Streetwise Professor

This article by George Priest about the incoherence of the USDOJ Antitrust Division’s attack on the ATT-TMobile merger is worth a read.

The key fact that Priest focuses on is the response of Sprint’s stock price to the announcement of the Division’s attempt to block the merger.  If the merger really would reduce competition, Sprint’s stock price should have fallen.  The fact that Sprint’s price in fact rose is strong evidence that the merger would have increased competition in the wireless market.

The key analytical point in the article is this:

Much of the Justice Department’s failing on this issue derives from its failure to understand that network industries must be evaluated differently from more traditional, manufacturing industries. The market share guidelines upon which the Justice Department relies to oppose this acquisition may make sense in the context of manufacturing industries. But they make no sense in the context of networks in which there are great benefits from large networks with large market shares.

This was the mistake the Justice Department made in the Microsoft case almost a decade ago. It wanted to break up Microsoft, supposedly to create greater competition among Web browsers. The courts prevented the effort, and to good effect.

The rise of Google, Facebook and the competition from smartphones that resemble computers have shown that the focus then on browser competition misunderstood the rapidly changing nature of network competition. The Obama administration is making the same mistake with its opposition to AT&T’s acquisition of T-Mobile.

This is exactly right.  And it helps explain the intellectual confusion at DOJ and in the European Commission on all matters relating to financial exchanges and financial markets.  Financial trading is a network industry, and the same failure to understand the implications of network economics for market structure that has muddled antitrust enforcement in telecomms and software is leading to a similar muddle in antitrust analysis of financial markets.

Back in June, at a nice lunch with several LCH.Clearnet executives in The City, I was asked my opinion on the company’s future.  Recent news, notably the offers for the company by Markit and LSE, have brought that conversation to mind.

My answer was that I thought that the trend towards vertical integration by exchanges was inexorable, and that there were good economic reasons for this (which I have discussed for years here on SWP).  As a result, I didn’t/don’t consider the model of an independent firm clearing for multiple execution venues/exchanges to be viable.  Especially with Frank-n-Dodd and Emir, but likely even without that impetus, there definitely will be increasing opportunities for clearing OTC derivatives.  (Although I cautioned that if the ambitions of regulators and legislators to make OTC trading exchange-like were successful, the same kind of dynamic now playing out in listed derivatives could occur in swaps.)  So SwapClear is clearly a viable business (similarly, RepoClear).  But major dealer firms would demand considerable influence over, and perhaps control over, the clearing entity.  Any such entity would either be, or closely resemble, a member cooperative.

My prediction was that (a) the exchange clearing business of LCH.Clearnet would either go away, or be absorbed into an exchange or exchanges, and (b) the swap clearing business would be largely in the orbit of the big dealer banks, although how that would be achieved organizationally remains to be seen.

The LSE offer is clearly intended to obtain the in-house clearing capability that LSE has lacked for decades (in part due to its own missteps in the 1970s and 1980s).  But LSE has no comparative advantage in operating the OTC clearing business, and the dealer banks have no interest in having LSE control it.

In contrast, the OTC derivatives business is a much closer fit with Markit, given the overlap between the membership of OTCDerivNet (which governs SwapClear) and the ownership of Markit, and the synergy between Markit’s OTC valuation, processing, and data business and OTC clearing.  But Markit really has no need for LCH.Clearnet’s listed clearing business.

So the sensible outcome would be to split the baby, with LSE taking over its own clearing by acquiring part of LCH.Clearnet, and Markit taking the OTC-related business.  That end state seems much more sensible than either LSE or Markit swallowing all of the big London-Paris clearer.  How that end state is reached–how the baby actually gets split–will be quite interesting to watch.  I am sure there will be much drama in the coming months.

There are news reports providing some glimpses into draft regulations regarding the regulation of derivatives and securities markets in Europe.  It looks like it is taking some of the worst of Frank-n-Dodd, and adding some dumb flourishes of its own.

Insofar as the worst of Frank-n-Dodd is concerned, despite initial indications to the contrary, it looks like the proposal is going to incorporate something like a SEF requirement.  You might recall that on The Monster’s first birthday, I named the SEF requirement as its worst feature.  Well, the Euros (don’t they have bigger problems right now? Just asking.) don’t look to be avoiding the US’s mistake:

Widely traded derivatives would have to be transacted on an electronic platform to improve transparency and safety, draft European Union rules showed on Monday.

The bloc is overhauling its markets in financial instruments directive (MiFID) to catch up with technological advances, apply lessons from the financial crisis and deal with problems such as price fragmentation raised by the original rules.

“The main aim of the proposal is to ensure that all organised trading is conducted on regulated venues and is fully transparent,” the draft, seen by Reuters, said.

More specifically, world leaders agreed in 2009 that derivatives, largely traded bilaterally between banks in an opaque $600 trillion sector, should be traded electronically.

This will give supervisors the full picture of who is affected when a counterparty gets into trouble, which they lacked when Lehman Brothers bank collapsed three years ago.

“The proposed revision will shift trading of the suitably developed derivatives to such platforms,” a draft of the MiFID reform, now circulating widely in Brussels, said.

“This obligation will be imposed on both financial and non financial counterparties,” the draft added.

Another unfortunate imitation is the adoption of restrictions on commodity speculation, including position limits:

The European Securities and Markets Authority should have the power to impose position limits on traders in crisis situations when “the stability of the whole or part of the financial system” is threatened or “delivery arrangements for physical commodities” could break down, the document says.

The Euro flourishes are clearing-related, although here I have to say that the reporting is not too clear.  As I’ve written in the past, European regulators are obsessed with the vertical integration of execution and clearing–the silo issue.  Various reports (including the two linked above) and this one suggest that the regulators will force CCPs to be open access.  The reporting also states that integrated exchanges will have to share data streams, including calculations of indexes that are the basis for traded products.

Insofar as open access is concerned, the FT article quotes language stating that CCPs will be required to accept trades for clearing “on a non-discriminatory and transparent basis, regardless of the trading venue on which the transaction is executed.”

The idea here is to facilitate competition between CCPs, apparently.  But it is fraught with difficulties.

For one, there is the question of why a dominant CCP, including one that is integrated with an execution venue, would turn away business.  Even if it is a monopoly, it could sell clearing services at the monopoly price.  If, as the anti-silo crowd commonly argues, the execution of transactions is potentially highly competitive, absent some cost, the monopoly CCP would maximize profits by selling its services at the monopoly price.  It wouldn’t be necessary to mandate open access.  The CCP would gladly offer access–for a price.

It is therefore necessary to understand why an integrated CCP wouldn’t sell clearing services to others on an open access basis.

One possible reason is that the dominant CCP believes that open access rules will eventually result in the regulation of the prices it can charge for its services.

I think a more important reason relates to a fundamental misunderstanding  among the Europeans of the way competition is likely to work.  There are two possibilities.

One possibility is that there remains a single clearer–given the cost conditions in clearing, that’s not unlikely, although it seems that the Europeans think that they are constructing rules that will reduce the likelihood of this outcome.  Note that particularly now, financial trading is highly technological.  There will thus be the necessity of coordinating technologies and changes in systems between the execution venues and the clearer.  This can be very difficult to achieve across firm boundaries; this is one of the factors that I identified as justifying integration well over 5 years ago.  It should also be noted that this is precisely the reason given for many recent exchange decisions to integrate into clearing; the LSE is the most recent and prominent example of this.

The other possibility is that there are multiple CCPs offering to clear a particular instrument.  There are myriad challenges to this, but I’ll focus on just one.  In particular, assume a transaction in a particular instrument is cleared at CCP A and CCP B.  A trade is executed on venue X.  If the parties to the trade can choose independently where to clear, the buyer may submit the trade to A and the seller to B.  In this case, A and B must be interoperable.  Interoperability is extremely challenging.  It is likely to increase collateral costs (as A and B are going to require collateral from each other).  Moreover, A and B may find it difficult to negotiate an interoperability arrangement because of (a) competitive pressures (the model the Europeans seem to have in mind involves a unique balance of competition and cooperation), and (b) distrust of each other’s risk management, arising from the difficulties of monitoring.  Moreover, the technology/system coordination issues are now multiplied, as X has to coordinate with both A and B.  And if there are multiple execution venues (Y and Z, say) as the Euros presumably hope and expect, these difficulties are multiplied accordingly.

Having an exclusive arrangement with an execution venue avoids this problem.  Those trading on X could be required to clear on A, for instance.  But that just raises the same kinds of problems as if there is only a single clearer.

In brief, it is hard to see how robust competition between CCPs is possible.  Once that is admitted, the whole basis of the regulation collapses.

The whole evolution of the exchange space–most notably in Europe–in the past 5 years is exactly contrary to the thrust of the proposed regulation.  And maybe that’s the point: the Euroregulators are clearly bugged by this trend.  But maybe they should try to understand it first; it’s pretty evident that they don’t now.

Case in point: LCH.Clearnet’s difficulties–its loss of exchange clearing business (EuronextLIFFE, ICE, and almost certainly LSE)–suggests that integration is not primarily driven by anticompetitive impulses.  Instead, in my view it reflects the difficulties of coordinating complementary activities across firm boundaries in a highly technologically dynamic industry.*  At the very least, the Euros should consider that possibility, and take it seriously, before attempting to micromanage the structure of a dynamic industry with strong network characteristics.

Instead, it seems that the regulations are based on an intellectual framework that would be suspect in any industry (as I’ve written about before), and which does not seem to take into account that unique characteristics of financial trading: network effects, scale  and scope economies, technological dynamism, and information asymmetries with respect to performance risk.

So, if the European endeavor is truly the son of Frank-n-Dodd, it may well be the ugly bastard child.  It has the defects of F-n-D, and adds some more–as if more were needed.

Perhaps this is Brussels’ negotiating position.  There is considerable opposition (particularly in Germany–go figure) to some of these initiatives, and maybe the EU is proposing a more radical change in the knowledge that it will have to be watered down.   One can only hope that it drowns.

* I spoke at an FIA panel that touched on this issue in March, 2007.  I made the coordination point.  Charlie Carey, then head of the CBT (which had already agreed to sell out to the CME–this was the day before ICE made its surprise offer) was sitting next to me.  After I made this point, he handed me a note that said that was an extremely important, but insufficiently appreciated, fact.

Via JRL (item #5), this article from Argumenty Nedeli assesses the domestic consequences of Putinism:

But as regards domestic politics and the economy, the situation here is completely different. It is hardly worth talking yet again about the crazy rise in (natural monopoly and municipal services) tariffs and the decline of Russian industry, science, and education. Although the fruits of this decline have become totally tangible. Inscrutable Chubays-type nanotechnologies attempt in front of the television cameras to sell him duff Chinese consumer goods in the shape of the latest e-books for school kids. In the last nine months alone the country has lost six satellites worth a total of 15 billion rubles. Military depots are blowing up, leaky ferry boats are sinking, aircraft are falling out of the skies in droves. The reason for this, analysts say, lies in the flawed model for managing sectors of the national economy. It has either been sold off or handed over not to experts but to “insiders.” It is toward them that Putin’s other face is turned. There are significantly fewer of them, but they control the levers of administration.

For example, our long-suffering civil aviation sector is run from the Trade Ministry (!) by Moscow State University Sociology Department graduate Manturov. It is he who is being described as the main destroyer of leading aircraft firms with a worldwide reputation. It is possible to familiarize yourself with the details at professional forums. Agriculture Minister Skrynnik graduated from the Chelyabinsk Medical Institute. Health Minister Golikova graduated from the Russian Economic University Named for G.V. Plekhanov. Her husband — Trade Minister Khristenko — is a Chelyabinsk Polytechnic graduate specializing in “construction engineering.” Defense Minister Serdyukov is a graduate of the Leningrad Institute of Soviet Trade and recently of the Law Department.

It would be possible to dig even deeper. But everything is clear anyway. According to the laws of nature, people who find themselves in the wrong place first get rid of those who are professionally smarter than they are. This is what is happening in the Health Ministry, the Defense Ministry, and the Agriculture Ministry alike…. And what is the result? In the last 10 years the Caucasus that Putin subjugated has started to consume more money than during the period of military operations. The Yeltsin oligarchs have been replaced by Putin oligarchs. There are more of them. And for understandable reasons they will do everything to ensure that Vladimir Vladimirovich remains in power for as long as possible. It can also be said that V. Putin’s entourage will not allow him to leave power. As members of the Communist Party of the Soviet Union Central Committee Politburo would not allow L. Brezhnev to go in the not-too-distant past. So the only thing left for us to do is to dream that he will nevertheless listen to the opinion of others. And his billionaire friends also have something to think about. As the experience of our neighbors shows, today there is nowhere to run. So it is becoming increasingly dangerous with every passing day to preserve the order of things whereby the country’s economy is run by “cooks.” And it is not even a matter of a possible revolution but of universal apathy.

It is hard to say what scheme might be used to form a new cabinet. But it cannot be done without consulting and taking account of the opinion of at least the establishment opposition represented in the State Duma. The current set of ministers consists totally of rich people. They no longer need anything.

Apart from guarantees against prosecution.

The most interesting aspect of this is the description of the non-entities in charge of various ministries outside of their ken of expertise, such as it is.   This is a natural strategy for someone like Putin: it makes it far less likely that a powerful rival will arise from  within the government.  I also found this sentence amusing: “According to the laws of nature, people who find themselves in the wrong place first get rid of those who are professionally smarter than they are.”  This is in accord with the accounts I’ve heard from people who have worked with Russian companies, especially energy companies, who tell of large operations under the direction of incompetents appointed for their political reliability and whose efforts are concentrated on crushing anyone who knows more than he does (and it is invariably a he)–which means trying to crush just about everybody.  Dilbert goes to Russia, in other words.

The desire of the made men for Putin to stay in control is understandable, and something I’ve discussed in the past years.  The political contingency of property means that no matter how wealthy you are today, that can disappear in an instant when political winds change.  Indeed, you can go from being a billionaire to being a convict in Siberia, or a man without a country (like Luzhkov).  Any political change bears with it the prospect of a reallocation of property.

Stultifying stability is therefore a virtue in this system, especially for the “elite” (where the term  is used loosely when applied to a group that includes a disproportionate number of mouth breathing judo experts).  Putin is the equilibrator, the balancer.  Without him, the balance would almost certainly be lost, sparking the equivalent of a mob war a la the Godfather, the Five Families in New York, or Capone vs. Bugs Moran in Chicago circa 1927.  Like in Tsarist Russia, before the Crimean War, anyways, real change is an anathema.  Only a systemic crisis, or a shattering military reverse, will spark real change.

There has been a lot in the news lately about the bankruptcy of solar panel maker Solyndra, the recipient of both massive Federal largesse (a mere $535 million), and lavish praise from Obama as the exemplar of the potential for green jobs and Federal programs to support them.  “The future is here” spake Obama (starting about the 9:00 mark):

Now, I actually have to agree completely with Obama on this one.  It is indeed a great example of what we can expect when subsidizing “clean energy” companies. Incredible potential to propel our economy for years. Right. But in which direction?

But that issue has been well-covered by others.  I want to focus on a narrower issue.  Remember in 2009, when the secured creditors of Chrysler were expropriated (that’s a nice way to say “hosed”) when that company went into bankruptcy?  Their purportedly senior claims were in fact subordinated to junior, unsecured creditors.  The secured creditors were the subject of vitriolic criticism from Obama personally, and from the administration and its media water boys.  It was an early indicator of the crony capitalism to come.

In the Solyndra case, a major Obama bundler George Kaiser–from very red-state Oklahoma, of all places–is an investor in Solyndra.  More to the point, when the company was in trouble back in March, it borrowed $75 million dollars, in part from the George Kaiser Family Foundation.   Crucially, this loan was made senior to most of the outstanding debts owed to the Federal government ($385 million out of the $535 million in total provided by Uncle Sucker).

So it will be quite interesting to see whether Kaiser, the Obama donor, gets the Chrysler secured creditor treatment, or whether the administration will have found a strange new respect for the virtues of strict adherence to priority rules in bankruptcy.

I read Mark Thoma’s Economist’s View blog to get a view on the views of people who think quite differently than I.  It is particularly useful in that regard because although Thoma writes quite a few posts, he is more of a linker than a writer, so EV is an efficient way to get exposed to the views emanating from the Keynesian-left of the blog world.

Which means that whereas I think “aggregate demand” has something to do with the cement market, Thoma is definitely of the what-we-have-here-is-a-failure-to-demand-enough-in-aggregate kind of guy.  Which further means that he is frequently looking to rebut alternative explanations for poor economic performance.  Him being him and me being me, I usually find his efforts implausible, but this one particular effort of his is particularly lacking, and is sufficiently close to my bailiwick to warrant a rebuttal.

“Of his” might be a little strong, for the post in question primarily endorses the analysis of another blog, but he doesn’t even quibble, so attributing ownership is fair.  In any event, the alternative theory at issue is “regime uncertainty”; the view (originally developed by Robert Higgs) that uncertainty about government policy (and the economic environment at large) discourages hiring and investment.  Higgs originally applied the idea to the Great Depression: he argued that the frenetic regulatory activity of the Roosevelt administration created investment-killing uncertainty that prevented a normal rebound.  The similarities between what happened in the 1930s and what is happening today has led to an application of this view to current circumstances, just as it has led to a revival of old school Keynesianism which was born during the Great Depression.

Thoma links to a Gary Burtless piece that purports to debunk regime uncertainty as a cause of the current lack of growth in hiring and investment:

A couple of hours after talking to an ABC correspondent about the woeful job numbers and what might be done to improve them, I was in the Bloomberg TV studios debating a guy from Heritage. He went on for several minutes about the damage being done by high taxes, excess regulation, business “uncertainty” about future tax hikes and regulatory burdens.  I asked Bloomberg’s host whether he was aware that corporate profits relative to national income had just hit a 60-year peak?  He had heard rumors to that effect.  Was he aware that taxes on corporate earnings were at a 60-year low?  The Heritage guy had heard that might be the case.

Then why was uncertainty about taxes and the future burden of the Affordable Care Act holding back business investment and hiring right now?  If managers thought taxes or regulatory costs might go up in the future, wouldn’t it make sense to take advantage of today’s low taxes and lower burdens to invest and hire today?  According to the “uncertainty” argument, businesses are fearful they might face high taxes and extra health costs in 2016 or 2018.  Shouldn’t they expand hiring right now and scale back employment when they actually face higher costs (if they ever do)?

The “tax uncertainty” and “regulatory uncertainty” arguments would make more sense if, say, taxes were already high and might be going higher or regulatory burdens were heavy and might be getting heavier. But when taxes are at a 60-year low and the regulations are pretty much the same as they were in the 1990s boom, the argument makes no sense at all.  As we used to say down on the farm, you should “make hay while the sun shines.” In other words, if you think it’s going to rain later in the week, it strengthens the case for cutting and baling right now.

This is utterly confused, and a complete mischaracterization of the regime uncertainty view.  It focuses on expected costs associated with policies like Obamacare (and, I might add, like Frank-n-Dodd and the EPA and the NLRB and on and on); the argument is essentially that if costs are expected to be higher in the future, why not hire more today?

But this focus on expectation (itself flawed–more below) is to misstate completely the essence of the regime uncertainty argument, which, believe it or not, is about uncertainty–variation around the expectation.   It can be conceived best as a real options argument.  Hiring is like an investment: there is a cost of hiring–and firing–workers.  This cost is not immaterial.  This cost is like the strike price of an option on the right to hire a worker and receive a stream of benefits from employing her.

This stream of benefits is uncertain.  Moreover, policy uncertainty is a major driver of the variability of this stream of benefits.  Nobody knows how Obamacare is going to play out.  Nobody knows what the actual costs of compliance are going to be.  If the burden turns out to be very high, the stream of benefits from hiring a worker (or investing in a new machine or a new product) could be quite low, and even negative.  If the burden turns out to be low, the stream will be commensurately higher.

Options pricing theory basically implies that in the face of such uncertainty, it is often optimal to defer paying a sunk cost (the strike price) until the uncertainty is resolved.  This is why it is usually better to defer the exercise of an option as long as possible, unless there is a stream of benefits (e.g., dividends, interest on the strike price) that can be obtained only after the option is exercised.  When to exercise the option–including exercising the option to hire somebody–depends on a trade-off between getting some benefits immediately, and waiting for the resolution of uncertainty about the value of those benefits in the future.

An immediate implication of this is that the greater the uncertainty about the future, the costlier it is to exercise an option early.  In the present context, higher uncertainty about the future means that firms will hire less today, all else equal.  Hiring a worker today (or investing in a machine or product) generates a stream of benefits for the employer in the short term, but if there is considerable uncertainty about the future value of that stream, it is often wise for potential employers to defer incurring the strike price (the cost of hiring) until some of that uncertainty is resolved.

In the investment literature, the option value of waiting for the resolution of uncertainty drives a wedge between the rate at which firms discount risky expected cash flows and the discount rate implied by something like the CAPM.  It helps explain why firms frequently use very high hurdle rates in capital budgeting decisions–and high hurdle rates tend to discourage investment, relative to those that would be undertaken using CAPM.  In other words, real optionality tends to reduce investment.

The same effect is at work here.   The Burtless argument endorsed by Thoma focuses on expected future benefits.  But since these future benefits are risky, and a cost must be sunk to achieve these benefits, there is a cost wedge–the option value of waiting–that is attributable to uncertainty.  The more the uncertainty, the greater the wedge.

In other words, the Burtless-Thoma “rebuttal” of the regime uncertainty analysis is nothing of the sort, because it completely misses the basic insight of that analysis.  When hiring is viewed as a real option–which is a fair analogy–uncertainty matters.  It is variation around the expected value that matters, but Burtless-Thoma focus on the expected value.

In other words: swing and a miss.  (Burtless’s argument is also strange even on its own terms because it presumes that firms don’t take future costs into account when making hiring decisions today.  Even absent uncertainty, higher future costs will deter hiring today if there is a fixed cost to hiring.)

There is no doubt that uncertainty is abounding today.  Just look at Europe for one example.  But even closer to (my) home, the uncertainty is immense.  One small example: the Obama administration’s request that the EPA defer action on ozone rules.  The key word here is defer.  It hasn’t been killed with certainty.  Its return depends on future political and economic developments: Obama loses, it is likely dead forever; Obama wins, it is likely to be revived, especially if the economy is doing somewhat better.  These future developments are fraught with uncertainty.  Moreover, the costs of the rule itself are highly uncertain, ranging from the EPA’s (typically risible) estimate of around $100 billion to more than ten times that.  Which means that although the suspension of the rule should reduce the expected cost of compliance which should in turn lead to greater economic activity, the suspension also creates a significant increase in uncertainty that will offset this effect.

One could repeat this exercise over and over and over.  Just focusing on one agency–the CFTC–would provide numerous examples.  And if you think that particular policy uncertainty would just affect, say, banks, you would be so wrong.

It is foolish in the extreme to disregard the economic drag that such policy uncertainty can create.   Most economic decisions–hiring and investment notable among them–are effectively real options.  The decisions to exercise real options depend on the amount of uncertainty.  Uncertainty has first-order effects on these decisions.  Thoma (and Burtless) may believe they have discredited regime uncertainty as an explanation for our current malaise, but they have done nothing of the kind.  Indeed, they completely miss the point and thrash a straw man.  Regime uncertainty is still a very viable and plausible explanation of the reluctance of firms to hire and investment.

Izabella Kaminska writes very interesting posts at FTAlphaville.  She finds unusual things in the markets, including the commodity markets, and writes about them intelligently and provocatively.  I have to take issue, however, with one of her more recent efforts.

She takes as her inspiration an article by the improbably named (to an American ear, anyways) Hilda Ochoa-Billembourg.  Izabella’s takeaway from HOB (you didn’t think I was going to type that again, did you?) is that the Achilles heel of QE2–which, remember, was specifically designed to produce some inflation–was that it did not produce the right kind of inflation (something which Bernanke adamantly, and not too plausibly, denies):

If you work with the premise that QE2 led to what has been described as ‘bad inflation’ — inflation being exported into commodity and emerging market securities rather than domestic ones — you could argue the Fed has always had an interest in sterilising that inflation effect.

What to do then?  Have the Fed intervene in the commodities markets by selling longer-dated futures, of course!  Kaminska suggests that the Fed–or some Government Body To Be Named Later–did this, although her argument here is highly circumstantial and, uhm, speculative.  Now that deflation fears are reviving given the European tumult and the palpably slowing US economy, she suggests that it could be just the right time for the Fed or GBTBNL to buy commodity futures.

Or not.  I have problems with the argument from start to finish.  It is predicated on the view that speculators are driving the curve (although Kaminska admits that it doesn’t affect spot prices)–a highly dubious proposition.  It presumes a sort of disconnect between the Treasury market and the energy (and other commodity) futures markets (“One might even say that the market has shifted from expressing inflationary views via the Treasury market to the oil market.”  If so, there’s money to be made!) Although she recognizes–blessedly–that speculators affect the risk premium embedded in futures prices, she confounds a risk premium with an inflation expectation effect (which should be impounded in the interest rate terms structure in any event).  Most notably, she makes the all-too-common mistake of confusing Keynesian contango/backwardation–which is a difference between a spot price and an unobserved expected future spot price–and contango/backwardation of the observed curve, which is the difference between traded prices.  (An expected spot price is not traded.)    The risk premium can change without having any impact on the shape of the futures curve; the effect of the risk premium–and hence hedging/speculative balance–on the futures curve is indirect, operating through the effect of the risk premium on inventory decisions: roughly speaking, more Keynesian backwardation (hedgers pay speculators a greater risk premium) leads to less inventory which tends to reduce the contango/increase the backwardation in the curve.  But detecting this effect is hard even in a simulated market, let alone in a real one.  Her story also depends on an implausible relation between speculation and the Brent-WTI spread.

But put all that aside.  Assume it’s all correct.  Do we really want the Fed, or any other GBTBNL, monkeying around with still more relative prices?  Really?

Several times I’ve recounted the story of the great economist Sherwin Rosen, who in 1982 startled an 830 AM section of his Econ301 class at Chicago by shouting: “And that’s the problem with inflation.  It FUCKS UP RELATIVE PRICES.”  Well, of late the Fed apparently thinks that effing up relative prices is its job.  Heretofore, its efforts (unless Izabella is right that the Fed has been active in commodity markets as well) have focused on the yield curve and inflation expectations: twisting this rate relative to that–or is it torquing?

How is that working out for us?  Trivial growth in the H1 2011.  And how about that last jobs report!  Or should I say, that no jobs report?

We really don’t need it attempting to affect–to f*ck up–the relative prices of commodities or anything else.  Indeed, the now common diagnosis of the failure of QE2 (which you might have read here first, well before its end) is that the Fed’s intervention screwed up relative prices: forcing down the dollar, which induced other countries to intervene to prevent undue appreciation of their currencies, thereby sparking inflation in emerging markets, which has led to yet further policy responses; forcing up commodity prices, which put a drag on developed economies.  So we should now believe that there will not be any unintended consequences on other relative prices from an attempt to intervene into the commodity markets?  Really?

The probability that the Fed could somehow tweak relative prices just right this time based on a theory that would do Professor Irwin Corey proud, and which could use a good trip to the barber for a shave with Occam’s razor, is vanishingly small.  The probability that it would wreak yet additional havoc through such an intervention approaches one.

The problems are almost beyond numbering.  There is the knowledge problem: how could the Fed possibly know what the “right” relative prices are?  There is the implementation problem: how could the Fed actually achieve the relative prices it wants to, if by some miracle it could divine what they should be?  There is the strategic/expectations problem: how could the Fed succeed given that it would not be acting on automotons, but on live, thinking, reactive, strategic actors who respond to the Fed in ways that are hard to predict?

No, as Sherwin might say if he were still alive: the Fed has f*cked up relative prices enough, thank you.

So Ben, et al: Stop before you do even more damage, and inject more uncertainty into an economy that is already reeling from it.  We need no more Sorcerer’s Apprentice interventions.  Don’t just do something, stand there.  Become what you were intended to be–a lender of last resort to address liquidity problems and banking crises–and stop trying to be some grandiose central planner that manipulates price signals to achieve some “aggregate” outcome.  It hasn’t worked up to now, and it won’t work any better if you double down.  Do more by doing less.  Go away and leave us alone.

In brief, we may need to revise Reagan’s statement of the ten scariest words in the English language: now, it should be “I’m from the Fed, and I’m here to help you.”  With help like this . . .

Yesterday SWP passed the 10,000 comment mark.  And the winner was . . . new commenter Pauli, who nosed out workhorses Pahoben and Tim Newman.  Thanks to everyone who has contributed their thoughts, views, sarcasm, invective, etc.

I hope all my US readers enjoy a good Labor Day weekend.

Thanks again to all readers, and especially all commenters.

The French–who were not shy about criticizing American motives in Iraq–have no compunction in profiting from their intervention in Libya:

French Foreign Minister Alain Juppé said he thought it would only be reasonable if French companies benefited from preferential access to Libyan contracts given that Paris, together with the U.K., led the foreign military offensive in Libya.

“The NTC has said very publicly that, in the reconstruction effort, it would give preferential treatment to those who supported them,” Mr. Juppé told French radio RTL. “That seems quite logical and fair.”

Bien sur.  Tres, tres logique.

This is very French, and very predictable.  Just keep it in mind, though, when evaluating French pronouncements on the motives of other nations.  Faites ce que je dis, pas ce que je fais.

The Russians have been even more shameless than usual.  Medvedev reluctantly decided not to veto UN authorization of military force in Libya, which set off fierce criticism within his country.  When it became evident that Gaddafi would lose, there was much wailing and gnashing of teeth–about how disastrous this would be for Russian commercial interests.  Now they are trying furiously to reverse field, and cozy up to the National Transition Council, which they just recognized as the legitimate government of the country.  For one reason only: the oil.  And whereas they were intent on securing privileged access to Libya when Gaddafi ruled the roost, and were highly critical of NATO’s efforts to remove him, now they want everybody to share:

Russia, which abstained when the United Nations Security Council passed its March resolution authorizing the use of force in Libya, has said the U.N., not a small group of countries, should take the lead in supporting Libya’s reconstruction.

Good luck with that.  The mercenary (e.g., the French, the Italians) can see their like coming from a mile away.

The whole Libyan episode has been a tag team between cynicism and incompetence.  What could have taken days if done with a will took months, at the cost of numerous additional civilian deaths–the prevention of which was the stated purpose of the intervention.

And if the past is any guide, it will only get worse from here.