Streetwise Professor

February 10, 2016

I[gor], Robot (Hater)

Filed under: Commodities,Derivatives,Economics,Energy,Exchanges,Russia — The Professor @ 9:40 pm

Igor Sechin comes in a close second to Rogozin the Ridiculous in providing Russian comic relief. Perhaps there are others in Russia that excel them, and I am only aware of these two because they have a bigger presence in the West, but both can be relied upon for some levity–unintentional, to be sure.

Sechin no longer has the outrageous mullet to amuse, but his public utterances suffice. Today at International Petroleum Week in London are a case in point. The mood at the event was gloomy, with pretty much everyone predicting that we are in a prolonged era of low prices, and everyone had their favorite culprit. But Sechin’s scapegoat was unique: Robots! Well, “robot traders”, anyways:

He blamed ‘financial players’ and automated ‘robot’ traders for driving down the price, saying the collapse to near $30 had little to do with supply and demand.

I presume he means algo traders and HFT. Just how these “robots” trading at subsecond frequencies have mesmerized producers and consumers to behave so as to lead to relentless buildups of inventory–including a looming topping out of capacity at Cushing–is beyond my mere economist’s skills to fathom.

Maybe Igor can commiserate with US cattle producers, who blame HFT for causing excessive volatility in beef prices.

Igor also seems to misunderstand that the “US” is not analogous to Saudi Arabia as a producer (although the phrasing is ambiguous, but I interpret this to include the US in “they”):

“At the end of 2014 some Middle East producers followed the US in their desire to increase production,” Mr Sechin told London’s International Petroleum Week. “They have deliberately created this situation and they are committed to low prices.”

The US oil sector is not a unitary decision maker in the way the Saudis are. The US industry is extremely fragmented and diffuse, with dozens of producers acting independently. They are price takers, not price makers. Very different from KSA or other producers with NOCs. (Relatedly, this is why calling the US the “new swing producer” analogous to the Saudis is dumb.)

It’s also more than a little hypocritical of him to criticize others for increasing output: Russian production has been increasing steadily over this same period.

Sechin also engaged in a little wishful thinking:

He forecast prices would recover later this year as US shale output slows. “We believe that in the coming years US shale will lose its grip on the market,” he said.

Good luck with that, Igor. US shale output has proved to be far more resilient than anyone had expected. Productivity gains and lower input costs have mitigated the impact of low prices. More importantly, the shale sector has the ability to ramp up output rapidly if prices do rise, either due to a rise in demand, or an attempt by other major producers to cut output. Indeed, this is likely the real reason the Saudis resist cutting output: they know it is futile because the supply of non-OPEC output is much more elastic than it used to be. This makes the demand for the output of the major producers, notably the Saudis (and the Russians!) more elastic than it used to be. This implies that it is not in the individual interest of any major producer to cut output unilaterally.

Which brings us to the most informative and refreshingly different part of Sechin’s remarks: his discussion of the prospects of a coordinated output cut involving OPEC and Russia.

This idea has captivated traders, who chase the idea like Randy Chasing the Dragon, shooting (the price!) up every time the rumor is floated, only to watch it fly away from their grasp. Once upon a time, Igor was notorious for encouraging such notions. Not this time around:

The most powerful figure in Russia’s oil industry on Wednesday signalled his steadfast opposition to combining with Opec to reverse the crude price rout through co-ordinated cuts in production.

. . . .
“Who are we supposed to be talking to about cuts?” Mr Sechin said when asked by the Financial Times if he was considering working with Opec, the producers’ cartel, to try to shore up the oil price. “Will Saudi Arabia or Iran cut production?”

Methinks that the real story is that the Saudis have made it clear that they trust neither the Russians nor (especially) other members of OPEC to adhere to any agree upon cuts, even assuming a deal can be cut, which is highly doubtful. So Sechin is acting as if he is the one rejecting the idea, primarily because he knows that it is DOA.

Not that this will stop all those Randys from chasing the next rumor of a coordinated cut.

Which raises the questions: Is Randy a robot? Are robots programmed to buy whenever a rumor of a Russo-Saudi oil deal is announced?

Maybe Igor will enlighten us in his next public appearance. Maybe he can do it to some musical accompaniment. Might I suggest this?:

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February 6, 2016

Putin Plays Pyrrhus

Filed under: Music,Politics,Russia — The Professor @ 7:46 pm

The Assad regime and the Russians are on the verge of victory in northern Syria. In particular, the rebel stronghold of Aleppo is on the verge of falling.

This is not all that surprising. It demonstrates the decisive effect of airpower if–and this is crucial–it is operated in support of an even minimally competent ground force, especially one with armor. This is particularly true if the airpower is utilized ruthlessly, with little squeamishness about civilian casualties.

The few victories against ISIS–Kobane, Sinjar, and Ramadi–demonstrate the same point, as does the ineffectualness of the “allied” air attacks against ISIS in Syria and Iraq generally, because these attacks are not mounted in support of a coherent ground attack undertaken by an even moderately effective infantry and armor force.

The Syrian-Russian success also provides an interesting contrast to the Saudi fiasco in Yemen. The Saudis have bombed ruthlessly, with little military effect, because the bombing is not coupled with a credible ground campaign against the Houthis. This no doubt reflects the Saudi’s knowledge of the severe limitations of their ground forces.

These limitations made me laugh at the Saudi offer to deploy troops to fight ISIS in Iraq and Syria. Even overlooking the logistical impracticality of this, the Saudis would be setting themselves up for an embarrassing failure.

The Russians and Syrians actually intensified their offensive in the lead-up to the farcical “peace” talks in Geneva. No surprises here. They are in this to win decisively, not to negotiate a compromise. And there is no better way to send that message than by victory on the battlefield on the cusp of talks.

This has left the US and Europeans and Gulf Arabs sputtering in ineffectual rage. John Kerry was particularly embarrassing (nothing new here!):

“Hospitals have been hit, civilian quarters have been hit, and in some cases, after the bombing has taken place, when the workers have gone in to try to pull out the wounded, the bombers come back and they kill the people who are pulling out the wounded,” Kerry told reporters in Washington. “This has to stop. Nobody has any question about that. But it’s not going to stop just by whining about it.”

But what else is he (or anyone else) doing about it other than whine? Nothing. It would have been better for Kerry to remain silent, rather than advertise his (and The US’s) impotence.

It is also interesting to note that Kerry is damning the Russians and Syrians for bombing civilians, yet is utterly silent on the equally bad (if not worse) Saudi air campaign in Yemen.

In response to the Aleppo debacle, Turkey has closed its border with Syria. Erdogan is no doubt attempting to create (exacerbate, really) a humanitarian crisis in order to goad the US and Europe into intervening. It will never happen. The Europeans lack both the will and the means. The US has the military capability, but not the will: whatever will existed at one time (which was minimal) disappeared when intervention meant a confrontation with the Russians.

So Putin will likely get a battlefield victory. But so what? He and his Syrian creature will conquer a depopulated and devastated country. This will have little impact on the strategic balance in the region, and virtually no impact on US interests. Yes, Erdogan’s imperial and sectarian ambitions will be thwarted. Saudi and Qatari sectarian supremism will be defeated. To the extent that the US is impacted, these are actually favorable developments.

Those in the West who fulminate over Putin’s success in Syria are ironically engaged in the vacuous zero-sum thinking that drives Putin. A Putin victory is not necessarily an American defeat.

But the zero-sum thinker Putin is probably gleeful at the shrieks of distress from Kerry, the head of the UN, the Europeans, and various anti-Russian elements in the Western media. It’s all music to his ears, and also quite useful to him domestically. Another irony, that: the more that Putin’s enemies in the West screech about what is happening in Syria, the more it helps him.

Putin’s victory may be hollow, though, and his glee short-lived. He initially attempted to utilize his intervention in Syria as a way of presenting Russia as an ally of the West in the war against ISIS in order to undermine the sanctions regime, and to bring Russia in from the diplomatic cold. However, his unabashedly pro-Assad campaign, his intensifying the offensive in the run-up to the Geneva talks, the resultant humanitarian and refugee crisis, and the minimal Russian targeting of ISIS will make it impossible for the Europeans to do anything that will appear to be rewarding him. Putin’s intervention, with its demonstration of the cynicism and pointlessness of American policy, and thereby make Obama look bad, will cause our petulant president to retaliate in his passive-aggressive way, but maintaining sanctions, and pressuring the Europeans to do the same.

Putin is overplaying his hand elsewhere in Europe as well. The Russian media and government histrionics over the “Lisa” fake rape case in Germany has deeply angered Merkel who is already under siege over the migrant crisis (and especially the sexual assault crisis that has followed in its wake). Further, Putin met with Bavarian governor Horst Seehofer, Merkel’s most strident critic on immigration.  This will also anger Angela.

Putin, of all people, should realize that if you strike at the king (or queen) you better strike to kill. If Merkel survives-which is likely-she will be ill-disposed to ease sanctions, especially since Putin is ratcheting up the conflict in Donbas as well. Long surviving politicians tend to have long memories as well.

In sum. Air power can be dominant when teamed with infantry and armor. Putin will likely win a tactical victory in Syria. But the victory will be strategically barren, and possibly counterproductive, because (a) the “winner” will inherit a blasted and dysfunctional battleground, and (b) this “victory” will set back Putin’s efforts to roll back sanctions.

If anyone “wins” out of this, it is Iran. The Iranians will maintain their pipeline to Hezbollah, and deal the Saudis a stinging defeat. So Putin will succeed as the mullahs’ muscle, and in the process he will gain the satisfaction of humiliating the US (which stupidly set itself up to be humiliated), but at the cost of perpetuating Russia’s economic isolation, which is exacting a terrible toll on a country already reeling from the collapse in oil prices. That is about as Pyrrhic a victory as one could imagine.

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February 2, 2016

Russian “Privatization”? Only If Putin Is Desperate Indeed

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 10:11 pm

Putin held a meeting with the CEOs of seven state-owned enterprises to discuss the sale of minority stakes in their companies (a move sometimes mischaracterized as “privatization”). Putin frankly admitted that the impetus for this discussion is Russia’s dire budgetary situation. Putin caused some confusion by saying the “new owners of privatized assets must have Russian jurisdiction,” leading some to conclude that he was ruling out foreign investment. Peskov clarified the next day, saying that Russia welcomed foreign investors, but “If the question is about a foreign investor, that’s one thing. If it’s about a Russian investor, it must not be another offshore scheme.”

I consider it likely that this initiative will be stillborn, at least insofar as sales of stakes to foreigners are concerned. Putin said that the sales must not take place at “knockdown prices.” Well, in the current environment, the prices (especially for Rosneft and VTB) are likely to be very low indeed.

This is especially so since foreign investors will demand a substantial discount to compensate for expropriation risk. Savvy investors with long memories will recall that Putin justified expropriating Shell’s Sakhalin II project by saying that the terms of the Sakhalin PSA were unfair to Russia, and that Shell had exploited Russia’s economic desperation when it signed the deal at a previous time of low energy prices. Putin (or whoever succeeds him) could easily resurrect such rhetoric in the future when oil prices rebound. Further, minority shareholders in Russian enterprises–especially state enterprises–have few protections against schemes that divert assets, or which dilute their holdings.

Given that prices are likely to be very low, if there are sales to foreigners, it will indicate (1) that Russia is desperate indeed, and (2) Putin et al consider it unlikely that sanctions will be relaxed anytime soon.

If there are sales, it is likely to be to Russian oligarchs, and in particular those with extensive holdings outside Russia. Just as Putin dragooned them into paying for Sochi and other prestige projects, he could well pressure them into overpaying for stakes in the state enterprises. This would allow him to kill two birds with one stone. It would help stanch the budgetary bleeding. It would also advance Putin’s longstanding goal of onshoring Russian capital. That would fit with the “owners must have Russian jurisdiction” remark.  And Putin has substantial leverage to get oligarchs to do his bidding–literally.

Even if partial sales take place, it will be merely a stopgap budgetary measure: it will not indicate a fundamental reconsideration of Russian economic policy.  Putin is still obviously a firm believer in the state control/state champion model, despite its manifest inefficiency. Putin prefers the control over resources that state control provides to having an efficient economy. Which is why he finds himself in his current straits.

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January 23, 2016

Russian Oil Hedging: A Little Late for Herpicide

Filed under: Commodities,Derivatives,Economics,Energy,Russia — The Professor @ 5:29 pm

My grandfather had a wealth of colorful expressions, most of which were the product of his Appalachian upbringing. One, however, was a little different. Whenever it was too late to do something about a particular problem, he’d say: “Well, it’s a little late for herpicide.” In context, I understood what he meant, but the exact meaning escaped me. I asked him one time, and it turns out that Herpicide was a (quack) hair loss cure in the ’30s or ’40s. The company’s add campaign pictured a cue ball-bald man with the caption: “A Little Late for Herpicide.” I guess now it would be “A Little Late for Rogaine.”

This expression came to mind when I read in the FT that “Russia considers hedging part of its oil revenues.” It would have been a good idea when the price was $100, or $90, or even $50. At $30 (or below, as happened on Wednesday and Thursday), well, it’s a little late for hedgicide. Yes, oil could indeed go lower, but hedging today would lock in prices that are low by historical levels.

Hedging would make sense for Russia, just as it does for a highly-leveraged corporate. It clearly incurs financial distress costs when prices are very low. Hedging would reduce the expected costs of financial distress.

Presumably Russia would implement a program like Mexico’s, buying large quantities of out-of-the-money puts. This would allow it to capture the upside but obtain protection on the downside. It would also avoid a problem that it might face if it sold swaps/forwards: finding a counterparty. Selling a put to Russia doesn’t involve counterparty risk. Buying swaps from them would. Although this would be a right-way risk, one could readily see Russia balking on performance if oil prices were to spike, putting a short swap position well out of the money. It would have the cash to pay: the willingness to pay, not so much. Further, although Russia’s ability to pay is closely related to oil prices, it is exposed to other risks that could impair that ability, and these risks would create credit risks for anyone buying swaps from Russia.

Buying puts does create an issue, though: this would require Russia paying a rather hefty premium upfront, at a time when it is cash-strapped. As an illustration of its financial straits, note that it is attempting to avoid having to come up with cash to stabilize troubled megabank VEB. Borrowing to pay the premium is also problematic, given its dicey creditworthiness. Russia’s CDS spread is around 370bp (which, although it has turned up as oil prices took their latest plunge, is still below post-Crimea levels, and even below the levels seen in August). Current sanctions and the prospect of the crystallization of future political risks may also make lenders reluctant to front Russia the premium money.

One interesting thing to consider is how hedging would affect Russia’s output decisions going forward. Hedging, whether by buying puts or selling swaps, would reduce its incentive to cut output in low price environments. As I’ve written before, Russia doesn’t have a strong incentive to cut output anyways because  market share, market demand elasticity, and the cost of shutting down production in Siberia make it a losing prospect (as its refusal to cut output in 2009 and in the past 18 months clearly indicate). However, whatever weak incentives Russia has to cut (in cooperation with the Saudis for instance) would be even weaker if it was hedged. If cooperation on output between OPEC and Russia has proved hard up to now, it would be harder still if Russia was hedged.

A Russian hedging program, if big enough, could affect market pricing, but not the price of oil (at least not directly*): hedging is a transfer of risk, and a big Russian hedge would affect the price of oil risks. Its hedging pressure would tend to increase market risk premia (i.e., reduce forward prices relative to expected spot prices). If done using puts, it would also tend to steepen the put-wing volatility skew and increase volatility risk premium. Adding its hedging pressure to the market would also necessitate the entry of additional speculative capital into the market in order to mitigate these effects. Sechin has criticized speculators in the past: hedging Russian oil price risk would be prohibitively expensive without them.

Although Russia has mooted the possibility, I doubt it will follow through. I would imagine that the combination of the cash cost of options and criticism within the ruling clique of locking in low prices will cause them to pass. If and when oil prices rise substantially, I predict they will forego hedging because they will convince themselves that prices won’t fall again, just as they did post-2009.

In sum, this sounds like an idea that the technocrats have advanced that will die at the hands of the siloviki, like various privatization initiatives.

* The spot price of oil depends on output and demand. Hedging affects spot prices to the extent that it affects output. One way that could happen is that if it reduced Russia’s incentive to cut output. Another way it could happen is that hedging increases Russia’s capacity to finance investments in oil production by reducing capital costs. In this case, investment would be higher and output would be higher.

In each of these scenarios hedging reduces spot oil prices in some states of the world, not because of the direct effects of forward selling, but because the hedging provides incentives to increase output. This is a good thing.

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January 7, 2016

Be Ready For Praying Mantis II: Other Than That, Stay the Hell Out

Filed under: History,Military,Politics,Russia — The Professor @ 9:35 pm

There is no good guy and no bad guy in the conflict between Iran and Saudi Arabia (and its GCC allies). In its essentials, it is a struggle for regional dominance between two benighted and malign powers.

The theater of the conflict is Iraq and Syria. Iran has some advantages, most notably, it is allied with the government of Syria (now supported by Russia), and for sectarian and geographical reasons has advantages in Iraq. In Syria, Saudi Arabia and its allies must resort to funding and arming the opposition. Its options in Iraq are more limited, but it is likely objectively pro-ISIS.

Neither Iran nor Saudi Arabia can pose a conventional military threat to the other. Iran’s air force is a collection of museum pieces (F-4s, F-14s and F-5s!) seized from the Shah and kept together with bubble gum an duct tape, and some Russian aircraft gifted to them by a desperate Saddam 25 years ago. Iran’s ground forces have no power projection capability. Its units have struggled in Syria and Iraq, and were noted during the Iran-Iraq war mainly for their ability to absorb appalling casualties. Iran’s navy also lacks any power projection capability. Logistics would also render impossible any Iranian attack on KSA.

Saudi Arabia has a very well-equipped air force, with 70 F-15E strike aircraft, 86 F-15C and D air superiority fighters, 72 Eurofighter Typhoon multirole aircraft, and 80 Tornado ground attack planes. This is more than adequate to defend KSA against anything that Iran could throw against it on air, sea, and land. But KSA’s ground forces are, like most Arab armies, woefully ineffective, and mainly intended for regime protection. The Saudis are bogged down in neighboring Yemen, and could not hope to project any force into Iraq, let alone Iran.

Even if Iran develops a nuclear weapon, it will have little effect on the balance of power. The Saudis will almost certainly obtain one as well, and a nuclear weapon is more of a regime protection weapon than an instrument of power projection.

Iran’s main weapon is subversion, but this is difficult to employ against a police state like KSA. Indeed, the execution of Nimr Nimr that precipitated the latest crisis was no doubt a signal to Iran that the Saudis were willing to use extreme measures to crush any uprising in the Shia population in the eastern provinces. Also look at the brutal crackdown in Bahrain to see how the KSA and its allies deal with Iran-fomented Shia internal dissent.

So there will be an intensified shadow war between KSA and Iran, fought mainly in Syria and Iraq. Things have intensified now because the Iran deal and the Russian intervention in Syria disturbed the previous equilibrium in the region: this was one of the main reasons the Iran deal, and the administration’s subsequently fecklessness in responding to Iranian provocations, was so ill-advised. The most likely outcome is an intensified struggle resulting in a renewed stalemate.

In terms of oil, the most likely outcome is that the Saudis will figure that Iran suffers from lower oil prices more than they do, so they will not cut output. The Iranians have every incentive to produce as much as they can.

There are loud calls from some quarters that we intervene on behalf of our Saudi “allies.” With allies like this, we need no enemies, given lavish Saudi support for Islamism (and terrorist groups) around the world: indeed, I consider the Iranians’ in-your-face chants of “Death to America” more palatable than the Saudis’ two-faced duplicity. The relationship between the US and KSA is transactional, at best, and is unfortunately suborned by Saudi money which greases far too many palms in DC and Europe.

Stalemate is probably a good outcome from the US perspective. Getting in the middle means we will get it from both sides.

Our main interest is continued flow of oil through the Persian/Arab Gulf. A policy similar to that adopted by the Reagan Administration during the Iran-Iraq War, which largely took a hands-off approach to the conflict on the ground, and focused on assuring the free navigation of the Gulf, is a prudent one. If either side tries to escalate by attacking shipping or laying mines, like during the Tanker War, the US can intervene and smack them down as it did in Operation Praying Mantis.

We have no interest in a civilizational and sectarian war, and probably couldn’t intervene effectively even if we decided to. Neither country is capable of achieving a decisive victory over the other. The main stakes are who gets to rule (albeit indirectly) over a ruined Syria and a dysfunctional Iraq. So limit our involvement to keeping the oil flowing and deterring and preventing terrorist spillover. And definitely don’t take the side of Wahhabi freaks, or think that they are allies worthy of the name.

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January 2, 2016

Fools Rush in Where Angels Fear to Tread: Avoiding the Islamic Civil War Is Prudence, Not Isolationism

Filed under: History,Politics,Russia — The Professor @ 7:43 pm

The combination dumpster fire, shit show, and clusterfuck AKA the Middle East got even more disastrous today when the Saudis beheaded a prominent Shia cleric (along with 46 Sunni radicals). The reaction from Iran was immediate: the Saudi embassy was sacked by outraged Shia.

And the reaction from certain quarters in the US was almost as swift: the usual (neocon) suspects in the US (e.g., Max Boot) immediately swung into action, shrieking loudly about the Iranian violation of the sanctity of the Saudi embassy (I wonder what really goes on there, besides, you know, slavery and stuff) but saying nary a word about the morals or justice or reasonableness of going medieval on Nimr al Nimr.

It is beyond bizarre that certain quarters of the right are so obsessed with Iran that they are willing to go all in with the Saudis and the other oil ticks of the GCC. How can they be blind to the facts that (a) the most direct terrorist threats that we face are all Sunni, and specifically Wahhabi-influenced, (b) these threats receive material and ideological support from Saudi Arabia, and (c) the Saudis have spent billions propagating their hateful creed, including supporting the very mosques in the US and Europe where terrorists are radicalized and recruit?

I stipulate that Iran under the Mullahs is dangerous. I further stipulate that Assad is evil. I further stipulate that Putin is a malign force.

It does not follow, however, that their enemies–the Wahhabi Sunni extremists–are good guys, or that following the enemy-of-my-enemy strategy is even remotely wise.

This is particularly true in the case of Syria, which is a proxy war between the Saudis and the other oil ticks (and the Sunni Turks) and the Iranians. Opposing Assad means throwing in on the side of the very same types of jihadis that are trying to kill us in Paris, Brussels, and San Bernardino. Empowering them today is a recipe for disaster tomorrow.

Just how far the anti-Iran cabal is willing to go is illustrated by their deification of Zarhan Alloush, whose extreme Sunni-sectarian background (he openly advocated a genocide of the Alawites in Syria) has been whitewashed in order to transform him into some martyred potential interlocutor of peace.

Insane.

There is a civil war in Islam. Indeed, there are multiple civil wars. Sunni vs. Shia. But even within the Islamist Sunni “community” there are deep divisions and vicious, brutal fights.

Intervening in a civil war, especially one between extreme sectarians with mindsets completely alien to our own–and indeed, actively hostile to our own–is a recipe for disaster.

But those who counsel staying out–such as Ted Cruz–are pilloried as “isolationists.” Rushing in where angels fear to tread is not isolationism. It’s prudence.

Cruz in fact was-and is-an ardent foe of the Iran deal. So he’s not dew-eyed about the mullahs, or an isolationist. But he’s smart enough to realize that you have to pick your battles, and even if you don’t like Iran (which he doesn’t), that doesn’t mean you have to fight their proxy in Syria.

Indeed, one of the reasons that the Iran deal was a disaster was precisely that it stoked the conflict between Iran and the Saudis. This was predictable, and predicted: well over a year ago I argued that one of the reasons the deal was a bad idea is that it would intensify the conflict in the Gulf specifically, and the Muslim civil war generally, because the Saudis would feel the need to take matters into their own hands and fight Iran before Iran became too strong. We are seeing that happen right before our eyes.

What’s particularly maddening about the interventionist crowd is that they have no specific strategy. This is epitomized by this Garry Kasparov article. Kasparov waxes eloquent about American exceptionalism, and our need to do something:

But the Iraq War was a rebuke to bad planning and lousy implementation, not a refutation of the idea that America can be an essential force for good in the world. America must do better, not do nothing.

OK. I’ll stipulate that doing nothing is not good. But it’s a long way from saying “do something!” to specifying just what that something is, and showing that it will make things better, not worse. After all, in this very paragraph Kasparov admits that we are capable of “bad planning and lousy implementation”: what’s to say we won’t have a repeat? Vacuous generalities about spreading democracy and freedom are exactly what gets us into trouble.

It is particularly irritating that Kasparov invokes Reagan’s name (as many neocons do, though he didn’t care for them, and the feeling was quite mutual). Reagan indeed engaged in soaring rhetoric about freedom and democracy. But he had a concrete strategy that he developed over years and implemented methodically when in office. The new interventionists have the rhetoric. The strategy, not so much.

Further, the situation Reagan faced–a Cold War with a military peer and ideological rival–is completely different than the one we currently face in the Middle East. There are no one size fits all solutions, and anyone who claims to know how Reagan would respond to these completely different circumstances is just full of it. That’s unknown and unknowable.

Perhaps as a chess player, Kasparov is used to there being  black pieces, and white pieces. But in the Middle East, there is no such clean divide. It is just different shades of anti-western and anti-modern sectarians looking to extirpate their enemies–who include us, by the way. Democracy and freedom are on no one’s agenda there, and we shouldn’t pretend otherwise. We made that mistake in Iraq: why repeat it again.

I am not a huge fan of Kissinger, James Baker, and Brent Scowcroft, but on these issues they have a more measured understanding of the realities. They recognize the importance of idealistic goals, but temper that with a recognition that realistic means are needed to achieve them.

Scowcroft:

Scowcroft does not believe that the promotion of American-style democracy abroad is a sufficiently good reason to use force. “I thought we ought to make it our duty to help make the world friendlier for the growth of liberal regimes,” he said. “You encourage democracy over time, with assistance, and aid, the traditional way. Not how the neocons do it.”

(The whole piece is worth reading.)

Kissinger and Baker:

Like most Americans, we believe that the United States should always support democracy and human rights politically, economically and diplomatically, just as we championed freedom for the captive peoples of the Soviet empire during the Cold War. Our values impel us to alleviate human suffering. But as a general principle, our country should do so militarily only when a national interest is also at stake. Such an approach could properly be labeled “pragmatic idealism.”

. . .

Sixth, and most important, the United States must develop a firm and differentiated understanding of its vital national interests. Not every upheaval in the region has the same origin or remedy. The Arab Spring has the potential to become a great opportunity for the people of the region and the world. Over time, fostering democracy may provide an alternative to Islamic extremism; it may also, in the short term, empower some of its supporters. We need to develop a realistic concept of what is achievable and in what time frame.

The last point is a jab at the End of History strain of neoconservatism, which is universalist and believes that everyone wants to be like us, and that the world is inevitably destined to be like us, as the result of some progressive, Hegelian process.

No and no.

Insofar as Syria in particular is concerned. Our national interest there is limited, and the cost of doing anything is prohibitive. Putin’s intervention there is not a bug, but a feature: if he is a fool who rushes in, we should take grim satisfaction, not engage in hysterical reactions like Kasparov (and Max Boot and Michael Weiss). (Relatedly, Boot slandered Cruz, tweeting that he has affection for Assad. This is scurrilous: not wanting to fight him does not imply affection, especially since those whom Assad is fighting are Islamic extremists.)

In sum, the isolationism charge is a canard when hurled at people who don’t want to get deeper into Syria, and who don’t want to take sides between medieval combatants in a sectarian civil war. Saying that the Iranians are bad is not sufficient to justify intervening on the side of their Wahhabi foes–who are just as bad, and are in fact more directly involved in attacking the US and the West than are the Iranians.

To paraphrase Kissinger again (specifically, his remarks about the Iran-Iraq War): we should hope that they both lose. In the meantime, we should look for ways of shielding ourself from the fallout. Jumping into the fray is not the way to do that.

 

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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.

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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.

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December 16, 2015

Russia’s Shambolic Logistics in Syria

Filed under: Military,Politics,Russia — The Professor @ 9:39 am

In responding to Micheal Weiss’s idiotic hyperventilating (but I repeat myself) about Russian intervention in Syria, I quoted the old adage: Amateurs talk tactics, professionals talk logistics.  I noted that logistics severely constrained Russia’s military capacity in Russia. Look no further than this for evidence of how shambolic Russia’s logistics are:

Earlier this year, an old refrigerator ship called the Georgiy Agafonov, built to transport fruit and vegetables for the Soviet Union, was quietly gathering rust in the Ukrainian port of Izmail where the Danube flows into the Black Sea.

Its owners, a Ukrainian state company, assumed it would never sail again. When a Turkish company offered to buy it for $300,000, they watched as the hulk was towed away, presumably for scrap.

Nine months later the ship is back at sea, renamed Kazan-60, reflagged as part of Russia’s naval auxiliary fleet, and repurposed as an unlikely part of Moscow’s biggest military operation outside the old Soviet boundaries since the Cold War.

. . . .

The need for the extra cargo ships arose because Russia’s warships did not by themselves have enough capacity to supply the mission, said Vasily Kashin, senior research fellow at the Moscow-based Centre for Analysis of Strategies and Technologies.

“Before we had to use amphibious landing ships to carry supplies to Syria. But now they are not sufficient and we are creating a new class of military transports which are part of the navy but in fact are pure cargo ships,” he said.

An icebreaker called the Yauza was also sent to the Mediterranean from the Arctic to beef up Moscow’s logistics. According to publicly available shipping data, it made two trips to Syria in October and November.

Buying old cargo ships gives Moscow more control than contracting out its transport to commercial carriers, said Gerry Northwood, chief operations officer with British maritime security firm MAST.

 

Russia has utilized some flashy weaponry–such as surface and submarine launched cruise missiles–in its Syria campaign. But this is military Potemkinism, a dazzling facade that distracts from the shabby and creaking structure beneath. Especially now, with rumblings about Turkey closing the Bosporus to Russia, those freaking out about Russia’s involvement in Syria need to look beneath the facade, and understand how the realities of logistics, which have doomed far more campaigns than anything that has transpired on battlefields, fundamentally limit what Russia can even hope to achieve.

 

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November 29, 2015

Erdogan Actually Does What Putin’s Enemies Implausibly Accuse Him of Doing: Exploiting the Syrian Refugee Crisis

Filed under: History,Military,Politics,Russia — The Professor @ 7:56 pm

One theme pushed very hard by Putin oppositions, including people like Garry Kasparov and numerous Ukrainian bloggers and tweeters, is that Putin is deliberately creating the refugee crisis in the EU. There is no doubt that he is benefitting, but there is no evidence that he is doing anything to create it. He gets it without having to lift a finger.

The refugee crisis is indeed creating huge political stresses in the EU that are benefiting rightist opposition parties (e.g., the National Front in France) that are sympathetic to (and in some cases, partially funded by) Russia. This redounds to Putin’s benefit, but he didn’t create the problem. The problem is largely due to the Syrian civil war, but not completely: only about one-half of the migrants swarming into Europe are Syrian. The other major contributor is European policy, notably Merkel’s grandiose humanitarian gesture, which served to open the flood gates.

No doubt Putin is pleased, but I cannot identify anything that he has done, that he wouldn’t have done anyways: for him, the refugee fallout is a happy unintended consequence. He has been all in for the Syrian government from the get go, and has supported its ruthless campaign. This has contributed to the refugee flow, but Putin would have done the same regardless.

One country that has definitely leveraged the refugee issue to its advantage is Turkey. Today, with great fanfare, Turkey and the EU announced a grand bargain whereby the EU would pay Turkey €3 billion, grant it visa free travel, and reopen Turkish accession talks. The €3 billion is to be used to improve conditions for Syrian refugees in Turkey. In return, Turkey will slow the flow of refugees to Europe.

In other words, Erdogan successfully blackmailed Europe. Unlike Putin, Erdogan can exercise considerable control over the flow of Syrians to Europe. He has basically exercised no control heretofore, and Europe has been overwhelmed. They have now agreed to pay Turkey to keep them, and also given Turkey other very important concessions to make it worth Erdo’s while.

This is bad news for Putin. Putin has been trying to leverage his role in Syria to get concessions from Europe on other issues, but as I have written before, he really doesn’t have that much leverage. Erdogan has leverage, and has just demonstrated that he can and will use it. He can also use it to make the Europeans think twice about making any concessions to Putin that would compromise Turkish interests in Syria. And since Turkish interests and Russian interests are close to zero sum there, this means that he wins, and Putin loses when he uses that leverage. Erdogan has therefore proved to Putin who has the whip hand in dealing with the Euroweenies.

When it comes to Syria, Erdogan’s policy is deeply problematic, to put it mildly. His policy towards ISIS can most charitably be described as ambivalent. He is certainly not an ardent foe, and is arguably an enabler–or worse. He is far more interested in crushing the Kurds, who happen to be the most reliable anti-ISIS force in the region. In that respect, Erdogan is objectively pro-ISIS. There is a colorable case that he is subjectively pro-ISIS as well. Furthermore, Turkey has been the main supporter of the Islamist forces–including al Qaeda-forces–fighting Assad. Once upon a time, supporting groups like this would have earned a star turn in the Axis of Evil.

Domestically, Erdogan is doing his best Putin imitation of crushing domestic opposition, including the arrest of journalists. Some antigovernment figures have been murdered (e.g., the Kurdish lawyer killed over the weekend), another similarity to Russia.

Thus, there is little to choose from between Erdogan and Putin in Syria. Indeed, as bad as Assad is, the Islamists fighting him are worse, so the nod goes to Putin here.

Unfortunately, the Kasparovs and Ukrainians who are so obsessed with Putin are completely in the grips of the enemy-of-my-enemy mindset that they are going all in for Erdogan and the Islamists for Syria. They are fighting Putin, so they must be great, right?

Wrong. They are dangerous and despicable, and Erdogan does a pretty good Putin doppelgänger impression.

It is possible to oppose Putin and Russia in Ukraine and elsewhere in Europe, without embracing his enemies in Syria. It is not only possible, it is necessary. Putin’s actions in Ukraine challenge the entire post-War order in Europe, and are deeply destabilizing. Indeed, they deeply challenge the Westphalian system that Putin and Russia claim to defend in Syria, Libya, the Balkans, and elsewhere, and constantly lecture the world about in the UN and elsewhere. So those actions should be opposed, and Europe and Nato in particular have to raise their games.

But that issue is completely separable from what is going on in Syria. And those whose hatred of Putin leads them to whitewash (and worse) Erdogan and the murderous Islamist anti-Assad forces in Syria are wrong as a matter of policy. This also deeply compromises their moral authority and undercuts their opposition to Putin in Russia and Ukraine.

Enemy-of-my-enemy logic almost always leads to a dead end, or worse. It prevents critical thinking, the ability to discriminate between threats, and between degrees of evil. All of that is particularly true in Syria, because siding with Putin’s enemies means siding with murderous Islamists, and a megalomaniacal would be emperor who is actually doing what Putin is only accused (rather implausibly) of doing: exploiting the refugee crisis in Syria in order to obtain political benefits from Europe.

 

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