Streetwise Professor

Russia is going to ban wheat exports, and is “coordinating” with the members of its “Customs Union,” Kazakhstan and Belarus, to do the same.  This ban has caused a worldwide spike in wheat prices; prices on the CBT and KCBT were limit up, about an 8 percent move on the former, and a 7 percent move on the latter.  Moreover, the cancellation is undermining Russia’s reputation (yeah, I know) as a reliable trading partner.

Cargill makes the point that Adam Smith made in the Wealth of Nations in the chapter “A Digression on the Corn Trade:”

Cargill, the world’s biggest trader of agricultural commodities, criticised Moscow’s move. “Such trade barriers further distort wheat markets by making it harder for supplies to move from areas of surplus to areas of deficit, and by preventing price signals from reaching wheat farmers,” it said.

Russian exporters argue that the precipitous announcement will make it harder for Russia to export going forward:

Arkady Zlochevsky, president of the Grain Union lobby group, said that the swift imposition of the ban risked undermining Russia’s reputation as a reliable supplier.

.  . . . .

Arkady Zlochevsky, president of the Grain Union lobby group, said the government needed to warn exporters ahead of such a decision and give them time to meet existing contracts, according to Interfax. “What are we to do with the grain that has already reached port?” he asked. “We have no mechanisms for returning it.”

There are understandable domestic reasons for this decision.  It is political, not economic, and reflects the government’s concern about a rekindling (no pun intended, given the current circumstances) of inflation, which has abated in recent months.   The immediate takes precedence over the future, especially in many Russian decisions.

The interesting question is the “coordination” with Kazakhstan and Belarus.  I haven’t been able to find out whether a Union-wide ban would prevent exports from say Kazakhstan to Russia, or just prevent exports from within the Union to without it.  I would imagine the latter.  Since it appears that Russia is hardest hit by the drought, a “coordinated” ban would benefit Russia, at the expense of the other two countries.  Is Russia leaning on the other countries in the Union?  Given recent Belarussian obstreperousness, it will be interesting to see how it reacts.  Will the threats fly?   Reporting I’ve seen doesn’t permit me to answer these questions now, but I will try to keep an eye on how Russia handles this particular issue in the “Near Abroad.”

Update (8/5/10, 2000 CT): Just saw a Stratfor video piece on the grain export ban.  According to Stratfor, (a) Russia is leaning on Kazakhstan and Belarus to export to Russia, rather than elsewhere, and (b) is making it plain that this is a loyalty test.  Loyalty being, like many Russian roads, a one way street.

If only this were about Cheech and Chong.  Russia’s Long Hot Summer is having devastating effects.  Some effects are economic (a devastated wheat crop, leading to calls to ban wheat exports in order to mitigate any price spike in Russia).  Some effects are actually fatal, such as the rash of drowning deaths I wrote on earlier.  And the epidemic of fires has both effects.  The death toll (the last count I read was 48, which is high compared to the kind of toll you see in wildfires in the western US) will likely climb.

Wildfires are extremely frightening things.  I have distinct memories of watching as a kid a documentary about a western wildfire–if memory serves, it was near Mt. Baker in Washington state.  They are literally chaotic, and can go non-linear in both space and time.  This makes them difficult to predict, and fight.

This means that effective firefighting requires a good deal of contingency planning; investment in equipment in quantities and types that can respond forcefully to a highly dynamic situation; excellent communications so that those in danger can be contacted and directed to safety, and so that information moves quickly; and a reliance on trained personnel who can act on the spot in response to sudden developments.

Even with all that, firefighting is always an uphill struggle, and firefighters lose many battles.

And it is clear that Russia doesn’t have all of that.  Part of that is understandable.  Russia is a poor country, still, especially as compared to say the US and California.  Whereas wildfires are an annual risk in the US (albeit one that waxes and wanes with weather conditions), they are more exceptional in Russia. The country is so vast and thinly populated that it would be hugely expensive to make the investments.

But what is going on in Russia now suggests that performance is poor, even giving allowances for the factors just mentioned.  It casts doubt on state capacity and competence; the rationality of spending priorities; and the ability of authorities to respond in a crisis.

Not surprisingly, perhaps, the official response seems as much focused on appearing to be in charge and doing something, rather than actually being in charge and doing something.  This staged dialog between Putin and Medvedev, and Putin’s on-the-spot  interventions are rather pathetic, actually:

On Friday, he flew to the Nizhny Novgorod region, where he visited a village that had been reduced to ashes. Dressed in a light blue shirt and dark blue jeans, Putin moved from one blackened ruin to another, shaking his head. He ended up surrounded by a big group of grieving residents.

“Before winter, all the houses will be standing,” Putin said, raising his voice to be heard by the entire crowd — and by cameras of all the main television networks that broadcast the meeting across Russia.

“Do you promise us?” a woman asked. “Yes, I promise,” Putin replied, adding that each family member will receive more than $6,000 in compensation.

“We will visit you with a huge bow [of gratitude] from the newly built village,” said one woman. Putin hugged and kissed her; she kissed him back.

In the next televised report, Putin is standing in a picturesque birch grove, his cellphone to his ear as he talks to Medvedev, who is sitting at his Kremlin desk.

Putin: “All the necessary measures on the spot we have taken, and I think it is expedient and would ask you to sanction the use of additional Defense Ministry forces and means to combat the fire.”

Medvedev: “As for the idea to use the Defense Ministry, I give such sanction.”

Putin: “We need to talk with the governors of other regions and take children out to other regions not as smoky as this one.”

Medvedev: “Yes, it is a good idea. Unfortunately we have casualties. Relatives of the deceased should be paid compensation.”

Putin: “We need to talk with the governors of other regions and take children out to other regions not as smoky as this one.”

Medvedev: “Yes, it is a good idea. Unfortunately we have casualties. Relatives of the deceased should be paid compensation.”

Putin: “We have done that already.”

Cut!  Print!  Jeez, all that’s about as genuine as Velveeta.  I admit to surprise that Putin still had his light blue shirt on (same color as the menty, BTW): I fully expected him to appear bare chested, shovel in hand, playing firejumper, with the cameras snapping and rolling.  But there’s still time.

This was all just transparent propaganda, with a mixture of Soviet and Cult of Personality production values.

Then there’s this:

Putin, Russia’s most popular politician, has tried to limit criticism of the response by visiting destroyed villages and promising compensation. But angry residents have surrounded him and complained that firefighters came too late, or that preventative measures were inadequate.

“Today I have given an order for video cameras to be installed on every construction site,” Putin told villagers in Mokhovoye, near Moscow. Pictures of the rebuilding of cottages would be beamed directly to “the government building, to me at home and to the website of the government”, he said, adding: “Any citizen will be able to watch in real time what is happening.”

A classic magician’s (or three card monte dealer’s) ploy: distract attention from the big picture to the trivial.  How about cameras at randomly chosen fire-affected locations?  Now that would be a much more effective way of monitoring government performance.  Which means that it won’t happen.  And I seriously don’t suggest trying it at home.

Another measure (alluded to in the first quote) is the dispatching of 40,000 soldiers to fight fires.  Firefodder, as it were.  For inter alia (a) the soldiers are almost certainly not trained for this duty, (b) they will not be supported by the water bombers and other equipment that is needed to make serious progress, and (c) the geographic scope of the fires is so immense, and the transportation network (again, the roads) so pathetic that it will be virtually impossible for the soldiers to move in response to changes in the location of the greatest fire dangers.

And the Russian military has not exactly covered itself with glory when the fire came to it, let alone when having to go to the fire:

Russian President Dmitry Medvedev fired senior navy officers for “criminal negligence” in the destruction of a base near Moscow by wildfires that have killed 48 people across the country to date.

The aviation supply base near Kolomna, 100 kilometers (62 miles) southwest of Moscow, burned on July 29, destroying the headquarters, 13 warehouses and 17 parking lots with vehicles, according to the Investigative Committee of the Prosecutor General’s Office.

The officers in charge of the base “failed to perform their duties” when “a fire that was spreading rather slowly wasn’t contained, and the base leadership were nowhere to be found,” Medvedev said at a government meeting in Moscow today.

And all Putinprop notwithstanding, a credible case can be made that his decisions were so much tinder that contributed to the fire crisis:

But critics blame the lower house of parliament (Duma) for rushing through a new Forest Code in 2006 on Putin’s orders. This disbanded a centralised system of forest protection and turned the country’s vast forests into a virtual no-man’s land.

. . . .

Environmentalists blame bureaucracy and business lobbies for the faults in the forestry legislation, which they say was aimed at milking the Russian forests for quick profits.

“This law is good for large companies with (close connections to the authorities), enabling them to quickly cut trees, make money and leave,” said Alexei Yaroshenko at Greenpeace Russia.

Yaroshenko also said the new code abolished Russia’s 70,000 forest guards, who used to watch over the trees and call in fire fighters to any blaze. It also made it easier to reclassify forest as lucrative development land.

Under Putin’s 2000-2008 presidency, the pro-Kremlin United Russia party drafted a forest strategy aiming to exploit the nation’s timber on a scale comparable to its oil and gas riches, which are the world’s largest.

Environmentalists say Russia’s largest timber processing firm Ilim Group was one of the main driving forces behind the new Forest Code.

President Dmitry Medvedev, Putin’s chosen successor in the Kremlin, once worked as head of Ilim’s legal department.

“There are excesses in the new code,” said Dmitry Chuiko, adviser to Ilim Group’s board. “The practical experience has shown that a centralised system of fire protection should be stronger than stipulated.”

But he added: “On the whole the code is good for us. It protected the interests of large forest users.”

I’m sure it did, Dmitry.  The natural state at work.  (To preempt a barrage of whataboutisms, I concede that regulatory capture has had similar effects in the US, in forestry and in banking and in energy.  Which is why I can just shake my head in amazement when people repeat the incantation “more regulation” will fix problem X.)

The LAT article (first quoted) focuses on the implications of the Kabuki Theater starring Putin and Medvedev for the future political course of Russia.  That’s understandable, if discouraging.  It would be far more illuminating to develop more information about actual state performance under Putin, either as President or PM, and evaluating critically the implications of Putin’s governance for the actual capacity of that state to carry out legitimate public functions, as opposed to its real function as a rent redistribution machine.

The fires, therefore, should cast an intense light on the fact that which personality sits atop the natural state is largely irrelevant.  It is the nature of that state–pun sort of intended–that should get the attention.

Missouri held its primary election yesterday. One of the initiatives on the ballot was Proposition C, which if implemented would bar the government from requiring to purchase health insurance, or collecting any penalty for failure to do so.

The measure passed 71.1 percent to 28.9 percent.

Seventy-one percent.

Now there are a lot of reasons not to get all excited, one way or the other.  It was a primary election in which 668,000 voters turned out in the blasting heat, as compared to nearly 3 million in the last Presidential Election.  The measure smacks of nullification, and has serious Constitutional problems.

But by the same token, it ain’t nothin, either.  It is a more reliable barometer of national sentiment than opinion polls.  It demonstrates that there is a considerable group of people with intense dislike for Obamacare.  People who vote.  Broken glass voters.  Given Missouri’s well-known bellwether status, and its past record as a good proxy for national views, it gives the lie to the assurances of Obama, Pelosi, Reid, etc. that people would fall into love with Obamacare once it passed.  Not happening.  People are falling deeply into hate, actually.  At least a lot of people are.

The national media is hilarious in its attempts to ignore this vote.  There is a palpable fingers-in-the-ears “na na na na I CAN’T HEAR YOU” aspect to the absence of coverage on the election.

Go ahead.  Keep thinking that.  See you in November.

The individual mandate is the cornerstone in the Obamacare arch.  All of the cross-subsidies inherent in the legislation depend on the ability of forcing those who are the net sources of transfers to stay in the system.

Now you can argue that a mandate is necessary to avoid adverse selection problems that can undermine efficiency enhancing risk pooling.  To which I reply: (a) the cross subsidies in Obamacare are excessive due to pricing restrictions, e.g., community rating, which would tend to exacerbate adverse selection problems, meaning that the mandate is even less palatable than it would be under more reasonable pricing policies, and (b) if your argument is so compelling, go ahead and make it support of a Constitutional amendment (analogous to the 13th Amendment which was necessary to adopt an income tax) that would eliminate all Constitutional objections to the mandate, and the prospect that court decisions in its favor would so warp the commerce and taxation clauses as to render the Constitution effectively a dead letter.  (Or, a deader letter than it already is.)  If you’re right, and you have a compelling argument, a Constitutional amendment should be no problem, right?

But that would require persuading a supermajority of voters, and we have seen demonstration after demonstration of the Progressive “elite’s” hostility to paying the slightest attention to vast swathes of hoi polloi, most notably the considerable Jacksonian element.  (Note that rural Missourians, the epitome of American Jacksonians, provided the vast bulk of Prop C votes.)

So we know that isn’t going to happen.  Which means that the intensity of the conflict will only increase in the coming months, and in the post-November period.  You blow off people, ignore them, on matters of great import to them, and you only turn up the heat on the boiling pot. We will move from the existing Era of Bad Feelings to the Era of Even Worse Feelings.

And it is almost certain that charges of racism will be among Obamacare’s supporters’ chosen ways of fighting back against a seething public.  You can already pick up intimations of that in looking at reactions to the Prop C vote on places like Twitter. This could usher in the Era of the Worst Feelings.

This will have so many awful effects.  It will only widen the divide between those who have legitimate objections to a mandate, and Obamacare generally, and its supporters.  The charge is so incendiary that it eliminates the possibility of any constructive dialog.  Baseless accusations only reduce the effectiveness of legitimate ones, thereby giving real racists cover.  It increases the emotional heat of the political environment without adding any substantive insight.

In brief, charges of racism are becoming the first and last refuges of political scoundrels.  That degrades our politics, divides our citizens, and is the recipe for protracted and ugly conflict.  And I think that the Missouri vote is the harbinger of a serious turn for the uglier.

Some Congressional Democrats testifying to their deep and abiding respect for the Constitution.

Rep. Phil Hare (D-IL).

Nancy Pelosi (D-CA)

Pete Stark (D-Senility) (Go forward to about the 2:37 mark.)

Gold Hat (Just another Federale):

I finally had a chance to do some preliminary analysis of cocoa data.  My initial findings are that price movements and price-stock relationships during July, 2010 were consistent with manipulation, and unlikely to have resulted from chance in a competitive market.

In brief, I executed the kind of event study described in my 2004 American Law and Economics article on manipulation, which examined the Ferruzzi soybean case.  For a January, 2000-June, 2010 control period, I regressed the change in the log of the July London cocoa price against the change in the logs of (a) the September London cocoa price, (b) the November London cocoa price, and (c) the July ICE New York cocoa price.  (I used the settlement prices for London, and the opening price from New York).  For each year, the data included in the sample runs from 1 March to the last trading day of the July contract.

Given the coefficients from the regression, I then forecast what the log change in the July price would have been for each day in the month of July, and take the difference between the actual log change and that forecast.  I then cumulated these residuals over the month of July, and calculated t-statistics using conventional methods.

The basic result is that the July, 2010 price rose about 6 percent more than one would have predicted, given the movements in the September, November, and July ICE prices.  The t-stat on this cumulative residual is as high as 2.95, which is statistically significant at all conventional levels.  (The p-value is about .1 percent.)  This rise in the relative price of July cocoa is exactly what you would expect to observe during a corner, and given the typical co-movements of all these prices, are highly unlikely to have occurred by chance in a competitive market.

Moreover, the July-September spread was the highest observed–by far–when the contract went off the board, then at any time dating back to 2000.  July was 235 GBP over September when the contract went off the board.  Prior to this year, the biggest back was under 100 GBP/ton.

Stocks rose rapidly in July at the same time that spreads were blowing out.  In a competitive market, you would expect stocks to plummet when spreads moved into a strong backwardation.

The spreads-stocks relation exhibits the typical “supply of storage” (or Working) curve shape, although it is somewhat noisy; backwardation is larger, the smaller are stocks.  By 12 July, 2010,  the stocks were very large for the amount of backwardation in the market.  Or put differently, given the level of stocks, backwardation was unusually large.  This is especially true if one adjusts for the strong downward time trend in stocks observed 2002-mid-2010.  After adjusting for the time trend in stocks, the spread usually associated with the level of stocks observed in mid-July 2010 was a contango of about 20 GBP–nowhere near a backwardation of 250 GBP.

Thus, the market exhibited all the indicia of market power manipulation during July, 2010.  There is no plausible competitive explanation.

The data cast the Sergeant Schultz “I see NUTHINK!” attitude of LIFFE, and the FT’s slobbering coverage of Tony Ward, in a very, very bad light.  The data support a manipulation claim quite strongly; LIFFE’s denials and the FT’s breathless Tiger Beat-esque coverage are very hard to square with this data.   One would have hoped that they would have taken at least a cursory–and skeptical look–at what transpired in the market before declaring that nothing is amiss.  One would have hoped in vain.

Jeremy Grant is going to town with stories and video interviews on the implications of clearing mandate on his FT TradingRoom site.  One that particularly caught my attention was this interview with Guy Sears.  They discussed the implications of clearing mandates on pension funds.  Sears says (about the 5:55 mark):

It’s about the governance and who carries the risk in this model.  Clearinghouses work by seeing an instrument and worrying about the risks of failure in an instrument.  How far away has it got from its original price?  What’s the market risk in the instrument?  At the end of the day, of course, what really matters is whether the guy holding the instrument is good for his money.  We would say that the pension schemes and savings pools are good for their money.  Making them provide margin to pay for everyone else’s risk is asking them to take part in socializing risks they really should have to pay for because they aren’t risky.

Sears makes a point that I’ve emphasized from early on that has largely been overlooked.  Specifically, two factors interact to determine the risk of default: instrument risk and balance sheet risk.  CCPs price instrument and generally don’t price balance sheet risk, except in the crudest and most problematic of ways.*

As Sears says, balance sheet risk–the risk that “the guy holding the instrument is good for his money”–is crucial.  Not pricing it leads to distortions in the allocation of trading activity across market participants.  It also means that those who use clearing do not pay a price for adding balance sheet risk, which distorts their risk taking decisions.

Sears effectively objects to charging pension funds the same price for risk as a hedge fund pays.  This is a fair objection.  It harms pension funds directly, but it can also distort trading activity, causing hedge funds to trade derivatives relatively more than they should, and pension funds relatively less.  Does this reduce systemic risk?  That seems difficult to argue.

Moreover, different entities have different ways of effectively undoing the effects of clearing.  High and frequently adjusted margins on cleared products mean, essentially, that market users are not in a credit relationship with the CCP, in the same way that they can be in a bilateral dealing.  But this means that mandating clearing frees up credit capacity that can be used to undo, in whole or in part, the debt-reducing effects of clearing.  Some entities, notably pension funds, have less ability to leverage up (and indeed, given their high creditworthiness, are not really in that much of a credit position relative to their counterparties in any event).  This means that a clearing requirement would hit pension funds particularly hard, and unjustifiably.

Pension funds will respond by (a) reducing their usage of derivatives, and (b) reducing their investments in higher return assets in order to accumulate the cash needed to post margins on the derivatives they do trade.  Response (a) means that these funds will incur higher transactions costs to achieve their investment and liability management objectives, and will bear more risks.  Response (b) means that pensions will be less remunerative.

The Frank-n-Dodd bill exempts retirement funds from the clearing mandate to the extent that they utilize derivatives for risk management/hedging purposes.  It is ambiguous whether this exemption would, for instance, cover a fund’s use of an equity derivative or commodity derivative contract to achieve an investment objective.  But the recognition that retirement funds might deserve different treatment is one good thing I can say about Dodd-Frank.  (Although it’s not evident whether this exemption was the result of a fluke moment of lucidity, or the lobbying power of pension funds–including public and union funds.  The latter would be rich indeed.)

But Sears’s main point holds.  Balance sheet risks are an important determinant of counterparty risks.  CCPs don’t price this risk.  This lack of risk pricing is costly.

* CCPs often impose capital requirements, but these are generally multiples of margins.  Since margins don’t vary with balance sheet risk, these capital requirements don’t either.  Moreover, CCPs sometimes condition margins on credit ratings.  Given the crudity of these ratings, and the perverse feedback that results from ratings change-induced increases in margin, this is a coarse and potentially destabilizing way of pricing balance sheet risk.

At a motorcycle rally, Vladimir Putin waxed eloquent on democracy and freedom (h/t So?, though I had seen something about it in my daily news trolling trawling):

Bike is the most democratic transport vehicle. Bike is the most daring, challenging as it gives its owner the tempting feeling of freedom, that is why one can say without any exaggeration, bike is a symbol of freedom.

I’d sooner listen to a mollusk orate on quantum mechanics than pay attention to a Putin disquisition on freedom and democracy.  The shellfish is more likely to know something about the subject, and will deliver his lecture without the hypocrisy oozing from Putin’s pores whenever he says anything about it.

As an illustration of the realities of democracy and freedom in Russia, consider this clip showing the arrest of Boris Nemtsov just walking to a 31 protest rally in Moscow (h/t R).

I find this puzzling.  I know (pace S/O and Mark A. and others) that it is widely asserted that “liberals” in Russia are highly marginalized, and widely despised.  So why go all dramatic with the arrests–before the guy even says anything–and the absurd crackdowns on any squeak of public protest?

One explanation.  Putin et al are so fearful of the precarious nature of their rule, so terrified of a color revolution in Russia, that they take no chances and snuff out any protest and protest movement, no matter how puny.  They suspect that opposition can go non-linear, and that permitting any protest could catalyze a chain reaction of opposition among a heretofore atomized but highly discontented populace.

Another explanation.  Knowing that liberals are widely despised in Russia, Putin et al pander to populist sentiments by harassing and humiliating them.

I don’t know how to test these competing hypotheses, and it is hard to evaluate them merely on their plausibility.

As for the first explanation, the level of fear and paranoia would have to be extreme, almost implausibly so.  It would speak volumes about the insecurity of the ruling clans.

The second explanation would reflect very badly not just on Putin and the ruling clique, but on Russians more generally.

Have at it folks, because I’m genuinely at a loss to reconcile  (a) the assertion that liberals are intensely unpopular and discredited, and (b) the Russian  government’s over-the-top reaction to any peep from them.