Streetwise Professor

Ten days ago Vladimir Putin gave his much anticipated “Victory Day” speech, and said . . . well, not much at all.

There was much anticipation and speculation in advance. He would declare war and full mobilization. He would declare victory, or announce some criteria for victory that even his shambolic military could achieve.

Instead, he basically affirmed the status quo. Russia would keep grinding away. It would not escalate. Nor would it de-escalate.

In other words, Putin tacitly admitted what I had asserted weeks ago: Putin/Russia are in Zugzwang: any move makes things worse, so Putin has basically chosen to do nothing, or at least to change nothing.

There has been much conjecture what the Z on Russian equipment means. Now you know. It means “Zugzwang.”

Things have gotten even worse for Russia since 9 May. Ukraine has mounted a modest counteroffensive (a real counteroffensive, not a local counterattack) north of Kharkiv, and pushed the Russian army back across its border in places. The Russian offensive in Donetsk and Luhansk is essentially stalled. Indeed, the Russians suffered a humiliating reverse in an attempt to mount a river crossing: an entire battalion tactical group and its equipment were destroyed, as was the bridging equipment.

Overall, Russian losses continue to mount, with nothing to show for it. The only simulacrum of an achievement is the surrender of the besieged and battered defenders of the Azovstal plant after weeks of relentless Russian assault and bombardment. But on net Ukraine gained far more from that battle by delaying and attriting Russian forces than Russia has by its ultimate capture of the facility.

And now the Russians appear to view their “triumph” as an excuse to commit a massive war crime by trying the captives as war criminals and threatening to execute the surrendered Ukrainians.

But of course they have to do that to justify their war propaganda that they are fighting Nazis. You know, act like Nazis to pretend they are fighting Nazis. But the Russian military and state are already so far down the war crimes road they won’t stop now, especially if this one provides something that they can use to sell this fiasco to the Russian public.

Now the battle resembles World War I far more than World War II. It is an artillery war being fought on a relatively static front. Even if Russia gains some local objectives, “the big push” and “breakthrough” are clearly beyond their capabilities.

Ukraine is clearly encouraged that it can win, with victory defined as pushing out Russians from all of Ukrainian territory. I think this is too optimistic, and even if it is realistic, the cost to Ukraine, let alone the world, is not worth it.

I understand the risk of leaving Putin/Russia with a rump of Ukrainian territory from which they can spin up a future justification for resuming hostilities once they’ve licked their wounds and convinced themselves that they have really fixed their military this time. But the pretext will exist, and in fact be even stronger, if Ukraine retakes the Donbas. For no doubt the Russians will claim that Ukraine is Nazifiing the recaptured Donbas if it retakes control, and this will be a future casus belli. Retaking it would alter the tactical situation somewhat in Ukraine’s favor for the next time, but not enough to change materially the probability of another Russian attempt. The war exists because Ukraine exists. Redrawing the lines of effective control in Ukraine won’t remove the Russian rationale for war. It is not worth it.

So the war will grind on, because Zugzwang Putin can’t admit he’s lost, and Ukraine believes it can win. Nothing good will come of that.

Despite all the hype over DeFi, there is nothing really new under the financial sun. Yes, the platform or technologies may differ, but most (if not all) of what is being hyped as revolutionary today is closely analogous to something that has been around for a long time.

Case in point: stablecoins. As I pointed out in a post several years ago (and as many others have pointed out as well), they are functionally equivalent to notes issued by banks prior to the National Banking Act of 1863. And they have the same fundamental problem: they are liabilities backed by opaque balance sheets that make them subject to runs. Uncertainty about the value of assets backing the notes can induce a run.

How to address this? Well, an algo right? Because don’t algorithms fix everything?

That is the idea behind stablecoin TerraUSD and its companion cryptocurrency TerraLuna. The algo was that the holder of the TerraUSD has the right to exchange $1 of TerraUSD for $1 of TerraLuna. Since the value of TerraLuna fluctuates, the number of TerraLuna exchanged for $1 of TerraUSD must fluctuate as well to maintain the peg. So in essence, TerraUSD is backed by Terra Luna. And TerraLuna is backed by: GEE! LOOK AT THAT SQUIRREL!

But here’s the thing. Regardless of what it is backed by, or not, or what people think that it is backed by, it almost certainly has a downward sloping demand curve: More Luna, lower price. And that’s where the problem lies.

The Magic Algo broke down when many people tried to exchange TerraUSD for Luna, and the supply of Luna exploded . . . and hence the value of Luna crashed. (The story behind what caused the surge of redemptions is convoluted, and really is beside the point for explaining the flaw in the algo: spikes in demand to liquidate can occur for many reasons–sunspots, anyone?–and any one of them can cause the problem.)

The crashing Luna increased the incentive to liquidate TerraUSD which accelerated the downward spiral.

If this problem sounds familiar, it should, and is another illustration of nothing new under the financial sun. Anybody know what I’m thinking about?

That’s right. Enron. Enron set up various special purpose entities in which it placed dodgy assets. Enron protected investors in the SPEs by promising to sell Enron stock to cover losses. When the losses crystalized, Enron had to sell more and more stock, driving down its stock price, a process that eventually resulted in Enron’s messy demise.

The analogy isn’t exact, but it surely rhymes. A scheme intended to prop up the value of one thing by promising to sell more of another thing is inherently unstable because performing on the guarantee undermines the value of what you are guaranteeing it with (because you have to issue more of it), which makes the guarantee worth less, which creates incentives to run to cash in on the guarantee while you can, which triggers a lot of issuance of what you are guaranteeing it with, driving down its value.

It’s an inherently unstable structure. It’s arguably less stable than a traditional stablecoin aka digital bank note because it essentially mandates fire sales in increasing quantities in response to liquidation shocks. With a downward sloping demand curve (e.g., for Luna) the fire sales cause price declines that can–and in this case did–cause the entire structure to implode.

So why did anybody think algorithmizing a doom loop was a good idea? Lunatics, apparently. Quite literally.

I guess I understand the allure of algos, especially to the tech/computer savvy. They seem transparent. Superficially they take out guesswork and human error and human judgment and weird human behavior. But it is exactly their mechanical nature that some find appealing that can lead to disaster, because they often encode positive feedback loops that are triggered by humans behaving like humans when they interact with the algorithm. And in financial markets, positive feedback almost always has negative effects.

And that is what the TerraUSD-Terra Luna algo did.

Algos can be exactly like the broomsticks in the Sorcerer’s Apprentice. They do exactly what they are told. And as in the Sorcerer’s Apprentice, that can be a big problem.

Mark Twain never grows old:

“Reader, suppose you were an idiot. And suppose you were a member of Congress. But I repeat myself.”

This came to mind when reading about the proposal of Rep. Katie Porter to impose some sort of price control on gasoline:

Oil giant @Shell reported a record $9 billion in quarterly profit—3x its earnings a year earlier. Like @exxonmobil and @Chevron, it plans to use windfall profits to enrich shareholders.

I just introduced a bill to crack down on Big Oil's price-gouging.https://t.co/qsF5wmLJ4Y

— Rep. Katie Porter (@RepKatiePorter) May 6, 2022

Since the beginning of recorded history–and that is not hyperbole–the stock government response to high prices is price controls. The Pharaohs. Hammurabi. Diocletian. And many other examples. And it continues through the ages to more recent history, e.g., rent control in NY starting in WWII, Nixon in 1973.

And the result is always the same: economic disaster. It is price controls result in real shortages: people standing in lines, empty shelves, etc.

Always. If price doesn’t clear the market, waste (e.g., time spent standing in line) will.

But politicians never learn.

Nancy Pelosi (who is old enough to remember gas lines–hell, she’s probably old enough to remember the Code of Diocletian, if not that of Hammurabi) is of course fully on board. Which is an illustration that the adage “those who don’t remember the past are condemned to repeat it” is wrong: many who can remember the past repeat its errors nonetheless.

Elizabeth Warren hasn’t weighed in on this yet, but you know she will, because she’s the main spokes-shrieker for The Gouger Theory of Prices.

The Gouger Theory is stupid on its face. Did oil companies wake up one morning and realize: “Whoa! We coulda jacked up prices and gouged the suckers! What were we thinking?” Did they have some sort of epileptic fit in 2020, when prices crashed? What were they thinking?

No. This isn’t gouging. This is-as it almost always is-fundamentals.

Oil prices are high. But in this week’s edition of “Find the Bottleneck,” that’s only one of the drivers (no pun intended) behind high gasoline and diesel prices. The bottleneck is in refining.

How do we know? Let’s look at the diesel crack:

It’s gone from around $22/bbl to as high as $70/bbl. (And the $22 is high compared to what it was a year ago). (Gasoline crack somewhat similar though not as bad–though it is likely to get so when the peak demand season kicks in.)

A high refining margin means that refinery capacity is constrained. And yes, it is constrained: it’s not as if refiners are exercising market power (i.e., gouging) by withholding output. Here is the capacity utilization in the US over time:

It’s running at pre-Pandemic levels.

And here’s another thing: post-Pandemic capacity is well below pre-Pandemic capacity:

That drop from pre-Pandemic levels is around 5 percent. That’s a lot.

So refineries are running flat out, and refinery capacity is down. What do you get?: big refining margins and high prices at the pump. Yes, it’s good to be a refiner now (though not so much two years ago). But it’s not good because you get to exercise market power. It’s because even under competition it’s highly profitable because of supply-demand fundamentals.

A variety of factors have contributed to this. The loss of a good chunk of Russian oil output is keeping the price of oil up, but the loss of Russian diesel supplies to Europe is probably a bigger factor. The US is to a large extent filling the gap, to the extent it can, by exporting.

But no matter how you break it down, it is clear that this is fundamentals driven. It is not gouging. And capping prices on the delusional belief that it is gouging will wreak economic havoc.

Which has never stopped the Democrats before, I know. (And Republicans too, e.g., Nixon).

One thing here does deserve emphasis. The decline in capacity is directly attributable to the Pandemic. Correction: it is directly attributable to the horrible policy choices that politicians and bureaucrats forced on us in the name of the Pandemic. The lockdowns in particular.

Like many, many things going on in commodity world right now, the current spike in product prices overall, and relative to crude, is yet another baleful consequence of completely mental decisions to shut down economies and crater the economics of producing and processing commodities.

In other news of economic-related political hysteria, there is also a lot of finger pointing going on about baby formula. I don’t have the information at hand to analyze in the same way as I can refined petroleum prices, but I can say what it isn’t. It isn’t “oligopoly.”

But again, those educated in politics (did I really use “educated” and “politics” in the same sentence?) and not economics immediately seize on this as an explanation.

Er, the baby formula business was an oligopoly a year ago. And a year before that. And a year before that. So . . . why all of a sudden did they supposedly decide to create a shortage? And pray tell–how do you make money if you aren’t selling stuff?

So whenever Congresspeople, or people who buzz around them like insects (yeah, I’m looking at you, journalists) come up with some economic brainstorm, remember Twain. They’re idiots. Dangerous idiots.

In the latest episode of Condescending Lectures From Our Betters: Shut Up, Proles!, Samantha Power (the Lioness of Libya) recently “informed” us that the drastic decline in the supply of chemical fertilizers is actually a good thing, as it will wean farmers off these horrible concoctions, and induce them to use natural alternatives like manure and compost instead:

Biden official Samantha Power celebrates fertilizer shortages that will force farmers to “hasten transitions” to “natural solutions, like manure and compost.”

“Never let a crisis go to waste." pic.twitter.com/rZ5uMy0K5U

— RNC Research (@RNCResearch) May 1, 2022

This is so bat shit delusional I don’t even know where to begin. Following Power’s advice would ravage agricultural productivity and condemn literally billions to starvation. And as if there isn’t a real time, ripped from the headlines case study that proves the insanity–and evil–of her prescription.

And, where, pray tell, is the manure to come from, if we follow another ukase of the ruling class, namely the war on meat and livestock? After all, livestock belch and fart, producing methane–and we can’t have THAT, can we? For example, Ireland is supposed to cull 1.3 million animals, and Northern Ireland another 1 million, to meet GHG emission standards.

No animals, no shit. No shit!

So we are supposed to become vegans, eating gruel produced from plants fertilized by livestock that don’t exist–smart! What would we do without smart people telling us how to live?

And even if meat survives, if you haven’t noticed: (a) collecting the manure of pasturing animals would cost rather a lot, and (b) pastureland and small grains farmland tend to be located rather far apart (because the former is not suited to be the latter), transporting the manure of pasturing animals to the fields would cost rather a lot (not to mention involve the release of massive GHGs–or did I forget that it would be transported in electric vehicles powered from wind and solar generators?)

In other words, Samantha Power is completely full of shit. As if you should have needed me to tell you that.

This is just another example–an egregious one, admittedly–of the utter insanity of those who presume not just to tell us how to live–but who presume to force us to live according to their obsessions. The utter unreality of the “energy transition” is another example.

You could get the idea that these people want to kill us. And in fact, you may be right. Based on the evidence, you cannot reject the hypothesis.

Its unexpected success on the battlefield has convinced Ukraine that it can achieve victory. And by “victory,” I mean driving Russia out of Ukraine altogether, including Donetsk, Luhansk, and yes, Crimea.

This is very disturbing. Defending against a shambolic attacking army with horrible logistics and a pathetic operational plan is one thing. Attacking–even against a shambolic army–is another. This is particularly true given that the Russian army was designed and trained to stop a Nato offensive (as ludicrous as that idea is), and has massive amounts of artillery that would make any attack a nightmare: if it was doctrinally unsuited for offense, and adopted a terrible offensive plan, that does not imply that it cannot defend (and against an army that has itself taken serious casualties in personnel and materiel). And all of the tactics that allowed the Ukrainians to blunt the Russian attack, notably ATGM ambushes and attacks on lengthening supply lines, could be turned against them. Ukraine would be giving up all the factors that have worked to its advantage, and would be courting all of the factors that contributed to Russia’s disaster.

The last time the Ukrainian army got the bit between its teeth, in Debaltseve in 2014, it did not turn out well. Yes, the Ukrainian army is far better now, but fools rush in.

Worse, the US appears to be encouraging this. And in an unbelievable and inexcusable error, the administration–SecDef Austin in particular–have publicly announced that the US objective is to weaken Russia. Even if this is the objective, and that would be defensible, it is not defensible at all to make it public. It only validates the Russian narrative that it is at war with the West, thereby bolstering Russian popular support for the war, but it encourages Ukraine to run risks that it should not.

What is the alternative? Alternatives have to be evaluated in terms of the ugly facts.

The war is exacting a horrific toll on Ukraine. Its people, its infrastructure, and its economy. Tens of thousands dead. Millions of refugees. Devastated cities. A ruined countryside.

But more, it is exacting an awful toll on the world, through its extraordinary disruptions of agriculture and energy markets. All the more because Russia appears to be exacerbating deliberately these impacts. This is not merely a matter of comfort and ease. It is a matter of survival for the world’s poorest.

Given this reality, a less than ideal, and likely temporary, resolution is preferable. Something that gives Putin (or whoever is really in charge) a pretext to cease hostilities, and leaves Ukraine not in control of all the territory within its official boundaries. Edward Luttwak suggests legitimate (emphasis on legitimate) plebiscites in various Ukrainian regions.

The downsides are apparent. Putin/Russia could come back for more in time: maybe “will” is the better word, because no deal with Putin/Russia can be considered binding. Such a deal would represent major concessions on fundamental principles.

But it would stop the slaughter and mayhem for a time. It would allow time to build up Ukraine, and to permit a development of a longer term strategy to deal with the Russia Problem. And it is a big problem.

Remember. There are no ideal “solutions” in foreign policy. There are only shitty options. Statesmanship is the ability to choose the least shitty, and make it reality. Neither Ukraine nor the US (nor Russia) is demonstrating such statesmanship.

One can understand, on a human level, the Ukrainian reaction. The US does not have the same excuse. It is a time for realism, realistically pursued with cold eyes. It is not the time for Wilsonian impulsiveness. That has never turned out well.

MacArthur said “there is no substitute for victory.” This was an absolutist statement that violated fundamental principles of choice. Substitutibility depends on relative costs. Victory–e.g., expelling Russia from all of Ukraine–would be very costly, if is achievable at all. Given such cost, there are substitutes, MacArthur notwithstanding.

The awful head of the Department of Homeland Security, Alejandro Mayorkos, set off a firestorm last week when he revealed that the DHS was setting up a “Disinformation Governance Board,” tasked with fighting disinformation. It has also been announced that a real head case, and a hyper-partisan one to boot, Nina Jankowicz will head the Board.

Left unanswered was how this new entity will combat disinformation. Here is my surmise. It will identify certain stories as disinformation, giving official imprimatur to this designation: it will not take any direct action against anyone disseminating this information. Instead, social media companies will then censor or suppress these stories, claiming that they have been identified as disinformation by the government–and who can argue with that, right? They always have our best interest at heart, right? Mommy is just protecting us from bad things!

This is the way that social media shut down COVID stories it didn’t like. If something contradicted CDC or WHO, Facebook and Twitter would label it disinformation and take efforts to suppress it.

In essence, with COVID, social media companies became the enforcers of bans on speech the government didn’t like. In an effort to circumvent First Amendment issues, the government essentially outsourced censorship to private entities. The private entities were happy to go along, because they were on board with the agenda.

The model worked so well that the government is now looking to expand this privatized censorship model to embrace all speech.

This transparent end run around the First Amendment cannot be allowed to stand. The first time Twitter or Facebook or anyone uses the Ministry of Truth’s guidance to remove or throttle or prevent the posting of content, there should be a 1A lawsuit.

Hell, there should have been such suits already over social media COVID censorship.

The real possibility that an Elon Musk-owned Twitter will not play this game is precisely why there has been such a hysterical reaction to his purchase.

This is the biggest threat to our 1A rights in our lifetime, and possibly ever. It cannot stand. It must be fought, and the battle must be won.