Streetwise Professor

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:

Defense Secretary Lloyd Austin warned that Ukraine’s recent attacks on Russian oil refineries risk impacting global energy markets https://t.co/3LgO2UfzHg

— Bloomberg (@business) April 9, 2024

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.

Suckers!

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.

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.

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.

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.

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.

It is a challenge to identify the worst of the worst Federal agencies, but the Environmental Protection Agency is clearly a heavy favorite.  (The security organs are in a class by themselves.  Here I refer to civil regulatory agencies.)

In a strong effort to cement winning this dubious distinction, last week the EPA announced new tailpipe standards that reduce by 50 percent allowable emissions of CO2 (relative to an already reduced 2026 level).  This is transparently intended to throttle internal combustion engines (ICE) and jam electric vehicles (EVs) down our throats.

The administration is crowing about this:

“Three years ago, I set an ambitious target: that half of all new cars and trucks sold in 2030 would be zero-emission,” Biden said in a statement, adding that the country will meet that goal “and race forward in the years ahead.”

Biden said in a statement issued in his name—written by someone else, of course, because he couldn’t form these sentences by himself.

 In numbers pulled straight from its collective ass, the EPA claims the reduction in CO2 emissions will produce $100 billion in benefits annually, the vast bulk of which are due to chimerical gains from ameliorating climate change. 

As the much-missed Sonic Charm (still mordant on X, but not in the blogosphere) said: all large calculations are wrong.  And that goes exponentially for any calculation involving alleged climate benefits and costs.  Despite all the claims about scientific consensus (which should make you neuralgic in the aftermath of Covid, where almost all claims about The Science flogged by governments and the media have turned out to be the inversion of the truth), estimates of the impact of changes in CO2 emissions on climate are speculative in the extreme.  And those speculations pale in comparison to estimates of the impact of climate changes on welfare, including effects on wealth, income, and living standards.

Climate is a complex system.  Economies are complex systems.  Only fools and the evil have the hubris to claim to know how small changes in one variable will affect outcomes in the interaction between two complex systems. 

Where does the EPA fit here? Both, clearly. 

It is particularly perverse that the EPA is attempting to socially engineer economic outcomes—namely, what vehicles people drive—at a time when the manifold defects of EVs are becoming clearly manifest.  Their performance sucks in multiple ways, including limited range, declining range over time (as batteries age), poor performance in cold weather, and long recharging times (human time is valuable—did the EPA take that into account? I crack myself up sometimes).  Repair costs are astronomical.  And the putative environmental benefits are dubious when the entire vehicle lifecycle is considered, or when the environmental impacts of mining the myriad materials EVs need are taken into account.  Moreover, there are other environmental costs—notably substantial road degradation and substantially increased particulate emissions from tire wear, both due to the great weight of EVs.

Increased awareness of these effects is turning EVs into the Typhoid Marys of automobiles.  Sales are well below what had been projected as consumers have become aware of the clear inferiority of EVs relative to ICE vehicles in doing the things people want—and need—their vehicles to do.  EVs are clogging dealer lots, and they don’t want to buy more.  Resale values are in the tank.  Insurance costs are prohibitive. 

EVs are far more expensive to drive off the lot, and are more expensive to operate, than ICE vehicles.  Is it any wonder why Ford is drastically cutting its production of electric F-150s, and why every other auto manufacturer is hedging on its previous promises to go all electric in the near future?

Two rental car companies—Hertz and Sixt—have recently pulled the plug on their EV fleets (figuratively and literally) because the economics are so atrocious.  The disastrous Hertz plunge into electrics cost the CEO his job.   

EV skeptic Toyota is looking pretty damned smart now, ain’t it?

The inadequacies and defects of EVs are particularly pronounced for anyone who lives outside of a major metro area, and the more exurban or rural you are, the less suitable EVs are for you.  So this regulation represents another front in the war on suburban, exurban, and rural America.

And maybe that is part of the plan.  Recall my post on the war on cars generally.  They want you to walk the road to serfdom, and to jam people into villages (soothingly named “15 minute cities”), just like castellans did in the 11^th century. 

Put differently: from the perspective of the progressive, globalist types who want to eliminate personal mobility (for the proles, that is, not for them), all the aforementioned bugs of EVs are features because they drastically raise the cost of mobility. 

Not to mention the strains that increased EV usage will place on already creaking electricity grids and generation systems.  The interaction between this regulation, and the EPA’s equally (or even more malign) regulations of power plants, poses extreme risk to the nation’s electricity system.

To compound the lies, the administration claims that this will be a boon for the domestic automobile industry:

Biden added that U.S. workers “will lead the world on autos making clean cars and trucks, each stamped ‘Made in America.‘”

As. Fucking.  If.  This regulation will wreak havoc on the existing ICE-centric US auto industry (and the entire supply chain for it), with all of the baleful consequences that will have for capital value and employment.  The US industry has shown little prospect of having a comparative advantage in EV manufacturing.  Note the huge losses Ford has racked up on a per vehicle basis on its electronic version of the stalwart F-150.  GM’s EV operation has also frolicked in pools of red ink. 

Trump claimed that the US auto industry would face a bloodbath due to Chinese manufacturing of cars in Mexico.  That is nothing compared to the ensuing bloodbath—economic bloodbath; it’s a metaphor!—if the EPA guts the ICE industry. (“Guts” is a metaphor too! Can’t assume anything these days, right?)

These regulations are beyond sickeningly perverse.  They represent an extreme exercise of arbitrary power in the service of a delusional ideological agenda embraced by a tiny sliver of the citizenry. 

And when I say extreme, I mean by the standards of rational behavior, not by the standards of the current American administrative state. Sadly, what the EPA is doing has strong parallels in what virtually every other Biden administrative agency is doing—don’t get me started on GiGi’s SEC.  Or the FTC.  Or the DoL. 

Extremism in the exercise of administrative power is definitely a vice.  It is the enemy of personal freedom, personal choice, and economic prosperity. 

Rein in the administrative state?  Is that even possible?  Doubtful.  The only sure remedy is the Carthaginian one.

There’s been a bit of a hullabaloo of late regarding the resurgence of short volatility trades in equities. This comes at a time when volatility is low by historical standards, which has led some to conclude that the shorting of volatility is causing the low volatility.

Wrong, wrong, wrong–or at least the correlation between the two is insufficient to demonstrate causation. This is another example of the error of reasoning from a price/price change.

The “logic” here is particularly dubious for derivatives (“selling vol” is a synonym for selling options) because they are in zero net supply. Quantity bought is equal to quantity sold. So “short volatility trades come roaring back” also means “long volatility trades come roaring back.” Determining what drives what is not immediately obvious.

Here’s another story. Some believe volatility is to cheap and want to buy it. Or some what to hedge volatility risk, and at the current low levels it appears attractive to do so. So rather than pushing into the vol market, shorts are being pulled in.

You can’t tell which is happening just looking at the level of vol and open interest. And here’s the key thing: derivatives are risk transfer markets. What is determined in these markets are primarily risk premia. And so to see who’s pushing and who’s pulling, you need to look at risk premia.

The long pull story should see the vol risk premium rise, specifically implied vols should rise relative to expected future vols (in the physical measure). A crude proxy for this is implied vols rising relative to realized vols.

The short push hypothesis predicts the opposite. It doesn’t predict that the level of implied vol should fall absolutely: it predicts that implied vols should fall relative to realized vols.

And according to CBOE’s vol maven Mandy Xu, it’s the former and not the latter:

Second, if volatility selling strategies were to blame for the low levels of the VIX index, you would expect the volatility risk premium (VRP) to shrink as the implied-realized volatility spread narrows (i.e. the VRP is what option sellers aim to monetize and thus should decrease as more sellers enter into the market). Instead, what we’ve seen over the past year is the opposite — the S&P 1M volatility risk premium (as measured by the difference between the VIX index vs SPX 1M realized volatility) actually increased quite meaningfully, from 1.5% in 2022 to 3.6% in 2023. Implied volatility may be low, but it’s not trading particularly cheap compared to realized volatility (SPX 1M realized vol went from averaging 24% in 2022 to just 13% in 2023).

Xu also notes that the vol curve has been more skewed to the call wing, i.e., out-of-the-money call vols have been rising relative to ATMs. This could be explained by a demand to hedge against volatility spikes from today’s current levels (a scenario that played out in the “Volmageddon” of 2018). (Pay attention class–by which I mean my real, actual classes–we’ll be discussing that after Spring Break.)

So the short vol crowded trade driving down vols story is certainly logically weak and factually unsupported, and the alternative that the rise in vol-related derivatives notionals is driven by buyers does have support in the data.

Remember children: never argue from a price change. Especially in derivatives markets with arguments based on open interest/volume.

There does appear to be some interesting intermediation going on. There has been a lot of activity in individual stock options (e.g., Nvidia). It appears that some buying pressure has been accommodated by hedge funds selling those options, and buying index options. This is a form of spread trading (in a way not dissimilar from the infamous basis trades) that hedge funds specialize in. It would tend to contribute to higher notionals in index vol positions–both long and short. There is also spreading between short-dated (especially “zero day”) options and longer-dated options.

Regardless of the underlying driver here (index vol bets or individual stock vol bets) it does appear that the surge in volatility trading has been buyer driven, not selling driven, as indicated by the behavior of risk premia.

Sadly, it is the Bank for International Settlements (BIS) that has pushed the “vol shorts have pushed down implied vols (absolutely–but not relative to realized vols). So it’s fair to say that the BIS is riding the volatility short bus. Which is embarrassing.

The “Cathars”–the target of (a) the first intra-Europe crusade (and arguably the first crusade period*) that resulted in the deaths of 10s of thousands (often by fire) and the desolation of vast swathes of southern France, and (b) an inquisition that killed more–are a source of fascination and mystery. They left little of a written record, and most of that which is “known” about them was written by a Catholic Church that ruthlessly persecuted them as “heretics.” Thus, what their “heresies” actually were is unknown.

In his fascinating The Rest is History Podcast, historian Tom Holland conjectures that their heresies had nothing to do with dualism or celibacy or any of the other theological sins with which they were charged. Instead, the Cathars’ (not something they called themselves, by the way) crime was essentially that they were rustics who were not willing to conform with aggressive reforms adopted by the Catholic Church in the early-13th century. In particular, they were in a way proto-Protestants who believed that salvation was not dependent on the intermediation of priests, bishops, archbishops, and Popes. One could become a “bon homme” destined for heaven by one’s own conduct and faith without priestly intermediation. This clashed with Pope Innocent III’s aggressive centralizing efforts to enforce the primacy of the priesthood and the formal church.

Put simply, this was a clash between self-governing rural traditionalists and an extremely assertive–and in fact murderous–bureaucratic government with universalists pretensions insistent on controlling the private and public lives of everyone.

Voltaire said that history does not repeat, but humans do. Viewing the current political landscape in the United States and Europe speaks to Voltaire’s veracity.

Case in point, the currently raging hysteria regarding “white rural rage” and “Christian nationalism” in the United States. Though the United States government has not–at least not yet–channeled its inner Innocent III and launched a murderous crusade against American rustics, the aforesaid hysteria echoes the Albigensian Crusade. (“Albegensian” was another epithet applied to the Cathars, and was a reference to Albi, Italy, which was a Cathar stronghold.)

Specifically, the heresy of non-urban Americans is that they fail to–refuse to–subordinate themselves to a zealous and distant bureaucracy, and who adhere instead to traditional beliefs about freedom, local control, and religious observance. Since those beliefs are inimical to a clerical class which arrogates to itself authority on all matters of belief, they are a threat to the establishment “elite” and must be crushed.

Hence the hysteria.

Although the Cathars resided in what is now France (though a “French” identity is an anachronism would have been alien to them), their experience rhymes with various events in American and British history in which rural peoples resisted centralizing government authority.

Case in point. The Hatfield-McCoy Feud of the 1880s-1890s was made into urbanist pornography–it was the subject of rapt and lurid coverage in big city dailies–in large part because it was a narrative that “othered” mountain people who resisted “progress” and attempted to maintain their autonomy. A major driver behind the legal consequences of the feud was that the Hatfields owned large tracts of timber and coal land coveted by large coal producers in particular. (Timber–used in mine construction–was a vital resource. One of my Hatfield ancestors was a timber cutter for coal mines.). (The Coal Wars of the 1920s was an aftershock of the victory of the large mining companies.)

Also in the late-19th century, the propaganda war against moonshiners was also directed at people who insisted on traditional practices that clashed with the interests of a distant government. But it goes back further than that. The Whiskey Rebellion and the subsequent military campaign against it (led by George Washington and importantly Alexander Hamilton) similarly involved a conflict between rustics (for whom alcohol was an essential staple of commerce) and a central government grasping for revenues.

But it goes even further back, and farther ashore. The actions of the British government (and the more settled and urbanized Lowland Scots) against the Highland Scots in the 18th century were driven by similar forces and accompanied by similar pejorative narratives. (Cf. Rob Roy.). Ditto the centuries-long depredations of England (and then Great Britain) in Ireland.

In brief, the current moral panic in “elite” circles about rural (really non-urban) whites is yet another example of an ages-old struggle between an arrogant, centralizing “elite” power structure and those who would quite prefer to live outside it, thank you very much. Heresy now and then is non-conformity and refusal to take the knee before central authority.

That is, it is about control, control, control. Period. The current chapter in this very long-running saga is particularly Orwellian because the war against the rural Other is waged in the name of “democracy”–i.e., self-government–when in fact what the “elite” desires is antithetical to true self-government. (It is also particularly disgusting because of its overt racism.)

Perhaps it is not coincidental that I am a (maternal) descendent of Hatfields, moonshiners, and Whiskey Rebels. For it is abundantly clear where my sympathies lie.

*The word “crusade” was not used in the 11th-12th centuries to describe the Christian campaigns in the Holy Land. Its first recorded usage was to describe the war waged on the Cathars.

There’s an old expression: “If it ain’t Boeing, I ain’t going.” Well, nowadays the only place you are going on a Boeing is to corporate hell.

Of course the severe problems with its civil aviation operation–specifically, the 737 Max and before that the 787 Dreamliner–are the current focus of attention. But Boeing is a full spectrum failure.

The KC-46 tanker program has been a disaster since day 1. The program was delayed for years, and was catastrophically over budget. Problems included a FOD (“foreign object debris”) issue, in which tools and random metal stuff was littered throughout the aircraft–indications that quality control problems are chronic at Boeing, and hence the 737 issues are not surprising. Another problem was faulty cargo locks–which meant that the aircraft could not carry cargo until it was fixed. Then there was a toilet problem. These are not complicated things.

The most mission-critical problem was with the supposedly advanced refueling boom system, which is operated by wire and a crewman located forward in the aircraft viewing the boom through a camera (not dissimilar from a rear view camera now nearly ubiquitous in automobiles) rather than by someone stationed in the tail with eyes on the boom and the approaching aircraft. However, the accuracy of this system leaves much to be desired, and resulted in some mishaps. The tanker can still refuel aircraft, but the accuracy issue has slowed down refueling operations, which is kind of a big deal because it effectively reduces the refueling capacity of the aircraft.

The company has supposedly lost around $5 billion on the program. And the Air Force is now looking to add KC-45 planes–built by Airbus.

Ironically, maybe if the engineers had retained more control of the company the problems that have the bean counters lamenting winning the tanker contract might never have occurred, or at least wouldn’t have been as bad.

The replacement for Air Force One is also way behind schedule and way over budget.

As was the CST-100 Starliner reusable space capsule. It’s satellite programs have also been plagued by problems.

Those who have paid attention as the company spiraled downward recognized that the engineers had lost out to the bean counters. A recent article in The Atlantic tells the sad story in some detail.

This is correct as far as it goes, but begs the question of how this slow motion plane crash could proceed in plain sight without anyone pulling the company out of its dive. The likely underlying cause is a severe lack of competitive discipline.

The civilian passenger aircraft industry is a duopoly. Customers dissatisfied with Boeing in theory have an option to switch to Airbus, but even in the medium term the ability to do so is limited. For one thing, it would take some time for Airbus to expand capacity to accommodate a large switch of Boeing customers. And given the fixed and sunk nature of capacity costs, it was/is willing to do so only given a high degree of confidence that many Boeing customers would switch–which creates something of a chicken-egg problem. Moreover, switching costs are important. Airlines have made investments in everything from maintenance to pilot training that are manufacturer specific. The cost of a substantial switchover from one manufacturer to another involves more than the cost of the aircraft themselves.

Southwest is an extreme example. A key to its low cost operation was utilizing a single basic aircraft type (737). Adding any Airbus planes to its fleet would disrupt its entire operating model.

With respect to military contracting, the situation is even more extreme. Not only did the Boeing-McDonnell Douglas merger bring over the poisonous management documented in The Atlantic piece: it resulted in the combination of the two manufacturers of multi-engine jets adaptable to military use, most notably refueling planes.

Until recently, competition from Airbus for this business has been even more muted than for civilian aircraft due to the inherently political nature of defense procurement, and the understandable desire to keep this production capacity onshore.

All meaning that Boeing has had a lot of room for chronic performance problems because the lack of serious competitive threats mean that those problems don’t translate into the risk of severe top line losses even in the medium, and to some degree the long, terms.

In the late-90s I was offered the Admiral Crowe Chair at the Naval Academy. The Chair was a research position, with a focus on defense economics issues, and defense industrial base issues in particular. It was a time of an imagined “peace dividend,” and a downsizing of the defense industry. A major part of this downsizing was achieved by industry consolidation. Boeing-MD was just one part of that.

The pitch that got me the job (which I turned down for a mixture of professional and personal reasons) was that I would study the effects of this consolidation, and in particular the effects of declining competition. In the subsequent years I have watched the serial procurement nightmares that have plagued the US military which have largely borne out the concerns that I raised when interviewing for the USNA position.

Lack of competitive discipline enables dysfunctional management. That’s the underlying problem at both the civilian and military sides of Boeing. And it’s not a problem that is addressed easily.

During WWII, management dysfunction at Ford Motor Company (still ruled by the iron hand of Henry Ford and his henchman Harry Bennett) posed a serious threat to the U.S. war effort. The government intervened, and essentially forced out Henry I and Harry, and installed Henry II (“Henry the Deuce”) to straighten out the company. After the war, the Deuce brought in the “Whiz Kids” to drag it kicking and screaming out of the Henry I cult of personality. (My dad was a very junior Whiz Kid, hence my living in West Wayne and Dearborn in my early years.). That brought on its own problems, of course, but it was likely necessary to save Ford Motor.

The situation at Boeing isn’t exactly the same, but it rhymes. So who is going to carry out the necessary intervention? Hard to see who that would be. And the same fundamental market factors that have allowed Boeing to be mismanaged for years will exist even if there is a complete turnover in the top management and the board room. Meaning that since the underlying causes of Boeing’s fall are structural, it’s hard to be optimistic about things turning around anytime soon.

The most stunning news from Russia in recent days–months or maybe years, for that matter–is the death of Alexei Navalny in a Siberian prison.

This was murder, if not by poisoning, strangulation, suffocation, beating, shooting, stabbing or what have you, then by incarceration in a 21st century gulag. (You wonder why so many Russian convicts “agreed” to fight in Ukraine for a promise–since reneged upon in some cases–of release upon completion of military service? You shouldn’t. And the prison to which Navalny was confined–often in solitary–was the worst of the worst.)

Navalny was obviously a brave man. Insanely so. He volunteered for martyrdom by returning to Russia after a failed poisoning attempt (in which he brilliantly proved state involvement by punking one of the perps in a prank phone call). And martyred he was.

And like many martyrs, he and his story are far more complex and ambiguous than the hagiography would lead you to believe. In particular, Navalny was no liberal, classical or otherwise, in the Western sense. He was, in fact, a Russian chauvinist and nationalist. He in fact supported the annexation of Crimea for a long time, and his rhetoric about Ukrainians was not all that different from Putin’s.

Indeed, it is plausible that the special enmity that Putin and his clique directed at Navalny, as opposed to other opposition figures, is attributable to the fact that he had the potential to appeal to their base (Russo-chauvinists) far more effectively than anyone else.

Those who have been following Russia for some time surely remember La Russophobe, whose virulent hatred for Putin was second to none. Yet she also held Navalny in disdain, precisely because he was a Russian nationalist. (La Russophobe went silent years ago–more than a decade if memory serves–because she saw the futility of raging against Putin, in part because Navalny was the only apparent alternative.). Not endorsing her. Just pointing out that anti-Putin definitely does not imply pro-liberal.

Yes, the Russian siloviki–of whom Putin is the front man, but not necessarily the head man (with Patrushev being the most likely eminence grise)–have killed many who have threatened them. But Navalny is not Progozhin is not Politkovskaya. They are all different, except in that they were perceived threats to the siloviki.

Navalny’s death is being used in the West generally, and the United States in particular, to resuscitate popular anti-Putin sentiment to facilitate the flow of further aid to Ukraine. As if we needed further proof of Putin’s–and the siloviki’s–ruthlessness and depravity.

The case for aid to Ukraine–and in what form and what amount–should not be based on Mr. Mackey-esque “Putin is bad, so don’t do Putin, uhm-kay” rhetoric.

Instead, it should be based on a sober appraisal of national interest.

Which brings me to the most recent battlefield development–the Russian capture of Avdiivka. This too is being used to make the case for continued (and lavish) American support.

But here’s the dirty little secret: Ukraine lost Avdiivka because of a shell shortage, period, and additional supplies from the US or Europe in the quantities needed are not forthcoming. The cupboard is bare. The US could pass a $1 trillion military aid package for Ukraine, and it would not make one iota of difference on the battlefield for months, because shell production is maxed out already, and US stocks have been reduced to dangerous levels.

Only shells matter. (Something I pointed out in March 2022.). Yes, more Patriots or HIMARs would help, but without copious artillery Ukraine is on the back foot. And shells are not forthcoming not because the US (and Europe) won’t supply them in the numbers needed, but because they can’t.

Militarily, the capture of Avdiivka is irrelevant. As I have written before, it was merely a salient in the front line, and even after collapsing it Russia does not have the capability of exploiting and breaking out. Ukraine will just withdraw to (belatedly) prepared lines to the west, and the stalemate will resume.

Indeed, Russia doesn’t even appear to be attempting to exploit its “victory.” Reports suggest that they are redeploying troops from Avdiivka to other points along the contact line, where they will pinch a salient here or there–at best.

And the cost that Russia has paid to gain a few square kilometers of blasted ground has been appalling. One must discount casualty reports, but sifting through both Ukrainian and Russian accounts it appears that Russia prevailed in Avdiivka by deploying disproportionate numbers of troops–and suffering disproportionate losses.

All so Vlad can squat over another blasted shithole and claim battlefield success as a reason to vote for him in a sham election from which he has banned any viable opponent. Or killed them, as in the case of Navalny.