Streetwise Professor

We all know the real reason Putin did a last hour gas deal with China: he wanted to make me look bad.

For yes, mere hours after I declared my perspicacity in doubting that the widely expected deal would get done, the Russians and Chinese announced that they had reached an agreement. So my powers of prognostication were short-lived. Don’t gloat too much, Vova.

That said, I believe that there is less here than meets the eye. Or at least, there are many outstanding questions.

Although the deal supposedly agrees on pricing, the pricing structure is very opaque. Gazprom’s Miller said the pricing was set, but a “commercial secret.” In other words, he would tell us, but he’d have to kill us.

People are widely quoting a number for the price, based on Gazprom leaks and back of the envelope calculations based on announcements of the notional value of the deal ($400 billion over 30 years) and the quantity (38bcm/year). But as I noted in the post a couple of days ago, there is no way that the parties would set a fixed price for the 30 year term. Instead, they would agree to some indexing formula. Gazprom said that a “base price” had been established, and Putin said that the contract utilizes oil indexing. (In my original post I said this was an important thing to look for. On its own, this is a win for Gazprom, which has been a diehard advocate of oil indexing. But given the lack of any gas hubs in Asia, it’s hard to see what other alternative there is. Perhaps indexing off a European hub, but this would present real problems for Gazprom.)

But all that said, the devil is in the details. Since the price is indexed, any statements about a flat price (e.g., $350/mcm) are based on a huge number of assumptions on the indexing formula. Since nobody knows what that formula is, they have no clue on what the real price is. (And since the oil forward curve doesn’t really go out much beyond 10 years, there would still be incredible uncertainty about the revenues that Russia will realize or could lock in by hedging even if the formula was known: given that the gas will not flow for another 6-7 years, the forward prices that would be input into the formula for the last 20+ years of the 30 year term of the deal can’t be known with any precision.)

And the devil is indeed in the details of these assumptions. There are infinitely many ways to create an oil-indexed formula, and the economic outcomes vary crucially with the exact parameters that are chosen as inputs to the indexing formula. (Indeed, the weights can be made to vary over time.)

Moreover, there are some clues that things aren’t quite as final as the public crowing suggests. Putin says that the Chinese have agreed to front $20 billion towards the construction of new infrastructure, with Russia ponying up $50+ billion. But Gazprom’s Miller says that the “two sides were still in talks over any advance.”

Well wait one cotton picking minute. Upfront payments have to be offset by favorable prices over the life of the deal, to compensate the Chinese for the principal amount of the advance and the interest on it. If the upfront payments haven’t been set there is no bleeping way that all of the pricing terms are set. These terms are interdependent.

That little slip by Miller is, my friends, a huge red flag that this deal isn’t as done as the principals claim. Huge. If that part is still under discussion, the entire thing is still under discussion.

Here is my cynical interpretation (and when Russia is involved, and China is involved, cynicism is the order of the day-and when both are involved, oi!). The failure to reach a deal was so embarrassing to Putin that he was desperate to leave Shanghai with his signature on something. So the parties basically memorialized what they had already agreed to, but there are crucial gaps to be filled, and the negotiations to fill these gaps continue. The basic contours of the deal (e.g., some sort of oil link) are known, but the exact parameters, and the upfront payment, are still TBD. The Chinese accommodated, because letting Putin save face cost them nothing, and could benefit them later.

Gazprom stock popped a couple of percent on the announcement, but given the continued ambiguity, and the past fading of these deals after the initial fanfare, I consider that market reaction to be optimistic. I won’t be convinced that this is real until I see pipe being laid. Talk is cheap, and all we have now is still just talk.

So as far as I am concerned, there are still substantial doubts over the solidity of this deal. The admitted lack of agreement over the upfront payment is telling. Until the parties agree on that, they haven’t really agreed on anything.

In other words, things are still as clear as mud.

I told you to ignore the hype (all of which originated from the Russian side) about an impending Russia-China gas deal. Despite being 98 percent done! Down to one digit! Putin left China with no deal to sell gas to China.

Again: don’t believe it until you see it.

There was the same old-same old blah, blah, blah to rationalize the failure:

According to Xinhua, the Chinese state news agency, after meeting Mr. Xi in Shanghai, Mr. Putin said, “I’m glad to be informed that the two sides have made significant progress in the price negotiation of the east route of the natural gas project.”

A joint statement said that Russian natural gas supplies would start flowing “as soon as possible,” a phrase used after many previous negotiations between Gazprom and the China National Petroleum Corporation, and an indication that the two sides could not close the gap on price in time for the two leaders to announce the deal at their meeting.

The linked NYT article quotes several people who are surprised at the outcome. I really need their contact information. I have some bridges to sell. These people are apparently afflicted with this time it’s different syndrome. But it never is.Yes, there are some differences now, but it’s really not that different.

The most telling thing (which I alluded to in yesterday’s post) is that all of the hype emanated from the Russian side. The Chinese were noticeably silent. Since it takes two to make a contract, this asymmetry was a major tip-off.

One wonders what the Russians hoped to gain by exaggerating the imminence and certainty of a deal.

Did they think that they would embarrass the Chinese into giving in? Why would they think that? That the Chinese would lose face if their guests left empty handed? As if the Chinese care. This is a commercial transaction, and the Chinese realize the Russians need the deal more than they do.  If anything, by trading them like obsequious hosts cringingly sensitive to world opinion, such a strategy would be more likely to tick off the Chinese and make them less likely to deal. If anything, the Chinese want to cultivate a reputation for being hard bargainers and actually expect to benefit from walking away.

Didn’t the Russians think that another failure would make them less likely to believed next time? Apparently not. But as the whole Ukraine episode demonstrates, they say outlandish things that are sure to be disproved with no apparent shame.

Actually, the most plausible explanation is that the Russians were pumping and dumping Gazprom stock. The price moved up as the market became convinced that a deal was impending, and then fell about 3 percent when the sure thing turned out to be not so sure . If Gazprom management and regime figures sold into the rally, they could have covered quite profitably on the selloff.

I say that only half in jest. Because otherwise I am at a loss to explain why the Russians would repeatedly over-hype the prospect for a China deal.

But I am also at a loss to understand how the stock would have rallied on the Russian pumping of the likelihood of a deal. This requires a lot of suckers to believe it.  After 10 years of this farce, you’d think people would wise up and heavily discount Russian assurances.  I guess there are a lot of suckers who want to believe. Charlie Brown lives.

Next time around don’t be a sucker. Sell rumors that Russians are peddling, and maybe-maybe-buy facts of an actual deal.

Several clearing related stories, each of which gives me a sense of deja vu. Or deja dit, to be more accurate.

The Bank of England just released a paper warning about the potential pro-cyclicality of CCP initial margin methodologies. I have expressed concern about this for some time.

BofE expresses concern that pro-cyclicality threatens to cause a measure intended to reduce credit risk create liquidity risk instead. This is another Clearing Cassandra theme. (Speaking of Cassandra, I will be returning to the old stomping grounds of Troy next week. And I don’t mean a city in upstate NY.)

BofE recommends that CCPs make public their margin methodologies, something that sends the clearinghouses into paroxysms of rage. But it makes sense to do that. And not just to reveal to the marketplace the potential liquidity demands that these methodologies can create, thereby allowing them to prepare accordingly. But to permit clearing participants to estimate their exposure to CCPs.

Clearing member exposure to CCPs depends on the likelihood that initial margins are sufficient to cover losses. Estimation of this exposure requires CMs to be able to evaluate margin calculations under a variety of market scenarios. If CCPs keep their methodologies secret, this is not possible. Discriminating choice among CCPs also requires market participants to understand margin costs and exposure under different scenarios. Such choice is not possible if CCPs keep secret their calculations.

CCPs are the beneficiaries of clearing mandates. Due to margin spirals and other feedback effects, margin calculations have external effects. There is therefore a strong efficiency case favoring disclosure to mitigate the externality, and any commercial/competitive inconvenience CCPs suffer as a result is more than compensated for by the fact that government mandates force huge quantities of business their way.

Another story that has come to my attention is that RBS is cutting back its rate clearing business, in large part due to the substantial capital commitment required, and the operational overhead.

This is another long-time SWP theme. The regulatory burdens of being a clearing member create scale economies that will result-and is resulting-in substantial consolidation of the clearing business. Thus, the systemic risks associated with clearing arise not only because of concentration of risk in CCPs, but in concentration of risks in a dwindling number of clearing firms who participate in multiple CCPs. Concentration of risks in a small number of CMs is, in my view, actually more systemically worrisome than concentration of risks in a small number of CCPs. Indeed, it is precisely the concentration of risks in CMs that makes failure of a systemically important CCP more likely.

Recall the good old days, when Gensler fought to reduce the minimum capital requirement for CMs to $25 million in order to spur competition in the supply of clearing services? Good times, good times. Little did he recognize that the other myriad burdens of Franendodd and Emir would inevitably lead to consolidation, making the minimum capital requirement irrelevant.

But this was only one of Gensler’s delusions (or was it lies?) about clearing. I was therefore pleased, and admittedly somewhat shocked, to see his (interim) replacement, Mark Wetjen, (implicitly) call bull on Gensler’s Panglossian propaganda on clearing:

He made an interesting and refreshingly blunt departure from the superseded Gensler script, by referring to Clearing Houses as potential sources of systemic risk.

“A clearinghouse’s failure to adhere to rigorous risk management practices established by the Commission’s regulations, now more than ever, could have significant economic consequences.”

His predecessor’s evangelical belief in CCPs as universal risk-mitigants, refused to countenance the heresy that central clearing may at best merely transfer credit risk, and may actually result in concentration of and increase in systemic risk. Fundamentalism should have no place in regulation, especially the more fundamental reforms; Wetjen’s implied recognition that a central pillar of the Dodd-Frank reforms is open for objective discussion, represents an important and consequential change in the Agency’s culture and governance.

That last part is the opinion of Nick Railton-Edwards (a somewhat Pythonesque handle, eh?), who wrote the piece, rather than Wetjen. (He sounds like a like-minded, not to say right-minded, bloke.) But it is a realistic characterization of the implications of Wetjen’s remarks. I would add that this evangelism is exactly what I hammered Gensler for repeatedly in 2009-2013: Indeed, I repeatedly used the term evangelist to refer to Gensler and his allies. (And that hammering is why he banned me from the CFTC building-something that I have on unimpeachable authority.)

The sad thing about all this is that all of these things were foreseeable before legislators and regulators* went all in on clearing as The Solution. Certain Cassandras did foresee it. But now this is where we are, and some adults like the BofE and Wetjen are trying to mitigate the dangers that this rash and thoughtless plunge created.

Would that this had occurred at the front end of the process rather than the back. Better late than never, perhaps. But better early than late.

*Timmah! was Gensler’s partner in crime on this. Geithner has just released his memoirs, and is flogging the book. I will give him another flogging in due course. For old times’ sake.

The US has indicted the Chinese military for cyberespionage. (Who knew?)

Meaning that soon there will be a Snowden “revelation” about NSA spying on China. Making book on that. (Recall that when he arrived in Hong Kong, Snowden revealed NSA operations to penetrate Chinese computers. That was his negotiating ploy to get Chinese protection. The Chinese, being no dummies, said thank you very much for that, and no doubt scraped everything they could off his computers, then pawned him off on the Russians.)

Before heading off to China, Putin announced that Russian troops currently deployed at the Ukraine border would return to their bases after spring training exercises.

Funny that, given that a couple of weeks ago he said that they had already withdrawn.

But never mind that little detail. Even after suppressing guffaws at the “training exercises” crock, you must recognize that Putin is not making any concession to the international community, or responding to international pressure, or having some deep change of heart over the prudence and justice of invading Ukraine. He is just bowing to a reality that readers of SWP should know well: the Russian military’s software/meatware problem.

The Russian military is still highly dependent on conscripts, despite efforts to increase the percentage of professional kontraktniki in the ranks. Due to demographic problems, and the scourge of dedovshchina, a few years back the Russians cut the term of conscript service from two years to one. These terms ended on 31 March, and new conscripts began to enter service on 1 April.

The terms of conscripts can be extended, but doing so for more than a couple of months is impractical. Draftees already pissed off at having to serve a one year sentence (and it is effectively a sentence to hard labor and corporal punishment, on the best of days) would likely become downright mutinous at the prospect of an extended term. (Inquiring minds want to know: has any genius journalist thought to try to determine if many of the 2013 class has indeed been held over?) Thus, it has been known for some time that after mid-May virtually all Russian units (with a few limited exceptions) would be unavailable for operations, let alone for offensive operations that might last some time. The deployed units would have to be pulled back,  the old conscripts mustered out, and the new conscripts mustered in and integrated with their units, a process that would take several months. (And it’s not like the newbies would be more of a danger to the Ukrainians than themselves after even a few months.)

And lo and behold. It’s mid-May, and Putin announces that the units will return to their bases.

This is not a coincidence, comrades. This is a military necessity. Therefore, read nothing into this about Putin’s intentions. Nothing. He is bowing to the fundamental fact that despite all the rubles he’s blown on hardware, the Russian military is severely hobbled by its archaic conscription-dependent mobilization model, the lack of warm bodies to fill the ranks, and the consequences of dysfunction in the barracks.

He has no  choice in this matter whatsoever. He is making lemonade out of lemons. Don’t be fooled. (But alas, many-including many in the markets, apparently-are being fooled. And badly.)

Some units, notably the VDV (airborne units), GRU spetznas, and air force units are less dependent on the conscription cycle. So watch to see whether these units also withdraw. I note that the Russians have deployed additional air force units to Belarus, and have announced a major air force exercise that just so happens to be scheduled for the date of the Ukrainian elections next Sunday. If airborne, GRU, and air force units remain deployed near the border, you can be doubly sure that Vlad is just biding his time while rotation process proceeds. I predict he will use the air force to maintain the pressure on Ukraine. The big exercise next week is part of that.

One moral of this story. Most commentary on Putin’s withdrawal order is tripe because it betrays not the slightest understanding of the realities of the Russian military. Anyone who does understand the constraints under which Putin is operating discounts the possibility that the withdrawal signals anything about Putin’s intentions or his assessment of the situation on the ground in Ukraine.

To be sure, that situation is not great, from the Russian perspective. There has been no great upswell of popular sentiment for secession or annexation even in the Donbas. (Who could have expected such from typically apathetic Sovoks?) Even the “commander” of the forces in the “People’s Republic of Donetsk”, the simultaneously sinister and comical Strelkov, was reduced to ranting about the failure of the locals to rally to the cause, and to call for women to take up arms. A motley collection of Sovok psychopaths, stiffened by some GRU cadres, is holding onto limited gains in places like Slovyansk. But although Donbas is not under Ukrainian control, it is not under Russian control either.

But if anything, that would provide an impetus for Putin to substitute Russian military intervention for a failed insurrection. I always discounted the possibility of an invasion, because even if the invasion succeeded the occupation would soon turn into a nightmarish quagmire. But Putin has used the threat of invasion (which can’t be discounted entirely despite its military insanity because one can’t discount that Putin is insane) to keep the pressure on Ukraine. If he is easing off on that pressure, it is not because he wants to. It’s because he has to.

Putin travels to China this week, and the big item on the agenda is the supposed signing of a long-awaited gas deal.

I’ve seen this show many times before, going back to 2004. Much fanfare ahead of the meeting! A deal is signed! But the price is TBD. Meaning there is no real deal. And then the charade occurs again a couple of years later.

So I’ll believe it when I see it.

The Russians, per usual, are doing all the talking about the impending deal. Apparently understanding that those who have seen the earlier episodes will be skeptical about any deal that doesn’t nail down pricing, they are at pains to claim that the pricing is all but set. Deputy Energy Minister Anatoly Yanovsky said the deal is “98 percent completed.” What does that mean anyways? By word count? Meaningless, if the missing 2 percent relates to price. Gazprom’s Alexi Miller says the deal is “one digit” away from completion. Well, which digit kinda matters. Is it in the hundreds column? The tens? The ones? (Or does the single digit refer to an upraised middle finger?)

If a deal does get done, pay close attention to the price. The Chinese have the bargaining power here. As they always have. But now it is greater because this is now part of Russia’s game with Europe and Ukraine. It very much wants to put pressure on the Europeans. So Putin/Gazprom might be willing to take a lower price to further that strategy.

Just as important, look at the formula. The reports I’ve seen are saying that the Russians will sell at a fixed price, in the range of $350-$380/MCM. If the deal is truly at a fixed price, this would be a major concession, as Gazprom is an ardent defender of oil-linked pricing. If it gives up the oil-link, that would be a major concession, and would put oil-linked deals in Europe under greater pressure than is already the case.

This figure is based on leaks from Gazprom, which is kind of appropriate given the massive leakage that occurs from its pipes. Perhaps the leaker is converting an oil-based formula number to a flat price. Moreover, regardless of how arrived at, is this a number for deliveries over the entire 30 year life of the contract, or just for the near term deliveries? I can’t imagine locking into a price over 30 years. There has to be some kind of indexing, but to what? That matters a lot. Moreover, I would not be surprised if  the Chinese agree to near-term prices that are comparable to European prices in order to give Russia a propaganda victory to use in its battle with the Euros, but get more than compensated at the back end through some convoluted pricing formula that is not publicly disclosed.

It is quite possible that it will be very difficult for outsiders to know exactly what terms the parties have agreed to, and to back out a price, or a price structure over the life of the contract. Recall the Rosneft/Transneft-Chinese oil deal that was signed in 2009. The Chinese made an upfront payment to pay for a pipeline, and presumably received a discount on the price. But the pricing terms were not transparent and who got the better of the deal was hard to figure. I wouldn’t be surprised to see the same thing happen here.

Also remember that Russian-Chinese deals are not ended with “and they lived happily ever after.” The Rosneft/Transneft-China ESPO deal has been marked by chronic pricing disputes between the parties. Don’t be surprised if that happens here too. The Chinese are also notorious for re-opening pricing terms after deals are signed. And their performance on contracts generally leaves something to be desired. They are notorious for defaulting on fixed price contracts when spot prices fall below the contract price: for this reason, most iron ore and coal sales to China are on spot terms only. Iran recently canceled a $2.5 billion deal with China to develop an oil field because the Iranians claim the Chinese are not living up to the terms of the deal (though this isn’t related to pricing per se). (H/T Neil C. Levine.) In other words, any deal is just setting the stage for ex post opportunism, by either party or both.

So even if Putin walks away from Beijing beaming a beatific botoxed grin, don’t draw too many conclusions. When two of the least transparent regimes in the world enter into a contract you cannot expect disclosure of the real terms, and the public announcements relating the deal will be intended primarily for propaganda purposes rather than to enlighten the world. When the inscrutable deal with the riddle/mystery/enigma folks, you can’t ever know what is really going on.

Further thoughts (added 5/19/14 at 1730 CDT). If and when a deal is announced, look to see whether there is a take-or-pay clause. The Russians usually insist on these, and they can be a source of major friction between the contracting parties if the price terms in the contract get out of alignment with spot market conditions, as is almost inevitable in a contract that extends over 30 years. I would be surprised if the agreement has take or pay terms and the Chinese also fund the construction of a pipeline upfront. Take-or-pay is usually a mechanism for protecting the party making the investment in the specific asset (like a pipeline or gas field): if the Chinese are funding the project, Gazprom doesn’t need take-or-pay to protect it. If anything, the Chinese would need protection against Gazprom’s opportunism.  If the Chinese indeed provide a substantial sum up front, as has been rumored (with sums of around $20 billion) the pricing terms of the contract become even more important: discounts later on in the life of the contract are necessary to pay the Chinese the principal and interest on the funding. There is no way that Gazprom will get European prices for sales to China if China also finances the investment. If Gazprom boasts that it indeed received European prices for sales to China, and the Chinese fronted the investment, you know there is something being hidden. (This happened with the Rosneft/Transneft deal.)  With respect to pricing, I can’t see any way that the deal would be at a fixed price for 30 years. There must be some sort of indexing. Again, if the boasting is about some price level that is anywhere near what the Russians get currently from Europe, be very suspicious. This is likely part of some sort of Three Card Monte game, with Russia tantalizingly flashing, then palming, the Black Queen to gull the suckers. If the deal is really for thirty years, there must be some sort of indexing mechanism, with a set of discounts, and the details here would be very devilish. Lastly (for now, anyways), I’ll be interested to see if the deal includes some sort of hostage exchange to protect each party against the predations of the other.

In the continuous process of Bayesian updating, my estimation of Noah Smith’s sensibility went up when I read his post on high frequency trading: he too recognized the ambiguous effects of informed trading. But my estimation plunged today when I read this. The piece comparing economists new and old is silly, superficial, and truth be told, embarrassingly ignorant.

Smith’s basic thesis is that economists of the 60s and 70s were “policy scientists”, theoretical rather than empirical, and ideological rather than practical, with that ideology being pro-market and anti-government: conservative, in a word. In contrast, modern economists are engineers focused on predicting human behavior rather than trying to influence policy, relentlessly empirical rather than theoretical, and due to their more practical grounding, less ideological, more skeptical of markets, and more supportive of government intervention.

All of which is tripe, of course.

Smith’s exemplar of the 60s-70s economist is Milton Friedman. Smith’s views of Friedman are apparently based on YouTube videos: he refers to those, but not to one piece of Friedman’s professional work. If he had paid the slightest attention to that work, he would have realized that his characterization is completely at odds with reality.

Friedman was all about using economics to explain human behavior and the consequences of the interactions between individuals in market settings. He was, first and foremost, a scientist.

Yes, Friedman did theory. But as his famous (and controversial) essay “The Methodology of Positive Economics” demonstrates, he viewed empirical evidence as the ultimate arbiter: theories were only as good as the empirical validity of their predictions. The objective of theory is to explain practical things. What’s more, Friedman practiced what he preached. He did empirical work. Lots of it. His PhD thesis, on the income from professional practice, was empirical. His most important and influential work, A Monetary History of the United States, 888 pages (!) of empirical work, done back when empirical work was a true labor.

Moreover, Friedman’s theoretical efforts spawned massive amounts of empirical research, precisely as he desired. The most notable example of this is his work on the theory of the consumption function, which was motivated by the empirical failures of the Keynesian consumption theory.

Nor was Friedman alone. The great Gary Becker just passed away. Becker was all about using economic theory to explain an incredible range of human behavior. He made practical predictions that are as amazing and empirically valid as those of auction theory and random utility discrete choice which Smith cites with approval as representative of modern economics.

In fact, the 1960s and 1970s were a period during which neoclassical economics was developed and applied extensively to produce tremendous insights on a broad range of human behavior, including family and fertility, crime, and myriad other subjects.  It was first and foremost about explaining human behavior. To the extent these explanations had policy implications, some economists were not shy about pointing them out. But that was a side-effect of the main thrust of their inquiries.

And believe it or not, these basic microeconomic tools are still amazingly powerful today.

Indeed, part of the reason that these theories were powerful is that they showed the flaws in numerous policies. Anti-trust and regulation immediately come to mind.

In other words, many economists of this earlier generation-and most notably Friedman-were all about understanding and solving real-world problems. This is not something that came to economics in the last decade or two. Noah Smith grossly mischaracterizes, and arguably slanders, the giants on whose shoulders he stands.

Such is the danger of doing the history of economic thought based on YouTube videos.

Smith notes that a larger fraction of published research today is empirical. Friedman would not be surprised. As Smith notes, the  price of empirical research relative to theoretical research  has gone down due to computation costs and the availability of data sets, and any good price theorist would predict that this will lead to substitution towards empirical work.

There is a corollary to this. The value of the marginal regression will fall to its marginal cost. As that cost has gone to zero, so has the value of the marginal piece of empirical research.

Insofar as the politics and ideology of economics is concerned, to say that economics was  a “conservative science” in the middle of the 20th century is beyond delusional. In what alternate universe?

In the 60s and 70s in particular, economists were broadly in favor of government intervention: this had been true since the 1930s. This was the golden age of Market Failure Economics. In macro, Keynesian fine tuning reigned supreme. To say otherwise is completely ahistorical.

Friedman and other avowedly pro-market economists were the exception, rather than the rule.

There was a shift among economists towards more pro-market, anti-government attitudes in the late-70s and early-80s due to the marked empirical failure of Keynesian economics in macro, the theoretical and empirical work on the actual causes and effects of regulation, and Coase’s logical evisceration of the Pigouvian market failure paradigm. To the extent that the pendulum has swung back it is due to the financial crisis, just as the shift to pro-intervention among economists in the 30s and 40s reflected the impact of the Great Depression.

Smith remarks that the  most well known current public economist, Krugman, is liberal, whereas the most well-known public economist of the 60s and 70s was Friedman, a conservative. But here again Smith is making a fundamental error. Yes, Friedman was a public figure in the earlier era, but there were many more economists on the left that played the role of public intellectual: Paul Samuelson is the most notable of these. Friedman was again the exception. What is remarkable is that these other economists have faded from view, whereas Friedman lives on, as the YouTube vids that Smith mentions attest. Who will remember Krugman 40 years from now? I am betting that Friedman will be better known in 40 years than Krugman will be. For myriad reasons, professional and personal.

Smith’s biggest blind spot-and the above shows that there are many-relates to government, and specifically government failure. He mentions how information economics has identified additional sources of market failure. But he utterly neglects to mention how some economists-including many from that earlier generation-have identified how private arrangements can mitigate these problems, and completely overlooks the fact that government may not be able to ameliorate these failures, and may create failures of its own. (And by saying “may” I am being overgenerous.)

Again, an awareness of the insights of some of those “policy scientists” whom Smith denigrates would disabuse him of this error. Coase in particular comes to mind. He emphasized that any analysis of policy could not end with the identification of a market failure: that was at best a beginning. Any analysis has to make comparisons between real world alternatives, rather than conjuring a magical government solution. I would further note that Coase was relentlessly empirical. “The Theory of Social Cost” grew out of an analysis of how the Federal Trade Commission actually worked.

Smith characterizes modern economists as more practical and less ideological than those of an earlier generation. And lo!, they are also liberal and favorably disposed to government intervention.

Smith is probably right about the political leanings of modern economists, and the basis for those views. So much the worse for modern economics.

But he can only make favorable comparisons between the current generation and Milton Friedman and others of an earlier generation by completely distorting the professional work of Friedman and his contemporaries. Smith probably does this out of ignorance, but that is no excuse. Smith doesn’t know what he doesn’t know, and this leads him to denigrate unfairly the legacy of the earlier generation and exaggerate the virtues of his own.

Hours after I wrote that a good model for understanding Ukraine would be medieval France or England, and that Putin would be perfectly fine with the country being ruled by local barons, Ukrainian Prime Minister Yatsenyuk warned of the dangers of the feudalization of the country, and said that was Russia’s goal.

Prime Minister Arseniy Yatsenyuk believes that separatists in the east are trying to achieve not federalization of state and its feudalization. But the central government will not allow it. Ukraine was, is and will be a unitary, independent and sovereign. The Head of Government said at the meeting of the second All-Ukrainian “round table” of national unity in Kharkov.

Yatsenyuk made another comparison that I had just mooted, namely that Ukraine would become a collection of rump statelets involved in frozen conflicts:

Ukraine should be a single unitary state with broad powers of regions and not to share small enclaves where every businessman will buy to itself local council, the local administration and have small Abkhazia, Ossetia and Transnistria in Ukraine.

Yatsenyuk seems to see what is transpiring in Ukraine, and Putin’s goals, similarly to what I’ve written here on SWP. Maybe we are both wrong, but I think this is a far more reasonable reading of Putin’s desired end state than to presume that he wants to invade and annex large swathes of Ukraine as he did Crimea.

Against this background, this article which is getting a great deal of play looks ridiculous. As I said in the comments to the earlier post:

[That] article is yet another example of the court press raving about Emperor Obama’s magnificent raiment, when in fact he is stark naked. The premise is that Putin wanted to invade and conquer Ukraine, and since he hasn’t, Obama must have deterred him. As I’ve written several times, I don’t believe that Putin had any intention of invading, let alone ruling over any part of Ukraine other than Crimea. Militarily it would be a disaster. Yes, he would likely succeed at first, but the occupation would become a bleeding ulcer. He is content to have frozen conflicts, and a balkanized and dysfunctional Ukraine. His primary objective is preventing Ukraine from moving closer to the EU and Nato, and having a weak Ukraine that he can manipulate from afar, primarily working through the oligarchs. He would be quite content having a purely transactional relationship with someone like Tymoshenko in charge.

With a few more Obama “victories” like Ukraine and Syria, we are well and truly ruined.

The NYT and Reuters are abuzz with stories about how Ukrainian oligarch Rinat Akhmetov has deployed his steelworkers to the streets of Mariupol, pushing out pro-Russian elements. Moreover, Akhmetov made statements that superficially seem to support the Kiev government, but which suggests that decentralization under a new constitution are the best way forward.

Be very, very suspicious. Saying that Akhmetov is untrustworthy is like saying that the core of the sun is pretty warm.

He rose to wealth and power during the early-90s, allegedly as an enforcer for organized crime elements in eastern Ukraine. He was a supporter of Yanukovych. There are allegations that he was a silent partner of Yanukovych’s son in a scheme to sell illegally mined coal that netted over $100 million. The Wikileaks cables include some more than unflattering references to him and his criminal connections.

In other words, he is as dirty as the soot spewing from the stacks of his steel mills.

Note that Putin and Russia appear to be unperturbed by developments in Mariupol, a sharp contrast to their hysterical reactions to attempts by the Kiev government to regain authority over the eastern provinces.

The Donbas scores a perfect 10 on the Sovok scale. Putin needs to have direct control over it like he needs a hole in the head. It suffices that Kiev does not control it. Another frozen conflict, a la Transnistria, South Ossetia, and Abkhazia, will serve his purpose, and he can no doubt reach an agreement with Akhmetov. And Akhmetov has no interest in direct Russian control. A Donbas that is not part of Russia spares Putin expense, and the headaches of dealing with the reprobates that are currently running wild there. But keeping the region on the boil undermines Kiev. It’s a win.

Pro-Maidan elements assert that Akhmetov was spurred to action not by the threat posed by the pro-Moscow rabble, but by the appearance of a pro-Kiev force from Dnipropetrovsk.

I don’t know exactly what Akhmetov’s game is, but he puts his interests first. He is not a Ukrainian patriot: he is a mobster and a thug. My guess is that Putin is happy to concede Akhmetov control over Donbas: he is much more biddable than the assortment of loons and lowlifes that comprise the Donetsk People’s Republic and the Luhansk People’s Republic. Akhmetov wants autonomy from Kiev, though he might pledge superficial fealty to it.

If you want a mental model, you could do worse than to harken back to medieval France, or medieval England during periods of weak monarchs or succession crises. Powerful local barons made formal pledges of loyalty to the monarch, but demanded virtual complete autonomy from central authority. They, and not the king, were the law wherever their writ ran. They schemed and fought to protect their property, and to take property and power from others. Outside nations pitched in to keep the country in turmoil and undermine the efforts of the center to bridle the barons.

Ukraine is cursed by its Sovok past, and the primitive capitalist accumulation that occurred upon the dissolution of the USSR. It is very close to Russia, and very far from God. People like Akhmetov have two goals: to protect the property and power that they secured through force and corruption, and to take additional property and power from other barons. Patriotism and principle have nothing to do with it.

Putin can exploit these circumstances to prevent Ukraine from forming a stable, unitary state that will move towards the west. He will reach agreements with the local barons.

There is every reason to be skeptical about the NYT and Reuter’s stories. Not the factual part, about Akhmetov dispatching legions of his laborers to assert control over parts of Donbas. But about the interpretation of his motives for doing so, and the implications of his actions. The western media appears locked into a simplistic narrative of Kiev vs. Moscow. Viewed through this lens, Akhmetov’s cracking down on separatists who are anti-Kiev must be anti-Moscow, and a separatist defeat must be a victory for Kiev and a defeat for Moscow. But it’s more complicated than that. The separatists have served a purpose for Putin-breaking up Ukraine-but he does not have a long term investment in them. A fractured Ukraine, with figures like Akhmetov exercising control over important regions can serve his long run purposes much better: he can reach accommodations with the Akhmetovs, whereas controlling the lumpenproletarians of the DPR is a much bigger headache. This works for Akhmetov too: indeed, his action followed close upon demands by the separatists that he pay taxes to them, so he has a strong incentive to put them in their place. But that doesn’t mean that he is acting in the interests of Kiev or the nation of Ukraine.

It took centuries for the French monarchy to suppress the local barons. Ukraine may become a modern, unitary state in a shorter time, but it isn’t going to happen soon.

There’s one other interesting angle here. The US has gone after one major Ukrainian oligarch: Dmytro Firtash, whom it is attempting to extradite from Austria. Akhmetov is as corrupt and criminal as Firtash, and indeed is closely associated with Yanukovych. But he seems under no legal threat from the US. Could it be that the US has decided that Akhmetov can facilitate a not war, not peace outcome that allows the US and EU to wash their hands of what is going on in Ukraine? That makes as much sense as anything.

The Russians are among the world’s greatest money launderers, if not the world’s greatest money launderers. (Just ask Bank of New York.) But before wholesale money laundering began in the 1990s, the Soviets were passed masters at laundering stories. Falsehoods, truth be told.

It worked like this. The KGB would plant stories in obscure publications in places like Pakistan. Some of these stories would be picked up by more established publications. Eventually, a few of these stories would make their way through the media food chain and appear in whole or in part in mainstream western publications, including some of the most prestigious ones like the NYT and WaPo.

I strongly suspect this is what is going on with a story that appeared in the German paper Bild am Sonntag on Sunday.

Russia has been pushing for months the story that American mercenaries from Blackwater or its successor firms Academi or Greystone have been employed in Ukraine to fight the separatists. This story first appeared in March. It got a second life in the aftermath of the fire in Odessa that resulted in the deaths of 40 separatists. There were accounts allegedly originating with ex-SBU (the Ukrainian equivalent to the FSB) agents that English speakers were directing the assault on the building that went up in flames. As if giving orders in English to Ukrainian soccer hooligans would be incredibly effective.

But the story went viral on Sunday with the Bild account. It stated that the German intelligence service, the BND, had reported to Merkel on 29 April that 400 Academi mercenaries were operating in eastern Ukraine, specifically in Slavyansk.

German intelligence has confirmed the presence of American mercenaries! QED!

Not so fast.

What was the source of the BND information? According to the Bild story, it was . . . wait for it . . . American intelligence.

So we are supposed to believe that US intelligence revealed what would have to be a highly classified operation that would almost certainly require a Presidential finding  to a foreign intelligence service. An operation that if disclosed would play right into Russian hands and have devastating effects on the US. And disclosing such an operation to the intelligence service of a country with which the US currently has a very fraught relationship in the aftermath of the Snowden revelations, no less.

As if.

I think I can reconstruct what actually happened. The Germans approached the US and asked about the rife rumors (originating in Russia and among pro-Russian elements in Ukraine) about American mercenaries operating in Ukraine. The US said Ha!. The BND duly reported this to Merkel. They told Bild that they had made a report to Merkel, who then reported that the BND had briefed Merkel about the story, insinuating that the BND had confirmed that mercenaries were in fact operating in Ukraine.

Bild is a rather dodgy tabloid. Respectable enough to be a credible source for the Russians, but hardly a pillar of establishment journalism.

Note that I haven’t linked to the Bild story. That’s because I haven’t been able to find a link. If you search the Bild website for “Academi” or “Blackwater” the search returns a story from early March. Sunday’s story is not online. That should raise  alarms.

Further note that no other more reputable publication has confirmed the Bild story, or found other reliable sources stating that US mercenaries are in Ukraine. In particular, no US publication has. Some of the many online sites that have run with the Bild story make a big deal out of this, insinuating that US publications are protecting the government.

Again: as if. The NYT and WaPo have run extremely damaging stories involving US intelligence operations, most notably related to Snowden revelations. So they are going to spike this story?

You know the way journalism works. If a blockbuster story breaks, every other major publication assigns its best reporters to the story, to see whether it can be confirmed, and to develop additional sources and/or different angles.

You know that’s what happened in response to the Bild story. But so far, not a peep from any major paper or news service. Meaning that either these outlets have found nothing, or are covering up to protect the US government.

So let’s say that you believe that the NYT and WaPo and AP and whoever are stonewalling to protect the administration or the CIA or the Pentagon. What about foreign papers? I am thinking specifically about Der Spiegel, the newsmag that runs Snowden story after Snowden story written by Laura Poitras, Holger Stark, and sometimes Jake Appelbaum.

You think that Spiegel would be running cover for the US? Hardly. Yet all the Spiegel has done is run a story repeating the Bild allegation.

So what we have is a single, rather marginal western publication running a story that story that echoes a Russian propaganda theme. It is highly implausible that the alleged ultimate source of the information-US intelligence-would in fact reveal it as described.  (Intelligence personnel who want to undermine administration policies they disagree with usually go directly to their pet reporters at the NYT or WaPo.) No other publication corroborates the story. The MO is similar to classic Soviet information operations.

So I totally  believe. Totally.

Some other reasons to doubt. The Ukrainian operation in Slavyansk and the Donbass generally has been hesitant and ineffectual. Hardly what one would expect from a force stiffened by 400 mercs. Moreover, one supposed reason to deploy the Academi force was to disrupt the referendum in the region. But the referendum went on, virtually undisturbed.

And I repeat: “American mercenaries in Ukraine” is a major Russian propaganda theme.  Lavrov reiterated it only yesterday, in his long interview with Bloomberg. He did it in his characteristically oily way, saying that Russian questions about American mercenaries had not been answered. In fact, they have been, rather emphatically.  It’s just that Lavrov is not willing to acknowledge this, wanting to keep the story going.

Given the impossibility of proving the negative, the mercenary story cannot be disproved. But everything about the story undermines its plausibility, not least its all too convenient echoing of Russian propaganda.

No. This has every sign of being a speciality of Russian information operations: a laundered story, originating from Russian sources and then put through several spin cycles involving western publications, emerging clean enough to convince those who want to believe that the US is the malign actor in this drama.

It cannot be emphasized enough that information warfare has been a central part of Russian operations in Ukraine. It also cannot be emphasized enough that the Ukrainians, but also the Americans, have been woefully overmatched in this war.

And speaking of overmatched, there is no doubt that Lavrov overmatches Kerry, and ridiculously so. Although every word out of Lavrov’s mouth was more mendacious than the one that preceded it, he is a far more impressive figure than Kerry. Whereas Kerry comes off as a posing, bloviating, superficial grandstander (probably because he is  a posing, bloviating, superficial grandstander), Lavrov comes off as a formidable and focused foe, and one who speaks English impeccably. No wonder he pwns Kerry every time they meet in Geneva.

Or to put it another way: it’s no wonder Lavrov takes Kerry to the cleaners. Just like he launders agitprop like the US mercenaries in Ukraine story.