Here’s a first. I appear in a comic strip history of the CME-ICE rivalry in Bloomberg Markets Magazine. Quite the likeness!

Other than the fact that I appeared at all, the most amusing part of the, er, article, is the panel depicting CME’s Terry Duffy getting the news that ICE was making a rival bid for CBOT via a note slipped under his hotel room door at the FIA at Boca at 0600. I had eaten dinner with Duffy and CME CEO Craig Donohue the night before. They were in a little better mood then than they were the next day.

Bloomberg’s Matt Leising called me at about 0630 to ask me about the development. That led to an appearance on Bloomberg TV, where I was interviewed right before Jeff Sprecher. He watched me give the interview, and was not pleased with my prediction that CME would eventually prevail, but have to pay a lot more: I saw him say to the woman next to him (who I later found out was his wife, Kelly Loeffler) “who is this guy?” That was exactly how it worked out though, and apparently there were no hard feelings because Sprecher spoke at a conference I organized at UH a couple of years later. Either that, or he didn’t connect me with “this guy.”

Evenhanded guy that I am, I invited Craig Donohue to speak at a conference a year or two after that. His speech was interrupted by some Occupy types (remember them?), whom my tiger of an assistant Avani and I bodily shoved out of the room while the rest of the audience sat in stunned silence (not knowing what was going on).

So yeah. My involvement with CME and ICE sometimes does sound like something out of the funny pages. Now it’s official.

Last week the Treasury Department announced that in a redesign of the $10 bill, Alexander Hamilton would be replaced, joined, or supplemented by a Historical American Woman to be Named Later. Considering that Jackson, Grant, McKinley, and Cleveland also grace US Federal Reserve Notes, the decision to replace Hamilton of all people is lamentable in the extreme. Even overlooking his, to put mildly, controversial career, as a hater of paper money, assassin (and proud of it!) of the predecessor to the Fed, and an economic imbecile, Jackson in particular is a dubious choice to grace a greenback.

Hamilton, in contrast, merits sole possession of a widely circulated bill because it is hard to identify any figure, of any sex, president or no, who made a greater contribution to American history, and to its economic success. Off the top of my head:

• A successful and brave staff and line officer during the Revolution. After long service on Washington’s staff (which led some to conclude, wrongly, that he was Washington’s brain), he took command of the Continental light infantry at Yorktown, and led the successful assault on Redoubt Number 10 which, along with the fall of adjoining Redoubt Number 9 to the French, sealed the fate of the besieged town.
• The moving force (along with Madison) of the Annapolis Convention, which played a role in the convocation of the Constitutional Convention the next year.
• Played a major role in the Convention.
• Along with Madison, as the author of the Federalist Papers, provided the intellectual case for the passage of the Constitution. Worked assiduously to secure ratification of the Constitution.
• First, and most important, Secretary of the Treasury. He righted the nation’s fraught fiscal situation, and made the nation creditworthy. He crafted a comprehensive fiscal and financial framework, including taxation, debt, and a national bank. (Even as the descendent of some Whiskey Rebels who objected to the whiskey taxes that were part of Hamilton’s system, I even understand his role as commander of the US forces sent to disperse the Rebels.) His Reports on Manufactures and Public Credit were incredibly economically sophisticated, and eminently practical. (I remember Robert Lucas in Econ 331 or 332 expressing his awe at Hamilton’s Reports.) It is not an exaggeration to say that the United States could not possibly have developed the way it did and as rapidly it did without his farsighted fiscal and economic stewardship
• Founder of the Bank of New York, which exists to this day.
• A man of liberal (in the Adam Smith/David Hume sense of the word) views, i.e., a lover of liberty. For all races. He was one of the few Founders who was not only a frank opponent of slavery and advocate of emancipation, but who also viewed those of African heritage equal as humans to whites.
• A man who rose from extremely poor beginnings to become a colossus. Proof that birth is not fate, and that America has long been a land of opportunity for the able, ambitious, and hard working. (At Cal-Berkeley those sentences would be considered a “microaggression.” 1. I don’t do microaggressions. I move straight onto macroaggressions. Or maybe I pool and tranche my microaggressions to create MBS: Microaggression Backed Securities. 2. Cal-Berkeley can sod off.)

In sum: Military hero. Political giant. Political scientist. Economist. Practical manager. Entrepreneur. I defy you to find anyone with as diversified a portfolio as Alexander Hamilton. He truly was Alexander the Great.

The fact that the Treasury is even countenancing removing Hamilton is proof of the historical idiocy of supposedly educated Americans. The excuse that the $10 bill was next in line for a redesign doesn’t cut it. That sounds like typical bureaucratic cowardice, hiding behind procedure and routine to avoid defending a position that is indefensible on the merits.

So by all means put a woman on a bill. Just not the $10. And use this as an opportunity to teach Americans who know far too little about their past about one of the most remarkable figures in American history.

As a blogger, I am long the option to point out when I call one right. Of course, I am short the option for you all to point out when I call one wrong, but I can’t help it if that option is usually so far out of the money (or if you don’t exercise it when it is in) 😉

I will exercise my option today, after reading this article by Greg Meyer in the FT:

West Texas Intermediate crude, once derided as a broken oil benchmark, is enjoying a comeback.

Volumes of futures tracking the yardstick have averaged 1m contracts a day this year through May, up more than 45 per cent from the same period of 2014, exchange data show. WTI has also sped ahead of volumes in rival Brent crude, less than two years after Brent unseated WTI as the most heavily traded oil futures market.

. . . .

WTI has also regained a more stable connection with global oil prices after suffering glaring discounts because of transport constraints at its delivery point of Cushing, Oklahoma. The gap led some to question WTI as a useful gauge of oil prices.

“I guess the death of the WTI contract was greatly exaggerated,” said Andy Lipow of consultancy Lipow Oil Associates.

But in the past two years, new pipeline capacity of more than 1m barrels a day has relinked Cushing to the US Gulf of Mexico coast, narrowing the discount between Brent and WTI to less than $4 a barrel.

Mark Vonderheide, managing partner of Geneva Energy Markets, a New York trading firm, said: “With WTI once again well connected to the global market, there is renewed interest from hedgers outside the US to trade it. When the spread between WTI and Brent was more than $20 and moving fast, WTI was much more difficult to trade.”

Things have played out exactly as I forecast in August, 2011:

One of the leading crude oil futures contracts–CME Group’s WTI–has been the subject of a drumbeat of criticism for months due to the divergence of WTI prices in Cushing from prices at the Gulf, and from the price of the other main oil benchmark–Brent.  But whereas WTI’s problem is one of logistics that is in the process of being addressed, Brent’s issues are more fundamental ones related to adequate supply, and less amenable to correction.

Indeed, WTI’s “problem” is actually the kind an exchange would like to have.  The divergence between WTI prices in the Midcontinent and waterborne crude prices reflects a surge of production in Canada and North Dakota.  Pipelines are currently lacking to ship this crude to the Gulf of Mexico, and Midcon refineries are running close to full capacity, meaning that the additional supply is backing up in Cushing and depressing prices.

But the yawning gap between the Cushing price at prices at the Gulf is sending a signal that more transportation capacity is needed, and the market is responding with alacrity.  If only the regulators were similarly speedy.

. . . .

Which means that those who are crowing about Brent today, and heaping scorn on WTI, will be begging for WTI’s problems in a few years.  For by then, WTI’s issues will be fixed, and it will be sitting astride a robust flow of oil tightly interconnected with the nexus of world oil trading.  But the Brent contract will be an inverted paper pyramid, resting on a thinner and thinner point of crude production.  There will be gains from trade–large ones–from redesigning the contract, but the difficulties of negotiating an agreement among numerous big players will prove nigh on to impossible to surmount.  Moreover, there will be no single regulator in a single jurisdiction that can bang heads together (for yes, that is needed sometimes) and cajole the parties toward agreement.

So Brent boosters, enjoy your laugh while it lasts.  It won’t last long, and remember, he who laughs last laughs best.

This really wasn’t that hard a call to make. The price signals were obvious, and its always safe to bet on market participants responding to price signals. That’s exactly what happened. The only surprising thing is that so few publicly employed this logic to predict that the disconnection between WTI and ocean borne crude prices would be self-correcting.

Speaking of not enjoying the laugh, the exchange where Brent is traded-ICE-issued a rather churlish statement:

Atlanta-based ICE blamed the shift on “increased volatility in WTI crude oil prices relative to Brent crude oil prices, which drove more trading by non-commercial firms in WTI, as well as increased financial incentive schemes offered by competitors”.

The first part of this statement is rather incomprehensible. Re-linking WTI improved the contract’s effectiveness as a hedge for crude outside the Mid-continent (PADD 2), which allowed hedgers to take advantage of the WTI liquidity pool, which in turn attracted more speculative interest.

Right now the only potential source of disconnect is the export ban. That is, markets corrected the infrastructure bottleneck, but politics has failed to correct the regulatory bottleneck. When that will happen, I am not so foolish to predict.

Not that further proof is needed, but still.

You may recall that NYT “reporter” (and by “reporter,” I mean “hack”) David Kocieniewski slimed me on the front page of the NYT on 31 December, 2013. In a nutshell, Kocieniewski accused me of being in the pocket of oil traders, and that this had led me to skew my research and policy positions. Specifically, he insinuated that I opposed position limits and defended speculation in energy markets because I had been suborned by oil traders who profited from high prices, like those that occurred in 2008 (before the crash). Kocieniewski’s main piece of “evidence” was that I had written a white paper sponsored by Trafigura. According to Kocieniewski, as an oil trader, Trafigura benefited from high prices.

At the time I pointed out that this demonstrates Kocieniewski’s appalling ignorance, as Trafigura is not a speculator, and is typically short futures (and other derivatives) to hedge its inventories of oil (and other commodities). Companies like Trafigura have no real interest in the direction of oil prices directly. They make money on margins and volumes. The relationship between these variables and the level of flat prices depends on what makes flat prices high or low.  I further said that if anything, commodity traders are likely to prefer a low price environment because (1) low prices reduce working capital needs, which can be punishing when prices are high, and (2) low price environments often create trading opportunities, in particular storage/contango plays that can be very profitable for those with access to storage assets.

Well, imagine my surprise (not!) when I saw this headline and article:

Crude slide bolsters Trafigura’s profits and trading margins

Trafigura has posted record half-year profits and a doubling of trading margins, illustrating how one of the world’s largest commodity trading houses has been a big beneficiary of the collapse in oil prices.

Profits at the group rose almost 40 per cent in the six months to 31 March, reaching $654m, while margins hit 3.1 per cent, as the Switzerland-based company used its global network of traders and storage facilities to buy cheap crude and take advantage of dislocations in the oil market.

. . . .
It was not the only company to benefit. Other trading groups including Vitol, the largest independent oil trader, and Gunvor have posted strong results for this period. Even Shell, BP and Total managed better-than-expected first quarter results thanks to the performance of muscular trading operations.

Wow. In Kocieniewskiworld, “Crude slide bolsters Trafigura’s profits” would be a metaphysical impossibility. Here on earth, that’s an eminently predictable event. Which I predicted. Not that that makes me a genius, just more knowledgeable about commodity markets than David Kocieniewski (which is a very low bar).

Not that there was ever anything to it in the first place, but this pretty much blows to hell the entire premise of Dim Dave’s story. Proof yet again that if you read the NYT for economics stories, you’ll wind up dumber after reading than before.

* As well as an unethical slug who blatantly violated the NYT’s ethics guidelines. Not that his editor gave a damn, making him as much of an unethical slug as Kocieniewski.

About 19 months ago I wrote about RINsanity, i.e., the United States’ nutty ethanol (and other biofuel) program. RINsanity has long outlived the phenomenon (Lin-sanity) that inspired the neologism. A couple of weeks ago, the EPA announced the ethanol and biodiesel quotas . . . for 2014. Who said time travel is impossible? That Einstein. What an idiot!  (The EPA also announced quotas for 2015 and 2016.)

In a nutshell, despite protestations to the contrary, the EPA largely conceded to the reality of the E10 “blend wall” (the fact that the vast bulk of auto engines are incapable of burning fuel with more than 10 percent ethanol), and announced quotas that were (a) smaller than the market expected, and (b) smaller than the statutory amounts that Congress specified in its farseeing omniscience 10 years ago. At the same time, the EPA decreed larger quotas for biodiesel.

As a result, the market did the splits. The price of ethanol RIN credits that count towards the ethanol quota plunged, while the price of biodiesel RIN credits that count towards the biodiesel quota rose. Scott Irwin and Darrell Good have all the gory details here. (Those are the guys to follow on this issue, folks. I’m just kibitzing.)

As a result, pretty much everyone is upset. The nauseating biofuel lobby is screaming bloody murder because the ethanol quota is too small, and is threatening to go to court. Those holding ethanol credits are fuming due to the forty plus percent price decline.

This all points out the dysfunctional nature of environmental markets in which the supply is set by some opaque politicized bureaucratic process unhinged from economic reality. (The European CO2 credit market is another classic example.) The Congressional mandate set quotas (supplies) years in advance based on forecasts of future fuel demand that turned out to be wildly incorrect. So the EPA played Mr. Fixit, and through some unknown process, divined what Congress meant to do-really!-and announced some surprising numbers that caused prices to plummet.

The EPA’s reaction? It is shocked! Shocked! to find gambling going on at Rick’s (ethanol served here!):

The EPA didn’t intend for the program to create a speculative market, and an agency spokesperson declined to comment on RIN price movement.

“RINs are used to demonstrate compliance under the Renewable Fuel Standard program,” the EPA said. The agency manages an electronic system that tracks the RINs, but not their prices on the open market.

Earth to EPA! Earth to EPA! (And hey-aren’t you supposed to be earth’s stewards? So what are you doing orbiting Pluto?): if you create a scarce resource (ethanol credits) a market-and yes, one with speculation!-will appear. This is inevitable as the sun rising in the east. Another unintended but metaphysically certain event.

Indeed, the kind of speculation that these markets foster is particularly bizarre, because of the necessity of speculating on the feedback between the market and the EPA’s decisions on the amount of the scarce resource it creates. A big part of the RIN prices is market participants’ expectations about what the EPA will decide. If the EPA’s decision takes the market price into account, in some unknown (and almost certainly unarticulated) way, the reasoning chain becomes mind-numbingly complex very quickly. Mr. Market guesses what the EPA will do. That affects prices. The EPA takes the price, and guesses what this says about what the market knows about fundamentals . . . and what the market thinks about what the EPA is going to do. It adjusts its decision accordingly. Market participants have to make judgments about the feedback between the price and the EPA’s decision, which can affect the EPA’s decision, and on and on, ad infinitum. (This is analogous to Keynes’s beauty contest metaphor, and Soros’s theory of market “reflexivity.” Sign of the apocalypse alert: I gave Keynes and Soros a favorable mention in a single blog post.)

That’s no way to run a market, but the alternatives are  likely worse. One alternative would be to set quotas for years far into the future, and then not adjust them based on the evolution of other fundamentals that cannot be foreseen when the quotas are set.

It’s pretty clear that events like have just rocked the biofuel world are an inherent part of the system. Somewhat arbitrary, inherently difficult to predict (in part because they are politicized), and “reflexive” decisions are a major determinant of supply. These decisions are made at discrete times. It is extremely likely that there will be disconnections between the quantity the market thinks the EPA will select and what the EPA actually chooses. Given the inelasticity of demand for energy products, these supply surprises lead to big price impacts.

All of which goes to show that a better use of ethanol is imbibing it to cope with the craziness of a faux market.

Of course it’s not just that the market is crazy: it’s crazy that there is a market. Ethanol is an economic and environmental and humanitarian monstrosity. Yes, ethanol would play a role without subsidies or mandates. But a much smaller role. Forcing and inducing its use is costly, not environmentally beneficial, and raises the price of food, which hits the poorest the hardest. So this crazy market shouldn’t exist in the first place. I think I need another drink.

Russians from Putin on down are freaking out about the possibility that the FIFA corruption scandal will cause the 2018 World Cup to be wrested from them. But never fear. The head of Russia’s organizing committee, Alexei Sorokin, claims that the Russian bid was “clean”:

The head of the organising committee for the Russia 2018 World Cup has insisted that the bid was clean, transparent and “done in accordance with all the practices that are in place in Fifa”.

Well that’s sort of the problem, Alexei. A “clean and transparent bid done in accordance with all the practices that are in place in Fifa” is an oxymoron. The practices in place in Fifa are dirty and opaque.

And of course, it was precisely because its bid was so clean, transparent, etc., that Russia destroyed the computers its committee had utilized:

But it was the lack of evidence provided by the bid team which was of most concern, according to the author of the summary, Fifa’s head judge, Hans-Joachim Eckert.

He wrote: “The Russia 2018 bid committee made only a limited number of documents available for review, which was explained by the fact that the computers used at the time by the Russia bid committee had been leased and returned to their owner after the bidding process.

“The owner has confirmed the computers were destroyed in the meantime. The bid committee also attempted to obtain access to the Gmail accounts used during the bidding process from Google USA. However, the Russia bid committee confirmed Google USA had not responded to the request.”

The head of Russia’s 2018 organising committee, Alexey Sorokin, told Sky Sports News: “We rented the equipment, we had to give it back, then it went back – we don’t even know where it went – to some sports schools, so quite naturally other people used it.

“Whatever we could supply, everything we could supply to the investigation we did. But we have to bear in mind that four years have passed since then, so some of the information we could just forget, naturally.”

The latest expose from Putin’s little monkey, Edward Snowden, desperate to maintain his relevance, is that the NSA monitors addresses and cybersignatures linked to foreign hackers, and specifically, foreign government-connected hackers:

In mid-2012, Justice Department lawyers wrote two secret memos permitting the spy agency to begin hunting on Internet cables, without a warrant and on American soil, for data linked to computer intrusions originating abroad — including traffic that flows to suspicious Internet addresses or contains malware, the documents show.

The Justice Department allowed the agency to monitor only addresses and “cybersignatures” — patterns associated with computer intrusions — that it could tie to foreign governments. But the documents also note that the NSA sought permission to target hackers even when it could not establish any links to foreign powers.

To which I say: I sure as hell hope so.

It is more than a little ironic that this article appeared almost simultaneously with the revelation that some foreign organization or government hacked into US government computers, and stole the personal information of millions of government employees. It’s hard to imagine a more telling, vivid contrast between the highly abstract and limited treat to American’s personal privacy posed by the measures described in the NYT article, and the very real threat to that privacy posed by the target of those measures.

This all points out the utter asininity of the Snowden fanatics (who, alas, include some members of Congress and at least one presidential candidate), who appear completely unwilling or unable to think of trade-offs and real world choices, but instead focus monomaniacally on the threat to their personal privacy posed by the US government, while ignoring other more serious threats that (unlike the NSA) operate subject to no legal constraint or oversight whatsoever. Yes, the USG can be abusive, at times to the point of being tyrannical. But we need to speak of specific cases.

Tell me. Whom do you believe is a bigger threat to your privacy? The NSA or hackers, foreign hackers in particular?

There is a pronounced whiff of narcissism from those who think that the NSA really gives a damn about them and their precious online secrets. Sorry to break it to you, but it doesn’t, unless perhaps you have had a bad breakup with an NSA employee. It hoovers up vast amounts of information, but is focused on filtering out the noise to get at intelligence-relevant signals. And believe it or not, the hours you spend on Tinder are nothing but noise.

Hackers, on the other hand, find your information quite fascinating, precisely because they can monetize that information. They can turn ethereal bytes into solid gold.

So there is a real trade off, and when you conceive of it as a trade off the choice becomes pretty obvious. At the cost of allowing the NSA to touch a highly limited sliver of your personal data, you can increase the odds of detecting or deterring a truly malign hack. Or, you can protect your address and cybersignature from the prying eyes of the NSA, and dramatically increase the odds of having your most valuable personal information fall victim to hackers. That’s the trade-off. That’s your choice. Deal with that reality. Those who choose to let the hackers run riot rather than have a few limited pieces of information reside on an NSA-controlled server deserve to have Died of a Theory as their financial epitaph.

(Regarding the hack of the US Office of Personnel Management, the administration pointed the finger at China with unseemly haste. Perhaps. But this seems more like a Russian MO than a Chinese. The Russians are interested in information they can monetize, the Chinese less so. Perhaps China is the culprit, but I wouldn’t rush to judgment.)

The NYT/PP article makes it clear that the DOJ only asked the FISA court for authority to collect the data from intruders connected to foreign governments. The NSA wanted a broader mandate,  including the ability to collect from foreign intruders not reliably tied to a government, but DOJ didn’t ask for it.

That’s too bad. Non-Government hackers, mainly operating from Russia, other FSU countries, and China, are arguably a bigger threat to personal privacy than governments. The non-government hackers have mercenary motives, and your data is particularly attractive to them. Most of the major hacks of valuable personal information have been executed by foreign criminal organizations with no demonstrable connections to foreign governments (though in the case of Russia, they likely operate under Russian government protection) So again looking at the trade-off, I’d prefer that the NSA have the broader authority. That would give me more privacy, and more information security.

With regards to Snowden, isn’t it interesting that Snowden’s organ grinder-Putin-would be one of the main beneficiaries of a restriction on the NSA’s authority to track foreign government hackers? Surely just a coincidence, right, because little monkeys never dance to their master’s tunes, do they?

In one of my periodic Quixotic moments, I tilted at the Cult of Elon Musk. First, I argued that he or someone manipulated the prices of Tesla and Solar City stocks: I stand by that analysis. Second, I argued that the supposed visionary’s true genius was for feeding lustily at the taxpayer teat.

It is a testament to my great influence that the Cult of Musk has grown only larger in the two years since I made a run at him. But maybe the spell is breaking. For the LA Times just ran a long article detailing just how much his fortune was picked from our pockets. According to the LAT, Musk companies have raked in $4.9 billion in various subsidies and tax breaks, give or take.

That’s 10 figures, people.

That’s bad enough. What’s worse is Musk’s “defense.” It is a farrago of intellectual dishonesty, logical fallacies, condescension, and arrogance.

Musk only replied to the LAT after repeated inquiries, but it is good that the paper persisted. Musk’s rationalizations have to be seen to be believed.

For one thing, he says he doesn’t really need the subsidies:

“If I cared about subsidies, I would have entered the oil and gas industry,” said Musk.

. . . .

“Tesla could be profitable right now if we went into low-growth mode and we just served premium buyers,” he said. “The reason we are not profitable is because we are making massive investments to create an affordable long-range electric car.”

We are making massive investments? What do you mean by “we”, paleface?

So fine. You don’t care about subsidies. You don’t need them.

Then put your money-excuse me, our money-where your big fat mouth is and don’t cash the checks.

The rest of Musk’s defense consists of various incarnations of N wrongs make a right (or, put differently, other people suck at the government teat, why shouldn’t I?):

Musk said the subsidies for Tesla and SolarCity are “a pittance” compared with government support of the oil and gas industry.

“What is remarkable about my companies is that they have been successful despite having such a tiny incentive from the government relative to our competitors,” Musk told The Times.

. . . .

Tesla, Musk said, competes with a mature auto industry that has seen massive federal bailouts for General Motors and Chrysler.

“Tesla and Ford are the only American auto companies not to have gone bankrupt,” Musk said.

SolarCity, he said, is in a nascent industry that must fight entrenched oil and gas interests that have myriad subsidies.

Throwing good money after bad is not good public policy.

Musk cites numerous junk studies to support his case. Some of these are studies of the alleged economic benefits arising from investments in his battery plants, etc. I guarantee, all such studies are garbage based on mythical multipliers and crypto-Keynesian mumbo jumbo. Others are studies of the alleged subsidies of other industries, notably the energy industry. Even taking the numbers at face value, the subsidies of fossil fuels are a pittance on a per BTU or megawatt basis compared to those for renewables. Further, fossil fuels are also heavily taxed directly and indirectly, including by substantial geopolitical and expropriation risks. The study that cites the environmental costs of fossil fuels is particularly susceptible to abuse. And to quote Sonicharm, of the blog Rhymes With Cars and Girls-also not a Musk fan!-all large calculations are wrong.

Elon Musk is a rent seeker masquerading as a visionary. If he is one-tenth the innovator and genius his fawning fans believe him to be he wouldn’t need any subsidies. We should give him the chance to prove it.

The FT, Goldman, Jonathan Stern at the Oxford Institute of Energy Research, Vitol, and others are now predicting that the emergence of the US as an LNG exporter, and the looming surplus driven by that plus supplies from Australia, PNG, and elsewhere, are inexorably pushing this commodity away from traditional oil-based long term contracts towards spot trading.

Huh. I remember reading something along those lines last September. Oh, yeah. Here it is. (Also available in Spanish!) I guess it’s more accurate to say I remember writing something exactly along those lines in September.

The opening of the Cheniere* and later the Freeport and Cameron LNG trains in the Gulf will be particularly important. The US is likely to be at the margin in Asia, Latin America and perhaps Europe. Prices are set at the margin, meaning that the LNG pricing mechanism can be integrated into the already robust US/Henry Hub pricing mechanism. Giving the tipping effects discussed in my paper, the transition in the pricing mechanism and the development of a robust spot market is likely to take place relatively rapidly.

I know there is skepticism in the industry about this, but I am pretty confident in my prediction. Experiences in other markets, notably iron ore and to some degree coal, indicate how rapid these transitions can be.

Funny story (to me anyways). I gave the keynote speech at LNG World Asia in Singapore in September, and I laid out my views on this subject. I gave the talk in front of the giant shark tank at the Singapore Aquarium, and I could help but think of Team America, Kim Jung Il, and Hans Blix. I’m sure there were a few people in the audience who would have liked to feed me to the sharks for calling oil-linked pricing “a barbarous relic” and encouraging them to embrace the brave new world of LNG trading.

But whether they like it or not, it’s coming. The inflection point is nigh.

*Full disclosure. Number One Daughter works for Cheniere.

The Chinese stock market and the Chinese economy are perplexing. The latter seems to be slowing rather dramatically, and there is widespread belief that the growth rate is, or soon will be, far below the 7 percent level the government is touting. Nonetheless, the stock market has been skyrocketing, with some periodic selloffs as occurred yesterday.

The government is allegedly intent on transitioning from the investment- and export-driven growth model towards a more consumption-oriented one: Fixed investment as a fraction of GDP is at stratospheric levels, and consumption as a fraction of GDP is extremely low. Its ability to navigate this transition, due to the inherent difficulties of trying to manage a huge economy as well as the political economy factors that tend  to impede change, is open to serious doubt. There is always the possibility that the government will respond to any growth slowdown the way it has in the past, through massive stimulus.

Further, the strength of the Chinese banking sector is always open to question. If the government (and the central bank) are concerned about it, that would also tend to bias them towards loosening credit.

Local governments are connected to all these issues. Local governments, through so-called Local Government Funding Vehicles, fund a substantial fraction (about 20 percent) of Chinese investment. These entities have exhibited signs of financial distress, as indicted by high yields. This reflects the dodgy quality of many of the investments these vehicles funded. This is a problem for Chinese banks, which have a large exposure the LTFVs.

The Chinese government recently provided a very strong indication that it is indeed deeply concerned. It announced a set of measures that look for all the  world to be a financial shell game intended to move local government risk onto the balance sheet of the People’s Bank of China and simultaneously create credit.

As originally announced, the banks were expected to swap LGFV debt for municipal bonds carrying a lower interest rate. The banks were obviously unenthusiastic about this, and the takeup was minimal. So the PBOC made it plain that this was not voluntary: banks were expected to buy the lower interest munis. To induce them to do so, the PBOC said that it would permit the banks to post these securities as collateral at the central bank, and use the proceeds of the collateralized borrowing to extend new loans.

The exact nature of the collateralized borrowing from the PBOC is about as clear as a Beijing sunset, but it is evident that this mechanism can serve as a way of passing the muni credit risk onto the PBOC. If the munis become distressed, and the loans are de jure or de facto non-recourse, the banks default on the loans, leaving the PBOC with the bad local government debt.

It is clear that this is a bailout of the local governments. They are now borrowing at below market rates: it wouldn’t have been necessary to coerce and induce the banks to buy the local government debt if they were sold at rates reflecting the credit risk. Since the banks now appear willing to lend, they must believe that the central bank is wearing the risk, and hence paying the subsidy. In other words, the pea is under the shell labeled “PBOC.”

The command that that banks lend the proceeds from the loans from the PBOC means that the overall effect of the program will be to expand bank balance sheets and increase credit. It is both bailout and stimulus.

Putting this all together, this suggests that the Chinese authorities are deeply concerned about the financial condition of local governments and the banks, and is also deeply concerned about growth prospects. It could also indicate hesitation about transitioning away from the investment/export-driven model. All of which makes the booming Chinese stock market all the more puzzling. Unless, that is, the betting is that the government will respond to weak growth by resuming the credit stimulus and blowing asset bubbles.

None of this are signs of a healthy economy, or healthy markets. It is instead symptomatic of massive distortions and imbalances produced by years of heavy-handed policies. The imbalances must correct eventually, but the Chinese are saying not yet, lord, not yet.

But they cannot defer the reckoning forever, and the longer it is delayed, the more brutal the correction will be. But like politicians everywhere, the current Chinese government no doubt is content that the blow up occur on the next guy’s watch.