his vision of himself as savior of Russia are a favor to Putin. Especially in times that bring back uncomfortable memories of the 90s collapse, the most notorious oligarch from that era makes a perfect foil for Putin. Breaking the oligarchs was one of the primary foundations of Putin’s reputation and popularity (with the war in Chechnya being another). What better way for Putin to remind Russians of why he is needed than the reemergence of Khodorkovsky?

And Khodorkovsky is definitely a very flawed vessel. Even if his prosecution and imprisonment was a travesty of justice, that’s not to say that he couldn’t have been convicted in a fair trial. For contemporary reporting, both Russian and non-Russian, makes it clear that Khordorkovsky was a ruthless operator who used every trick in the book to avoid taxation, and expropriate minority shareholders and creditors. This article from April, 2000 provides the chapter and verse.

Most of these tricks involved offshore shell companies that he owned. For instance, Khordorkovsky would engage in asset stripping, whereby assets of his Russian enterprises were transferred to the shell companies he owned. Another trick was stock watering, whereby his entities would issue large numbers of new shares of stock that were sold to his shell companies, thereby diluting the ownership of outside investors. He used these devices to great effect in the immediate aftermath of the  financial crisis. Non-Russian banks who had made loans to Khodorkovsky’s Menatep Bank collateralized by Yukos shares saw the values of these shares plummet when he stripped Yukos assets and watered the stock in a way that would have made Daniel Drew and Jay Gould blush.

Khodorkovsky was also the past-master at transfer pricing schemes, whereby output of his Russian companies would be sold to offshore entities at a fraction of the world price; the offshore entities would then sell at the world price. According to the Foreign Affairs article, during the first nine months of 1999, Yukos sold 240mm barrels of oil at about 10 percent of the world price to offshore entities, pocketing $800 million.

And of course, there is the way that he acquired Yukos, via the Loans for Shares deal, and the rigged auction that followed the (inevitable) government default on the loans.

Khodorkovsky was definitely not the hero of western investors back then. In fact, he was a villain.

For all this, Khodorkovsky exhibits little remorse. Arguably none:

I ask about the “loans-for-shares” auctions in 1995 when a handful of businessmen — the oligarchs — lent money to the near-bankrupt Russian state and received stakes in state businesses as collateral. When the state failed to repay the loans, the oligarchs sold the stakes to themselves at knockdown prices. Today the auctions are seen, I remark, as a kind of “original sin” hanging over Russian business.

“I wouldn’t entirely agree,” Khodork­ovsky says. At the time it looked, he continues, as if a Communist candidate would beat President Boris Yeltsin in the elections, which would have spelt the end of private business. Given the risks, no foreign investor was interested. So the shares were worth only what Russian investors would pay — in Khodorkovsky’s case, about $300m, for just under 80 per cent of Yukos.

. . . .

The tax “minimisation” schemes — selling oil through onshore tax havens — at Yukos that were the heart of the trials against him were known to the authorities and even senior ministers, he insists. “In tax law, it’s a crime in most countries if you’ve hidden something. But we didn’t hide anything.” [This remark is particularly disingenuous.]

Note that his justification of the loans for shares fails altogether to address the issue of the rigged auctions. If no other investors were interested, why were the auctions rigged in order to ensure that none could possibly win?

The unapologetic attitude towards not paying taxes is not new:

Khodorkovsky was robustly unapologetic. ‘ As long as the tax regime is unjust, I will try to find a way round it.’

What complicates the Khodorkovsky story is his apparent conversion in around 2000, when Yukos adopted GAAP accounting and western governance standards, and began hiring American managers, including Bruce Misamore as CFO. Was this a Road to Damascus conversion, or a calculated strategy to make the company attractive to western supermajors? Certainly this was the effect: at the time of his arrest, he was on the brink of selling a large stake in Yukos to either Exxon Mobil or Chevron.

His late-in-the-day embrace of western business practices and his persecution are relevant in evaluating his character and motives today, but his history cannot be overlooked. I for one am very skeptical that he has undergone a fundamental change. The failure to repudiate some of his more outrageous actions certainly raises doubts. Someone should address them.

There’s a possible candidate. One of the initiatives that Khodorkovsky funds in order to advance his agenda is Interpreter Magazine, edited by Michael Weiss. This is beyond passing strange, because Weiss has crusaded against Russian money laundering through the use of shell companies and transfer pricing schemes-the very techniques that his paymaster refined into an art 20 years ago. Interestingly, I can find no evidence that Weiss has subjected his patron to similar scrutiny. Not even an acknowledgment that the denizens of Londonograd that he excoriates are pikers compared to his pioneering patron, let alone an inquiry that could attempt to determine whether the man who emerged from prison a year ago is different from the man who went into prison in 2003, and who did the things that put him there.

This would be a truly valuable investigation, far more important than anything Weiss or Interpreter has done. This is particularly true given Khodorkovsky’s return to political life.

There is another strange twist here. Khodorkovsky has come out in opposition to sanctions, and in support of Russia’s annexation of Crimea: he claims that returning it would be undemocraticthe act of a dictator. Given that Putin also claims to be carrying out the public will, this raises questions about how differently Khodorkovsky would act if he were in Putin’s place. It also raises questions about his commitment to the rule of law, which he claims to support.

In sum, Khodorkovsky is playing a political role. Indeed, he is holding himself out as the man who can put Russia on the path away from autocracy towards the rule of law and respect for civil society. He has a past. A very disreputable one, though one perhaps redeemed by reform and punishment. But one can never be sure that the past is truly gone. Given that the most scurrilous acts in the past involved money laundering and shell companies, you’d think that a journalist who has crusaded against those things would be the man to find out.

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