Streetwise Professor

In an unhinged speech earlier this week, Vladimir Putin (a) threatened (again) to use nukes, and (b) announced the mobilization of 300,000 reservists–although there are reports that the order actually calls for the mobilization of 1 million. This raises the issues of what this means about the state of the war, and the effect that the mobilization will have on it.

The speech speaks volumes about the state of the war. Putin realizes that he is losing, badly, and is desperate to reverse the reverses. He is in essence following Eisenhower’s advice:  “Whenever I run into a problem I can’t solve, I always make it bigger.  I can never solve it by trying to make it smaller, but if I make it big enough, I can begin to see the outlines of a solution.” Or, as it is often expressed: when a problem appears insoluble, enlarge it.

Putin has two margins on which he can enlarge: nukes and bodies. He’s threatening the former and implementing the latter.

When I say Putin’s speech was unhinged, I do not exaggerate. Look at the videos. He was incandescently angry. His rhetoric recycled the common themes–Nazis, Banderaists–and added twists on his West-directed paranoia by way of rationalizing (although not admitting) the defeats: Ukrainian forces are not just armed by the West, but Nato generals are in command and western troops are in the ranks. The speech was filled with projection about violations of sovereign territory and atrocities. Perhaps it was all for effect–Mad Vlad–to make the nuclear threats more credible. But it seems all too genuine to me.

As for the effect of the mobilization, a quote from Lincoln comes to mind: “Sending armies to McClellan is like shoveling fleas across a barnyard: not half of them get there.” My surmise is that far less than half the fleas that Putin is madly trying to shovel into Ukraine will get there.

If the front line Russian military has proved shambolic on the Ukrainian steppes, the Russian reserve system is beyond shambolic. It was allowed to decay after the collapse of the USSR (which depended on mass mobilization), and the military “reforms” of the last decade only accelerated its decay: the goal of the “reforms” (which were realized more in the promise than the delivery) was to move away from conscription-based forces towards a professional military.

It is therefore best to view what is happening not as a mobilization of an existing reserve force (e.g., the mobilizations seen in August 1914) but as an improvised, hurried mass conscription. Although the initial announcements stated that the mobilization would be targeted at those with combat experience and with specialized military skills, there are reports–all too believable–that the authorities are casting their net far beyond these categories, and that the unfortunates caught up in it are being assigned to units willy-nilly with no regard to their past duties. Tellingly, the dragnet is most intense in the republics: ethnic minorities have already borne the brunt of the war, and Putin wants to shelter metropolitan Russia as much as possible for fear of sparking unrest in the cities.

The existing Russian conscription system is a disaster, rife with evasion and corruption. And that was just to escape the miseries of peacetime service. Both will be far worse when the prospect is being shoveled to Donbas.

No this is not a mobilization. It is press ganging and the yield will be far less than Putin wants.

And what will be the effectiveness those poor fleas who do make it across the barnyard? More bodies will not fix the deep dysfunctions that have been revealed on the battlefield. The high command will still prove to be incompetent. Already poor leadership at the regimental, battalion, company, and platoon level will become even worse as poorly trained and dispirited officers will be put in charge of scared and resentful losers of the conscription lottery. Further, there will be an adverse selection problem: the cleverer and more fit will find ways to escape the net, leaving a disproportionately dimwitted, sociopathic, and addicted rump to fight. More bodies will not fix the paralyzing over-centralization of the Russian command. More bodies will not fix Russia’s disastrous logistics: indeed, trying to supply more bodies will actually exacerbate the logistical problems. More bodies will not fix Russia’s underperforming air forces. More bodies are not the same as more precision guided munitions. Historically Russia has used more bodies successfully when supported by massive artillery, but now ammunition shortages (is another “Shell Crisis” a la 1915 coming?) loom and Ukrainian counterbattery fire has proved devastating thanks to HIMARS and M177s. More bodies will not address Russia’s repeated intelligence failures at the operational or tactical levels. Russian armor has proved extremely vulnerable, but the more bodies will deploy in older and even less well-maintained AFVs.

In sum, more bodies cannot and will not fix the real reasons for Russian battlefield disasters. They will just be more victims for these reasons.

There is also the issue of how the new bodies will be deployed: as replacements or in entire units. The time involved in standing up new units is considerable, even if rushed. Putin is in a hurry, so I conjecture that the unfortunates swept up by the press ganskis will receive lick-and-a-promise “training” of a few weeks (after all, they are veterans, right?, so they just need a refresher course!) and be shoveled to the front and shoved into shattered units. If you look at say the American army in WWII, you’ll find that the life expectancy of replacements is often measured in hours or a few days. (Experienced infantrymen often avoided learning the names of replacements, because it was pointless.) That will happen here as well.

Historically, Russia relied on a huge demographic advantage vis a vis its foes in a quantity-over-quality approach. But even when Russia did have a demographic advantage, the results were often disastrous: cf. the Russo-Japanese War, and Tannenberg and other WWI battles. Now a demographically devastated Russia is falling back on old formulae. To call it tragic is an understatement.

In sum, more cannon fodder without more cannon (and logistics, and leadership, and on and on) to support them will result in a bloody disaster. But it will allow Putin to defer deciding whether to resort to his only other option: nukes.

It is also important to consider how Putin’s adversaries–not just Ukraine, but the US and the rest of Nato–will respond. The prospect of facing greater numbers (even of a low quality) incentivizes Ukraine to accelerate its offensives and press its advantages, even though that will entail larger losses. If successful, that would in turn accelerate when Putin has to decide whether to back down or resort to his only remaining way of expanding the problem. Ukraine will redouble its already frenzied efforts to lobby western governments for more weapons.

The US and Nato need to turn their attention from what is happening on the battlefield to focus intensely on forestalling Putin concluding that it’s nukes or nothing. Sadly, that means hoping that Putin’s more bodies measure will extend the stalemate, thereby buying time for some diplomatic resolution.

Alas, the US and its allies appear set on Ukrainian victory on the battlefield and on the humiliation of Putin, rather than on securing an unsatisfying and messy diplomatic compromise. That is gambling with millions of lives–and perhaps many more.

Which means that where things go may hinge crucially on the Russian popular reaction to Putin’s desperate measure. It is optimistic in the extreme to believe that the mobilization will spur a 1905 or February 1917 or August 1991 moment in Russia. And it is equally optimistic to believe that if such a moment indeed occurs, that it will not result in Putin’s replacement with someone even worse.

Today is the 160th anniversary of the Battle of Antietam (Sharpsburg to the Confederates). As is widely known, it was the bloodiest single day in American history.

What is remarkable is that although the casualties on 17 September 1862 were the largest in American history, the armies were relatively small. Both had experienced substantial wastage in the Second Manassas Campaign, in the march into Maryland, and in the Battle of South Mountain. By the time the Army of the Potomac and the Army of Northern Virginia reached Sharpsburg on 16 September, the Federals numbered only about 65,000 and the Confederates somewhat south of 40,000 (with 37,500 being a common estimate).

Meaning that relatively small armies absorbed the massive casualties. (By contrast, at Gettysburg Lee’s army was around 75,000 strong, and Meade’s probably 10,000 more).

Confederate casualties are usually given as 10,300, which amounts to a percentage loss of 27.5 percent. When accounting for the fact that about 20,000 Union troops (of the V and VI Corps) were only slightly engaged, the Federal percentage loss is similar. The bulk of the fighting was done by the I, II, IX, and XII Corps, which amounted to around 46,000 men (not much more than Lee, and certainly not a large enough margin to overcome the defender’s usual advantage) that suffered 11864 casualties, or about 26 percent.

Interestingly, though high, these percentages do not match Stones River or Chickamauga, although those were admittedly 2 day battles.

Like many Civil War battles, Antietam is the subject of considerable controversy. Should Lee have invaded in the first place? Once he invaded, and learned that McClellan was hot on his heels, should he have fought the battle where he did, or withdrawn to Virginia? How was McClellan’s generalship? And of course there are many subsidiary controversies.

On the first, it’s a close call. Given what he knew at the beginning of September, there were defensible reasons for Lee to take the offensive to Maryland: exploiting the initiative and the momentum from Manassas, the apparent chaos in Union ranks after the Manassas debacle, the possibility of recruiting in Maryland (which of course came a cropper but Lee could not have known that in advance), giving northern Virginia a chance to recover from Yankee occupation (and depredations), influencing the fall of 1862 congressional election. Against all that was the exhausted state of the Army of Northern Virginia, which had been fighting and marching intensely since the end of May. The march into Maryland only exacerbated that exhaustion and the slow bleeding of his ranks–something that Lee should have been able to predict. He did not, perhaps because a form of what the Japanese called “victory disease” had given him the perception that his men were superhuman.

Once in Maryland, the decision to fight on the banks of Antietam Creek is far less defensible, especially once Lee had learned of McClellan’s unexpected speed in reconstituting shattered Union formations and moving west to confront Lee. Lee courted catastrophe by fighting with his back against the Potomac, with a tired and diminished force. He escaped disaster by only the thinnest of margins.

Which brings us to McClellan, who is largely responsible for Lee’s escape. The Union general is always a lightning rod, and he has intense partisans for and against at Antietam in particular. My view is that his conduct of the campaign up until early on the 17th of September was quite creditable, and somewhat atypical. He did move with relative alacrity: whether the “Lost Order” and its disclosure of Lee’s distributions was the cause of McClellan’s unaccustomed aggressiveness will never be resolved. His assembling a fighting force from the hodgepodge of defeated and demoralized units from two armies (his Army of the Potomac and Pope’s Army of Virginia) is quite remarkable.

His plan on the morning of the 17th was understandable, and somewhat conventional in that (like Lee on 2 July 1863 at Gettysburg) he ordered an en echelon attack, with the left attacking first, then the center, then the right. (Civil War commanders seemed to favor the echelon attack, despite its repeated failure.) In the event, however, this gave Lee the opportunity to shift troops from one sector of his front to those under direct threat: the near destruction of Sedgwick’s division by units that Lee frantically shifted from his center and right is the best example of this. A simultaneous attack would have increased the odds of success.

Moreover, McClellan’s hands-off approach to the battle contrasts poorly with Lee’s decisive hands-on generalship. For most of the day, McClellan was a spectator watching from the Pry House while his units fought essentially three separate and uncoordinated battles on the left, center, and right. In contrast, Lee imposed his will and personally pushed divisions to where they were desperately needed when they were needed.

McClellan’s distant approach is even less defensible given that he was working with subordinates and units with whom he was unfamiliar in their current roles, or whom he had considerable cause not to delegate control to. On the left, Hooker was new in command to the I Corps, which had been under the Army of Virginia and which McClellan had never seen in action. Also on the left, the XII Corps was another ex-Army of Virginia unit under a commander (Mansfield) that had never led any unit, let alone a corps, in the field. In the center, the II Corps was commanded by “Bull” Sumner, of whom it was said bullets would bounce off his hard head. McClellan knew Sumner to be brave, but totally unsuited for autonomy on the battlefield. Burnside was an old friend of McClellan (though they would be estranged after Antietam), but he too had never commanded a large formation in a major battle anywhere, let alone under McClellan’s eye. What’s more, none of these Corps commanders had worked with each other before.

So McClellan had ample reason to realize that the Army of the Potomac and its corps commanders needed close supervision and could not just be turned loose to execute a plan while he watched from afar. Yet watch from afar he did.

Moreover, whereas Lee used every man–and used many men at multiple points on the battlefield–two of McClellan’s major units–V and VI Corps, ironically commanded by McClellan’s “pets” Porter and Franklin–remained largely idle the entire day. Based on numbers compiled by Antietam historian (and battle veteran) Ezra Carmen, only about 30 percent of those units saw action, and even those did not engage in intense fights: those engaged suffered less than 10 percent casualties.

Even though Lee’s center was virtually naked in the afternoon, I am skeptical that a push by Porter’s Corps would have resulted in a disaster for Lee’s army: space/time factors meant that any such attack would have lost force in or shortly beyond Sharpsburg itself even if it had pushed Lee off the Sharpsburg ridge. But “putt[ing] in all your men” (as Lincoln told Hooker when he assumed command of the Army of the Potomac, no doubt with the memory of Antietam in mind) would have greatly increased McClellan’s odds of achieving a more decisive victory than he did–especially if he had put them in all at once.

By the time the sun set on America’s bloodiest day, the outcome on the field was a stalemate. But it was arguably the most decisive and important drawn battle in history. For Lee was forced to withdraw across the Potomac, and that gave Lincoln enough of a claim to victory to issue the Emancipation Proclamation, which changed not just the trajectory of the Civil War, but of American history.

I’ve written before that I have visited Antietam dozens of times, and that it is my favorite battlefield. I can’t be there today except in memory. If you have been there, or even if you haven’t, it is worth spending a moment to remember the carnage in the pastoral countryside of western Maryland, and the weighty history birthed by the death of so many.

Gary Gensler has long lusted to get his regulatory hooks into cryptocurrency. To do so as head of the SEC, he has to find a way to transform crypto (e.g., Bitcoin, Ether, various tokens) into securities, as defined under laws dating from the 1930s. Although Gensler has stated that crypto regulation is a long way off–presumably because it is no mean feat to jam an innovation of the 2010s into a regulatory framework of the 1930s–he thinks that he may have found a way to get at the second largest crypto, Ether.

Gensler pictured here:

Sorry! Sorry! Understandable mistake! Here’s his actual image:

Ether just switched from a “proof of work” model–the model employed by Bitcoin–to a “proof of stake” model. Gensler recently said that Ether may therefore qualify as a security under the Howey test, established in a 1946 Supreme Court decision–handed down when computers filled large rooms, had no memory, and caused the lights to dim in entire cities when they were powered up.

Per Gensler:

Securities and Exchange Commission Chairman Gary Gensler said Thursday that cryptocurrencies and intermediaries that allow holders to “stake” their coins might pass a key test used by courts to determine whether an asset is a security. Known as the Howey test, it examines whether investors expect to earn a return from the work of third parties. 

“From the coin’s perspective…that’s another indicia that under the Howey test, the investing public is anticipating profits based on the efforts of others,” Mr. Gensler told reporters after a congressional hearing. He said he wasn’t referring to any specific cryptocurrency. 

To call that a stretch is an understatement. A huge one. Because the function of proof of stake is entirely different than the function of a security.

Proof of work and proof of stake are alternative ways of operating an anonymous, trustless crypto currency. As I’ve written in several pieces here and elsewhere, eliminating the need for trusted institutions to guarantee transactions does not come for free. Those tempted to defraud must incur a cost if they do in order to be deterred. A performance bond sacrificed on non-performance or deceit is a common way to do that. Proofs of stake and work both are effectively performance bonds. With proof of work, a “miner” incurs a cost (electricity, computing resources) to get the right to add blocks to the blockchain: if a majority of other miners don’t concur with the proposal, the block is not validated, the proposing miner gets no reward, and sacrifices the expenditure required to make the proposal. Proof of stake is a more traditional sort of bond: you lose your stake if your proposal is rejected.

A security is something totally different, and serves a completely different function. (NB. I favor the “functional model of regulation” proposed by Merton many years ago. Regulation should be based on function, not institution.). The function of a security is to raise capital with a marketable instrument that can be bought and sold by third parties at mutually agreed upon prices.

So with a lot of squinting, you can say that both securities and staking mechanism involve “the efforts of others,” but to effect completely different purposes and functions. The fundamental difference in function/purpose means that even if they have something in common, they are totally different and the regulatory framework for one is totally inappropriate to the regulation of the other.

This illustrates an issue that I often come across in my work on commodities, securities, and antitrust litigation: the common confusion of sufficient and necessary conditions. Arguably profiting from the efforts of others could be a necessary condition to be considered a security. It is not, however, a sufficient condition–as Gensler is essentially advocating.

But what’s logic when there’s a regulatory empire to build, right?

I’m also at a loss to explain how Gensler could think that proof of stake involves the “efforts” (i.e., work) of others, but proof of, you know, work doesn’t.

Gensler’s “logic” would probably even embarrass Sir Bedevere:

“What also floats in water?” “A security!”

Gensler might have more of a leg to stand on when it comes to tokens. But with Bitcoin, Ether, and other similar things, hammering the crypto peg into the securities law hole is idiotic.

But never let logic stand in the way of Gary’s pursuit of his precious:

GiGi is not solely focused on crypto of course. He has many preciouses. This week the SEC released a proposed rule to mandate clearing of many cash Treasury trades.

Clearing of course has always been a mania of Gary’s. His deep affection for me no doubt dates from my extensive writing on his Ahab-like pursuit of clearing mandates in derivatives more than a decade ago. Clearing is Gensler’s hammer, and he sees in every financial problem a nail to be driven.

The problem at issue here is the periodic episodes of large price moves and illiquidity in the Treasury market in recent years, most notably in March 2020 (the subject of a JACF article by me).

Clearing is a mechanism to mitigate counterparty credit risk. There is no evidence, nor reasonable basis to believe, that counterparty credit risk precipitated these episodes, or that these episodes (whatever their cause) raised the risk of a chain reaction via a counterparty credit risk channel in cash Treasuries.

Moreover, as I have said ad nauseum, clearing and the associated margining mechanism is a major potential source of financial instability.

Indeed, as I point out in the JACF article, clearing and margin in Treasury futures and other fixed income securities markets is what threatened to turn the price (and basis) movement sparked by Covid (and policy responses to Covid) into a systemic event that required Fed intervention to prevent.

I note that as I discussed at the time, margining also contributed greatly to the instability surrounding the GameStop fiasco.

Meaning that in the name of promoting financial market stability Gensler and the SEC (the vote on the proposal was unanimous) are in fact expanding the use of the very mechanism that exacerbated the problem they are allegedly addressing.

Like the Bourbons, Gensler has learned nothing, and forgotten nothing. He has not forgotten his misbegotten notions of the consequences of clearing, and hasn’t learned what the real consequences are.

Of course these two issues do not exhaust the catalog of Gensler’s regulatory imperium. Another big one is his climate change reporting initiative. I’ll turn to that another day, but in the meantime definitely check out John Cochrane’s dismantling of that piece of GiGi’s handiwork.

As Gideon John Tucker said famously 156 years ago: “No man’s life, liberty or property are safe while the Legislature is in session.” Nor are they when Gary Gensler heads a regulatory agency.

European politicians are desperate, and desperate politicians thrash around and grab stupid ideas–any idea–that they think will alleviate the source of their desperation.

The cost of energy is extremely high now in Europe, and that is stoking political desperation. The politicians don’t like the price signals that the market is sending, and so they are exploring myriad ways of interfering with the price system. These policies (e.g., price controls) cannot solve the underlying problem: Europe is structurally short energy. Moreover, they will create their own problems, which will result in panicked reactions that will create new problems. Wash, rinse, repeat. The whole thing is doomed to collapse. In tears.

There is no better illustration of the European failure to come to grips with their real problems than some of the recent proposals surrounding LNG. One is to cap the price of imported LNG.

Brilliant! That way you’ll have even less gas, and the marginal value of power will go up! Yay!

Er, the LNG market is a world market. Yes, Europe collectively is large enough to have some monopsony power and thus can reduce price: but one exercises monopsony power by cutting purchases. That is, less gas will flow to Europe. Europeans will consume less electricity, and they will substitute higher cost ways of generating it. The shadow price (the opportunity cost, i.e., the real cost) of electricity and gas will increase, not fall.

Another proposal is in some ways even whackier: to replace the Dutch Title Transfer Facility (TTF) price with the Japan-Korea Marker (JKM) as the benchmark price for gas in Europe. Because the JKM price is lower. Or something:

As a last resort in case of supply disruption in Europe the EU could also explore temporarily pegging the TTF to the JKM Asian benchmark as a dynamic cap. Yet that would require the use of other hubs or mechanisms to allocate gas inside Europe, the commission said in the document on benchmarks for the wholesale gas market. “In this situation, JKM would become the world price for international gas for some time,” the commission said. “The wholesale market would be therefore determined by LNG supply/demand, and not by the EU’s internal bottlenecks. LNG would still be attracted by the fact transport costs are lower to the EU.”

In other words, the EC doesn’t like the basis between the price of pipeline gas in Europe (as measured by the TTF price in the Netherlands) and JKM. So, voilà! Make JKM the benchmark and tie the TTF price to the JKM price.

This begs the question of why the basis is what it is. The basis–the spread–reflects bottlenecks as well as shipping costs. If TTF is at a premium to JKM (which it is) even though shipping costs to Europe are lower, that means that there is some bottleneck to transform LNG on the European coast into gas in a pipeline on the continent. The most likely bottlenecks is gasification capacity. The Europeans are scrambling to get floating LNG gasification facilities operating, but the basis/spread is saying that a lot more capacity is needed.

The EC concedes that TTF is at a premium, and that the premium has increased: ““The price premium between the TTF and Europe’s LNG delivered ex-ship indices has widened significantly bringing up questions about its representativeness as an index for linking the contracts in the whole EU-27.”

It only brings up questions to fools. Non-fools get it.

If by “pegging” the Europeans impose some spread between TTF and JKM (adjusted for shipping cost differentials) that does not reflect these EU bottlenecks and their associated costs, the supply of LNG to Europe will be reduced. The only way to incentivize the flow of gas from overseas into European pipes is to have a price that covers the cost of that transformation. If there are bottlenecks, that transformation is expensive.

Thus, it is utterly delusional to think that a price that does not reflect “the EU’s internal bottlenecks” is a good thing: you want a price that does reflect them. The bottlenecks don’t go away because you don’t let the market price reflect them. If you don’t let the market price reflect them, the gas will go away. (Asia will send its regards, by the way.)

You may not like the message the price sends, but you cannot wish it away. And if you try, the message will be sent in an even more painful way. The Europeans (and the UK) seem hell bent on proving this very basic point the hard way, rather than learning from the hard experience of others dating back millennia.

Although one has to be skeptical about all real time reports from battle zones–especially in Ukraine, given the intense information warfare waged by all sides–all indications are that the Ukrainian military has achieved dramatic success, not in a counteroffensive in Kherson, but in Karkiv/Kharkov. The Russians have acknowledged that they have “redeployed” troops from Kharkiv Oblast to Donbas to continue their offensive there. This is risible, and reminds me of McClellan claiming that his retreat from the front of Richmond in June 1862 was a “change of base.” Ukrainian reports that they have routed Russian defenders appear far more credible.

Like all battlefield victories and defeats, what is transpiring now is an amalgam of competence and incompetence. (Or, as my mother always used to say on our Civil War battlefield tours–nobody ever won a battle: somebody lost it.). On the Ukrainian side, it appears that they achieved considerable surprise, based on months of shaping the information space. They tipped a right uppercut (into Kherson) then delivered a thundering left hook crashing into the Russian right temple (in Kharkiv).

In other words, the judo expert was fooled, caught off balance, and is now reeling.

The attention for months was on a highly touted forthcoming Kherson offensive. Attacks in Crimea further served to direct attention to the south. Russia apparently directed reinforcements to the south and denuded (or at least did not strengthen) its forces around Kharkiv. Ukraine thus was able to achieve solid gains in the east, and now threatens to create what in WWII was called a “cauldron battle” by pivoting south to cut off large number of Russian troops. (Which is why Russian troops are apparently “bugging out,” to borrow Korean War lingo.)

The flip side to Ukrainian operational surprise facilitated by distraction is a Russian intelligence failure. Russian aerial reconnaissance, signals intelligence/electronic warfare, and human intelligence obviously fell woefully short. They did not see through the ruse, and were unable to suss out the real distribution of Ukrainian forces or Ukrainian defenses.

I wonder if Ukraine may be following the example of Montgomery at El Alamein, who alternated advances on two widely separated axes, ramping up one when Rommel shuttled reinforcements to counter the other. If so, expect increased effort on the Kherson axis in the coming days and weeks, especially if Russia rushes troops to the east in an attempt to stymie Ukrainian progress there.

Despite the large disparity in populations, Ukrainian forces outnumber the Russian now. The Russians are reportedly assembling outfits of old men and young boys, an expedient the Germans did not resort to until 1944 (Volksgrenadiers). The Russians are also reportedly scouring the prisons for potential cannon fodder.

Further, the Ukrainians are operating on interior lines, the Russians on exterior ones, and what’s more, Ukraine has shown the ability to strike in Russian rear areas with indirect fires more effectively than Russia has been able to strike the Ukrainian rear, and this despite the on paper superiority of Russian air forces.

So the balance has shifted. Ukraine has made gains in days that took the Russians months to achieve in Donbas.

That said, I expect that this will mainly move the line of stalemate to the east and south, rather than result in a decisive ejection of the Russians from Ukrainian territory, and a termination of the war by Putin.

Indeed, some crazed nationalist elements in Russia are celebrating the defeat. Now, they say, the gloves will come off!

The problem, of course, is not that Russia has been stymied because its blows have been softened by strategic and tactical gloves: it is that Russia has not landed any real blows to speak of since about 1 March. Those celebrating reverses in the east say now Russia has no choice but to strike at the infrastructure that Ukraine uses to deliver western weapons (mainly American). But how they do not explain.

They seem to be operating under the same assumptions (or more accurately delusions) that most western observers (me included) held on 24 February, namely, that Russian air and missile forces would overwhelm Ukrainian defenses and allow Russia to romp unhindered against Ukrainian lines of communication. But actual events put paid to this assumption months ago.

What’s more, in an ineffectual and futile campaign of missile and air strikes, Russia has expended the vast bulk of its precision weapons. Not that they have proved at all effective heretofore, but they still would be more effective than whatever else remains in the Russian quiver.

In other words, Russian failures to interdict Ukraine’s lines of supply reflect incapacity, not a failure to utilize capacities. And the capabilities now are less than they were six months ago. Taking off the gloves helps little when you have no fists.

Thus, non-victory is staring Putin in the face, and there is little he can do about it. Little conventionally, that is. Which is disturbing. Putin cannot be so out of touch as the mouth breathers in Moscow. His only escalation options are unconventional–and hence extreme. The only other choice is to hang on and let the war drag on. Although I would not exclude the possibility of an extreme escalation, I think he will make the latter choice, and hang on by his fingertips while condemning thousands of Russians and Ukrainians to death and maiming.

The invaluable eugyppius has read Klaus Schwab’s latest epistle, so we don’t have to. Thanks! A great public service.

One thing that struck me in reading eugyppius’ review is that Schwab repeatedly says things like this:

A pandemic is a complex adaptive system comprising many different components or pieces of information (as diverse as biology or psychology), whose behaviour is influenced by such variables as the role of companies, economic policies, government intervention, healthcare politics or national governance … The management … of a complex adaptive system requires continuous real-time but ever-changing collaboration between a vast array of disciplines and between different fields within these disciplines. 

and:

[I]n global risk terms, it is with climate change and ecosystem collapse … that the pandemic most easily equates. The three represent, by nature and to varying degrees, existential threats to humankind, and we could argue that COVID-19 has already given us a glimpse, or foretaste, of what a full-fledged climate crisis and ecosystem collapse could entail from an economic perspective … The five main shared attributes are: 1) they are known … systemic risks that propagate very fast in our interconnected world and, in so doing, amplify other risks from different categories; 2) they are non-linear, meaning that beyond a certrain threshold, or tipping point, they can exercise catastrophic effects; 3) the probabilities and distribution of their impacts are very hard, if not impossible, to measure …; 4) they are global in nature and therefore can only be properly addressed in a globally coordinated fashion; and 5) they affect disproportionately already the most vulnerable countries and segments of the population. (p. 133f.)

There are additional examples, but these suffice to demonstrate the category error that is at the root of Schwab’s thinking (if you can call it that): He has a mania for controlling and managing complex, interconnected, nonlinear system, via a global elite. But complex, interconnected, and nonlinear systems (emergent systems) are by their fundamental nature not subject to central control! “The world is really, really complex, in the technical sense of the word, therefore we the anointed need to control it” is the oxymoron to end all oxymorons. (Or the non sequitur of all non sequiturs.)

And for reasons Schwab himself states! I repeat: “the probabilities and distribution of their impacts are very hard, if not impossible, to measure.”

So, genius, how are you supposed to control something where it is impossible to understand the distribution of impacts–or even the probability distributions of impacts? So Schwab apparently grasps the Knowledge Problem, but completely misunderstands its implications. Whereas Schwab believes that it implies the need for greater central control (on a global scale, no less), in fact as Hayek pointed out long ago it implies the utter futility–indeed, the destructiveness–of attempts at such control.

This is the mindset of the Sorcerer’s Apprentice, and the results would be exactly the same.

Schwab is an archetype of what James C. Scott referred to as “high modernism” in his book, Seeing Like a State. The subtitle of Scott’s book couldn’t be more appropriate: “How Certain Schemes to Improve the Human Condition Have Failed.” They failed, Scott shows through numerous examples, precisely because these high modernist schemes (usually predicated on claims of scientific authority) represented attempts to control and manage complex, emergent systems. To control the uncontrollable. Or worse: things that behave badly when you try to control them.

Schwab’s main allies are in the managerial class, indeed, they are at the pinnacle of that class being the CEOs of massive corporations. But an organization–a business–is fundamentally different than an economic and social system, and the methods that work for an organization don’t work for a complex system in which formal organizations are just a part. (This is why, for instance, avatars of high modernist management and engineering, like Herbert Hoover and Jimmy Carter, failed miserably as presidents.)

Hence the category error. Viewing complex systems as things that can be managed, like organizations. They aren’t, and attempts to do so–especially on the grandiose scale envisioned by Schwab and his fellow travelers–are doomed not just to failure, but disaster, as James C. Scott so vividly demonstrates.

I don’t have much to add to all that has been said about Gibbering Joe’s jeremiad against traditional Americans who want to make the country great. The projection. The vicious partisanship in a speech billed as non-political. The excommunication of vast swathes of Americans from polite political society. The bizarre, lurid backdrop. (NB. Claims that you are fighting for the soul of the nation take on a very different meaning when presented in Satanic lighting.) The Marines standing praetorian like behind the would-be emperor. (Thereby emphasizing his threat from earlier in the week to unleash the US military against those who dare challenge his regime.)

The location was particularly disturbing, and sickly ironic. Independence Hall is where the members of the Continental Congress promulgated a Declaration predicated on a belief in natural rights–including the right to resist and replace despotic government:

That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness. Prudence, indeed, will dictate that Governments long established should not be changed for light and transient causes; and accordingly all experience hath shewn, that mankind are more disposed to suffer, while evils are sufferable, than to right themselves by abolishing the forms to which they are accustomed. But when a long train of abuses and usurpations, pursuing invariably the same Object evinces a design to reduce them under absolute Despotism, it is their right, it is their duty, to throw off such Government, and to provide new Guards for their future security.

You may or may not believe that the current US government has engaged in a “long train of abuses and usurpations” sufficient to justify the people exercising their right “to alter or abolish it,” but if you don’t, make that case on the merits, rather than relying on invocations of F-15s and Marines to assert that might makes right. Independence Hall is also Constitution Hall, of course, and it is also ironic that Biden’s first bill of particulars against MAGA supporters is that they do not recognize a right not explicitly in the Constitution (that to abortion), but that he also declaims repeatedly and viciously and ridiculously against one that is (the right to bear arms). Or that he repeatedly resorts to anti-Constitutional measures (e.g., college loan forgiveness via executive ukase) to advance his agenda.

In other words, Biden adamantly advanced a totalist progressive agenda on the site of the creation of documents (the Declaration and the Constitution) that progressives loathe. (Cf., Woodrow Wilson et al.)

Biden anathematized people who, to the extent they have a common foundational political belief, it is grounded in the Founding on the site of the Founding. He claimed the mantle of the Founders while asserting that the only acceptable political beliefs are progressive (i.e., anti-Founder) ones.

The speech was a shocking one. Arguably the most shocking every delivered by an American president: even many (or course not all) leftists/progressives were disturbed. So why did he give it?

Well, for one thing because he believes it. Or, at least, the forces for whom he is the front man, the skin suit, believe it. (Hey! Obama! We see your lips move!)

That’s neither a necessary nor sufficient condition though: unlike Humpty Dumpty, politicians don’t always say what they mean and mean what they say.

The obvious (though denied) political nature of the speech provides the explanation. Of course it is red meat thrown to his faction/party to energize them for the coming midterms. But I don’t think that’s the main objective here, or the main audience.

Instead, I view his speech as an attempt to induce preference falsification in the mushy middle. People who might otherwise be sympathetic to the anti-progressive cause, but who don’t want to be seen as revolutionaries and knuckle draggers, who don’t want to be ostracized by the anointed who dominate the commanding heights of politics, media, and education. People who are afraid that taking an anti-progressive stand will result in cancelation, social death–or worse (e.g., the tender mercies of the IRS or federal “law enforcement”).

That is, the speech was not intended to persuade anyone: it was intended to intimidate those are not already progressive into acquiescing and submitting.

To work in protecting a regime, preference falsification only requires that people do not oppose it publicly, not that they support it openly. The more people who go along, and remain silent, the more other people will infer that the regime actually has broad support.

To me, therefore, the seemingly over the top nature of Biden’s speech–including the crimson atmospherics and the violent rhetoric–is no accident, comrades. It was a tried and true method widely employed by authoritarian figures and regimes to cow the meek into avoiding outright opposition that if it becomes known, creates a feedback loop that causes the regime to crash.

And I guess that is something of a silver lining peering through the red light. Confident regimes do not resort to such measures. Insecure ones do.

While writing the post on European electricity prices, I was wondering about the drivers. How much due to fuel prices? How much due to capacity constraints? Risk premia?

Spreads, specifically spark and dark spreads, are the best way to assess these issues. Spark spreads are the difference between the price of electricity and the cost of natural gas necessary to generate it. And no, dark spreads are not the odds that Europe will shiver in the dark this winter–though I’m sure that you can find a bookie that will quote that for you!: a dark spread is the difference between the price of power and the cost of coal required to generate it. In essence, spark and dark spreads tell you the gross margin of generators, and the value of generation capacity. High spreads indicate that capacity is highly utilized: low spreads that capacity constraints are not a maor issue.

Sparks and darks depend on the efficiency of generators, which can vary. Efficiency is measured by a “heat rate” which is the number of mmBTU necessary to generate a MWh of electricity. Efficiency can be converted into a percentage by dividing the BTU content of electricity (3,412,000).

Electricity is a highly “spatial” commodity, with variations across geographic locations due to the geographic distribution of generation and load, and the transmission system (and the potential for constraints thereon). Moreover, since electricity cannot be stored economically (although hydro does provide an element of storability) forward prices for delivery of power at different dates can differ dramatically.

Looking at sparks and darks in Europe reveals some very interesting patterns. For example, comparing the UK with Germany reveals that German day ahead “clean” sparks (which also adjust for carbon costs) are negative for relatively low efficiency (~45 percent) units, and modestly positive (~€35) for higher efficiency (~50 percent) generators. In contrast, UK day ahead sparks are much higher–around €200.

Another example of “identify the bottleneck.” The driver of high spot power prices in Germany is not limitations on generating capacity–it is the high fuel prices. (Presumably the lower efficiency units are offline in Germany now, as their gross margin is negative.) Conversely, generation capacity limits are evidently much more binding in the UK.

But if you look at forward prices, the story is different. Quarter ahead clean sparks in Germany are around €200, while in the UK they are over €300. Two quarter ahead (the depth of winter) are almost €600 in Germany and a mere €300 or so in the UK. (All figures for 50 percent efficiency units).

These suggests that capacity will be an issue in both countries, but especially Germany. Way to go, Germany! Relying on solar in a country with long nights ain’t looking so good, is it?

The wide sparks also undermine attempts to blame it all on Putin. Yes, high gas prices/gas scarcity courtesy of Vova is contributing to high power prices, but that’s not the entire story. Though to be fair, more gas generating capacity wouldn’t help that much if they become energy limited resources due to a lack of Russian gas.

The high forward prices may also reflect a high risk premium. My academic work from the 2000s showed that there is an “upward bias” in electricity forward prices. That is, forward prices are above–and often substantially above–expected future spot prices. My interpretation was that this reflects “spikeaphobia”: power prices can spike up, but they are supported by a floor. This means that being caught short is much riskier than being long. This creates an imbalance between long hedging (to protect against price spikes) and short hedging (to protect against price declines that are likely to be far smaller than upward spikes). This creates “hedging pressure” on the long side: if speculative capital to absorb this imbalance is constrained, this hedging pressure drives up forward prices relative to expected spot prices.

The imbalance is likely exacerbated by the fact that there are large fuel price spike risks too. Moreover, the price and liquidity risks that speculators absorbing the imbalances must shoulder is likely raising the cost of speculative capital in electricity trading, meaning that there is both a demand pull and cost push driving the risk premium. Thus, I conjecture that some portion–perhaps a hefty portion–of the large spark spreads for German and the UK is risk premium. (Back in the days I started to estimate the risk premium in the US markets in the late-90s, the risk premium was as much as 50 percent of the forward price. That decline substantially over the next decade to about 10 percent for summer peak as the electricity markets became more “financialized.” Financialization, by the way, is usually a pejorative, which drives me nuts. Financialization typically reduces the cost of hedging.).

In the aftermath of the mooting of EU proposals to intervene massively in electricity markets, especially through price controls, forward power prices have plummeted: the above figures are from before the collapse. Price controls would impact both the expected spot price and the risk premium–because they take the spikes out of the price. However, as I noted in my prior post, this is not good news: if prices cannot clear the market, rationing will.

Dark sparks also tell a fascinating story. They are HUGE. The German dark spark for 2 quarters ahead (Jan-Mar) is over €1000, and the UK dark spread is over €600. In other words, it’s good to own a coal plant! By the way, these are clean darks, so they take into account the cost of carbon. Meaning that the market is sending a signal that the value of coal generation–even taking into account carbon–is very high. This no doubt explains why despite massive green and renewable rhetoric in China, the Chinese are building coal capacity hand over fist. It also points out the insanity of European policies to eliminate coal generation. Even if you believe in the dangers of carbon, the way to deal with that is to price it, rather than to dictate generation technology.

To give some perspective, the above figures imply that a 500MW coal plant in Germany was anticipated to produce €870 million in value in 23Q3 (24 hours/day x .80 operating rate x 91 days/quarter x 500 MW x €1000/MW). That’s more than the cost of a plant. Even if you cut that in half to take into account today’s power price collapse, it’s a huge number.

Think about that for a minute.

In sum, spreads tell fascinating stories about what is happening in the European electricity market, and in particular the roles of input prices and capacity constraints and risk premia in driving the historically high prices. But perhaps the most fascinating story they tell is the high price that Europe is paying to kill coal.