Streetwise Professor

January 25, 2015

Mewling Oligarchs Move Putin Not At All: The Security Forces Are a Different Matter

Filed under: Military,Politics,Russia — The Professor @ 8:36 pm

Bloomberg breathlessly reports that oligarchs are irked at Putin because he adamantly refuses to countenance backing down in Ukraine.

And Putin really doesn’t care. Mewling oligarchs move him not in the least. Or if they have an effect on him, it is to create disgust and disdain. Putin cares about retaining power, and the oligarchs don’t threaten that.  He can destroy them, in a trice, and they know that: the recent example of Evtushenkov is surely fresh in their minds.

The Bloomberg piece states that Putin’s circle has shrunk to a few:

The ruble’s plunge has heightened opposition to Putin’s backing of the rebellion in Ukraine among his wealthiest allies, prompting the president to shrink his inner circle from dozens of confidants to a small group of security officials united by their support for the separatists, two longtime associates said.

. . . .

The core group around Putin is led by Security Council Secretary Nikolai Patrushev, Federal Security Service head Alexander Bortnikov, Foreign Intelligence Service chief Mikhail Fradkov and Defense Minister Sergei Shoigu, according to Markov.

This selection is probably overdetermined. As a Chekist, Putin’s views are likely broadly similar to those in the security services and the military. But perhaps more importantly, these people can actually pose a threat to Putin. A challenge is most likely to arise from their ranks, and unlike oligarchs, these people have force at their disposal.

Meaning that Putin is likely acting along the lines of the old adage: “Hold your friends close, and your enemies closer.” Putin doesn’t need the oligarchs as friends. Patrushev et al may not be enemies, as such, at least not yet, but they are a threat. And so keeping them close, and satisfied, is wise as a survival strategy.

This has broader implications. Putin likely has every intention of continuing his attempts to bring Ukraine to heel. But if he thinks about backing off in the face of pressure, or because of rising casualties and costs of continuing the campaign, he realizes that he risks running afoul of the hard men around him. Which implies that internal political forces will continue to impel Putin to continuing confrontation.

This further implies that outraged denunciations by Kerry or the Euros or even Obama will have little effect on Putin. Something sterner is required, for behind Putin stand some very stern men.

 

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From Birth to Adulthood in a Few Short Years: HFT’s Predictable Convergence to Competitive Normalcy

Filed under: Commodities,Derivatives,Economics,Exchanges,HFT — The Professor @ 2:05 pm

Once upon a time, high frequency trading-HFT-was viewed to be a juggernaut, a money-making machine that would have Wall Street and LaSalle Street in its thrall. These dire predictions were based on the remarkable growth in HFT in 2009 and 2010 in particular, but the narrative outlived the heady growth.

In fact, HFT has followed the trajectory of any technological innovation in a highly competitive environment. At its inception, it was a dramatically innovative way of performing longstanding functions undertaken by intermediaries in financial markets: market making and arbitrage. It did so much more efficiently than incumbents did, and so rapidly it displaced the old-style intermediaries. During this transitional period, the first-movers earned supernormal profits because of cost and speed advantages over the old school intermediaries. HFT market share expanded dramatically, and the profits attracted expansion in the capital and capacity of the first-movers, and the entry of new firms. And as day follows night, this entry of new HFT capacity and the intensification of competition dissipated these profits. This is basic economics in action.

According to the Tabb Group, HFT profits declined from $7 billion in 2009 to only $1.3 billion today. Moreover, HFT market share in both has declined from its peak of 61 percent in equities in 2009 (to 48.4 percent today) and 64 percent in futures in 2011 (to 60 percent today). The profit decline and topping out of market share are both symptomatic of sector settling down into a steady state of normal competitive profits and growth commensurate with the increase in the size of the overall market in the aftermath of a technological shock. Fittingly, this convergence in the HFT sector has been notable for its rapidity, with the transition from birth to adulthood occurring within a mere handful of years.

A little perspective is in order too. Equity market volume in the US is on the order of $100 billion per day. HFT profits now represent on the order of 1/250th of one percent of equity turnover. Since HFT profits include profits from derivatives, their share of turnover of everything they trade overall is smaller still, meaning that although they trade a lot, their margins are razor thin. This is another sign of a highly competitive market.

We are now witnessing further evidence of the maturation of HFT. There is a pronounced trend to consolidation, with HFT pioneer Allston Trading exiting the market, and DRW purchasing Chopper Trading. Such consolidation is a normal phase in the evolution of a sector that has experienced a technological shock. Expect to see more departures and acquisitions as the industry (again predictably) turns its focus to cost containment as competition means that the days of easy money are fading in the rearview mirror.

It’s interesting in this context to think about Schumpeter’s argument in Capitalism, Socialism, and Democracy.  One motivation for the book was to examine whether there was, as Marx and earlier classical economists predicted, a tendency for profit to diminish to zero (where costs of capital are included in determining economic profit).  That may be true in a totally static setting, but as Schumpeter noted the development of new, disruptive technologies overturns these results.  The process of creative destruction can result in the introduction of a sequence of new technologies or products that displace the old, earn large profits for a while, but are then either displaced by new disruptive technologies, or see profits vanish due to classical/neoclassical competitive forces.

Whether it is by the entry of a new destructively creative technology, or the inexorable forces of entry and expansion in a technologically static setting, one expects profits earned by firms in one wave of creative destruction to decline.  That’s what we’re seeing in HFT.  It was definitely a disruptive technology that reaped substantial profits at the time of its introduction, but those profits are eroding.

That shouldn’t be a surprise.  But it no doubt is to many of those who have made apocalyptic predictions about the machines taking over the earth.  Or the markets, anyways.

Or, as Herb Stein famously said as a caution against extrapolating from current trends, “If something cannot go on forever, it will stop.” Those making dire predictions about HFT were largely extrapolating from the events of 2008-2010, and ignored the natural economic forces that constrain growth and dissipate profits. HFT is now a normal, competitive business earning normal, competitive profits.  And hopefully this reality will eventually sink in, and the hysteria surrounding HFT will fade away just as its profits did.

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January 24, 2015

Farewell, Mr. Cub

Filed under: History,Sports — The Professor @ 6:07 pm

Ernie Banks, AKA Mr. Cub, passed away last night on the cusp of his 84th birthday. He was a great ballplayer, and the kind of man who was rare at the time and almost non-existent today.

Banks was my first childhood sports idol, growing up as I did in a bleed blue Cubs household. His greatest years-and they were great-were centered on the year of my birth, so I didn’t see him at his prime. In 1958-1960, he lead the league in RBIs twice, home runs twice, and in one of those years (1958) led in both. He won back-to-back MVPs in ’58 and ’59. This was a remarkable achievement for two reasons. First, other all time greats, including Mays, Aaron, and Frank Robinson were active and in their primes, so the competition was intense. Second, the Cubs were horrible. It’s rare for a player on a last place team to win an MVP. He did it twice.

Although Banks was known for his hitting, he was also a Gold Glove winning shortstop with a good arm and decent range. He was truly a rare player, manning the most difficult defensive position while hitting for power. A Rod without the steroids (Ernie was rail thin, but man, those wrists and hands).

By the time I was cognizant of baseball, Banks had moved to first base because he had lost range at shortstop. He had become a complementary player, with Ron Santo and Billy Williams playing the leading roles on the team. He still hit for power, but didn’t put up the monster numbers like he did in the 50s.

I got Ernie’s autograph twice. The most memorable time was opening day, April 8, 1969. Along with many other kids, I leaned over the dugout with a comic book, believe it or not (because my mother was too cheap to buy a program!), and Ernie signed it. (Mom did buy me a Frosty Malt, though.) This was memorialized in a photo on the front page of the Tribune the next day.

Although Banks was a great between the lines, what made him exceptional was his carried himself outside them. Despite playing on horrible teams, and suffering through a crushing disappointment when the best team he played for, the ’69 club, collapsed in September, he was always ebullient. “Let’s play two!” “It’s a beautiful day for baseball!” Even when Leo Durocher treated him badly in the clubhouse, he didn’t let it show. He didn’t blast Durocher. He didn’t try to undermine Durocher. He didn’t demand a trade. He always had a smile and a kind word for everyone.

I defy you to name a single star player today that has Ernie’s attitude.

So farewell, Mr. Cub. A player such as you will likely not be seen again soon, if ever.

 

 

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The World in Flames: Another Low, Dishonest Decade

Filed under: History,Military,Politics,Russia — The Professor @ 3:36 pm

Recent days have seen a dramatic escalation of military operations in eastern Ukraine. The New York Times headline is on point: “War Is Exploding Anew in Ukraine.” The Russians* launched an assault on the battered hulk of the Donetsk airport, which had held out for 242 days. The airport fell, with the garrison of “cyborgs” being killed or captured. A counterattack by Ukrainian regulars was abortive. Recent days have seen rocket attacks in Donetsk and Luhansk,with civilians dying. Today a Grad attack in Mariupol killed over 30.  A Ukrainian salient centered on Debaltseve (between Donetsk and Luhansk) is evidently under attack. The “leadership” of the rebels in Donetsk announced-and then unannounced-that an assault on Mariupol was underway.

As I wrote in November, an attack along the coast to open up a route to Crimea would be an obvious move. As for those (including some former military) who claim that major offensive operations would be postponed to the spring, I say: Huh? Winter warfare is a Russian specialty, and even a passing familiarity with the history of campaigns in Russia (Napoleon’s, WWI, and WWII) shows that it is spring (and fall) mud that is a far greater impediment to military operations than cold and snow. The notorious “raputitsa” that follows the snow melt (or fall rains) causes movement to grind to a halt until the fields and roads dry.

This offensive could be underway now, but given the lack of reliable reporting it is impossible to know.

What is Putin’s objective here? Securing Crimea, which is now isolated and vulnerable and difficult to supply, is clearly paramount. Beyond that, I doubt he really wants to take ownership of a Sovok sh*thole like the Donbas. His main objective is to force Kiev to sacrifice its sovereignty, and become a reliable satrapy of Russia. A combination of economic and military pressure falling short of an all out invasion is likely sufficient for that purpose. This is especially true inasmuch as the feckless West is quite clearly unwilling to risk anything to protect Ukraine. Keeping the meat grinder turning in Donbas advances this objective.

As for the indiscriminate attacks on cities, I have no good explanation. Perhaps it is just the thuggishness of the anti-Kiev forces. Perhaps it is part of Putin’s testing of the West. If killing of civilians elicits no more than a shrug of indifference, Putin can be assured that further escalation will come at little cost.

So much for Obama’s State of the Union boast:

Second, we are demonstrating the power of American strength and diplomacy. We’re upholding the principle that bigger nations can’t bully the small — by opposing Russian aggression, supporting Ukraine’s democracy, and reassuring our NATO allies.

Putin apparently didn’t notice. Ukraine certainly hasn’t noticed that the bullying has stopped. Indeed, the final assault on the Donetsk airport occurred on the day that Obama uttered these words.

Traveling to the south and west, Syria and Iraq are also in flames, and making a liar of Obama.

Back in December I discerned the outlines of a campaign that will culminate with an attack on Mosul. Last week it became clear that this campaign is indeed proceeding. The Kurds, supported by American airpower, are shaping the battlefield and isolating Mosul from the west and south. The Kurds have made advances around Sinjar and Tal Afar, thereby interfering with ISIS supply lines to its Syrian fastness. The US military has indicated, however, that an assault on Mosul will not occur until the summer, when sufficient numbers of Iraqi regulars have been trained.

In Syria meanwhile, the US is pounding Kobani regularly, and the Kurds are painstakingly pushing back ISIS.

The US commander in the region, General Lloyd Austin stated that ISIS had lost approximately 6000 KIA, and was having manpower problems. This theme was picked up by the US ambassador to Iraq, but the Pentagon quickly squelched this discussion, due to Viet Nam body count flashbacks.

But other than attrition and shaping the battlefield around Mosul, there has been scant progress against ISIS. Indeed, ISIS has been expanding rather dramatically throughout Syria, giving the lie to this SOTU statement: “In Iraq and Syria, American leadership — including our military power — is stopping ISIL’s advance.” That’s true to a limited degree in Kobani and Mosul, but flatly wrong elsewhere in Iraq and especially Syria. Don’t even get me started on another Obama delusion: the “success” in Yemen, which has descended into absolute chaos with competing “Death to America” factions, both Shia and Sunni, vying for control.

It’s rather depressing to see the President of the United States do a Baghdad Bob imitation while addressing a joint session of Congress.

In sum, at present it appears that Putin is on the advance in Ukraine and ISIS is at best stalemated in Iraq and Syria. And the West’s leaders, reflecting the indifference of their citizenry, are content to let it happen, or at least do too little to prevent it from happening. In other words, we are in the midst of another low and dishonest decade.

*There is a war of labels in Ukraine. What to call those fighting against the Kiev government? Rebels? Separatists? Pro-Russians? Terrorists (the preferred Ukrainian label)? Russians? The problem is that each label describes a part of the anti-Kiev combatants, but none describes it completely. Yes, there are Ukrainian citizens who are engaged in a separatist rebellion that aims to achieve unification with Russia, and they are advancing Russian interests, making them pro-Russian. Yes, sometimes they employ terrorist methods, though they primarily use conventional military tactics. Yes, there are Russian troops involved, of various types (GRU spetsnaz, artillery and air defense units, armored and infantry elements) in fluctuating numbers. Russian number spiked in August, and appear to be increasing now.

This is  a Russian owned and run operation. The indigenous forces in Donbas obviously obtain massive quantities of Russian ammunition and weapons from Russia, and can’t pay for these arms themselves. Their objectives largely overlap with Putin’s. In addition, there is direct Russian involvement, and that will increase if Putin indeed decides to escalate.

 

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January 18, 2015

Chris Kyle & Alvin York: Avatars of Jacksonian America

Filed under: History,Military,Politics — The Professor @ 10:11 pm

Last night I saw American Sniper. I recommend it. It’s a very straightforward telling of the story of Chris Kyle, a Navy SEAL who served four tours in Iraq, serving mainly as a sniper providing “overwatch” for Marines operating in the mean streets of places like Fallujah and Sadr City. Kyle was credited with 160 kills, an American record. (The all-time record is held by a Finn who killed over 500 Russians in a few weeks during the Russo-Finnish War of 1940.) This tally included a 2000+ yard shot, which is the sort-of climax of the movie. (Amazingly, he did this with a Macmillan Tac 338,  rather than a 50 caliber Barrett.)

I say sort-of climax, because the movie doesn’t have the standard narrative arc. That reflects its hewing closely to Kyle’s life, and most lives aren’t like classic movie scripts.

Bradley Cooper does an excellent job at portraying Kyle. You can see interviews with Kyle on YouTube, and Cooper’s Kyle captures the real thing in appearance, voice, and mannerisms.

The movie is quite powerful, and the ending which uses film from Kyle’s funeral procession and memorial service in Cowboys Stadium is quite moving.

The best indicator of the impact of the movie is that when screen darkened and people were departing the theater, no one spoke a single word. I am not exaggerating: I did not hear anyone speak, and after noticing the silence I listened for voices, and heard none. People shuffled out in silence, as they might leaving a funeral of a friend struck down too young.*

Walking back from the theater, my mind flashed back to one of my favorite old movies, Sergeant York starring Gary Cooper. (And no, it wasn’t the common last name of the stars that brought that comparison to mind: I honestly didn’t notice that until just now.) There are some interesting comparisons and contrasts. Both Kyle and Alvin York were Southerners who grew up around firearms and hunting. Both were somewhat rambunctious as young men. Both were very patriotic.  Both became celebrated war heroes, and of course, subjects of biopics.

There are of course substantial differences. York found religion, foreswore his previous wild ways, and became an ardent pacifist. He attempted to obtain an exemption from conscription as a conscientious objector, but as his sect was not recognized his request was rejected. Kyle, conversely, volunteered for a branch of the service most likely to see combat.  York’s heroism was compressed into a few hours-a few minutes, really-on a single day in October, 1918: he killed as many as 28 Germans, with as many shots. Kyle served four long tours in Iraq, and his tally was spread out over nearly 1000 days.

The most striking similarity is how they justified killing. Here’s the dialog from Sergeant York:

Colonel: Of course, if you’d rather not tell me,why, it’s quite all right.
York: Well, I’m as much against killing as ever,sir. But it was this way, Colonel. When I started out I felt just like you said. But when I hear them machine guns a-going and all them fellows are dropping around me, I figured that them guns was killing hundreds, maybe thousands, and there weren’t nothing anybody could do, but to stop them guns.
And that’s what I done.
Colonel: You mean to tell me that you did it to save lives?
York: Yes, sir. That was why.
Colonel: Well, York, what you’ve just told me is the most extraordinary thing of all.

In American Sniper, Kyle says that he was killing to protect his comrades, and that the only thing that he regretted is the ones he couldn’t save.  The psychologist to whom Kyle tells this is as surprised at this statement as York’s colonel was. (Other noted American snipers, such as Chuck Mawhinney and Carlos Hathcock, expressed similar views.)

A similarity in the movies is that both were nominated for Oscars as Best Picture, and both Coopers received nominations for Best Actor. Gary won in 1941, though the movie did not. It remains to be seen how Bradley and his movie do 74 years later.

That may have something to do with politics, and perhaps the most interesting contrast between Sergeant York and American Sniper relates to politics.

In some respects, there is a very strong political subtext to Sergeant York. When the movie was released, the US was very divided about whether to become involved in the World War that was then raging in Europe, and in China. There was a strong isolationist and pacifist streak in the nation, and although Roosevelt was nudge the country towards intervention, there was considerable opposition. Indeed, while Sergeant York was still in theaters, the House of Representatives extended conscription by the margin of a single vote. Viewed against that background, York can be seen as an allegorical figure: a committed pacifist who comes to recognize that killing is sometimes justified because it saves more lives, just as some were arguing that a peace loving US needed to intervene in the world conflict in order to save humanity from murderous regimes.

Even given this political subtext, the movie was not controversial. It was, in fact, wildly popular: it was the largest grossing film in 1941. Moreover, it did not generate any real political controversy. Indeed, its patriotic themes were widely praised. On December 7, 1941, it seemed prescient.

In contrast, Clint Eastwood’s American Sniper is not avowedly political, but it has been the focus of intense political criticism, mostly from the left. Eastwood portrays Kyle like he was. Patriotic. An ardent supporter of the war in Iraq. A man who believed that the US was fighting evil there.

And all of that just won’t do, will it? Since all of these things are an anathema to the progressive left, they have subjected the movie to shrill criticism. The most absurd example of this being the “review” in The New Republic, which was written by someone who hadn’t seen the movie. (I refuse to link to such tripe: you can find it yourself if you want to read it.) Because, hey, who needs to see a movie to judge it, when its plot and its real life protagonist conflict with the accept progressive narrative, right? The most odious example is fittingly from that most odious of progs (quite a competition, that), Michael Moore, who tweeted that snipers are backshooting cowards. (Again, not linking. You’re own your own if you want to subject yourself to his bile.)

Kyle was the type of man who gives the left the vapors. He epitomized the people Obama belittled as “clinging to their guns and religion.” He was a Jacksonian par excellence, and any movie fairly portraying a Jacksonian is beyond the progressive pale. Such men are the true enemies of the progressive left, far more threatening than any jihadi/Salafist/Islamist terrorist, as Obama’s stubborn refusal to utter these words plainly reveals.

But the key thing to note is that Kyle stands out in the movie for his commitment to the war in Iraq: he is the exception, not the rule, among his comrades in arms. There is a scene where Kyle unexpectedly meets his brother, a Marine, on a tarmac in Iraq. His brother is going home after his combat tour, and makes it clear that he detested the war and wants to get far away from it as soon as possible: this leaves Kyle befuddled. One of Kyle’s comrades on several tours is killed, and at the funeral stateside his grieving mother reads his last letter, which is a cri du couer condemning the futility of the war. Kyle tells his wife that the letter killed his friend: he had lost his commitment to the cause, and it had killed him. Eastwood presents both sides and in this, and other parts of the movie, he conveys the grays of the war and the diverse responses of those who fought it. Which is utterly unacceptable to those who see it purely in black and black, and who can only conceive of Kyle as a blood-crazed psychopath.

This should not be surprising, as a recent speech by James Bowman indicates:

Miss Ryzik’s application [in a review of Zero Dark Thirty] of progressive historicism to movie criticism may at first seem just a little incongruous, but it shouldn’t. The politicization both of movie criticism and of the movies themselves has been progressing, too, for decades. Nowadays almost everything written about movies or popular culture by the scholars and academics paid to study such subjects by universities is so reliably progressive, as we now understand the term, that it will seem to ordinary readers already to come from the future. This impression is reinforced by the fact that it is written in a futuristic language only vaguely related to English, a language which is beginning to leave its impression on our own with words like Melena Ryzik’s “narrative” in place of an old-fashioned word like “movie.” She is far from being the only person to think nowadays that “narrative” sounds more intelligent and sophisticated than more concrete language.

We are seeing this in spades with American Sniper.

But this too is revealing: the disconnect between progressive opinion and the popularity of the film is telling. It cleared over $90 million over the weekend of its release, and with tomorrow being MLK holiday, the opening weekend take is likely to be on the order of $115-$120 million. As I noted, the movie clearly moved the audience, and I believe that this is because they admired him and were saddened by the closing scenes of his funeral procession, memorial service, and funeral. Perhaps saddened specifically by the knowledge that he was killed by an emotionally troubled veteran he was trying to help. The progressives may hate Chris Kyle and what he stands for, but apparently vast swathes of America don’t.

In his article on the Jacksonian tradition in American politics (linked above, and which is a must read), Walter Russell Mead notes:

Despite its undoubted limitations and liabilities, however, Jacksonian policy and politics are indispensable elements of American strength. Although Wilsonians, Jeffersonians and the more delicately constructed Hamiltonians do not like to admit it, every American school needs Jacksonians to get what it wants. If the American people had exhibited the fighting qualities of, say, the French in World War II, neither Hamiltonians, nor Jeffersonians nor Wilsonians would have had the opportunity to have much to do with shaping the postwar international order.

Two men portrayed by actors named Cooper nearly 75 years apart-Chris Kyle and Alvin York-personified what Mead writes. At times of trial, Jacksonian America has produced remarkable men who would be misfits in a faculty lounge or the halls of politics, but who make those things possible. They were rough men of a type that permit us to sleep in our beds at night because of their willingness-one reluctantly, one enthusiastically-to do violence on our behalf (to paraphrase the remark often attributed to Orwell). They are the kind of men whom progressives despise. Fortunately, however, it appears there plenty of Americans who think otherwise. Maybe there’s hope for us yet.

*Scott relates a similar experience in the comments. When I was waiting to get into the Rec center this morning, several students were talking about the film, and made the same observation. My daughter said that friends had told her the same thing. It’s a phenomenon.

 

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Putin, Inc.: How Russia’s Current Crisis Will Condemn It to Enduring Stagnation

Filed under: Commodities,Economics,Politics,Russia — The Professor @ 1:59 pm

Russia’s economic position remains parlous. The ruble has continued to weaken, and although the price of oil rallied somewhat late last week, it still remains far below levels necessary to permit growth. The World Bank is predicting a 2.9 percent decline in GDP in 2015. 9.2 percent is more likely.

So what is Putin/Russia going to do? The options are limited. Given the weak economic conditions, and the lack of access of the banking and corporate sectors to international funding, there appears to be only one option. As a lawyer friend sagely put it, the government will essentially have to move massive amounts of liabilities from big banks and large state enterprises onto the government balance sheet. Formally, it will be done through the banks. The banks will extend credit to the corporate sector (including most notably big state firms) and the government will capitalize or guarantee/backstop the banks.

This is certainly the view of Sberbank’s Chairman, German Gref (one of the last liberals-as Russians go-in the power structure):

The head of Russia’s largest bank, German Gref, offered a bleak picture of the fate awaiting the country’s banking sector in 2015 during the set piece Gaidar economic forum in Moscow this week.

“It’s obvious that the banking crisis will be massive,” the Sberbank chief told reporters.

“The state will capitalize the banks and increase its stake in them, and the banks will buy industrial enterprises and become financial-industrial groups,” Gref said Wednesday. “All our economy will be state-run.”

The result will be a simulacrum of the Soviet economy.

Two things are worth noting. The first is that this gives the lie to those who are sanguine about the prospects of a sovereign default in Russia. These optimists downplay the impending downgrades by the rating agencies, and the  fact that Russian CDS are trading well into the junk range by pointing out that Russia’s government debt is relatively small compared to GDP. But one always needs to pay attention to the contingent liabilities, and in the current circumstances these contingent liabilities include a large fraction of the liabilities of the banking and corporate sectors. That’s why Russian 5 year CDS are trading at implied default probabilities of around 10 percent despite modest levels of government indebtedness.

The second notable fact is that once things move onto the government balance sheet, it’s hard to move them off. Companies get quite comfortable with government support and the avoidance of capital market discipline: soft budget constraints-or no budget constraints at all-have their attractions. It’s easier for managers in the elite to influence the members of the elite in government than it is to persuade investors, especially foreign ones. The managers can muster 1000 excuses: think of all the justifications Sechin pushed to stave off privatization of a large stake in Rosneft. Even more excuses will be forthcoming in the midst or even the aftermath of a crisis. What’s more, appeals to patriotism-chauvinism and paranoia, really-will be quite effective. And perhaps most importantly, Putin and his clique will relish exercising even greater control over big firms than they do now. For reasons of power and personal profit.

This means that the prospects for any real structural change in Russia will be even more doubtful than they ever were, and they were never very good, especially in the mature stages of Putinism. Thus, the consequences of the immediate crisis will be severe, but the consequences of the likely response to the crisis will be enduring and quite negative. An even more statist economy even more thoroughly dominated by Putin and his cronies is doomed to stagnation.

We have already seen that to some degree in the aftermath of the last crisis: Russia’s post-2009 growth has been a fraction of its pre-crisis growth. I expect that post-2015, long run growth will ratchet down yet again, as the dead hand of the state and the dying hand of Putin weigh heavily upon the economy.

The geopolitical consequences of this are hard to discern, because there are conflicting forces at work. An economically moribund Russia will have less capacity for adventurism. But a resentful Russia that will blame the crisis and its dreary aftermath on its enemies abroad, and a Putin who will be looking to stoke these resentments for domestic political gain, will be more likely to provoke conflict.

Some years ago Andrei Shleifer said that Russia was becoming a normal,  middle income country. I always thought that was doubtful, especially once Putinism really took hold. I think it is utterly fantastical now. A combination of economic and political factors accentuated by a crisis brought on by sanctions and especially low oil prices will defer indefinitely Russia’s convergence to western-style normalcy.

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January 15, 2015

Alexei Miller Blows More Gas

Filed under: Commodities,Economics,Politics,Regulation — The Professor @ 8:07 pm

As is its wont when desperate, Russia is throwing around threats. And Gazprom and its CEO Alexei Miller are the usual heavies in this role, like mouth-breathers that mafiosi send around to talk to you about how you have such a nice family and it would be a shame if something happened to it.

Yesterday, Miller told Europe it better support Gazprom’s initiative to circumvent Ukraine by shipping gas through Turkey by building a connector between Turkey and Greece, or else:

“Our European partners have been informed of this and now their task is to create the necessary gas transport infrastructure from the Greek and Turkish border,” said Miller, according to a Gazprom statement. [Can the Russians please give this “partners” thing a rest? With partners like them, who needs Ebola?]

“They have a couple of years at most to do this. It’s a very, very tight deadline. In order to meet the deadline, the work on building new trunk gas pipelines in European Union countries must start immediately today,” Miller warned.

Or else what, Alexei?:

“Otherwise, these volumes of gas could end up in other markets.”

Hahahahahaha.

Like where? And don’t tell me China. Heard that one. Over and over and over again.

Look, if you make threats, you need to make them credible. Miller is basically saying that if gas can’t move to Europe via Turkey, Gazprom won’t ship it via Ukraine. If it comes to that, and if Europe is the most valuable destination for Russian gas, Gazprom will sell it there, and ship it via Ukrainian pipes. It can’t afford not to.

This is  a bluff that even the Euroweenies will have no problem calling. This is particularly true if market conditions are like at present, where LNG prices have cratered in Asia, and gas imports are now viable. When the big Australian and US projects come on line later this year, there is a real possibility of an LNG glut which would undercut Russian leverage, not just in Europe, but in China too. (And you know that the Chinese will squeeze Putin’s kiwis like a hungry python.)

What’s more, the whole Turkish route looks like a stitch up job done at the last moment when Bulgaria toed the European line and rejected South Stream. There are so many problems.

First, even ignoring the Turkey-Greece link (and yeah, they always play so well together), it is by no means clear that Turkey has the domestic infrastructure to get the gas from the Black Sea shore to the Aegean. From an Oxford Institute for Energy Studies report (h/t Number One Daughter):

The BOTS [the Turkish national gas company] transport system’s throughput capacity is not sufficiently developed to accept and ship all the contracted gas volume from the eastern suppliers due to the limited installed capacity of the existing compressor stations. BOTAS is able to take some 90% of the gas from the Trans-Balkan Gas Pipeline (the Western Line) and the Blue Stream pipeline from Russia, but has struggled to cope with volumes contracted from Azerbaijan and Iran. Therefore, the company has had to pay billions of dollars for ‘untaken’ gas.

That’s given current flows: it will obviously take a substantial investment in Turkey to handle large additional flows via the new pipeline.

Second, just who is going to pay for this? It ain’t like Gazprom is rollin’ in the dough. To the contrary, like all Russian corporations, Gazprom is in desperate straits. It’s not sanctioned now, but that could change with one wrong move in Ukraine. Moreover, its hard currency revenue picture is dire. Gazprom shipments to Europe were down more than 9 percent last year, no gas is yet flowing to China, and the best part is still to come: Gazprom prices-at its own insistence!-are tied to lagged oil prices. So it is looking at a potential revenue decline from European sales in the 60 percent ballpark.

Schadenfreude doesn’t even come close to describing my feelings at contemplating Gazprom getting what it asked for-nay, insisted on: an oil price link. It made this link a matter of principle, and marshaled one inane argument after another to justify it.

How’s that working out for y’all? Be careful what you ask for!

Third, there’s the little matter of price. Isn’t there always? Immediately after the ballyhooed announcement of the Turkish project, it became known that the Russians and Turks were far apart on price. Look at the history of Vapor Pipe (analogous to vaporware) deals announced with China going back to 2006: they didn’t materialize because of an inability to come to agreement on price. (Even the deal signed when Putin was under the gun has not fully resolved price issues.) This “deal” has every prospect of having the same issues, especially since the Turks realize Russia’s weak bargaining hand here.

Hell, the Russians and Turks can’t even agree on the gas price for this year. They are going to magically lock in a long term price/pricing formula? As if.

So this Turkey route looks like . . . a turkey. Miller is blowing gas. Yet again. I’d be astounded if 1 percent of what that guy says in public turns out to be true.

One last thing. There was a report in the Daily Mail yesterday claiming that shipments of Russian gas via Ukraine to 6 southern European countries had been cut off. This was duly repeated breathlessly by the usual Kremlin echo chambers like Zero Hedge and Infowars. But I have yet to see confirmation in any other source, and I pinged an industry contact who can’t find confirmation either.

It sounds like this is another way of delivering a threat, directed at the most vulnerable parts of the EU, including a country (Greece) that is in political turmoil and which could cause no end of headaches to the Euros-and the Euro. This happens at a time when the wets in Europe are making noises about easing off on sanctions. So I’m getting the impression that this is a story planted in the Daily Mail with the same purpose that Don Corleone places a horse’s head in someone’s bed.

Update. Do I feel like an idiot. Apparently ZH linked to a Daily Mail story from 6 years ago and made it sound like it was from yesterday. When you click through the link, the current date appears at the top of the story. That’s beyond bizarre even for ZH. Shame on me. [The story is that someone emailed asking if I’d seen that ZH story. I hadn’t, but clicked through the link. Like I say, shame on me.]

 

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January 13, 2015

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

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

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

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

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

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

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

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

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

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

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Call Me Buffy

Filed under: Commodities,Economics,Energy — The Professor @ 7:31 pm

When it comes to the Saudi predatory pricing meme, I feel like Buffy the Vampire Slayer. No matter how many times I drive a stake through its heart, in the next episode it reappears in a different guise.

Here’s yet another example. 

I stipulate that the current low price environment is imposing substantial financial losses on shale producers. I further stipulate that they are currently slashing capex, which will lead to production growth declines at the least, and perhaps production declines  (depending on the race between reduced number of new wells and the increase in well productivity), while prices remain low. I stipulate further still that these effects would be reduced, if the Saudis had cut output to support prices.

Yet it does not follow that the Saudis are not cutting output because they are attempting to drive out shale producers. Because they can’t do so for long. The capital that is leaving the industry now can come back in when demand rebounds. This will limit the price upside, thereby depriving the Saudis of any payoff to recoup the losses they are incurring now.

Instead, the Saudis, just like everybody else in the industry, are coping with the consequences of a decline in demand the best way they can. Given Saudi market share, the elasticity of demand for oil, and crucially, the elasticity of supply of shale oil (which is relatively high, due to the relative flexibility of the technology and the availability of a large amount of prospects), the demand for Saudi oil is relatively elastic. This makes output cuts money losing: the cuts don’t increase price enough to offset the lower number of barrels sold. So keep producing, and pray for a demand turnaround.

Tune in soon for the next installment of Buffy the Saudi Conspiracy Theory Slayer. Alas, I think it will be a long running series, and there’s not a lot of variation in the plot lines, because the economics don’t really change.

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January 11, 2015

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

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

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

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

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

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

Ed Markey. I should have known.

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

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

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

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

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

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

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

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

 

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