Streetwise Professor

January 30, 2009

NOFX

Filed under: Commodities,Derivatives,Economics,Energy,Politics,Russia — The Professor @ 6:11 pm

No, this isn’t a review of a punk rock CD: It’s the latest installment in an ongoing series on the ruble’s gyrations in the foreign exchange (“FX”) market, and the title is a commentary on what is becoming a more likely outcome by the day.

Well, gyrations is not quite the right word; it connotes movement in all directions, but the ruble has been moving only one way–down.  Today (per MICEX), the ruble closed at 35.4886, about a 1.8 percent move.  Although the currency gained a bit on the Euro (which was down against the dollar), it is approaching the 41 rubles vs. the basket that central bank head Sergei Ignatiev has pledged to defend unless Urals crude plunges to $30 and remains there for an extended period.  Speculators are taking this as a challenge, it appears.  

The behavior of the ruble in the days since the band was widened to 10 percent suggests to me that the government is spending FX to defend the band, even before it is reached.  The currency has been down several days in a row, and is on an extended losing streak since the widening of the band.  Absent intervention, you’d expect the number of losing days and gaining days to be about equal.  Runs of consecutive days with adverse moves can happen, but are relatively unlikely.   In contrast, if the central bank is trying to slow the fall in the currency, and is preventing it from reaching its equilibrium level on a single day, you’d see losses day after day–which is what’s going on.  

Moreover, I’ve looked at the intraday charts on MICEX this week.  Each day the currency has gapped lower (RUB/USD–higher USD/RUB) right at the open, and then hovered there, with at most a slight movement over the remainder of the day.  Again, this suggests that the central bank is effectively setting limit orders at progressively lower levels each day, and then maintaining that level within the day.  

All of this would burn through reserves.  

The central bank–and Putin–have put their credibility on the line.  They have said that 41 vs. the basket is the limit absent a collapse in the oil price.  The market is pushing there very hard.  The conditions for a speculative attack are clearly evident.  The government’s/bank’s credibility is on the line  How much will it spend to defend it?  If it tries, NOFX is a real possibility.

Indeed, other news provides further evidence that the condition is ripe for a speculative attack.  Kudrin stated that government revenues will likely fall 40 percent in 2009.  He states further that most–but not all–of the reserve fund will be spent to cover the budget shortfall.  Of course, if oil prices fall further (and the chronic economic weakness around the world makes that a very real possibility), all of the reserve funds will go down the chute.  It should also be noted that although Kudrin anticipates that the situation will turn around in 2010, government revenues usually lag economic recovery.  Therefore, even if the Russian economy–and the world economy–begins to turn around in late-2009 or early-2010, it is likely that revenues will remain weak well into 2010.  This means that even if some of the reserve fund survives 2009, it may be dissipated in 2010.

It’s of course better for Russia that it has such a cushion than not.  But, as I noted in several posts when the crisis began in the late-summer and early-fall, the existence of the currency stockpile and the reserve funds likely provided a false sense of security, and arguably led to a delayed response to the crisis.  I specifically noted that one thing the crisis proved is how quickly it is possible to blow through $600 billion, and that’s being proven right in the Russian instance.  

The weak government revenue picture is just more blood in the water that will attract yet more sharks to the ruble market.   Given the budget picture, it’s hard to see how the central bank can credibly defend the currency at the 41 level. Trying to do so will (a) waste–waste–the country’s currency reserves, because it will merely delay the inevitable, and (b) exacerbate the weakness in the real economy, particularly the manufacturing sector.  

So, push is coming to shove.  As the FX rate approaches the band, the speculators will test the government’s commitment to maintaining that band absent a further, severe erosion of fundamentals.  Flexing to defend the ruble will be very expensive, and arguably ruinously expensive.  The next week or two should be very interesting.  Although currency and capital controls have not been widely discussed, if the attack is as severe as I expect it to be, I wouldn’t be surprised to see such measures implemented.  

It is no picnic to be a policy maker anywhere in the world right now, but Russia has to be among the worst.  This could explain Putin’s rather bizarre behavior at Davos, where he alternated between giving lectures about the virtues of a free market (!) and delivering testy–nay, ferocious–responses to genuine (if naive) offers of assistance from Michael Dell.  

Putin has essentially placed a huge long bet on the ruble.  He has staked his credibility on avoiding a precipitous drop in the currency, cost what it will.  Like many traders on a losing streak, he is effectively doubling down by stating that the band will not be widened further.  Doubling down can work, but the odds are usually quite unfavorable.

Hence, the coming days could be quite significant, not just economically, but politically.  With Medvedev showing signs of independence, and the ruble battle reaching a climax, the long-anticipated tension–and perhaps rupture–in the diumvirate could be coming.

January 28, 2009

Fools and Drunkards

Filed under: Derivatives,Economics,Exchanges,Politics — The Professor @ 11:26 pm

I have always held Congress in low regard, but never so low as now.  Capitol Hill has become a veritable vortex of stupidity.  

Exhibit 1: The laughably mis-characterized “stimulus” bill, which will do nothing of the sort.  If a private business engaged in such blatant false advertising, the FTC would shut it down tomorrow.  This bill is nothing more than a Trojan Horse stuffed with every political boondoggle conceived over the last decade.

Exhibit 2: “A draft bill circulated in Congress that would change how over-the-counter derivatives are regulated might ban most trading in the $29 trillion credit-default swap market.”  The bill forces central clearing of CDSs.  As I’ve argued ad nauseum, this is a bad idea.  But that’s not the worst of it:

House of Representatives Agriculture Committee Chairman  Collin Peterson  of Minnesota unveiled an updated draft bill today that would prohibit credit-default swap trading unless investors owned the underlying bonds. The draft, distributed by e-mail by the committee staff in Washington, would also force U.S. trading in the$684 trillion  over-the-counter derivatives market to be processed by a clearinghouse.

This requirement that CDS traders “own the underlying bonds” would prevent the credit derivatives market from performing its vital risk transfer function.  Note to Congress, and to Rep. Peterson: Hedgers (who own the bonds) want to reduce their exposure to that risk.  They do so by buying protection FROM SOMEBODY THAT DOESN”T OWN THE BOND.  That is, the bond owner can’t hedge unless he can buy protection, almost always from somebody who doesn’t own the bond.  The CDS market effectively transfers risk from the current bondholder to a speculator.  This is a transaction between consenting adults that presumably makes both of them better off-or else they wouldn’t do the deal.   Put differently, if you want to permit bond holders to reduce their exposure to the risk of that bond’s default, you need to let somebody else increase that exposure.  

But this is apparently lost on Rep. Peterson, and the bill’s supporters.  They have apparently internalized the view that hedging is good but that speculation is bad.  But you can’t have hedging without speculation.  

This is especially true in the corporate debt market.  In commodities, you have natural long exposures (e.g., oil producers) and natural short exposures (e.g., airlines) who can hedge by trading with one another.  Speculators are necessary only to the extent that the hedging demands of the natural longs and natural shorts don’t match completely.  In corporate bonds, there is a lot of natural long exposure looking to hedge, but not a significant natural short exposure.  Hence, speculators–market participants willing to absorb exposure to default risk–are especially important.  

Some reporting I’ve seen about the bill talks about how its supporters denigrate “naked shorting” via the CDS market.  Sheesh, just when I’m glad to see Christopher Cox’s taillights fade to black, here are legislators parroting his moronic moralizing about perfectly legitimate–and essential–actions.  

Peterson is (as I recall) a former insurance commissioner in Minnesota.  Perhaps he would understand this analogy: his bill makes as much sense as one that would allow only firms that own high rise buildings to insure high rise buildings.  

This measure is exactly NOT what is needed in the market right now.  If anything, our shaky banking system needs better, more robust mechanisms to manage credit risks.  It definitely does not need the decapitation of the existing mechanism for managing these risks, as imperfect as that mechanism may be.  

I actually wonder why the bill even bothers to mandate creation of a clearinghouse.  The provision I’ve just discussed means that there won’t be any trades to clear.  So what’s the point of creating a clearinghouse?  

Who knows whether this absurd provision will actually become law.  Of course it will be distressing–and very costly to the market and to the economy–if it does.  But even if it doesn’t, it is bad enough that such a clearly idiotic proposal, predicated in a complete and willful misunderstanding of the role of derivatives markets, has made it this far.  It is a testament to a truly frightening combination of ignorance and arrogance that is rife in Congress.    So convinced of their own rectitude, and their own ability to control complex markets, they meddle ceaselessly in what they do not understand.  They are modern day sorcerer’s apprentices, who wreak havoc in the vain belief that they are doing good.  

I say again: I hope Bismarck was right when he said there is a special providence for fools, drunkards, small children, and the United States of America, for we have fools and drunkards (on power) governing America, and imposing crushing burdens on small children–and the children of today’s small children.

Neurosis

Filed under: Politics,Russia — The Professor @ 6:09 pm

This article from Nezavisimaya Gazeta, by Dmitriy Furman (courtesy JRL, no link) expresses something I’ve often thought.   Namely, the pronounced neurotic–and self-destructive–tendencies in how Russia relates to the world:

We do not have separation of powers or even a diarchy. We have highly hampered powers.

Another scandal has broken out in the European home. Everyone lives in tranquility in this home and everyone is friendly to some extent. Wailing can always be heard near the eastern entrance, however. Many people live on this side of the building, but when the shouts are heard, everyone knows it is not Ukraine bickering with Belarus, not Latvia fighting with Lithuania, and not even Armenia arguing with Azerbaijan (they were at war and they still “do not say hello to each other,” but they do not start any scandals either). It is Russia “getting up off its knees” and fighting with one of its neighbors.

We Rail Against the Social Order

This happens for a variety of reasons — because Estonia moved the Bronze Soldier, because we do not like Moldovan wine, because we support the separatists in Georgia, and certainly because of the prices of the gas we deliver and the transit fees for this gas. We are more or less accustomed to gas controversies, but this time the scandal acquired colossal dimensions, affected all of the people in the building, and is being discussed in every household.

The argument that these scandals are neurotic in nature and give Russia exactly what it does not want (the anger of its neighbors, who dream of being less dependent on it and having less to do with it in general, and the Western countries’ treatment of it as a “problem state,” with   which “something has to be done”) is self-evident.

The connection between this policy (if it can be described as such) and the evolution of our social order is also quite obvious. On the one hand, our order is the main cause of our isolation and the reason for the impossibility of our integration into the alliances of the developed democratic countries and for the danger of the expansion of these alliances. On the other, the disappearance of the opposition in our country and the total unanimity of our main media outlets are a sign of the atrophy of critical thinking, which can restrain neurotic impulses and correct behavior. All of this is understandable, but something else is less understandable: the reason that our conflicts with our neighbors acquired this unprecedented intensity after Putin left office as the president.

The self-defeating nature of this behavior seems pretty evident (though I am sure that certain enablers will deny this–you know who you are!   Put down the KoolAid!;-).   Russia has so many problems at home it doesn’t need to go (to the near) abroad chasing monsters–or inventing them.   But it does, even though it seldom turns out well.

Furman’s discussion of the atrophying of critical thinking in a political and media monoculture is particularly on point.   A vibrant, contentious, civil society and political system, as disorderly as they may appear, are essential checks on power, and the tendency of those in power to make mistakes.   Every system needs a feedback mechanism.     Societies that suppress this mechanism in the name of order may appear placid and stable, but they are very brittle, and more vulnerable to catastrophic error and collapse.

Those who obsessively strive for control inevitably lose control, and in a system run by such obsessives, self-destructive neuroses can run rampant.   This is not recommended for healthy social development.

January 27, 2009

Well Said

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 11:02 pm

Putin speaks the Davos urp-fest tomorrow, and has a lot to feel chastened about since his previous, boastful appearance–not that he will.  This quote hits the nail on the head, though:

“Putin will attempt to paint Russia as a willing player looking to deepen its integration into the global economy and eager to attract global investors,” said  James Beadle, chief investment strategist at Pilgrim Asset Management in Moscow. “Sadly, Russia has berated and abused many of its global partners, and now that the stakes have balanced, few will trust this new, benign rhetoric.”

Fool me once, shame on you.  Fool me twice, shame on me.  Anybody who buys what Putin is selling is a fool.  But very early on in the history of this blog, and many times since, I’ve expressed amazement at the credulity of western investors when it comes to Russia, and their belief that they’re special and will avoid becoming just another statistic.  We’ll see if Putin can succeed, yet again, playing Lucy with the football, with western investors reprising their role as Charlie Brown.  Beadle thinks not.  I’m not so sure.

That’s the Way to Encourage Foreign Investment!

Filed under: Commodities,Economics,Politics,Russia — The Professor @ 8:51 pm

The financial crisis has increased Russia’s need to tap foreign capital markets.  Not only do Russian companies need money, they often need foreign expertise.  Particularly in the aftermath of rough treatment of numerous foreign investors, this is hardly calculated to build confidence and encourage direct investment in the Russian economy:

Russia has the power to stop foreign companies developing “strategic” deposits, Natural Resources Minister  Yuri Trutnev  told Kinross Gold Corp. Chief Executive Officer  Tye Burt  in a meeting today, according to the ministry.

“This doesn’t mean the power will be exercised,” Trutnev said in a statement e-mailed by the ministry today.

The minister and Burt discussed the Canadian company’s plans to develop the Kupol gold field and a venture with OAO Polyus Gold to mine Siberia’s Nezhdaninskoye deposit, the statement said.

Russia last year passed a law that limits the holding of a foreign company in developments of Russia’s biggest deposits of oil, natural gas, gold and other minerals. Kupol, which is 75 percent owned by Kinross, is exempt from the legislation because it was acquired before the law came into effect.

Fields with more than 50 metric tons of gold are considered strategic and must be controlled by Russian companies.

“That doesn’t mean the power will be exercised.” Boy, that inspires confidence!  Where do I sign up?  Having the sword of Damocles hanging over one’s head adds a little frisson to the investment process, no?

And it’s not just foreign investors.  Arbitrary state action is also used to expropriate domestic firms:

Russian electricity producer Mosenergo (MSNG3.MM:  Quote,  Profile,  Research) is suspending plans to build four new turbines after regulators capped the price of power from recently-installed plant, a company spokesman said.

A company source said that at the tariff allowed by the regulator, it would take Mosenergo more than 20 years to see a return on an investment of some $2 billion.

Power-hungry corporations such as steel and oil firms buy capacity offered by utilies at auction. But they face intense cost pressure amid the global financial crisis and are lobbying hard for state watchdogs to rein in growing electricity costs.

At the most recent capacity auction in December, Mosenergo, which is controlled by gas export monopoly Gazprom (GAZP.MM:  Quote,  Profile,Research), offered the output from two existing state-of-the-art turbines.

The Mosenergo source said the industry watchdog capped prices at 370,000 roubles ($11,490) per megawatt for one proposed turbine and at 402,000 roubles per megawatt for the other.

The source spoke on condition of anonymity as the regulator does not make the prices public from power auctions.

“We think that our (initial) offers were capped. On average the price set for the new capacity is about a third lower than what we first offered. Aside from that, there was no clear methodology for making these adjustments,” Mosenergo spokesman Vitaly Koskovetsky told Reuters in seperate comments.

The firm’s investment committee has already approved the partial suspension of its spending plans, which must still be finalised by the board of directors at its next meeting.

The power sector’s regulator, known as the Market Council, insisted last August that Mosenergo lower its asking price at the first ever capacity auction. After days of negotiation, they agreed on a price cut of 20 percent on Mosenergo’s original offer. The watchdog at first demanded a 30 percent cut.

Near the top of the government’s economic agenda in recent months has been controlling inflation, which topped 13 percent last year.

Even though the power sector underwent sweeping free-market reforms in recent years, the Energy Ministry and the Market Council still reserve the right to cap power prices at the auctions if they deem them unjustified.  

Although the economic collapse has led to sharp drops in electricity consumption and prices,  going forward, Russia needs massive investment in its generating capacity.  Arbitrary, opaque actions such as those described above are hardly the way to encourage such investment.

And for those who would argue with my assertion that the Russian economy is collapsing, a couple of data points.  First, even the Russian government, which for months had been denying the possibility that the country could experience negative growth in 2009, now admits that the economy will contract in 2009.  (This sounds like another attempt to tell the truth slowly/boil the frog.)  Second, industrial output declined 13.2 percent in December, after a 10.3 percent fall in November, and Markit group projects that December 2008 GDP was below December 2007 GDP. Third, real wages and investment fell for the first time in 9 years in December, and unemployment rose by 500,000 (per official stats–so it’s likely worse than that).  

There’s an interesting quote in this last article:

Prime Minister Vladimir Putin has vowed there will be no repeat of 1998 and the latest polls show his ratings remain high in a financial crisis stretching back to September.  

What would de Custine say about that?  How about this:

The popularity of an autocrat appears to me as suspicious in Russia, as does the honesty of the men who in France preach absolute democracy in the name of liberty–both are murderous sophisms.  To destroy liberty while preaching liberality is assassination, for society lives by truth; to make tyranny patriarchal is assassination also.

More words to ponder.  

 

 

 

The Past as Prelude

Filed under: Economics,Russia — The Professor @ 8:17 pm

De Custine, 1839:

No one can leave Russia until he has forewarned all his creditors of his intention, that is to say, until he has announced his departure three times in the gazettes, at an interval of eight days between each publication.

This is strictly enforced, unless at least you pay the police to shorten the prescribed time, and even then, you must make the insertion once or twice.  No one can obtain post-horses without a document from the authorities, certifying that he owes nothing.

So much precaution shows the bad faith that exists in the country, for as, hitherto, the Russians have had little personal intercourse with foreigners, they must have taken lessons in wariness from themselves alone.  

Reuters, 2009:

Russian bailiffs have recovered millions of rubles in debt from delinquent borrowers by barring them from travelling abroad until they pay up.

Government bailiffs said they had signed orders for 82,000 foreign travel bans and recovered almost 800 million roubles ($24.25 million) from debtors — some of whom only found out when they arrived at the border with their bags packed.

“The scheme has been very effective, a phenomenal success,” Natalya Selivanova, a spokeswoman for the Federal Bailiff Service, said on Tuesday.

The foreign travel bans, introduced early last year, were issued only after several warnings and a court decision, Federal Bailiff Service Director Artur Parfenchikov said.

“If someone can’t keep up his payments on a $100,000 debt and then buys a package tour to Thailand … that’s not just illegal, it’s immoral,” he told a briefing in Moscow.

Russia has long been forced to use unusual measures to reclaim debts as its legal system often favours poorer borrowers over their lenders, said Richard Hainsworth, director of RusRating, a credit agency in Moscow.

Russian authorities have posted the names of people with unpaid bills on billboards in recent years to shame them into paying.

Fascinating, no?

January 26, 2009

CDS Follies

Filed under: Derivatives,Economics,Politics — The Professor @ 8:24 pm

The NYT reports that the Obama administration is planning to require central clearing of CDS products:

The administration is also preparing to require that  derivatives  like  credit default swaps, a type of insurance against loan defaults that were at the center of the financial meltdown last year, be traded through a central clearinghouse and possibly on one or more exchanges. That would make it significantly easier for regulators to supervise their use.

. . . .

Officials said some credit default swaps with unique characteristics negotiated between companies might not be able to trade on exchanges or through clearinghouses. But standardized or uniform ones could.

“We want to make sure that the standardized part of those markets move into a central clearinghouse and onto exchanges as quickly as possible,” Mr. Geithner testified. “I think that’s really important for the system. It will help reduce risk and the system as a whole.”

The new trading procedures for derivatives could also enable regulators to impose capital and collateral requirements on companies that issue credit default swaps that would make them safer investments.  American International Group, one of the largest issuer of such swaps, never had to post collateral and nearly collapsed as a result of issuing a huge volume of such instruments that it was unable to support.

I’m tired of writing about why mandatory clearing and/or mandatory exchange trading is a bad idea, and perhaps you’re tired of reading about it.   Suffice it to say that it is possible to improve transparency to regulators without creating a clearinghouse and the associated risk sharing mechanism that can actually exacerbate systemic risks.   Moreover, I have yet to see any serious consideration from regulators about the effects of concentrating risk in a single entity that almost certainly has less information that existing bilateral market participants.  Nor have they presented any serious comparative analysis of the costs and benefits of alternative default risk sharing mechanisms.  The analysis presented in public, including in Congressional testimony, does not even reach the level of superficial.  

For those who want a more detailed analysis supporting my position on the undesirability of forcing clearing, I suggest my piece in the most recent issue of Regulation.  I’ll link to my gruesomely long analysis when I have a chance to move the latest version into my webspace.    

I should also note that this is only one issue among many that makes me less than impressed with Geithner.  His comments on China were foolish.  His behavior on his taxes was no mistake, and cast serious doubts on his judgment.  

But, perhaps we’ll be lucky to escape with only mandatory clearing, rather than something more draconian.  Also in today’s NYT, Gretchen Morgenstern  Morgenson [HT John M] argues for far more onerous restrictions on the CDS market, perhaps including its outright elimination.

Morgenstern’s  Morgenson’s “argument” and “evidence” in support of this position are seriously lacking, to say the least.  She completely misses the point on the role of CDS market in particular, and the operation of risk sharing (i.e., insurance) markets in general.   Consider this example of her clueless prose:

Normally, if a company goes bankrupt, a trustee steps in and helps it get back on its feet. The process can be brutal for creditors, suppliers and employees. But the ill effects of a bankruptcy are magnified if billions of dollars in insurance must also be paid out by companies that wrote protection on a beleaguered company’s debt.

To observe how idiotic this is, consider the following rewrite:

 But the ill effects of a hurricane are magnified if billions of dollars in insurance must also be paid out by companies that wrote protection on a stricken city’s property.

Uhm, Gretchen, babe, think of how brutal the process of a bankruptcy would be for, say, “creditors” if NONE of them can insure against bankruptcy.   Do you think it’s just possible that some creditors are better off because they are able to insure against the event of a bankruptcy by buying protection through the CDS market?  

Sure, it sucks for the protection seller–or the company that insures houses against hurricanes–when it has to pay out.  But the whole idea behind this market, and the market for property insurance, is that it would suck a whole lot worse if creditors/property owners had no ability to protect against such adverse events.  It’s an ex ante mutually beneficial exchange of risks.  It’s beyond weird to criticize these instruments because they perform their risk transfer function in the way the parties agree.  

Morgenstern  Morgenson cites two supporters of heavy regulation of CDS markets,  Sylvain R. Raynes and  Christopher Whalen.  Whalen argues for 50 percent margins on CDS trades.  Just where does that number come from?  Any thought to the possibility that excessive collateralization can be unduly costly?  No evidence of any thought, whatsoever. Raynes wants to euthanize all outstanding CDS contracts, effectively unwinding them.  That is, he wants to require termination of outstanding insurance contracts that consenting adults entered.  So, how is this supposed to make them better off? Moreover, the existing counterparties have the ability to reverse deals, if it is in their mutual interest.  The fact they don’t do so, tells you something–or should.  But apparently not Mr. Raynes–or Ms. Morgenstern  Morgenson.

Here’s another pearl of (populist) wisdom:

Obviously, something must be done to eliminate the possibility that taxpayers will wind up paying off entities that essentially bet against the American economy.  

Betting against the American economy!  How unpatriotic!  

Note the “essentially” in that sentence.  She had to say that because those buying protection didn’t ACTUALLY do any such thing–they bought protection against a bankruptcy in order to preserve their wealth in such an event.  But to make it sound really bad, she has to demonize prudent financial strategies.  

There’s an argument as to whether the government should make counterparties whole, or let them receive only incomplete coverage because the protection seller can’t perform.  You can make that argument without stupid BS about “betting against the American economy.”  I mean, grow up.

Here’s another howler:

Mr. Raynes’s proposal would treat hedgers — buyers who bought C.D.S.’s to protect themselves because they actually hold the underlying debt — differently from speculators who bought C.D.S.’s simply to bet against a troubled company.

Some basic finance here, people–derivatives markets are markets to trade risk.  Usually they REQUIRE speculators to operate effectively; without speculators, who will take the risk from hedgers?  (Insurance companies are “speculating” on fires, hurricanes, and other bringers of human misery.  Want to get rid of them too?) This demonization of speculators, and proposals to treat them differently, is more populist boob bait; various proposals to regulate energy derivatives mooted over the summer contained similar inanities.  

Moreover, it will never work.  I defy anyone to find a way to separate hedging sheep from speculative goats that a couple of lawyers won’t be able to circumvent in about 10 minutes.

I’m all for a serious debate about CDS markets, and ways to improve their efficiency.  Unfortunately, a serious debate has yet to begin–at least on the pages of the New York Times.

Gasputin Speaks!

Filed under: Economics,Energy,Politics,Russia — The Professor @ 7:11 pm

And blames the United States for the just (maybe) completed battle of the Russo-Ukrainian gas war.  Putin’s remarks are a variant on Gazprom’s Aleksandr Medvedev’s, but represent a somewhat broader indictment.  Putin blames the US, and the Bush Administration in particular, for the political instability in the Ukraine which Putin argues that is the root cause of the War.  Putin also denigrates the US role in Georgia.

In a nutshell: Putin’s view is that the US (and its Sancho Panza, the EU) encouraged the Ukrainians and Georgians to get all uppity.  This, in turn led to a shooting war in the Caucusus, and a Gas War between Russia and Ukraine.  If the hot headed Georgians and the upstart Ukrainians would only remember their proper places, that corner of the world would be all sweetness and light.  For the Russians, anyways.  And presumably for the Europeans too, for why should they have to worry their pretty heads about where their gas is coming from, and whether the national aspirations of former imperial subjects are crushed to ensure the steady flow of that gas?

This is just another manifestation of the Russian elite worldview that refuses to acknowledge that the post-1991 settlement is in any ways final.  Indeed, they believe it to be an aberration; an affront to Russian dignity; and a geopolitical mistake to be reversed.  

Further illustration one: Putin’s remark to Bush that “Ukraine isn’t even a real country.”

Further illustration two: The ongoing efforts to delegitimize Ukrainian control over the Crimea.

Further illustration three: Russia’s outrage at Ukrainian insistence that they suffered uniquely under Soviet collectivization, and that the Ukrainian famine was genocide.  (Dmitri Medvedev made particularly dismissive remarks about this.)

The Russian case on the latter episode is that all of the USSR’s peasantry suffered from collectivization, and that Ukraine is without justification in claiming either greater suffering, or an ethnic component to Soviet policy (thus transforming a mere mass murder into a genocide analogous to the Holocaust, or the Armenian genocide.)

But there is considerable evidence that Ukrainians did suffer more, were the particular object of Stalin’s ire, and that the Ukrainian famine was genocidal.  In his authoritative Harvest of Sorrow, Robert Conquest writes:

Fifty years ago as I write these words, the Ukraine and the Ukrainian , Cossack, and other areas to its east . . . was like one vast Beslan.  A quarter of the rural population, men, women, and children, lay dead or dying. . . .  At the same time, (as at Belsen), well-fed squads of police or party officials supervised the victims.

. . . .

The events with which we deal may be summed up as follows: In 1929-1932 the Soviet Communist Party under Stalin’s leadership . . . struck a double blow at the peasantry of the USSR as a whole: dekulakization and collectivization. . . . These two measures resulted in millions of deaths–among the deportees in particular, but also among the undeported in certain areas such as Kazakhstan.

Then in 1932-1933 came what may be described as a terror-famine inflicted on the collectivized peasants of the Ukraine and the largely Ukrainian Kuban . . . . This action, even more destructive of life than those of 1929-1932 was accompanied by a wide-ranging attack on all Ukrainian cultural and intellectual centres and leaders, and on the Ukrainian churches.  The supposed contumanciousness of the Ukrainian peasants in not surrendering grain they did not have was explicitly blamed on nationalism: all of which was in accord with Stalin’s dictum that the national problem was in essence a peasant problem.  The Ukrainian peasant thus suffered in double guise, as a peasant and as a Ukrainian.

Thus there are two distinct, or partly distinct elements before us: The Party’s struggle with the peasantry, and the Party’s struggle with Ukrainian national feeling.

Conquest shows in telling–and heart-rending–detail how the Great Famine of 1932-1933 fits into the longstanding Muscovite ambition to extirpate the Ukrainian nation.

Putin is the heir to that policy.  No, he is not Stalinist in his choice of means, but he is Stalinist in his goals.  And he is a tsarist as well.  Like both (bizarrely in the Georgian Stalin’s case) he is a Great Russian imperialist, and he views the Gas War as just another episode in Russia’s campaign to submerge Ukraine in a Great Russian empire.

It is not all about gas and dollars.  It is not merely a commercial dispute.  Sure, money matters to these people.  But it’s not all that matters.  Indeed, it’s not likely the most important thing.  Putin wants to reverse the “greatest geopolitical tragedy of the 20th century” and the most important step in achieving that ambition is reabsorbing Ukraine, either de jure or de facto.  

It is essential, therefore, to put the gas war in its broader historical context.  Putin certainly does.  As for the Pomo Europeans, that’s doubtful in the extreme.  Certain elements of the Bush administration did–and that’s why it earned Putin’s particular ire.  (He probably thinks–I gave you free rein in Afghanistan, the quid pro quo was I get free rein in the Near Abroad, and you welshed.)  

As for the Obama administration, the jury is still out.  Putin’s remarks about Obama are clearly a signal.  Putin’s “hopes” for Obama can be translated as “we have hope that you will see things our way; that you understand the natural order of things; and will sacrifice Ukraine and others in the sake of restoring that natural order.”  It is also another effort at divide and conquer, suggesting to the Europeans that American intransigence and unrealism is why their cozy warm homes are at risk, thereby hoping to spark European pressure on a presumably pliable Obama to throw Ukraine under the bus.  (A very likely possibility, as it is very crowded under Obama’s bus, cf. Jeremiah Wright, Bill Richardson, Susan Power, etc., etc., etc.)    

In short, the Gas War is just the surface of things.  Under the surface one finds the true dynamic–Russian imperial ambition resisted by a nation struggling to realize an independence long denied, but doing so under a confused, divided, and corrupt leadership.

And that’s just one reason why this is far from over.  This is a real global test, one in which there is an acute imbalance between the test givers (Russia) and the test takers (US & EU) on such dimensions as importance, scruple, and will.  Whether Russian advantages on these dimensions are sufficient to overcome that nation’s fundamental strategic and economic weakness, and its propensity to over-reach and self-destruct, remain to be seen.

January 24, 2009

Hey, Big Spender

Filed under: Economics,Politics — The Professor @ 9:37 pm

When I was an undergrad, and in my first year of grad school, my goal was to become a macroeconomist.  I took Bob Lucas’s grad macro sequence as a senior at UC, and was excited by the subject.  But while in grad school, I became disenchanted with macro.  For one thing–and I will expand on this below–I found the focus on aggregates misleading.  As a result, I switched into a microeconomics/industrial organization concentration, and haven’t really kept up with the macro literature in any serious way (except insofar as to see seminars time to time where macro issues crop up in finance.)

Therefore, the opinions I am about to offer about the proposed stimulus package are not those of a professional macroeconomist.  However, hopefully they will be somewhat useful, in that my skepticism about a good deal of macroeconomics arises from what I perceive to be tenuous–at best–microeconomic foundations.  By pointing those out, and raising some other questions that have not been answered adequately (in my mind, anyways) by stimulus advocates, perhaps I can make my readers more critical consumers of stimulus news and advocacy.

My basic objections to the stimulus fall under several heads.

Beware Offers of Free Lunches.  The multiplier effects that are the basis for pro-stimulus arguments always seemed arbitrary and ungrounded to me, the macroeconomics version of perpetual motion machines.  They sound like free lunches.  

Robert Barro argued that multipliers are less than one, and has caught grief from the pro-government spending crowd.  One of their objections is that Barro used WWII spending as his main measure of the effect of spending on GNP.  ”But Wait!” the stimulus gang has shouted–multipliers are likely to exhibit diminishing returns, and the WWII stimulus was huge (about $5 trillion in 2009 dollars), so it does not tell us the average or marginal effect of a $1 trillion stimulus.

But that seems to raise other difficulties.  First, what is the basis for the claim that there is diminishing returns to government spending?  Since the multiplier models are on such shaky theoretical footings, how can one be so sure?  This claim seems to rest merely on the common sense notion that everything is subject to diminishing returns.

Second, there is a potentially more damning empirical issue.  If multipliers are subject to diminishing returns, and are on the order of 1.5 (according to Romer) for the huge stimulus Obama has proposed, normal variations in government spending should show up in the data as having big, measurable effects on the variation in consumption and aggregate income.  But it’s my understanding that this isn’t the case.  So, by attempting to shield our eyes from the lessons of WWII, the pro-spending folks merely draw attention to the lack of robust empirical support for the multipliers.  

It seems that the pro-stimulus folks are playing Goldilocks.  WWII stimulus was TOO BIG.  Variations in government spending in most times DON’T OCCUR WHEN THERE ARE SUFFICIENT IDLE RESOURCES.  But it just so happens that the Obama Stimulus is JUST RIGHT–just big enough to avoid diminishing returns, and implemented when there are just the right amount of idle resources.  I wouldn’t be so sure ’bout dat.

Also, I wonder whether costs and benefits are actually being computed properly.  Government spending on infrastructure, for instance, is essentially computed as the total expenditure on inputs used on the infrastructure projects.  That’s not how the value of output is calculated for other goods and services.  That value depends on the price which the seller receives for the output when it is sold on the market.  No market for infrastructure, so no market estimate of its value.  Bridges to nowhere are valued at cost.  This makes the accountants happy, but it is economically idiotic.  

Also, most calculations of the benefits of a stimulus that I’ve seen assume that the opportunity cost of idle resources is zero.  Leisure is valuable, so it’s worth more than zero.

Perhaps most importantly, the fiscal spending will be determined by political means, reflecting political considerations and the lobbying power of different interests, rather than by market means which guide resources to their highest value use.   Again, when you don your green eyeshades, it may look like income has gone up when the government spends more, but that could well be an accounting mirage based on equating value and cost.  Bridges to nowhere, or more holes, or broadband rolled out to people who don’t have it and aren’t willing to pay for it, are almost certainly worth less than cost.  Businesses that spend resources to make investments that turn out unprofitable report losses.  With its bizarre accounting, the government doesn’t do this.

Relatedly, How Will the Stimulus Be Paid For?  The stimulus can be paid for either by printing money, or through taxes on the Fram Filter Plan–you can pay now, or you can pay later.  (Paying later means that the spending is financed by debt.)  The first method is a tax too–on holdings of money balances.  

The pesky detail of paying for a dramatic increase in government spending creates serious doubts that this spending will indeed stimulate.

The first source of my doubts is Ricardian equivalence.  If consumption is driven by wealth (including the discounted stream of income flowing to labor and human capital), an increase in government spending will not increase current consumption as individuals will realize that their current income has increased, but their future income has decreased due to the increased future tax burden.  So, they will save, rather than consume, the increase in current income so as to be able to pay their future tax burden.

Now, there is some debate about whether there is full Ricardian equivalence.  Probably not, so current households may perceive that their wealth has risen, and hence consume more.  But that isn’t necessarily good news when one considers why Ricardian equivalence may fail.  One reason that current households (those making decisions today) may ignore future generations.  If not completely altruistic towards their progeny, those currently living (or those currently making decisions) will gladly consume more today at the expense of the consumption of future generations.

That’s good news?  Seems like a market failure to me.  

Similarly, those who receive an income windfall today may figure that others will bear the tax burden. That is, to the extent that the stimulus has distributive impacts, if those who pay and those who don’t have different marginal propensities to consume, consumption may increase.  But again, is a good thing? In particular, it means that saving goes down.  And the welfare implications of this redistribution are not obvious.  Even if aggregate consumption goes up, the spending and taxation policy may not be Pareto improving because there is no Mr. and Mrs. Aggregate.  There are numerous individuals, some of whom are likely to be hurt by the stimulus policy.  

This all bears on the spenders’ common retort to suggestions that it would be better to merely distribute cash to individuals (by reducing taxes, for instance) and let them choose what to do with it rather than have the government direct the spending: “They’ll just save it.”  Uhm, maybe that’s because individuals are Ricardians, who realize that the “windfall” is not really a windfall–it’s just a loan that has to be paid back with higher taxes in the future.   (Analogy–if the IRS sends you a check by mistake, would you spend it?)  I don’t see how to square a belief in multipliers (which seems to presume that people are not Ricardians) with a belief that direct payments to individuals will not lead them to increase consumption (which suggests that they are.)  

Another issue is the deadweight effects of any tax policy.  As I recall, a good deal of the literature assumes non-distorting lump sum taxation–taxation that exists only on blackboards and academic journals.  Here on earth, all taxes distort.  This creates deadweight losses, which may be very large indeed.  (Martin Feldstein has presented evidence that income taxes create very large deadweight losses.)

What a Fine Mess You’ve Gotten Us Into, Ollie–And You Plan to Get Us Out the Same Way?    One theory of the current economic mess is that individuals consumed too much, bought too much housing, all financed by too much debt.  So we’re supposed to fix this by having the government issuing huge amounts of debt in order to stimulate consumption and pay for construction.  Huh?  And remember, apropos Pogo, We have met the guvmint, and it is us, so government borrowing is a form of identity theft–somebody borrowing money in our name.  The logic behind the stimulus proposal therefore seems to be that we address a crisis caused by overconsumption and overborrowing by borrowing and consuming more.   So, presumably the stimulus is the hair of the dog cure.  

There’s No Such Thing as Aggregate Output.  Aggregate output is a social construction, a modeling fiction that helps advance our understanding of certain issues, but which also obfuscates essential facts.  In most   models, output is homogeneous, capital is homogeneous, labor is homogeneous.  As a result, if labor is idle, lumps of it can be lured into producing lumps of output.  Here on the planet with the blue sky, however, labor, capital, and output is anything but homogeneous.  Idle autoworkers in Michigan are not perfect substitutes for health care workers, or engineers, or road builders.

There will be no discriminating match between the demands for resources created by a political process, and the supplies of “idle” resources.  There will be bottlenecks in everything the government spends on, and the owners of the bottleneck resources will be the main beneficiaries of government largesse.  This will limit the beneficial effects of the stimulus to the population at large.

So, I am deeply skeptical that big spending will deliver the goods.  It is most likely to be a big boondoggle that creates windfalls for some, and greater tax burdens for others.  

The usual response to such skepticism is: Well, smart guy, what would YOU do?  

My reply–rather than giving a spendthrift Congress a trillion or so to blow on their pet projects and political pals, we should address a massive problem that (a) is the root source of our current difficulties, (b) is potentially fixable, and (c) will cost huge sums: the banking system.  We will need every dollar we can muster to address our colossal banking problems, and every one flushed down useless infrastructure projects is one less that can be used to stanch the bleeding in the banking sector.  

Of course, it is possible to screw up a banking system fix too.  I’ll solve that problem in a future post;-)

January 22, 2009

Deeply Disturbing

Filed under: Politics,Russia — The Professor @ 11:36 pm

Few things have disturbed me more in a long time than the Markelov-Baburova assassination.  I alternate between deep sadness, disgust, and fury.  

One thing that says a great deal is that there are numerous potential suspects.  That is, it is widely understood that there are numerous individuals and groups in Russia, within government and without, that are willing to and capable of using deadly force to achieve their ends.

Another thing that is very telling is the disdainful silence from the powers that be.  Yes, the Duma engaged in some meaningless histrionics.  But the people who really matter have said nothing.

Perhaps that’s for the best, as hypocritical crocodile tears, or meaningless OJ-esque promises of unceasing efforts to find the real killers would only add insult to grievous injury.  

A “normal country”?  Not yet, by a longshot–or, more accurately, by a point blank shot to the head.

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