Streetwise Professor

June 29, 2013

The Fed Plays a Global Game, and Loses

Filed under: Economics,Financial Crisis II,Politics,Regulation — The Professor @ 7:21 pm

The Fed is reeling at the violent market response to Bernanke’s statements regarding the eventual taper of Quantitative Easing.  High level Fed officials flooded the zone last week, making soothing noises and arguing that the market had overreacted to Bernanke’s words.

There is some solid economic theory that predicts that the public release of “small” pieces of information can lead to big changes in behavior and market outcomes.  Specifically, the theory of Global Games (see a variety of paper written by Morris and Shin, in particular) predicts that the release of objectively trivial information can lead to a discontinuous jump from one equilibrium to another in coordination games.  The Fed is quite consciously playing a coordination game: it is trying to coordinate the expectations of market participants with the understanding that market outcomes depend quite crucially on consensus beliefs and expectations that tend to be self-fulfilling This is precisely why the market hangs on every Fed statement, every Bernanke utterance.  And this is precisely why a seemingly benign public statement with little information content can lead to a big market move.  It’s inherent in the game the Fed is playing.  They really shouldn’t be all that surprised.

The game the Fed is playing is actually even more complicated than those analyzed in the Global Games literature.  Specifically, there is a reflexivity and endogeneity in the Fed expectations game.  That is, in the real world game game, the Fed responds to the market’s response to the Fed’s actions, and on and on.   That’s not taken into account in the Global Games models, makes things even more complicated, and adds another level of beliefs on which the players of the game (which includes the Fed, prominently) must coordinate.

This is why QE and other exceptional monetary policies are so fraught with danger and risk.  This makes chess look like checkers.  Mistakes will be made.  You will pay for them.

The Ugly American

Filed under: Derivatives,Economics,Politics,Regulation — The Professor @ 6:39 pm

Outgoing CFTC Commissioner Jill Sommers always struck me as a careful, precise, controlled person.  Certainly not a bombthrower, or someone prone to outspoken outbursts.  Which is precisely why I did a double take when I read this:

“No one has ever accused Gary Gensler of being reasonable,” Sommers said in her statement. “I may not totally agree with it, but Commissioner Wetjen has put a reasonable proposal on the table that would achieve multiple goals. He understands the importance of working in good faith with other global regulators.”

Whoa. Well said, Commissioner.

Truth be told, Gensler has pretty much worn out his welcome in DC-not to mention the rest of the world.  He is on his way out in July, and there will be few that will lament his departure.  I was just in London, and my criticism of Gensler (you’re shocked, I’m sure), and in particular of his obsession with moving forward with proposed guidance on cross-border regulation, went over quite well.  Based on my observations in London, the EU, and Canada, Gensler is viewed as the Ugly American, intent on imposing his worldview benighted furriners.

But even in the US Gensler has worn out his welcome.  A group of 6 Democratic senators-including Chuckie Schumer, for crissakes-wrote a letter asking Gensler to back off.

Despite his lame duck status, Gensler is stubbornly holding out against this near unanimous criticism.

Or perhaps I should say, because of his lame duck status, Gensler is stubbornly holding out.  For his insistence on plunging ahead in the face of near universal opposition gives every appearance of being the product of pique at not being reappointed to another term as Chairman.

But he has an enthusiastic supporter in Elizabeth Warren.  So there’s that.

Need I say more?

The Cartwright Leak Investigation: A Small, Ugly Story With Disturbingly Russian Overtones

Filed under: Military,Politics,Russia — The Professor @ 5:11 pm

Retired Marine Corps general, and former Vice Chairman of the JCS, General James Cartwright, is apparently on the verge of being indicted for the leaking of information about the Stuxnet virus.  Many things are disturbing about this.  Yes, the leak-if Cartwright did indeed leak-is disturbing, and I excoriated the administration for this leak last year.

But that’s not the only thing that is disturbing.  Sadly, leaking by figures in the government and the military is ubiquitous.  The leak is the tool-or weapon-of choice of virtually every major figure in DC.  Some very esteemed figures are alleged to be notorious wielders of the leak weapon (Colin Powell comes to mind).  Meaning that since pretty much everybody does it, the few prosecutions that do occur are inherently arbitrary.  The fact that a damaging leak occurred is not the catalyst for an investigation or prosecution: instead, the ubiquity of the leaks and the rarity of prosecution makes it clear that prosecution is driven by score settling or ass covering or something other than the leak itself.  That is, a leak is not a sufficient condition for prosecution.

It’s very Russian, in a way.  In Russia, high-level corruption is rife-nay, universal-but investigations and prosecutions of high-level corruption are extraordinarily rare. The investigations or prosecutions (Surdyukov comes to mind) are a cudgel used to punish those who have fallen from favor, or attracted powerful enemies, or have become inconvenient for some reason.  A corruption allegation is a handy hammer to bludgeon someone who has committed some other sin.

Obviously, this analogy to Russia is not a compliment.

I don’t know why Cartwright is in the crosshairs, but I’m sure that the leak qua leak isn’t it: if it were, every heavy hitter in DC would be perp walking.  There’s a real story here, and I am sure it is a very small, ugly story indeed.

June 27, 2013

Did the PBOC Blink? Uhm, Yes.

Filed under: China,Economics,Financial Crisis II,Politics — The Professor @ 6:36 pm

The WSJ’s ChinaRealTime blog asks that question.  The answer is fairly obvious.

Recall about a week ago that China was experiencing an acute liquidity shortage, resulting in the spiking of repo rates to 25 percent intraday.  The PBOC remained aloof.  Then it intervened, providing liquidity and making soothing noises.  Interbank rates (SHIBOR) and repo came back down, though they still remained at elevated levels.

The narrative is that the PBOC was trying to teach banks and shadow banks (trust companies, marketers of wealth management products and the like) a lesson: cut down on the extension of dodgy credit, or else!

But as I noted in my post last week, the PBOC was in a bind.  It could refuse to supply liquidity, and watch the system blow up.  Or it could supply liquidity, and undermine the credibility of its “or else” threat.  Not surprisingly, PBOC chose the latter course.

The ultimate result is likely to be quite different than the PBOC had hoped for.  Banks and shadow banks will likely conclude that the PBOC will always come to the rescue.  The “or else!” threat is incredible.

Meaning that Chinese credit will continue to grow, and the ultimate reckoning-which must occur-has been merely delayed.

I have read some reports questioning where money invested in WMPs will go at the end of the quarter, when they mature.  Well that’s the problem, isn’t it?  If the WMPs can’t roll over, if the money invested in them goes somewhere else, the rather dicey assets they hold can’t be funded, with the following consequences: (a) some WMPs will default, (b) others will call on the (implicit) liquidity puts extended by banks, thereby communicating the contagion to the banks, and/or (c) WMPs will dump assets on the market, depressing prices, with deleterious consequences for others holding similar assets.

The PBOC is riding the tiger. Its relenting at the last minute makes it clear that it is loath to dismount.  Market participants will note this, and respond accordingly.  Meaning that the supposed teaching moment will not provide the lesson that the PBOC intended.  It will instead convince market participants that they will be rescued if it looks like the system is about to crack.

Again: the reckoning with China’s extreme financial imbalances and malinvestment has merely been deferred.

The Sun Rose in the East Today

Filed under: Economics,Energy,Politics,Russia — The Professor @ 3:10 pm

And in other news of the completely predictable, Russia announced that it was backing off on its privatization plans:

The Russian government halved its privatisation target for next year on Thursday, as Kremlin officials loyal to President Vladimir Putin tightened their grip on economic policy.

And I bet that half will be halved.  And that quarter will be halved . . . until in the limit it will approach zero.

And, of course, the reason is that the price isn’t right.  The price is never right.  Bob Barker could never earn a living in Russia:

“The current state of financial markets is such that it would, with rare exceptions, be impossible to avoid lasting damage from selling stakes in these companies,” Olga Dergunova, head of the State Property Agency, told ministers.

Singing the Sechin tune. Russian companies are undervalued! We can’t sell them now!  It’s funny, that.  They’re always undervalued, regardless of the state of the financial markets, frothy or depressed.

And speaking of Sechin, there was no mention of the privatization of Rosneft.

If you are surprised at that, you probably wake up at 4 o’clock in the morning and look west, thinking that today is the day that the sun will rise there.

Cost-Benefit Confusion

Filed under: Uncategorized — The Professor @ 2:41 pm

Obama gave a big speech on the environment, and specifically climate change and CO2.  The left swooned. The right raged.


Not that I like the content of the speech (if you can call what he said “content”)-more on this in a bit.  It’s just that presidential speeches tend to be long on promises and calls to action, and very short on follow through.  That’s doubly or triply true of Obama speeches.  Look at all his speeches on gun control, and how little that came from them.  Like nothing.  This is a little different, because he can actually direct the EPA to do some things, and nothing in the speech was dependent on legislative approval (which is revealing in itself). Moreover, even the EPA process will be long and drawn out, and its outcome uncertain.  Obama was equivocal on Keystone XL, basically setting out a set of criteria that he will use to evaluate it.  These criteria are so elastic that it is possible to use them to justify rejection or approval, and indeed, both sides said they were encouraged by Obama’s remarks.

Righties should actually like the speech.  The fact that Obama feels obliged to pander to his base should make them happy.  Hedge fund billionaire Thomas Steyer had made Keystone a litmus test for continued proggy support for Obama.  If he has to spend time, effort, and political capital to appease the Steyers of the world, righties should be pleased.

Insofar as the content, such as it is, goes, a couple of things jumped out.

The first is the condescending characterization of the state of the science on global warming.  The snide references to the “Flat Earth Society” and the like.  And silliness like this:

Here at home, 2012 was the warmest year in our history. Midwest farms were parched by the worst drought since the Dust Bowl, and then drenched by the wettest spring on record. Western wildfires scorched an area larger than the state of Maryland. Just last week, a heat wave in Alaska shot temperatures into the 90s.

And we know that the costs of these events can be measured in lost lives and lost livelihoods, lost homes, lost businesses, hundreds of billions of dollars in emergency services and disaster relief. In fact, those who are already feeling the effects of climate change don’t have time to deny it — they’re busy dealing with it. Firefighters are braving longer wildfire seasons, and states and federal governments have to figure out how to budget for that. I had to sit on a meeting with the Department of Interior and Agriculture and some of the rest of my team just to figure out how we’re going to pay for more and more expensive fire seasons.

Farmers see crops wilted one year, washed away the next; and the higher food prices get passed on to you, the American consumer.

Yeah.  Like that’s never happened before.

And the mention of higher food prices is a nice segue to the next problem: the confusion over costs and benefits.

I am convinced this is the fight America can, and will, lead in the 21st century. And I’m convinced this is a fight that America must lead. But it will require all of us to do our part. We’ll need scientists to design new fuels, and we’ll need farmers to grow new fuels. We’ll need engineers to devise new technologies, and we’ll need businesses to make and sell those technologies. We’ll need workers to operate assembly lines that hum with high-tech, zero-carbon components, but we’ll also need builders to hammer into place the foundations for a new clean energy era.

Obama touts these things as benefits of policies that encourage development of renewable fuels, when in fact they are the costs.  Scientists could spend their time and brains working on producing other things that could be of even greater value.  Farmers could grow crops to feed people, instead of growing them to feed an insanely inefficient renewable fuels industry that brings dubious environmental benefits (and may actually be environmentally destructive, all things considered).  And which also brings higher food prices, which hit poor people both in the US and abroad with particular force: the Arab Spring owes not a little to discontent over rising food prices.  If Obama is so concerned about higher food prices, as his one remarks suggests, he would take seriously the implications of his support of renewables for food prices.  A serious man would make an argument that acknowledged the true costs of what he advocates.  And a serious man would not tout costs as benefits.  But we’re talking Obama here.

In fairness to Obama, he is by no means alone in his inability to tell costs from benefits.  It is a failing of politicians of all stripes and parties.  It is this confused thinking that results in government programs producing waste rather than results.  In the un-economical minds of politicians, spending, jobs, etc., are ends in themselves, and are counted as benefits, when they are in fact the costs of implementing the policy.

Insofar as the specifics of the policies Obama advocates are considered, a few quick words.  Assuming that the EPA does implement restrictions on CO2 output, this will be a boon for natural gas consumption and production in the US, and a hit to coal.  The main domestic impact will be that it would reduce LNG exports, and reduce the profitability of the firms in that business.  It will encourage export of coal, to both Europe and China, which will reduce the environmental benefits of the reduction of coal consumption in the US.  Not one for one, but considerably.  The impact on gas markets overseas will be mixed.  Less US LNG exports will keep gas prices higher, but the substitution of cheap coal for expensive gas will mitigate that impact.  Probably close to a push for European electricity consumers, and for sellers of gas in Europe (notably Gazprom).

Gazprom on the Spot

Filed under: Commodities,Economics,Energy,Russia — The Professor @ 12:02 pm

An arbitration tribunal dealt Gazprom a major blow with a ruling in a case involving the company’s contract with German utility RWE:

Russian gas export monopoly Gazprom’s efforts to keep a link between the price it sells gas and costlier oil were dealt a blow on Thursday, when a court ruled it had to include market pricing in the rates it charged Germany’s RWE.

Gazprom must also reimburse Germany’s second-largest utility for overpayments it made on gas purchases, RWE said on Thursday, adding to pressure on the Russian firm from European clients who say they have lost billions of dollars on long-term supply deals agreed at higher prices than current market spot rates.

Citing a ruling by the International Court of Arbitration of the International Chamber of Commerce, RWE said Gazprom had to reimburse it for gas purchases since May 2010, but declined to comment on the size of the expected payout.

Analysts said it was the first court ruling to impose spot pricing on Gazprom, which includes some spot pricing in its contracts, but has largely stuck to reducing oil-linked pricing to placate customers that have suffered losses on its gas.

The money matters, but that’s about the past.  What’s important going forward is the imposition of the spot pricing mechanism.  Gazprom has fought this tooth and nail, claiming inadequate liquidity in the European spot markets.  But it’s preferable to have gas contracts priced off a relatively illiquid (as compared to oil) spot market in gas, than off oil prices, given the low correlations between gas prices and oil prices.  Moreover, as I’ve noted many times, there is a virtuous cycle: moving to hub pricing will encourage trading at hubs, and the development of hedging instruments with payoffs tied to hub prices, which will encourage more trading at hubs, and so on.  This happened, and quickly, in US gas soon after the deregulation of pipelines in the late-80s and early-90s.

This is a world trend.  Asia, and Japan in particular, are pushing to move away from oil indexed pricing and pricing LNG imports based off of gas prices. This is particularly ironic in that Gazprom wants to use the Japan Crude Cocktail formula to price future LNG exports to Asia.  (Assuming, perhaps heroically that Gazprom is ever able to do this in a serious way.)

It must suck to be Gazprom right now.  Nothing makes me happier.

There’s bonus material in the article!:

“For me it is an evidence of huge shift in the European attitude towards the sanctity of contracts,” Tatiana Mitrova, the head of the oil and gas department at the Russian Academy of Sciences Energy Research Institute, said.

It’s always a matter of amusement whenever the Russians talk about the “sanctity of contracts.”  The devil, as they say, can quote scripture for his purpose.

Snowden: Putin’s Tar Baby?

Filed under: Military,Politics,Russia — The Professor @ 8:38 am

Has Edward Snowden become Vladimir Putin’s very own special tar baby?  Oh yes, it was great sport to jerk around the Americans, and mock the administration for its impotence, when Snowden arrived in Sheremetyevo airport in Moscow.  And no doubt the intelligence services had great fun with Snowden’s pilfered NSA computers, and squeezing him for information.  No doubt he’s an easy target, given his grandiosity and narcissism, and what has to be the dawning recognition that he is totally dependent on the tender mercies of FSB types: I wouldn’t be surprised if Snowden will be the poster boy for Sheremetyevo Syndrome-sort of like the Stockholm Syndrome on steroids.  Snowden imagined that he was working with an evil intelligence service at the NSA.  No doubt he’s getting a real education in the subject now.

But Putin and the Russians got pretty much the entire PR and intelligence bonanza in a couple of days.  Those oranges are well-squeezed, and from Putin’s perspective, it’s past time for Snowden to be on his merry way.  To anywhere.  Besides, Russia could get the benefit of American discomfiture if Snowden was in Ecuador or Venezuela: indeed, it would be particularly amusing to Putin to see a country like Ecuador stymie the US, and you can believe he would make the most of his opportunities to point this out in his inimitable ridiculing way.  All without having to deal with the bother of having Snowden in Russia.

But now Snowden is starting to be like that fling who decides to cling.  I can see Putin saying: Jeez, it was fun while it lasted, but now why won’t he just go? From Putin’s perspective, in the future Snowden will bring only trouble and annoyance if he stays in Russia.

But Snowden has nowhere to go.  Despite the mendacious Wikileaks’ assurances that Snowden had travel documents from Ecuador, the Ecuadorans say they have issued no such paperwork.  They are also saying that they’ll make a decision on giving Snowden asylum mañana.  Or maybe the day after mañana.  Or maybe a couple of months after mañana. Pretty much everywhere he would have to fly through to get to Ecuador or Venezuela has an extradition treaty with the US, and these countries are no doubt not really all that stoked about confronting the US on this one.  Hell, what’s the upside even for Cuba?

So Snowden is living The Terminal in real life, and thinking that Frank Dixon would be a vast improvement on whatever FSB mouth breathers he has to spend time with.  (Well, maybe he is: nobody has seen him.  Maybe he’s ensconced in an FSB apartment.  And there’s always Lubyanka!  But regardless, he ain’t walking around free and living large, and has an entourage of spooks committed to messing with him.)

And every minute that he’s there, he becomes a bigger headache for Putin.  He’s exploited the PR and intelligence, but in the future Snowden’s presence will just be a major irritant in dealing with the US.  Putin is a realist, and doesn’t want to indulge in conflict for conflict’s sake: there has to be a payoff, and from here on out, there is no payoff potential in continued conflict with the US over Snowden.  Moreover, after the big statements he made about Snowden being a free man, and it being legally impossible for Russia to hand him over (which is bullshit, but there it is), Putin can’t very well back down and hand him over.   Finally, I am sure that Putin despises Snowden as an untrustworthy weasel.  The Russians don’t trust anyone, especially one who has done something that is treasonous in their eyes.  And Snowden’s obvious psychological issues make him a major risk.  He f*cked his own country to indulge his grandiose fantasies: no way the Russians want anything to do with him once they’ve squeezed him dry.

So Putin held Snowden close in his opportunistic way to get the propaganda and intelligence benefits.  Now he wants to get shed of him, but finds that the baby won’t come unstuck.  Seeing this, others are unlikely to rush to free him from it.  Let’s just hope no one throws Putin in the b’rer patch and lets him  escape from this sticky situation he’s gotten himself into.

I guess we have to take our solace where we find it.  It’s pretty much the only silver lining in this clusterf*ck.

June 21, 2013

Be Afraid. Be Very Afraid.

Filed under: Economics,Energy,Politics,Russia — The Professor @ 3:27 pm

If you’re Russian.  For the Russian Finance Minister Sulianov has stated that Russia can survive a Fed taper, and that “Russia, as opposed to other developing countries, will be less impacted by that occurrence.”

Why afraid? Because recall that Putin and Medvedev said in September 2008 that Russia was an “island of stability.”

Yeah.  That worked out.  Russia had the biggest decline of any major economy in 2008-2009, and has experience moribund growth since.

Expressions of Russia’s ability to weather world economic storms are delusional. Russia is a high beta economy, due to its extreme exposure to highly pro cyclical commodity prices, meaning that if the taper (and the fraught situation in China) lead to an economic slowdown.  Indeed, the relatively steep declines in Russian stock prices in the tumult of the last days illustrates this point.

But this was not the most risible part of Sulianov’s statement.  This was:

Russia is also investing $70 billion into its upcoming global sports events, the Sochi Winter Olympics 2014 and the 2018 World Cup. However, Siluanov told CNN said the investment was not purely designed for growth.

Sochi, the cost of which is reportedly $50 billion and rising, was “never meant to be a purely economic growth stimulating initiative,” he said. “It was always an infrastructure project.”

According to Siluanov, “it is designed to improve life in the region,” and “make it more popular and attractive for our citizens.”

I’m dying here.  Seriously.  Improving life for whom in the region? The corruptocrats? That I can believe.  As if the typical “citizen” of “the region” is going to see anything but crumbs, while many billions disappear into bureaucratic and oligarchic rat holes.

Hostage to Vanity

Filed under: Politics — The Professor @ 3:16 pm

The State Department careens from embarrassing moment to embarrassing moment.  Especially on Twitter.  McFaul routinely makes a fool of himself there.  The tweets from Cairo about the Mohammed video which had exactly nothing to do with anything during the “demonstrations” on 9-11-12 were cringeworthy.  Beyond cringeworthy.

But they’ve only gone downhill from there.  The State Department has been AWOL on the events in Turkey.  On Twitter they peeped in protest to Erdogan’s comparison of the Turkish authorities’ handling of the protests to the way the US (local) authorities handled Occupy protests, but then they cravenly deleted even these sotto voce disagreements with Erdogan, and have since limited themselves to calling for all sides to remain calm.  No criticism whatsoever of the Turkish premier’s lurch to authoritarianism.  Germany, in contrast, has been forthright in its disagreement: Germany has put a block on Turkish EU membership in protest against the government’s thuggish response to opposition protests.

But it is even worse in Egypt.  The US Ambassador, Anne Patterson, criticized the anti-Morsi protests there and met with the Muslim Brotherhood. She even had the audacity to say “Some say that street action will produce better results than elections. To be honest, my government and I are deeply skeptical.”

Um, didn’t the previous Mubarak government fall, to be replaced by Morsi’s, as the result of “street action”?  Didn’t her government hail this as a great advance?

The muteness on Morsi and Erdogan is, sadly, easily explained.  Obama has lionized Morsi and Erdogan: Erdogan is widely understood to be the leader with whom Obama has bonded most closely.  To criticize them would be to admit he is wrong.  And Obama cannot abide that.  So US policy is hostage to Obama’s vanity.

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