Streetwise Professor

I am following around Iranian negotiator Javad Zarif, arriving this morning in Geneva, and then going to Brussels next week. Don’t worry, I won’t go biking. Certainly not in the absurd getup that Zarif’s interlocutor-or should I say Sancho Panza-John Kerry did here on the shores of Lac Leman. The man is obviously immune to mockery.

I am resigned that Sancho-I mean John-and Javad (remember, they are on a first name basis!) will reach some sort of deal that will clear Iran’s path to becoming a nuclear power in the near-to-medium term, with all of the malign consequences that entails. Which leads me to contemplate some of those consequences.

One of which relates to the price of oil (and natural gas), the malignity of which depends on whether you are long or short oil (and gas). Of course, one of the countries that is very long oil (and gas) is Russia, and from its perspective the consequences of a deal will be very malign. Which makes one wonder if Putin (or whoever is really in charge these days!) will attempt to do something to derail it. (Or are they too distracted by the folly in Ukraine? Or by dog fights under the carpet?)

The crucial issue is how rapidly, and by how much, Iranian output will ramp up if a deal is reached. There is both a political dimension to this, and an operational one.

The political issue is how rapidly a deal will result in the dismantling of the myriad sanctions that impede Iran’s ability to sell oil:

“Don’t expect to open the tap on oil,” one Gulf-based Western diplomat told Reuters. It is much easier to lift financial sanctions because so many components of Iran’s oil trade have been targeted, the diplomat said.

. . . .

But for Iran to sell significantly more crude and repatriate hard currency earnings, many U.S. and European restrictions on its shipping, insurance, ports, banking, and oil trade would have to be lifted or waived.

Yet because they represent the bulk of world powers’ leverage over Iran, initial relief would probably be modest, said Zachary Goldman, a former policy advisor at the U.S. Treasury Department’s Office of Terrorism and Financial Intelligence, where he helped develop Iransanctions policy.

Goldman predicted the first step would be to allow Tehran to use more of its foreign currency reserves abroad, now limited to specific bilateral trade.

“It’s discrete, and it doesn’t involve dismantling the architecture of sanctions that has been built up painstakingly over the last five years,” said Goldman, who now heads the Center on Law and Security at New York University.

Even with a nuclear deal, oil sanctions would probably effectively stay in place until early 2016, said Bob McNally, a former White House adviser under George W. Bush and now president of the Rapidan Group energy consultancy.

The operational issue is how rapidly Iran can reactivate its idled fields, and how much damage they have suffered while they have been off-line. The Iranians claim that 1mm barrels per day can come online within months. The IEA concurs:

Turning lots of production back on suddenly can be complicated—and time consuming—even if wells and reservoirs are maintained studiously. It could be even harder in complex Iranian fields that have been pumping for decades.

Still, some analysts have concluded that a good deal of that lost output could return more quickly than often anticipated. The International Energy Agency, for example, has said that it expects a relatively rapid burst of exports if sanctions are lifted.

“They’ve deployed considerable ingenuity in getting around sanctions and keeping fields in tiptop shape. We think Iran could pretty much come back to the market on a dime,” Antoine Halff, head of the IEA’s oil industry and markets division, recently told an audience at the Center for Strategic Studies in Washington.

Perhaps up to 2mm bpd of additional output could come back later. Then there is the issue of how a relaxation or elimination of sanctions would affect output in the long run as (a) western investment flows into the Iranian oil sector, and (b) other producers, and notably OPEC, respond to Iran’s return to the market.

In the short run, the 1mm bpd number  (corresponding to about 1.1 percent of world output) looks reasonable, and given a demand elasticity of approximately 10, that would result in a 10 percent decline in oil prices. Additional flows in the medium term would produce additional declines.

Even if Iran’s return to the market is expected to take some time, due to the aforementioned complications of undoing sanctions, much of the price effect would be immediate. The mechanism is that an anticipated rise in future output reduces the demand to store oil today: the anticipated increase in future output reduces future scarcity relative to current scarcity, reducing the benefit of carrying inventories. There will be de-stocking, which will put downward pressure on spot prices. Moreover, since an increase in expected future output reduces future scarcity relative to current scarcity, future prices will fall more than the spot price, meaning that contango will decline.

Some of the price decline effect may have already occurred due to anticipation of the clinching of a deal: the May Brent price has declined about $10/bbl in the last month. However, the movement in the May-December spread is not consistent with the recent price decline being driven by the market’s estimation that the odds  that Iranian output will increase in the future have risen. The May-December spread has fallen from -$4.47 (contango) to -$6.36. This is consistent with a near-term supply-demand imbalance rather than an anticipated change in the future balance in favor of greater supply. So too is the increase in inventories seen in recent weeks.

Predicting the magnitude of the price response to the announcement of a deal-or the breakdown of negotiations-is difficult because that requires knowing how much has already been priced in. My lack of a yacht that would make a Russian oligarch jealous indicates quite clearly that I lack such penetrating insight. However, the directional effect is pretty clear-down (for a deal, up for a breakdown).

Which is very bad news for the Russian government and economy, which are groaning under the effects of the oil price decline that has already occurred. Indeed, Iran’s return to the market would weigh on prices for years, reducing the odds that Russia could count on a 2009-like rebound to retrieve its fortunes.

Add to this the fact that a lifting of sanctions would open Iran’s vast gas reserves (second only to Russia’s) to be supplied to Europe and Asia, dramatically reducing the profitability of Russian gas sales in the future, and Iran’s return to the energy markets is a near term and long term threat to Russia.

Which makes Putin’s apparent indifference to a deal passing strange. The Russians freak out over developments (e.g., the prospect for an antitrust investigation of Gazprom, or pipsqueak pipeline projects like Nabucco) that pose a much smaller threat than the reemergence of Iran as a major energy producer. But they have not done anything overt to scupper a deal, nor have they unleashed their usual screeching rhetoric.

What gives? Acceptance of the inevitable? A belief that in the long run the deal will actually increase the likelihood of chaos in the Middle East that will redound to Russia’s benefit? Strategic myopia (i.e., an obsession with reassembling Sovokistan, starting with Donbas) that makes the leadership blind to broader strategic considerations? Distraction by internal disputes? Or does Putin (or whoever is calling the shots!) have something up his (their) sleeve(s)?

My aforementioned pining for a super yacht that would make Abramovich turn green again betrays my inability to penetrate such mysteries. But it is quite a puzzle, for at least insofar as the immediate economic consequences are concerned, Russia would be the Biggest Loser from a deal that clears Iran’s return to the oil market.

H/T to @libertylynx for the idea for this post.

I haven’t written about “climate change” for quite a while, mainly because the debate has become as flat as the global temperature trend. But two recent articles have stirred me to respond, in part because they ignore (or should I say deny?) that inconvenient truth. And in that tale there is the suggestion that the climate change paradigm is entering a crisis stage.

The most egregious is a study that purports to link the horrific Syrian civil war to climate change. Specifically it alleges that CO2->higher temperature->drought in Syria->civil war. This work is unscientific and manipulative, to the point of being mendacious, because every link in that causal chain is in dispute.

Even if one stipulates the first link, the second link is tenuous in the extreme. Like temperatures pretty much everywhere, temperatures in Syria experienced a jump around 1998, and have exhibited no real trend since. Climate models do predict that anthropogenic global warming should lead to drying in the eastern Mediterranean, but the mechanisms associated with this, namely a rise in air pressure and a change in sea surface temperature patterns, are not observed in the data. Yes, there has been an anomalous drop in precipitation in Syria, but this drop is substantially greater than CO2-driven climate models predict. Thus, the models upon which the CO2-drought causal link is based do not explain the observed data. Finally, as the study itself acknowledges, the water crisis in Syria has also been driven by bad water use policy as much or more as it has been by the decline in precipitation.

Then we get to the last link. Attributing any complex social phenomenon like a civil war to a single factor like a change in climate is a dubious exercise. Dubious in the extreme. Moreover, taken seriously, this hypothesis would predict that civil unrest/revolution in the Middle East would be associated with drought, and hence other countries in the region experiencing drought would be susceptible to revolution, and those not experiencing drought conditions would be less susceptible.

This prediction fails on both counts. Note that the Syrian revolution was a part of the “Arab Spring,” which resulted in a near simultaneous outbreak of civil strife in Libya, Egypt, Yemen, and Bahrain, as well as Syria. None of the first four countries experienced drought in the years leading up to 2011. Further, one country that did experience a decline in precipitation similar to that in Syria-Jordan-did not experience unrest. In other words, the theory has false positives and false negatives. Indeed, Syria is the only data point that matches. Cherry pick much?

Further, there are numerous other factors unique to Syria that help explain the outbreak of unrest and the subsequent horrific civil war. These include most notably the existence of a long-ruling dictatorship of a religious minority regime locked in a decades-long death struggle with the Muslim Brotherhood, and the dramatic growth in Islamism in the region generally. Perhaps the socioeconomic dislocations resulting from the drought exacerbated the potential for conflict, but to promote that to the center of the narrative is dubious at best.

No, this seems another example of cynical opportunism, whereby the climate change establishment hijacks human misery to advance its cause. The recipe is familiar. Find some tragic event, and then construct some story-usually quite tenuous-linking that tragedy to AGW in order to push the agenda. This is not science. This is propaganda.

The other example is a study that uses an ensemble of climate models to make the frightening prediction that the rate of global temperature increase is almost certain to accelerate in the coming decade.  The Guardian article states that this is based on “data from more than two dozen climate models.” Well, that’s exactly the problem. Models don’t produce data. They produce predictions, and the predictions of these models fail to match the real data in crucial ways. Most importantly, the lack of warming in the last 17 years is a black swan event that the models have uniformly failed to predict. But unabashed by the failure of their models to reproduce the recent past, and in particular to the failure of the real world data to live up to the models’ apocalyptic predictions over that period, the modelers confidently predict the near future: “Pay no attention to the last decade. Just wait! Apocalypse is around the corner!” This is Heaven’s Gate, not science.

The increasingly frantic efforts of the AGW alarmists is most likely a symptom of the failure of previous predictions to come true, combined with the failure of the previous alarmism to generate popular support for costly policies to mitigate CO2 emissions. It is a doubling down on belief, rather than a sober application of the scientific method. It is right out of Kuhn-the crisis stage of a paradigm. And that’s what AGW is: a paradigm, not “settled science” (which is an oxymoron).

Sadly, in an age where science has become politicized, this is accompanied by political witch hunts, such as the one waged by a watermelon Arizona congressman, that has led at least one scientist (Roger Pielke, Jr.) to “shift . . . academic work away from climate issues.”

Ironically, no doubt many of those who cheer such efforts also think Galileo was a hero. Square that circle for me.

As of this moment, Vladimir Putin has not been seen in public for more than 9 days: you can keep up to the minute track here. Of course this has set off a flurry of speculation about his condition-or his fate. I obviously have no better idea than anyone else, but I’ll just lay out some possibilities.

• He’s ill, with a condition ranging in severity from a bad cold to a coma, or in the limiting case, he’s dead.
• There is an attempt to oust him. (Of course, illness and ouster are not mutually exclusive: a physically weakened Putin is a tempting target, and a dead one obviously requires a replacement with multiple contenders making a play.) Anders Aslund hypothesizes that Putin and Sechin, backed by the interior ministry and its forces, are locked in a death struggle with Sergei Ivanov, Russian nationalists, and the FSB. Andrei Illarionov claims that the generals are out to oust Putin. The Nemtsov murder is seen as a catalyst or symptom of these events. One theory is that the FSB is furious with Putin giving Kadyrov a free rein, and is trying to pin the murder on Chechens in order to strike at Kadyrov. It is worth noting that Sechin has been subject to public criticism lately, including by Putin. That could signal some attempt to reallocate power and property that could lead all of the various contending clans to take to the mattresses. Who knows?
• Putin is playing possum, feigning incapacitation in order to see whether anyone thinks this is an opportunity to seize power. That would be a good way for a paranoid man to smoke out threats.

The Kremlin’s ham fisted handling of the publicity (reporting on meetings that have yet to occur, and releasing photos and video from a meeting that likely occurred before Putin submerged) is only fueling the speculation.

As for illness, it would have to be pretty bad to induce him to go incommunicado for so long, given the angst this is creating. Julia Ioffe argues that Putin cannot even admit to having a cold, as this would puncture the aura of invincibility that he needs to rule successfully. Given the choice between admitting to a cold, and doing something that leads to wild speculation that he’s lying on a cold slab (speculation that can be destabilizing), I would think he’d load up on the DayQuil, make a few public appearances, and bluff his way through. So if it is illness, it would likely be severe.

And if it isn’t, and Ioffe is correct, just think of what that means about Russia’s political system, and its future. A system whose stability depends on the illusion of an invulnerable leader is doomed to collapse with probability one, because the illusion is just that-a chimera. Putin isn’t getting any younger, and Russian men are not noted for their longevity: for most, their old age begins in the early-to-mid-60s, if they are lucky enough to make it that long. So before too long, Putin will suffer a serious health problem, with all the uncertainty that entails in a personalized system with no tried and stable succession mechanism and which has a vast security apparatus that just might be tempted to seize power.

A power struggle in the Kremlin is a possibility, but the dogs are always fighting under the carpet. It’s hard to determine whether anything out of the ordinary is going on now. Isn’t it interesting how Kremlinology is making a comeback?

As for a coup, I’m skeptical. If that was occurring, or had happened, you would expect to see a noticeable increase in military and OMON activity in the capital. A big increase. Either as a defensive measure by Putin, or as a movement by the plotters, or both. No such movement has been reported.

In the absence of information, people are putting dark interpretations on unremarkable events: minds seem to need to fill in blanks.  For instance, last night Twitter was ablaze with speculation about what was going on in Red Square. Semis were seen driving to the square, and there were pictures of bleachers and some sort of construction work. Theories trying to connect this to Putin’s disappearance ran rampant. But the explanation was simple: the outdoor ice rink near GUM was being taken down. (Is there rampant speculation when the Rink at Rockefeller Center is taken down?)

Another kerfuffle: the flag that normally flies over the Kremlin was absent. A sign! An omen! Whatever. If there’s a coup you’ll know soon enough.

This is just Russia living up to Churchill’s aphorism: a riddle, wrapped in a mystery inside an enigma. This makes it extremely susceptible to bouts of severe unpredictability, which is a sobering prospect given its aggressive tendencies and massive arsenal (especially its nuclear arsenal). Given the lilliputians in the US and Europe who are responsible for reacting to such a spasm this is not comforting. Meaning all I have to say is: Vlad! Get well soon!

That’s especially true because anyone who replaces Putin is likely to be as bad, or worse. That’s especially true if he’s ousted by a coup, because that’s a process of the survival of the baddest.

In other words, we don’t have a Putin problem. We have a Russia problem. Putin is a symptom of a political system that will survive him, and will evolve, but likely into something worse.

@libertylynx points out a very interesting contrast. The awful developments in Iraq over the last several years, most notably the rampage of Isis and the dramatic expansion of Iranian influence in the country, are directly attributable to Obama’s decision to withdraw all US military forces.  He did so after failing to negotiate a Status of Forces agreement with the Maliki government. This occurred primarily because of a particular demand that Obama made of Maliki: namely, that the Iraqi premier get his parliament’s approval of any agreement. Obama stated that such approval was necessary to make the deal credible and viable. He said legislative buy in was essential. Of course, this did not happen, and almost certainly Obama knew it would not happen. This gave him the pretext to bug out.

Fast forward 3-4 years. Whereas Obama had insisted on Iraqi legislative approval of a deal with the US, now Obama is dead set against letting the American legislative branch have any say whatsoever in a deal with Iran. So much for the need for legislative approval to give a deal credibility.

Obama obviously has no principled view of the role of the legislature in foreign policy. He didn’t want a Status of Forces agreement, so he insisted on Iraqi legislative approval because he knew it would not be forthcoming. He desperately wants a deal with Iran, so he adamantly opposes American legislative approval because he knows it is not likely to happen. His views on legislative involvement in diplomacy are not principled, but merely instrumental and change with the circumstances.

Indeed, not only is Obama not shutting out Congress, he is actively demonizing it in the most demagogic fashion for having the temerity to insist on having a voice. When he said that Senate Republicans were making common cause with “hardliners” in Iran, he was basically dog whistling, and his attack dogs responded with alacrity, accusing the Republicans-including the leader of the effort, Tom Cotton, a Marine combat veteran-of treason. The new  cry, advanced by another of the administration’s transparent social media manipulation campaigns is #GOPWantsWar.

A typical Obama false choice. His claim is that the only alternative to the specific deal he is “negotiating” is war. Think about that for a moment. It presumes that (a) absent any deal, Iran will proceed hell bent for a nuclear weapon, and (b) a nuclear Iran is such a dangerous regime that it must be prevented from acquiring the bomb, by war if necessary.

But apparently such a regime is a suitable negotiating partner, will adhere to any deal, and will eschew its nuclear ambitions even though a deal will effectively take both economic and military coercive measures off the table. Moreover, Iran clearly has hegemonic ambitions in the region, and a deal will give them greater resources to achieve them.

It is therefore by no means clear that a deal will reduce the likelihood of war. In my view, it is likely that the reverse is true. Moreover, those opposing a deal-who include many Democrats, as well as most Republicans-are advocating measures other than war, notably an increase in economic pressure, to force the Iranian government to forego its nuclear ambitions, and to limit its ability to achieve that capability. #GOPWantsWar is therefore a slur of the most scurrilous sort.

It gets worse, actually. Obama, claiming to be embarrassed for the Republicans, lies shamelessly about what the letter the 47 Republicans wrote. The Republicans never suggested that Obama was untrustworthy.

Further, catch this: “For them to address a letter to the Ayatollah who, they claim, is our mortal enemy . . . .” That is, Obama asserts that it is merely a Republican claim that Iran is an enemy of the US. The implication is clearly that Obama believes that it is not. That explains a lot.

I don’t believe Obama wants war, though I do believe that a soft deal with Iran like the one that is apparently imminent makes it more likely. I don’t believe in the slightest that he wanted Isis to run amok in Iraq, but his misjudgments and Machiavellian maneuvers made this outcome possible.

It is necessary to turn away from questioning motives, and to focus on substance. And I will close by noting that those who are most aggressive in questioning the motives of their opponents are the ones who believe they cannot prevail on the merits.

This nice piece from the WaPo points out the link between oil prices and Russian aggressiveness:

From this perspective, Russia is not so much an insecure superpower as it is a typical petrostate with a short-term horizon that gets aggressive and ambitious once it accumulates substantive oil revenues. Back in the early 2000s when the price of oil was $25 a barrel, Putin was a friend of the United States and didn’t mind NATO enlargement in 2004. According to Hendrix’s research, this is exactly how petrostates behave when the oil prices are low: In fact, at oil prices below $33 a barrel, oil exporters become much more peaceful than even non-petrostates. Back in 2002 when the Urals price was around $20, in his Address to the Federal Assembly Putin enumerated multiple steps to European integration and active collaboration aimed at creating a single economic space with the European Union among Russia’s top priorities. In 2014 – with the price of oil price around $110 – Putin invaded Ukraine to punish it for the attempts to create that same single economic space with the E.U.

I made these basic points eight years ago, in a post titled “Cocaine Blues.”

The graph depicts Gaddy’s estimates of the energy rents accruing to the Soviet–and Russian–economy. Each of the two spikes in the graph corresponds to a period of Soviet/Russian adventurism. The first shot of oil/cocaine during the 1970s oil shock fueled Soviet aggressiveness around the world. The second oil/cocaine shot–the post-2003 runup in oil prices–is powering Putin’s recent revanchism.

There were some follow up posts on the same theme.

This post from Window on Eurasia quotes a Russian social scientist who disputes the importance of oil prices in explaining Russian behavior in the Putin era. Instead, Vladislav Inozemtsev identifies the lack of formal institutions as the characteristic feature of Putinism.

But these things are not mutually exclusive. Indeed, another SWP theme from about this same time period (2007-2008) is that Russia is a natural state in which Putin uses control over resource rents to maintain a political equilibrium. Resource rents permit personalized rule and impede the development of formal, impersonal institutions.

In other words, in Russia, resource rents, and especially oil/energy rents matter, both for its political structure and evolution, and its behavior as an international actor.

China is notorious for flouting intellectual property rights. From stolen technology (including notably military gear) to designer knock-offs, China pirates everything and everyone. It is therefore a rather jaw-dropping act of chutzpah for to Chinese Zhengzhou Commodities Exchange to send a nasty cease-and-desist letter to the Singapore subsidiary of ICE demanding that ICE not copy ZCE’s cotton and sugar contracts:

Intercontinental Exchange has been forced to delay the launch of its new Singapore platform after a Chinese exchange threatened legal action to stop the US group launching two commodity futures that are copies of contracts offered in China.

The move by the Zhengzhou Commodity Exchange is likely to send shockwaves through the global futures industry because it signals that China will not tolerate foreign exchanges copying its futures contracts, and comes despite the practice of offering “lookalike” contracts being accepted around the world for years.

The ICE contracts are not copies, exactly. Similar to its “NYMEX lookalike” contracts, which cash settle against the expiring NYMEX future, the ICE Singapore commodity contracts are to be cash settled based on the settlement price of the expiring ZCE future. The ZCE future is delivery-settled. Meaning that the delivery mechanism ensures convergence between physical and futures prices, and the lookalike contract can ensure convergence by cash-settling against the delivery-settled contract.

The issues here are common to all intellectual property controversies. Strong intellectual property rights impede competition. Against that, free riding off the creativity or investment of others can impede innovation.

There isn’t a one-size-fits-all answer to this trade-off. In the case of exchange traded contracts, I tend to lean towards weak intellectual property rights.  The network effects of liquidity tend to weaken competition, and to give incumbents a strong advantage over entrants. There is already a substantial stream of rents to being first that gives strong (and maybe overly-strong) incentives to innovate, making strong intellectual property rights superfluous, and indeed damaging because they place another burden on already weak competition.

The US courts arrived at a similar conclusion, ruling that NYMEX did not have property rights over its settlement prices that it could use to preclude ICE from using them to cash settle its contracts. This is one factor that has encouraged a relatively robust competition in energy derivatives, which is the exception rather than the rule.

In sum, I hope ICE is able to prevail in its battle with ZCE. In part on economic grounds, and in part on the grounds that it burns me to see IP pirates protect their turf by asserting IP, especially over something for which IP is unwarranted.

I have compared Obama to a previous progressive president enamored of executive power and impatient with checks and balances: namely, Woodrow Wilson. Obama is now moving into the League of Nations phase of Wilson’s presidency, intent on ramming through a foreign policy deal in defiance of intense Senate opposition.

Actually, this comparison is unfair. To Wilson. At least he submitted the treaty to the Senate for ratification. It failed because he refused to compromise on Article X. Obama in contrast, refuses to involve Congress in any way, least of all by submitting any agreement for ratification. He scorns the very idea.

Today Obama stooped to a new low. In response to a letter from 47 Republican senators warning him that without ratification, Obama’s deal with the mullahs would not bind a future president or Congress, Obama responded by questioning their loyalty: “It’s somewhat ironic to see some members of Congress wanting to make common cause with the hardliners in Iran.”

Really. The hardliners oppose a deal because it might put a speed bump in the way of their race to develop an atomic weapon and the means to deliver it. The Republicans oppose the deal because they believe that the deal would not go nearly far enough to prevent, or even seriously delay Iran’s building of the bomb.

See the difference? I knew you could. That people with radically opposed objectives both attack a proposed agreement doesn’t mean it is just right. Indeed, the hardliners’ opposition validates the Republicans’ fear that the mullahs are hell-bent on getting the bomb as soon as possible.

Obama would be wise to heed the lesson of Wilson, whose obstinacy and refusal to compromise prevented him from achieving his the legacy-building agreement he craves so intensely. But we know that is not in his nature. It is not in the prog nature.

On the subject of Iran, I’ve been pondering the last couple of days what Putin wants to see here. My sense is that he would actually prefer that Obama fail. Another nuclear power on Russia’s borders cannot be a comforting thought. What’s more, Russia has long harbored imperial ambitions in Iran: the more insane nationalist elements in Russian (e.g., Zhirinovsky) are quite open in their ambitions to move south into Iran. A nuclear Iran would make those ambitions even less realistic than they already are.

But the main factor, at least in the short to medium term, is oil and gas. A deal that would expedite the elimination of sanctions that have limited Iran’s oil sales, and which have kept its gas almost completely out of reach, would be adverse to Russia’s economic interests. A substantial increase in Iranian oil output would put considerable downward pressrun prices. The elimination of sanctions would open Iran’s vast gas reserves. In not too long, this gas could flow to Europe, where it would compete with Gazprom’s.

It’s hard to see an upside to Russia in a deal. Meaning that Putin will be trying to find a way to scupper it. Which will give Obama an opportunity to accuse the Republicans of being in league with Putin as well as the mullahs.

John Kerry actually said this:”[Kerry] insisted the Obama administration’s diplomatic record with Iran entitles the U.S. to ‘the benefit of the doubt.'” Seriously? The administration that is synonymous with foreign policy failure-the Reset, Libya (including but not limited to Benghazi), Syria, Iraq/Isis, Yemen, to name just the most egregious examples-deserves the benefit of the doubt? Why exactly? Do we look that stupid? It’s like Hoover asking Dean Woermer to give Delta House one last chance at the end of Animal House, while chaos is rampant on the streets of Faber. Or the Apprentice asking the Sorcerer for just one more try with the brooms. He’ll nail it this time! Promise!

I wrote several posts eviscerating Obama’s risible, not to say mendacious, claim that oil transported via Keystone would be exported. Apparently the odor emanating from Obama’s full-of-it-iveness was so obvious that even reliable lefty “fact checker” Glenn Kessler couldn’t ignore it. So he awarded Obama’s Keystone claim a cherished Four Pinnochios. This was pretty good:

When Obama first started making the claim that the crude oil in the Keystone pipeline would bypass the United States, we wavered between Three and Four Pinocchios — and strongly suggested he take the time to review the State Department report.

Clearly, the report remains unread.

Of course it does! It’s not like the truth could trump politics, or anything.

Tonight we learned that while Secretary of State, Hillary was using private email exclusively to conduct professional business. (What was her email? [email protected]?)  Hillary trying to avoid scrutiny of her dealings? How could you suggest such a thing? I’m sure that every message was read and stored for posterity-by the Russians, Chinese, North Koreans, Iranians, and assorted Islamist hackers.

I could go on. But you get the idea.

F. Scott Fitzgerald wrote that “[t]he test of a first-rate intelligence is the ability to hold two opposed ideas in mind at the same time and still retain the ability to function.” By this standard, Obama and his foreign policy team must be far into the right tail of the MENSA distribution, because they are able to hold about 10 opposed ideas in mind.

For instance, the operation against Tikrit is a vital step in the campaign against Isis, but the US is not involved. In part it is not involved because Iran and Shia militias are taking the lead in the offensive there, and the US has grave, grave concerns about growing Iranian influence-control, really-in Iraq and elsewhere in the region (e.g., Yemen). We are so concerned about Iran, in fact, that we are negotiating-I use the term loosely, because it usually involves both give and take, and we are just giving-a deal that would give Iran a clear path to becoming a nuclear power. Once it becomes a nuclear power, of course, it will have dramatically enhanced capability to exert its power in the entire Middle East. Even before it gets the bomb, sanctions will be ended, giving Iran the economic wherewithal to support terrorism and extend its influence the region. (Kerry is in Geneva with his buddy, the Iranian foreign minister Javad. They’re on a first name basis, you see. I wonder if they’re reminiscing about the old days. You know, the American Embassy; the Marine Barracks; Khobar Towers; supplying Iraqi terrorists with shaped charge IEDs to kill Americans. Good times. Good times. The list of topics is endless.)

Meanwhile, Obama has long said that he wants to rid the world of nuclear weapons. Not only is he negotiating a deal that will create a new nuclear power, Iran’s acquisition of the bomb will set off a race by the Saudis, Turks, Egyptians, etc., to get it too.

Further, Obama wants to get the Sunnis in Iraq, and Sunni nations in the Middle East, on board to fight Isis. All the while he is standing aside while Iran and Shia militias, whom the Sunnis hate with the heat of 1000 suns, operate pretty much at will in Iraq.

But I’m not done!  The administration also has a soft spot for the Sunni Muslim Brotherhood (witness its continued hostility to Sisi in Egypt, who tossed out the MB), despite the fact that the Brotherhood views Shia as subhuman.

Another part of the administration policy-supposedly-is to support “moderate” Syrian opposition fighters. Who is the opposition opposed to? Iran’s biggest ally: Assad. What’s more, the first group of fighters that we were supporting were rolled over by an Al Qaeda-linked group, and switched allegiances. In response, Obama’s “Special Presidential Envoy for the Global Coalition to Counter ISIL” (how does he fit that on his business card?) Gen. John Allen (ret.), says that the US will protect moderate Syrian opposition fighters “when the time comes.” I’ll bet that’s a real enticement to enlist. Somehow, I get the vision that the protection that will be offered is an honor guard at a mass burial, because when the time comes it will be too late.

Of course, this is not genius. It is drooling incoherence. The administration has more foreign policy personalities than Sybil. Simultaneously attempting to pursue wildly contradictory, and indeed mutually exclusive, policies, which will inevitably result in a train wreck of historic proportions.

At the root of this is Obama’s Ahab-like pursuit of a deal with Iran. That is the primary source of incoherence. Why he harbors this obsession, I do not know. I cannot think of a good reason. I can think of many bad ones, including some very, very bad ones.

I have written often of the Clayton Rule of Manipulation, named after a cotton broker who, in testimony before Congress, uttered these wise words:

“The word ‘manipulation’ . . . in its use is so broad as to include any operation of the cotton market that does not suit the gentleman who is speaking at the moment.”

High Frequency Trading has created the possibility of the promiscuous application of the Clayton Rule, because there is a lot of things about HFT that do not suit a lot of gentlemen at this moment, and a lot of ladies for that matter. The CFTC’s Frankendodd-based Disruptive Practices Rule, plus the fraud based manipulation Rule 180.1 (also a product of Dodd-Frank) provide the agency’s enforcement staff with the tools to pursue a pretty much anything that does not suit them at any particular moment.

At present, the thing that least suits government enforcers-including not just CFTC but the Department of Justice as well-is spoofing. As I discussed late last year, the DOJ has filed criminal charges in a spoofing case.

Here’s my description of spoofing:

What is spoofing? It’s the futures market equivalent of Lucy and the football. A trader submits buy (sell) orders above (below) the inside market in the hope that this convinces other market participants that there is strong demand (supply) for (of) the futures contract. If others are so fooled, they will raise their bids (lower their offers). Right before they do this, the spoofer pulls his orders just like Lucy pulls the football away from Charlie Brown, and then hits (lifts) the higher (lower) bids (offers). If the pre-spoof prices are “right”, the post-spoof bids (offers) are too high (too low), which means the spoofer sells high and buys low.

Order cancellation is a crucial component of the spoofing strategy, and this has created widespread suspicion about the legitimacy of order cancellation generally. Whatever you think about spoofing, if such futures market rule enforcers (exchanges, the CFTC, or the dreaded DOJ) begin to believe that traders who cancel orders at a high rate are doing something nefarious, and begin applying the Clayton Rule to such traders, the potential for mischief-and far worse-is great.

Many legitimate strategies involve high rates of order cancellation. In particular, market making strategies, including market making strategies pursued by HFT firms, typically involve high cancellation rates, especially in markets with small ticks, narrow spreads, and high volatility. Market makers can quote tighter spreads if they can adjust their quotes rapidly in response to new information. High volatility essentially means a high rate of information flow, and a need to adjust quotes frequently. Moreover, HFT traders can condition their quotes in a given market based on information (e.g., trades or quote changes) in other markets. Thus, to be able to quote tight markets in these conditions, market makers need to be able to adjust quotes frequently, and this in turn requires frequent order cancellations.

Order cancellation is also a means of protecting market making HFTs from being picked off by traders with better information. HFTs attempt to identify when order flow becomes “toxic” (i.e., is characterized by a large proportion of better-informed traders) and rationally cancel orders when this occurs. This reduces the cost of making markets.

This creates a considerable tension if order cancellation rates are used as a metric to detect potential manipulative conduct. Tweaking strategies to reduce cancellation rates to reduce the probability of getting caught in an enforcement dragnet increases the frequency that a trader is picked off and thereby raises trading costs: the rational response is to quote less aggressively, which reduces market liquidity. But not doing so raises the risk of a torturous investigation, or worse.

What’s more, the complexity of HFT strategies will make ex post forensic analyses of traders’ activities fraught with potential error. There is likely to be a high rate of false positives-the identification of legitimate strategies as manipulative. This is particularly true for firms that trade intensively in multiple markets. With some frequency, such firms will quote one side of the market, cancel, and then take liquidity from the other side of the market (the pattern that is symptomatic of spoofing). They will do that because that can be the rational response to some patterns of information arrival. But try explaining that to a suspicious regulator.

The problem here inheres in large part in the inductive nature of legal reasoning, which generalizes from specific cases and relies heavily on analogy. With such reasoning there is always a danger that a necessary condition (“all spoofing strategies involve high rates of order cancellation”) morphs into a sufficient condition (“high rates of order cancellation indicate manipulation”). This danger is particularly acute in complex environments in which subtle differences in strategies that are difficult for laymen to grasp (and may even be difficult for the strategist or experts to explain) can lead to very different conclusions about their legitimacy.

The potential for a regulatory dragnet directed against spoofing catching legitimate strategies by mistake is probably the greatest near-term concern that traders should have, because such a dragnet is underway. But the widespread misunderstanding and suspicion of HFT more generally means that over the medium to long term, the scope of the Clayton Rule may expand dramatically.

This is particularly worrisome given that suspected offenders are at risk to criminal charges. This dramatic escalation in the stakes raises compliance costs because every inquiry, even from an exchange, demands a fully-lawyered response. Moreover, it will make firms avoid some perfectly rational strategies that reduce the costs of making markets, thereby reducing liquidity and inflating trading costs for everyone.

The vagueness of the statute and the regulations that derive from it pose a huge risk to HFT firms. The only saving grace is that this vagueness may result in the law being declared unconstitutional and preventing it from being used in criminal prosecutions.

Although he wrote in a non-official capacity, an article by CFTC attorney Gregory Scopino illustrates how expansive regulators may become in their criminalization of HFT strategies. In a Connecticut Law Review article, Scopino questions the legality of “high-speed ‘pinging’ and ‘front running’ in futures markets.” It’s frightening to watch him stretch the concepts of fraud and “deceptive contrivance or device” to cover a variety of defensible practices which he seems not to understand.

In particular, he is very exercised by “pinging”, that is, the submission of small orders in an attempt to detect large orders. As remarkable as it might sound, his understanding of this seems to be even more limited than Michael Lewis’s: see Peter Kovac’s demolition of Lewis in his Not so Fast.

When there is hidden liquidity (due to non-displayed orders or iceberg orders), it makes perfect sense for traders to attempt to learn about market depth. This can be valuable information for liquidity providers, who get to know about competitive conditions in the market and can gauge better the potential profitability of supply ing liquidity. It can also be valuable to informed strategic traders, whose optimal trading strategy depends on market depth (as Pete Kyle showed more than 30 years ago): see a nice paper by Clark-Joseph on such “exploratory trading”, which sadly has been misrepresented by many (including Lewis and Scopino) to mean that HFT firms front run, a conclusion that Clark-Joseph explicitly denies. To call either of these strategies front running, or deem them deceptive or fraudulent is disturbing, to say the least.

Scopino and other critics of HFT also criticize the alleged practice of order anticipation, whereby a trader infers the existence of a large order being executed in pieces as soon as the first pieces trade. I say alleged, because as Kovac points out, the noisiness of order flow sharply limits the ability to detect a large latent order on the basis of a few trades.

What’s more, as I wrote in some posts on HFT just about a year ago, and in a piece in the Journal of Applied Corporate Finance, it’s by no means clear that order anticipation is inefficient, due to the equivocal nature of informed trading. Informed trading reduces liquidity, making it particularly perverse that Scopino wants to treat order anticipation as a form of insider trading (i.e., trading on non-public information). Talk about getting things totally backwards: this would criminalize a type of trading that actually impedes liquidity-reducing informed trading. Maybe there’s a planet on which that makes sense, but its sky ain’t blue.

Fortunately, these are now just gleams in an ambitious attorney’s eye. But from such gleams often come regulatory progeny. Indeed, since there is a strong and vocal constituency to impede HFT, the political economy of regulation tends to favor such an outcome. Regulators gonna regulate, especially when importuned by interested parties. Look no further than the net neutrality debacle.

In sum, the Clayton Rule has been around for the good part of a century, but I fear we ain’t seen nothing yet. HFT doesn’t suit a lot of people, often because of ignorance or self-interest, and as Mr. Clayton observed so long ago, it’s a short step from that to an accusation of manipulation. Regulators armed with broad, vague, and elastic authority (and things don’t get much broader, vaguer, or more elastic than “deceptive contrivance or device”) pose a great danger of running amok and impairing market performance in the name of improving it.