Streetwise Professor

April 29, 2024

Learning by Doing in Solar, Even if Proven, Would Not Imply Solar Was Subsidized Too Little, Too Late

Filed under: Climate Change,Economics,Energy,Politics,Regulation — cpirrong @ 10:01 am

The estimable Francis Menton has noted repeatedly that the “energy transition” has set loose upon the world a host of innumerates who assure us that they know best when in fact they know less than nothing. And perhaps to coin a phrase, I would add that they are ineconimate, i.e., know nothing about economics. Arrogance and ignorance is a lethal combination. Such people will make us poor, and likely shivering in the dark.

Alas, the mind eating virus has even infected many who were once sensible, or at least periodically sensate or sentient. Such as the FT’s Tim Harford. (I am guessing that the brain eating ameobae at the FT have finally gotten to him.)

Harford wrote that instead of saying “I could’ve had a V8” 40 years ago, we should have said “I could’ve subsidized solar and then all our energy and climate problems would have been already solved.”

In a nutshell, Harford invokes learning by doing, which he refers to as Wright’s Law in honor of an aeronautical engineer in the 1930s who first identified this phenomenon. It has since been documented in numerous other areas, starting probably with Liberty Ships in WWII.

Yes, LBD is a thing. It has been part of the theory of economic growth since at least the 1970s, starting most notably with Paul David’s work on the antebellum cotton spinning industry in the US, and earlier than that even with work by Kenneth Arrow. Robert Lucas taught about it in the economic growth undergraduate (!) course I took as a small child at Chicago in 1981, FFS. (What a privilege and experience it was to be in that course.) I was so taken by the subject that my paper for George Stigler’s economic policy course in 1982 (when he won the Nobel Prize) examined empirically learning by doing at the Springfield and Harpers Ferry Arsenals prior to 1860. It’s hardly a new idea, or an unexplored one.

Alas, there are numerous problems with Harford’s application of LBD/Wright’s Law to solar.

One issue is: who is to say that the highly touted reductions in the cost of solar aren’t due to LBD?

That is, since cumulative output in solar panels has indeed increased dramatically over the years, learning would presumably have taken place and that plausibly accounts for some of the cost reductions. Harford himself says “PV is now so cheap that the question is moot.” So, perhaps LBD did its work.

Empirical evidence would be nice. And at most what Harford is saying is that we could have learned earlier. But if the learning has taken place (as evidenced by it being “so cheap”), albeit belatedly, solar should be taking over the world now, without subsidies, right?

Further, if Harford really means that too little learning has taken place, or it has occurred too late, then that would require (a) externalities/spillovers in learning, (b) the large subsidies to solar (which Harford pooh-poohs) were in fact too small and/or too late to generate the right amount of learning at the right time, and (c) market participants were unaware of the spillovers and did not take obvious steps to internalize them. He provides support for none of these.

With respect to externalities, it is not obvious that LBD effects are largely external to firms. Firms may be able to keep the benefits of their experience largely to themselves. To the extent they are internalized, there is no rationale for subsidies, and competitive firms will treat current production in part as an investment in future lower costs and expand output accordingly without need for government support or protection.

(NB. Non-compete agreements may be one way firms attempt to keep the benefits of experience internalized. I will soon write a post on the idiocy of the FTC’s ban of such agreements.)

I have analyzed LBD in the US shale sector in detail. I have found extensive learning effects, but the evidence for learning spillovers is weak. A firm’s own experience contributes more to its productivity than collective industry experience. This is evidence that learning is internalized.

Further, firms respond rationally to spillovers–by trying to internalize them. Mergers, consolidation, and concentration are means of internalizing learning. I note that consolidation is coming to shale only after more than a decade after the industry dramatically increased output and drilling experience.

In shale, it is plausible that much of the learning is done by service firms who internalize the benefits. Thus, even to the extent that industry experience explains productivity improvement, to the extent that service firms who, well, service the industry are the ones who generate this learning, these industry experience effects may be internalized as well.

That is, just because there is learning by doing, doesn’t necessarily mean that there are learning spillovers of the type that justify subsidies (or tariffs) to increase output (and hence learning). And if there are, there are strong economic incentives to internalize them. And if there aren’t, there’s no justification for subsidization. (David’s work on the cotton industry addressed the question of whether tariffs to stimulate domestic cotton cloth output were justified because of learning spillovers.)

All of these factors undercut the argument that the PV industry learned too little, too late. Where is the evidence that PV is unlike shale, and characterized by large learning spillovers which industry participants did not attempt to internalize through merger or other means? (I would also like to highlight the irony that Harford’s argument would imply that shale, for which there is actual evidence of LBD, should have been subsidized decades ago.)

Harford also has a myopic focus on PV cost, and fails to consider the total cost of renewables, including solar. Like other renewables, solar has intermittency and diffusiveness problems. Moreover, it has large and predictable output fluctuations (e.g., the “duck curve” problem in which solar output plunges when the sun starts to set). Due to these inherent features, useful solar will require beyond revolutionary innovations in battery technology (something Menton has analyzed in detail) that are not anywhere on the horizon.

(I note that battery technology has been the subject of massive research. It has also experienced tremendous growth in cumulative output, which has presumably contributed to learning. Yet it is nowhere even close to being an economical way to address output variability for renewables.)

Word to the wise: we are not going to be able to learn our way out of the sun rising, and more importantly setting. Or out of rain, clouds, and hailstorms. Or out of voracious needs for land to site renewables. Or out of the difficulties of disposing defunct panels.

Solar is part of a complex energy system. The cost of solar panels is actually among the least important aspects of the cost of relying on solar as a source of energy.

And talk about hindsight. Harford laments our failure to gaze into the distant future and foresee with precision the obsession with CO2 and climate change, and supersize solar panel output in time to provide cheap solar power when those obsessions became manifest. Yeah, and I should have invested in Apple when Harford says we should have subsidized solar. Or Bitcoin in 2013.

In sum, Harford’s woulda, coulda, shoulda lament in the FT is yet another example–as if more were needed–of the intellectual vacuity of those hyping the “energy transition.” Harford invokes a respectable economic concept–learning by doing–but does so in a superficial way that betrays a complete lack of understanding of it. And in a way that also betrays a lack of understanding of the real challenges of transforming an extremely complex energy system. Cheap solar panels may be a necessary condition for a cheap transition, but it’s hardly a sufficient one, or indeed, even likely an important one.

Alas, learning by doing doesn’t appear to apply in the writing of newspaper columns.

April 20, 2024

Why Do Governments Repeatedly Engage in Energy and Environmental Boondoggles?

Filed under: Climate Change,CoronaCrisis,Economics,Energy,Politics,Regulation — cpirrong @ 1:34 pm

In the Wealth of Nations, Adam Smith famously wrote:

By means of glasses, hotbeds, and hotwalls, very good grapes can be raised in Scotland, and very good wine too can be made of them at about thirty times the expense for which at least equally good can be brought from foreign countries. Would it be a reasonable law to prohibit the importation of all foreign wines, merely to encourage the making of claret and burgundy in Scotland? (WN IV.ii.15)

This came to mind when reading this Bloomberg article about an “efuels” venture:

At its plant, electrolyzers break down water into hydrogen and oxygen, using electricity generated from nearby wind and solar farms. The hydrogen is then transported to a reactor, where it meets CO2 captured from local refineries, setting off a series of complex chemical reactions aided by patented catalysts. The result is a synthetic fuel with the same chemical properties as its fossil fuel-based cousins.

Yes, this process can create “equally good” fuel as traditional hydrocarbons. But at what cost? Well, they could tell you, but then they’d have to kill you:

How Infinium fits into that future remains to be seen. Schuetzle is tight-lipped about the company’s exact plans. While acknowledging that Infinium’s e-fuel is “more expensive” than conventional fuel, he didn’t disclose the cost difference. 

Probably not the 30x of Adam Smith’s Scottish wine, but evidently a large enough multiple to frighten the horses if disclosed.

Because of this cost differential, this industry will come into existence only as the result of heavy-handed government policy, in the form of subsidies, kneecapping competitors (namely traditional fuels), or more likely both. And echoing Smith, the question becomes “is it a reasonable law or policy to rig they system to favor this technology, merely to encourage the making of efuels?”

Smith did not answer his question because it answered itself. And the same is true of mine.

To repurpose an old joke, the government wants to address climate change in the worst way, and it is. Picking technologies that are feasible but exorbitantly costly in order to achieve a putatively desirable objective is a tried and false modus operandi of government. And this has been especially true of environmental and energy policies in the United States going back to the dawn of the EPA in the early 1970s, and the energy crisis of the mid-to-late 1970s.

I recall the “synfuels” boondoggles of the late-70s, e.g., making oil from shale. No, not the shale revolution you might be thinking of that actually resulted in the economical production of vast amounts of crude oil and natural gas, but taking shale rock in Wyoming with embedded hydrocarbons, subjecting it to energy intensive transformations (redolent of those described above for the efuels project) to produce oil at vastly higher cost than even the then-elevated price of conventionally produced oil. The government spent billions back when a billion actually meant something on this effort (and other synfuel efforts). And every dollar was wasted.

And reading the Bloomberg article demonstrates that the government, in its wisdom, is doing Adam Smith one better: it wants to mandate technologies that don’t really exist (unlike Smith’s “glasses, hotbeds, and hotwalls”):

Some regulators seem to agree with that thinking. The EU will phase out government subsidies for e-fuel made with fossil fuel-sourced CO2 by 2041. 

In its place, governments will mandate that efuels be made from CO2 obtained from air capture, a technology that the Bloomberg article describes as “nascent” but is more accurately described as “pie in the sky” (literally, in this case).

This generation of efuels will come into existence only as the result of government diktat, just as the first generation–ethanol and biodiesel–did. And the efuel technological greenhouse forcing is just one small part of an array of mandating of technology choices, all in the name of fighting global warming. The electrification of everything is if anything a more extreme example: the EPA’s mileage mandates (intended to make ICE vehicles uncompetitive with EVs), its emission standards for fossil fuel generation, and the lavish subsidization of inefficient (because diffuse and intermittent) renewables are if anything more egregious than growing the efuels industry like orchids.

But bureaucrats are geniuses, and will only do what’s best, right? Right? To disabuse yourself of such notions, refer back to the synfuels case discussed above. Or consider two more recent examples.

One was the European policy to force the replacement of gasoline engines with diesel ones in passenger vehicles, with the unintended–but totes foreseeable–result of increased particulate emissions (and widespread fraud by automakers to conceal that). Europe had to jettison that policy, so it has substituted another: eliminating ICE vehicles altogether. I’m sure that will work out swell.

Another that I find particularly rich is the sulfur standards for marine fuels introduced in 2020. In another unintended (but again foreseeable) consequence, the resulting reduction in particulate emissions is allegedly contributing to global warming. The irony behind this (compounded by the fact that efuels funder Bill Gates is also a fan of this technology) is demonstrated by serious proposals–recently experimented with–to inject particulates into the atmosphere to, yes, mitigate global warming.

So why do governments repeatedly adopt excessively costly policies to address putative problems? One part of the answer is hubris combined with the knowledge problem: they think they know a lot more than they do. But that’s not the entire answer.

At root, I think the more fundamental driver is public choice-related. Specifically, specific technologies have specific constituencies who would benefit from their subsidization (or other forms of policy support). They exert influence on legislators and bureaucrats to implement policies that favor them. (It is not a coincidence, comrades, that Bill Gates and the like have connections with many of these schemes.)

In contrast the effects of policies such as a carbon tax or cap and trade are much more diffuse and far less predictable because the ultimate outcome would be determined by market processes in a complex system. Adjustments would occur on myriad margins, not just by large firms but billions of individuals. The winners and losers in such a process are unknown, unknowable, and highly diffuse–these are not the concentrated interests that exert disproportionate influence on public policy.

(NB: I am not endorsing a carbon tax or cap and trade. I merely assert that they would be better ways of reducing carbon emissions than subsidizing or mandating technologies to do so. An exercise in the Theory of the Second Worst, if you will.)

In sum, political systems produce bad “solutions” to problems because of the very nature of politics, a nature that Mancur Olson and others pointed out years ago. A nature in which “public choice” means that the public gets screwed.

April 13, 2024

Would You Believe . . . Ukraine Refinery Attack Edition

Filed under: History,Military,Politics,Russia,Ukraine — cpirrong @ 10:53 am

As I noted in a previous post, the Biden administration has tried to restrain Ukraine from attacking Russian oil refineries. The previous reason, as set forth by SecDef Lloyd “AWOL” Austin, was that these attacks would disrupt world energy markets.

Translation: these attacks would increase gasoline prices which scares the bejesus out of an inflation-battered administration in an election year.

But apparently the administration decided that wasn’t a very good look. Too obviously self-serving, and perhaps too dissonant with its the-war-in-Ukraine-is-a-vital-US-national-interest one.

So, would you believe, the administration is REALLY concerned on humanitarian, just war grounds:

Nah, we wouldn’t believe that, actually. Especially since this oh-so high minded critique of Ukrainian military tactics has heretofore been completely absent from American policy makers’ discourses. It’s obviously a lie to cover the election-obsessed administration’s true motivations. That is, AWOL Austin committed the Kinseyan gaffe of speaking the truth, and this gaffe had to be cleaned up.

This justification is also utterly ridiculous on myriad grounds. For one thing, as Rep. Scott pointed out, why should Ukraine fight asymmetrically, but in a bad way, taking blow after blow to its civilian targets but not striking back. For another, oil refineries are a legitimate military target, given (a) Russia’s armies in Ukraine run on the fuel they produce, (b) fuel exports are a material source of revenue for the Russian government, and (c) the Kremlin is clearly concerned about higher fuel prices, and the potential effect they would have on support for the war.

For yet another, in military conflicts in the modern age the United States has made attacking enemy energy assets a primary target. In WWII, the most effective element of the strategic bombing offensive (and one that probably should have been introduced earlier) was the attacks on Germany synthetic fuel production. (The attacks on the oil fields at Ploesti, Romania in 1943 less successful, but the April-August 1944 attacks did materially restrict fuel supplies to the Wehrmacht and Luftwaffe). In Gulf War I, one of the first targets of American air strikes (after Iraqi air defenses were dismantled in the first wave) were Iraqi electric power plants, which were attacked with graphite bombs. Soon after, the US turned its attention to, yes, Iraqi oil refineries. In 1999 the US unleashed graphite bombs on Serbian power plants.

The US, in other words, has long recognized the strategic importance of enemy energy production, and has made it a priority target. So why shouldn’t Ukraine?

And note that given the previous history, Wallender is implicitly accusing the United States of violating the laws of armed conflict.

It’s actually quite disgusting that the administration covers its nakedly political motivations with high sounding blather about “the laws of armed conflict” and the “standards of European democracy.” Maxwell Smart was funny. These clowns are not.

April 9, 2024

To Call Biden Administration Energy Policy “Schizo” Is an Insult. To Schizos.

Filed under: Commodities,Economics,Energy,Politics,Russia — cpirrong @ 3:13 pm

Not surprisingly given its avatar, the Biden administration is a picture of drooling incoherence. This is especially true when it comes to energy policy and the Russo-Ukrainian War and especially the intersection of these.

Case in point. The administration constantly asserts that it is a vital US interest for Ukraine to prevail and Russia to lose. Secretary of State Blinken went so far as to promise that Ukraine would join Nato, despite the fact that this is akin to waving a red flag in front of a bull (in the form of Putin). Ukraine must win! We must provide massive military aid! UKRAINE MUST WIN! FREEDOM AND OUR DEMOCRACY ARE AT STAKE!

But not if it raises the price of gasoline in an election year, apparently. In recent months one of Ukraine’s most successful gambits has been drone attacks on Russian oil refineries. These attacks focused on distillation units, the disabling of which sharply cuts refinery output. As a result, Russian refined product output is supposedly down around 10-15 percent, exports of gasoline have been banned for six months, and the country is desperately seeking imports of gasoline from Kazakhstan. This is a serious economic blow to Russia, and also crimps military efforts which are obviously dependent on fuel supplies.

Further, the impact is likely to be long lasting because repairs depend on foreign parts and foreign expertise that Russia cannot readily obtain due to sanctions.

These attacks are also mirror images to Russia’s relentless bombardments of Ukrainian energy facilities, especially electric power generation.

Especially given the trivial resources devoted to the campaign (which is carried out using drones), this is arguably one of the most effective measures that Ukraine has implemented in the two plus years of war.

So given the allegedly existential stakes in a Ukrainian victory, the administration is gung ho in its support for these attacks, right? Right?

Wrong! The administration, first in the form of the execrable Ichabod Crane doppelgänger Jake Sullivan, then in the form of the utterly embarrassing Secretary of Defense Lloyd “AWOL” Austin, is intensely pressuring Ukraine to cease its campaign against Russian refineries.

Why? Because it might raise gasoline prices. It’s an election year dontcha know:

The incoherence is only compounded when you consider the administration’s antipathy for fossil fuels in its obsession over climate change. The administration thinks that fossil fuels are really, really bad, m’kay, and wants to reduce sharply their use. What better way to do that but to make them more expensive?

Now that I mention it, none, actually. Demand curves slope down. So for the climate change obsessed, burning Russian refineries and the consequent increase in fuel prices is a good thing. A great thing, according to the theory of the second best! And something that harms our alleged arch enemy to boot! What could be better?

Well, what could be better to someone who thinks logically is the real question. The freak out over the refinery attacks is clearly symptomatic of people who refuse to think logically. People who apparently elide the word “foolish” from Ralph Waldo Emerson’s epigram that “a foolish consistency is the hobgoblin of little minds.”

The administration’s draining of the Strategic Oil Reserve is another example of its foolish inconsistency.

There are many other examples. One that also checks the Russia and energy boxes is the insane pause on US LNG development approvals. This will also “impact global energy markets,” and not in a good way. And in particular not in a way that helps those whom we hope will help Ukraine.

When European natural gas prices reached stratospheric levels in the immediate aftermath of Russia’s invasion of Ukraine, Biden proclaimed that the US had Europe’s back, and would replace Russian gas with good ol’ ‘Merican LNG.


The administration’s obsession with keeping down the most visible price of energy (that paid at the gas pump) also clashes starkly with an array of other policies that will dramatically increase the cost of energy. The push towards electrification of everything, with the electricity generated by renewables, is just one example. Renewables are not cheap. They are expensive. Hella expensive–just look at how much higher electricity costs are in jurisdictions here (e.g., California) and abroad (e.g., Denmark and Germany) where renewables penetration is highest. Driving up demand (e.g., by penalizing the use of ICE vehicles) of a high cost resource is a recipe for higher energy costs. Much higher.

The force feeding via vast subsidies of high cost efuels and hydrogen will also inflate energy costs, though here (not coincidentally) the cost will be concealed in your tax bill and higher interest rates (required ot get people to buy US debt).

In sum, to call Biden administration energy policies “schizo” is an insult. To schizos. It is full spectrum contradiction and incoherence that simultaneously strives to lower energy costs and raise them, and to protect Russia while demonizing it.

April 8, 2024

The U.S. Navy In Existential Crisis

Filed under: China,Military,Politics — cpirrong @ 11:50 am

The United States Navy is broken. The 2010s saw numerous operational SNAFUs, ship collisions and the like. Those have abated somewhat, the most recent being the collision of the Seawolf Class submarine USS Connecticut with an undersea mountain about 2.5 years ago. But serious long term structural problems are metastasizing. And these are much more difficult to address than reprioritizing seamanship.

The Navy desperately needs to be recapitalized. Major ship classes are reaching retirement. These include Ticonderga Class cruisers, and Ohio Class SSBNs (nuclear missile submarines) and SSGNs (guided missile submarines). Ship numbers have plummeted, and most troubling, replacement ships have either proven to be failures (LCS), wildly expensive without a coherent mission (Zumwalt), or pathetically behind schedule.

The Ohio replacements–Columbia Class SSBNs–are the least pathetic, being only a year behind. (Allegedly. I predict that number will slip.) Ford Class carriers (CVN) are 2-3 years behind. Virginia Class SSNs (arguably the single-most important ship type) are 3 years behind. The reasonable replacement for the hapless LCS–Constellation Class frigates–is 3 years behind.

When I was at the Naval Academy, the only acceptable answer to the question “Why did you f-up?” was “no excuse, sir!” Now, the Navy is nothing but excuses. Covid (natch), “supply chain woes” (natch), retirement of experienced labor at shipyards (euphemistically called “greening of the labor force”). (Though now the Navy has apparently stopped making excuses. It’s decided to take the 5th instead–which is denying a problem rather than admitting it.)

Which all brings to mind another old Naval adage: PPPPPP, i.e., “Prior planning prevents piss-poor performance.” Covid excepted, the other supposed problems were predictable and observable, and should have been anticipated, recognized, and addressed before they mushroomed into full-blown disasters.

And it is essential to emphasize that “Covid” was not the problem: the problem was catastrophic government policies justified by Covid. And in these, the Navy–and the military generally–was an eager participant. It exacerbated the military’s other ongoing crisis (in recruiting and force retention) through its draconian vaccine policies. Moreover, it is clear that significant resources were diverted from doing with the Navy should do to managing idiotic Covid policies.

Case in point. When I went to my USNA class reunion in 2021, at the Superintendent’s Call the Supe spent a good portion of the time bragging about all the efforts necessary to keep the academy running during Covid (e.g., arranging for the handling of the massive increase in trash caused by having meals served in Mids’ rooms–truly a national defense priority!). That type of diversion of leadership time was no doubt the rule, rather than the exception.

(The other biggest subject of the Supe’s talk was related to DEI efforts–another subject, but also symptomatic of the diversion of the Navy/military resources and leadership time into non-mission-critical matters.)

Pace JFK, failure is not an orphan. The Navy’s failure has many fathers (and mothers, nowadays). Service leadership is at the head, of course. Civilian “leadership” at the Pentagon is also greatly culpable. The procurement process is utterly broken. Resources are diverted to chasing chimeras, the aforementioned DEI being one, but climate change being another. And Congress bears considerable blame, most notably for the non-budgeting process which has resulted in year after year of continuing resolutions that (rather than budgets) that make long-term planning and management and procurement extremely difficult. Congress is also largely responsible for prioritizing the chimeras.

The Navy and the Air Force are the most vital branches in any prospective conflict with China in the Pacific. The Navy’s complete dysfunction is therefore a grave national security issue. The most grave of all, in fact.

So what is to be done? The problems are so deep and so structurally embedded that easy fixes are off the table. Congress’ dysfunction is unlikely to change, absent some sort of miracle in November (but even there truth be told the Republicans bear considerable culpability for the existing problems). Similarly, a change of administration is a necessary but not sufficient condition: Trump’s record at appointing civilian Pentagon leadership was appalling, and the dysfunction continued and arguably accelerated on his watch. Given the inertia of the massive Pentagon bureaucracy and its hostility to Trump, moreover, it is doubtful whether he can clean the Augean Stables on the Potomac, even if he has the urge to try (also doubtful). The current flag ranks and those in line to succeed them are the products of a politicized military produced primarily by 8 years under Obama.

An Admiral Byng approach is tempting, but it will take more than one firing squad “pour encourager les autres.” Many more.

I wish I could offer solutions, or even suggestions. But in order to get those responsible (but apparently unaccountable, alas) focused on getting the ship back on course it is necessary to alert them to the looming iceberg ahead. So the best I can do is sound the crash alarm and hope that it is heeded before it is too late.

April 2, 2024

Missing the Big Point on FCM Concentration and Systemic Risk

Filed under: Clearing,Derivatives,Economics,Exchanges,Regulation — cpirrong @ 1:58 pm

The increasing concentration of the futures commission merchant (FCM)/clearing broker business has been a pronounced feature of the world derivatives markets in recent years. This has raised concerns among at least some regulators, including CFTC commissioner Summer K. Mersinger. In a speech generally rah-rah-ing clearing mandates, Commissioner Mersinger did raise one discordant note. Specifically, implementation of the Basel III standards would contribute to further concentration in the FCM/CB space:

Second, the Basel III Endgame Proposal would weaken the clearing system by exacerbating the downward trend in the number of entities offering client clearing services.  In January 2004, there were 177 futures commission merchants (“FCMs”) registered with the CFTC.  Twenty years later, as of January 2024, there are 62 FCMs registered with the CFTC, representing a 65% decline. But over the same period, there has been a dramatic increase in customer funds held at FCMs to support derivatives trading.  In January 2004, FCMs held over $87 billion of customer funds.  Today, that smaller number of FCMs is holding five-and-a-half times that amount of customer funds—$490 billion.  And of that customer money, approximately 60% is concentrated in the top five FCMs. [Footnotes omitted.]

This is a problem because

Third, a further decline in the number of FCMs would create systemic risk. In addition to concentration concerns, a decline in the number of FCMs would raise serious challenges regarding the portability of customer positions should a clearing member fail.  Consider this potential scenario: a clearing member defaults, and its customers’ positions need to be ported to a different clearing member; however, porting those positions proves difficult or even impossible because the Basel III Endgame Proposal has both decreased the number of clearing members and reduced client clearing capacity at the remaining clearing members.  This outcome of the Basel III Endgame Proposal would increase systemic risk, not reduce systemic risk.

It’s a shame nobody saw this coming.

Oh wait. Someone did. Thirteen years ago: “Moreover, this means of facilitating connections of end users to multiple CCPs tends to encourage the concentration of client business in a small number of clearing member firms. This concentration has systemic implications.”

(See also here, from the Chicago Fed.)

On this blog, I have also written on numerous occasions how various aspects of Dodd-Frank contribute to consolidation among FCMs. Regulatory overhead is a largely fixed cost, which contributes to scale economies and hence concentration. Moreover, diversification effects and the need for big balance sheets to intermediate large derivatives positions also contributes to concentration. Note that the OTC dealer market has always been quite concentrated for these reasons, and this concentration has migrated to the cleared world as clearing of OTC derivatives has been mandated.

Commissioner Mersinger did not identify the causes of increasing concentration that has already occurred among FCMs: her speech focuses on how the Basel III End Game may make this problem even more acute. But she does not recognize that the central clearing that she lauds in her speech is a major driving force of the trend she laments: “But recent policy proposals in the United States risk upending the success we have experienced through the efforts of the G-20 and the move to central clearing.” In other words, central clearing good, but you are screwing it up, Basel.

I said Basel! Not Basil!

In actual fact, regulation generally, and clearing mandates specifically, have been the major driver of market structure in the post-Frankendodd era. It’s good that regulators are starting to recognize the systemic risks inherent in this structure. It’s disappointing that they don’t recognize that what they praise lavishly (and pat themselves on the back for) is the underlying source of the problem.

April 1, 2024

Erdoğan’s Crown Begins to Slip

Filed under: Politics,Turkey — cpirrong @ 6:14 pm

Tayyip Recep Erdoğan suffered a resounding electoral spanking in yesterday’s mayoral elections in Turkey. (Or Türkiye, as Erdoğan insists you call it.)

Erdoğan’s AKP party suffered a loss of 15 mayor’s posts, with most of those going to its main rival, the CHP. CHP actually outpolled AKP on a national level, which is unprecedented. The most stinging losses were in Istanbul (Erdoğan’s home city) and Ankara. In Istanbul, which Erdoğan desperately wanted to retake, Ekrem İmamoğlu handily retained the mayor’s office.

İmamoğlu’s victory is indeed impressive, and he has received almost all of the attention in the aftermath of the election: he has been anointed as the likely replacement as president for Erdoğan in four years’ time. Yet all of the focus on İmamoğlu obscures another figure, Ankara mayor Mansur Yavaş.

Yavaş’s margin of victory was even more resounding than İmamoğlu’s, with him winning over 60 percent of the vote, as opposed to İmamoğlu’s smidge over 50 percent. Yavaş has a sky-high approval rating–as his electoral landslide demonstrates.

Moreover, although İmamoğlu may be more appealing to westerners and westernized bougie Turks who are the core CHP constituency, a series of electoral failures (13 consecutive losses in parliamentary and presidential elections under the hapless “leadership” of former party boss Kemal Kılıçdaroğlu, who selfishly insisted on leading the party in the 2023 presidential and parliamentary elections) has demonstrated clearly that CHP cannot secure an electoral majority on its own. Further, demographics are its enemy–religious AKP types outbreed secular (and often atheist) CHP types.

Yavaş is not really CHP, despite the fact that he has run on its ticket in Ankara. His political origins lie in the MHP, a nationalist party founded by one of the leaders of the May 1960 coup, Alparsan Türkeş (“bashbo,” who is still something of a cult figure among Turkish nationalists). He split with MHP because its longtime leader Devlet Bahçeli allied with Erdoğan and the AKP (perhaps because of blackmail).

As a result of this background, Yavaş has the potential to expand the CHP’s appeal to nationalists (who represent a smallish but potentially pivotal segment of the Turkish electorate) in a way that İmamoğlu does not. Yavaş’s main problem is that MHP has historically been anti-Kurdish. But the AKP has been harshly anti-Kurdish as well, and Kurds will likely conclude that CHP will constrain any anti-Kurdish inclinations Yavaş may harbor, making him the lesser of two evils. In sum, Yavaş has a greater potential of forming a coalition that can displace AKP than does İmamoğlu.

Yavaş is also a very tough guy, a lawyer who has frequently faced down Erdoğan in Ankara. Erdoğan fears him more than İmamoğlu.

So don’t be so sure that Turkey’s political future is in the hands of the more telegenic, western-appealing İmamoğlu rather than in those of the more dour, less well-known, and more Turkish qua Turkish Yavaş.

That said, having two highly credible leadership candidates can be both a blessing and a curse. CHP has a long history of infighting and back-biting, and no doubt Erdoğan will try to stoke a rivalry between Yavaş and İmamoğlu. But the very fact that he may have to do so in order to maintain his party’s grip on power is an indication that his position is far weaker than it was when he waltzed to victory a year ago.

Resource Nationalism and Nationalization is the Root of Corruption

Filed under: Commodities,Economics,Energy — cpirrong @ 5:35 pm

Recently major commodity trading firms have plead guilty to, and/or had employees convicted of, violations of the US Foreign Corrupt Practices Act. The companies collectively have paid billions in fines, and the convicted traders face decades in the Club Fed.

Corruption is bad, uhm-kay, but the rather lurid focus on the traders is unbalanced and gives a misleading impression of the real root of this evil. It takes two to tango: in these situations, the briber and the bribe taker. Here the bribe takers are the real drivers, and they derive their power from the simple fact that they are agents of nationalized companies. That is, the “root causes” here are the nationalization of resources, and the creation of national companies that control access to resources. Yet the bribe payers get most of the attention.

The firms that have been charged and plead are not a random selection of trading companies. Instead, they are the biggest oil trading companies–Vitol, Trafigura, Gunvor, and Glencore. Not grain traders or softs traders or even the metals, natural gas, or power trading operations of these companies. Why? Because whereas national oil companies are common, traders dealing outside oil markets are typically not dealing with national companies.

As the DOJ put it in its announcement of a $1.5 billion 2022 plea agreement with Glencore:

Between approximately 2007 and 2018, Glencore and its subsidiaries caused approximately $79.6 million in payments to be made to intermediary companies in order to secure improper advantages to obtain and retain business with state-owned and state-controlled entities in the West African countries of Nigeria, Cameroon, Ivory Coast, and Equatorial Guinea. (Emphasis added.)

The fundamental problem here is that South American and African countries with oil tend to be extremely corrupt. Indeed, they are likely corrupt in large part because they have oil. It is also likely that national oil companies are the norm in such places precisely because they provide a structure that allows elites to appropriate oil resource rents (via bribery and various tunneling schemes).

Levying substantial penalties on trader will reduce these companies’ derived demand for corruption, and this will reduce bribery income of kleptocrats. But if the big guys leave, or sharply reduce their activities in these countries, their place will be taken by dodgier outfits who will pay bribes. The recent experience with Russian and Venezuelan sanctions shows that eliminating illicit transactions in oil is devilish hard.

The incentive is immense. According to the DOJ, Glencore paid about $80 million over 11 years to get access to oil flows that generated hundreds of millions in profit–roughly a 5-to-1 ratio. Basically what will happen is that the dodgier outfits will pay lower bribes to get these benefits, with the lower bribes being a compensating differential for the legal risk.

Nationalization was originally adopted because international oil companies (IOCs) were allegedly exploiting nations with oil resources. Even if that was indeed true, nationalization merely changed the identity of the exploiters from the IOCs to local elites who obtained power by force, or yes corruption, or both. Further, nationalized companies are notoriously inefficient and putting them in charge has reduced the value of oil resources, further reducing the benefits that the citizens of these nations (as opposed to the elites) derive from these resources. (To get an extreme example of the grotesque inefficiency of nationalized companies, look at PDVSA especially starting with Chavez over 20 years ago. But wherever you look, the inefficiencies are manifest.)

In sum, bribery by major oil trading firms is just another symptom of an underlying disease–resource nationalism. The focus on the payers of bribes, rather than on those who demand and receive them, obscures that fundamental truth.

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