Streetwise Professor

Something of a kerfuffle has broken out over the issue of China’s economic angst. On one side is Adam Posen, who in a Foreign Affairs article attributes China’s current predicament to the reluctance of private firms to invest, which he in turn attributes to their fears that an authoritarian regime like Xi’s will not respect their property rights and may expropriate them. On the other side, Adam Tooze (on Substack) and Michael Pettis (on X or Twitter or whatever it identifies as these days) claim no, China’s problems are the consequences of fundamental structural imbalances dating back years, and rooted in pre-Xi economic policies.

All of them are right in parts, and wrong in parts. I assert my post of the other day synthesizes the right parts 😉

It’s perhaps convenient to boil things down thus:

• What mess does China find itself in?
• How did it get into this mess?
• What prospects does it have to get out of this mess?

Pettis and Tooze (and others, including me and not just the other day) attribute China’s current mess as the result of huge imbalances (over-investment, underconsumption) and secular demographic problems compounded by a very weak social safety net.

It got into this mess as the result of a development model and associated policies that heavily favored fixed investment (especially in infrastructure and housing financed by debt) and exports, and punished private consumption. The policies involved are myriad, but they can be summarized as central planning without complete government ownership. That is, the direction of even private enterprise was substantially guided by government policies that caused prices to encourage the types of economic activity that the government favored. The hand of the state was very visible indeed in China–something which fanboyz such as Thomas Friedman and too many western CEOs to count waxed rhapsodic about. (To which I should add the incentives faced by government employees at all levels who were rewarded for meeting certain aggregate growth targets that were most easily achieved by borrowing to make fixed investments–high powered incentives can be dangerous, my friends.).

But that model is played out, and was in fact always unsustainable: what’s amazing to me is how long they sustained it. But as Herb Stein said, if something can’t go on forever, it will stop. And that model couldn’t go on forever. It’s stopping time is about now. Hence China’s current distress.

So how to get out? The hydraulic economists who rely primarily on accounting identities (for all my admiration for Pettis’ diagnosis of structural imbalances, he fits that description to a large degree), the answer is: Correct the imbalances! Shift China from an investment focus to a consumption focus!

Well, how, exactly? And that’s where Posen’s critique of Xi-o-nomics–and mine–comes in. Achieving a new balance would require the CCP and the state to reduce their control over the economy. But the authoritarian Xi is hell-bent on increasing the Party’s–and his–control. For the reasons that Posen sets out, and many more besides, Xi’s kontrolle uber alles mentality is inimical to a fundamental structural shift in China’s economy, and especially a shift driven by private enterprise and private consumers, that is, a shift driven from below not from above. And below is the only place it can possibly come from.

So I would say that Pettis and Tooze prevail on the “how did China get into this mess?” issue, Posen on the “how does China get out of this mess (or not)?” issue, and all are largely in agreement in describing the just what the mess is.

The upshot of this synthesis is that China is shtupped. And the concern for those outside of China should be how a shtupped autocrat responds.

Evidence abounds that the Chinese economy is in the midst of a fundamental structural crisis. To which I respond: “It’s about time!”

I say this because I have written for over a decade that the Chinese development model is fundamentally flawed, and that signs of its distress have been emerging for years. My main surprise is that it has taken so long.

Signs abound of fundamental structural defects that cannot be addressed using the means that the CCP has used to extend and pretend for the past decade or so. The Chinese economy did not rebound robustly from the lockdown. Indeed, “flaccid” is a good descriptor of the economic performance in the last year. Despite reported growth estimates of 5 pct annually, it is virtually impossible to reconcile these official figures with more granular measures of economic performance (many of which are less subject to manipulation than top line growth numbers). For example, imports and exports have fallen–a troubling development for a trade-heavy economy.

Other indicators include widespread youth unemployment–especially among urban, educated young adults. A real estate collapse, with property development firms falling like dominoes and property turnover approaching zero. Accelerating debt-to-GDP ratios. Reduced marginal productivity of investment, as proxied by increasing debt per unit of GDP growth. Financial distress among local governments. This is another symptom of the real estate problem, as local revenues are significantly dependent on land sales. The local government troubles really represent a national fiscal crisis because local governments account for a disproportionate share of total government expenditure (and debt) in China. Banks are increasingly shaky due to a deterioration of the credit quality of their loan portfolios.

In the past China has responded to growth recessions with increased stimulus. But the government apparently increasingly realizes that the issues are structural, and that if anything increased stimulus will exacerbate rather than mitigate these problems.

Inside and outside China, there is a growing realization of the deep structural imbalances within China–something that has been obvious (and which I have written about for years) but which are now receiving attention. In particular, the investment intensity of Chinese economic activity, and the concomitant enervation of private consumption is the focus of most post-COVID analyses of the Chinese economy.

These diagnoses are fine as far as they go, but all too often those offering cures for the disease are slaves to economic aggregates and the hydraulic model of how economies work. Aggregate investment too high? Aggregate consumption too low? Well, just shut this valve and open that one and the economic shmoo will flow from investment to consumption. Problem solved! Easy peasy!

No, actually. The imbalances in the Chinese economy are the product of its very structure and most importantly its policy and political infrastructure. There are no valves to open or close, no dials to twiddle, that can alter these imbalances. Change would require a fundamental reordering of the entire Chinese system. Moreover, any fundamental adjustment in the allocation of resources would entail substantial adjustment costs, including the junking of much existing capital and widespread unemployment as people lose jobs in contracting sectors before they can find employment in new ones–not to mention that the human capital accumulated in the present structure is likely to be less than ideally suited for employment in the new consumer sector.

Low consumption and investment intensity are built into the existing system by design, and many of the problems that are metastasizing now are manifestations of this structure. The near absence of a social safety net encourages high savings and low consumption–a phenomenon that is deepened by the since discarded but still relevant One Child Policy that deprived the elderly of their traditional support, namely their children. Moreover, myriad policies have distorted relative prices to favor investment in infrastructure and state-owned enterprises (SOEs).

A salient example is “financial repression” which reduces returns to savings–and interest costs to borrowers, especially capital intensive industries, thereby channeling wealth to them. So what is a middle-aged Chinese person to do when he or she wants to save for old age, but can’t achieve high returns through traditional investments? Well, buy real estate for one–the massive overbuilding of apartments in China (illustrated by the many “ghost cities”) is emblematic of this malinvestment. The periodic proliferation of “wealth management” products offered by banks and other financial intermediaries desperate to secure funding for dodgy loan portfolios is another. I could go on.

These various policies are deeply embedded. They cannot be changed at a whim. And perhaps most crucially, they have created powerful political constituencies who are dependent upon their continuation: think of how many businesses (banks most notably) that would collapse during a fundamental rebalancing. And news flash: individual Chinese citizens/consumers are not a powerful political constituency.

Which brings us to the biggest bull in the China shop: supreme leader Xi Jinping. Xi is a devoted communist ideologue with a cult of personality. Basically Mao with a better haberdasher and hairline.

Xi’s overriding–not to say obsessive–ambition is extending, deepening, and strengthening the control of the CCP over every aspect of Chinese society. A fundamental reordering of the Chinese economy to correct the increasingly unsustainable structural imbalances would require massive decentralization, and a grant of considerable autonomy to Chinese individuals as consumers, investors, and entrepreneurs.

And that is an anathema to Xi.

Add to this Xi’s reading of the history of the Soviet Union. He–not wrongly–attributes the collapse of the USSR to Gorbachev’s attempt to loosen the grip of the state and the party over the economy. Xi is hell-bent on avoiding the same mistake. As a result he is consciously adopting an anti-Gorbachev strategy, and increasing centralization, and the power of the party over the economy. And since he has basically declared le Parti, c’est moi, increasing his power over the economy (not to mention virtually every other aspect of Chinese social life).

This foreshadows a fundamental conflict between economic and political realities. Xi’s political agenda will only exacerbate China’s current structural problems. His “solution” is a version-on-steroids of the source of the problems.

Unlike those who screech “OMG China’s slowdown will reduce world GDP growth,” in some respects (economic respects in particular) I don’t care much one way or the other: I don’t consume Chinese GDP growth (and especially not the official statistics on that growth), and the indirect effects on the US economy don’t trouble me that much.

The reason that I do care is the nexus between the Chinese economy and its foreign policy. I can see this cutting in at least a couple of ways.

On the one had, an economically hobbled and distracted China could turn inward and be more focused on foreign domestic issues than foreign adventurism and dreams of reordering the world to be subservient to Chinese domination and a desire to take revenge on centuries of alleged humiliation by foreigners.

On the other hand, intractable domestic problems can lead a personalist system–and China is clearly that now, in contrast to the more collectivist leadership of the post-Mao, pre-Xi era–to ramp up the foreign adventurism. This is particularly true when the personalist person is a seventy-something guy who wants to cement his place in history by, say, “liberating” Taiwan.

Prudence and an objective reading of Xi leads me to place greater weight on the latter possibility. Prudence, because it is the alternative that poses the greatest threat to the United States. Objective reading because of the Xi-as-anti-Gorbachev phenomenon discussed above. Gorbachev’s rapprochement to the United States was driven in large part by his recognition of the strategic and geopolitical ramifications of the USSR’s deep structural economic problems. A player of the Gorbachev Opposite Game–a fair characterization of Xi–would ramp up tension, rather than attempt to ameliorate it.

Xi is clearly ascendent in China now, but there are palimpsests that suggest discontent beneath the propaganda facade. What does an autocrat facing internal opposition do? He removes them. Note that the recently appointed Chinese foreign minister disappeared–and had much of the evidence of his existence erased: perhaps he’s exploring exciting new opportunities in organ donation! Further, commanders of the People Liberation Army’s strategic rocket forces were also recently replaced. Thus, these moves by Xi could be evidence of a dark star of opposition to Xi’s sun.

Intra-CCP politics were always highly factionalized. Xi has apparently triumphed over all of these factions. But short of Stalinist methods–which Xi has not employed–oppressed factions do not disappear, but take cover and can reemerge given the opportunity.

Alas, Chinese is the riddle, mystery, enigma on steroids–it puts even Russia in the shade in this regard. The United States, and the West generally, have very little insight on what is going on in China. Meaning that economic dislocation in a personalist system ruled by a Han exceptionalist, communism with Chinese characteristics autocrat creates extreme risks for the US and the rest of the non-Chinese world. But to compound the angst, the governing “elite” in the US and its allies is clearly not up to the challenge–and indeed may not even recognize its existence, and/or may be personally compromised in their ability to respond.

Meaning that economic tumult in the Middle Kingdom is fraught with risk for you and me. But China is where it is, and the tumult is inevitable.

There is considerable angst over the glacial pace of the Ukrainian counteroffensive. This angst is a product of unrealistic hopes and expectations derived from totally different circumstances.

The unrealistic expectations derived from the stunning success of the Ukrainians last year, around Kharkiv/Kharkov and Kherson. These successes were rooted in Russian errors. The Russians overextended themselves in their initial offensive in 2022, leaving open flanks and exhausted forces that made them extremely vulnerable to Ukrainian attacks. The Russian situation last summer was in many respects comparable to the Ukrainian situation in 2014, when they overextended themselves in pushing at separatist forces, leaving them open to a devastating attack by Russian forces.

(Both episodes remind me of a maxim my mother uttered during one of our many tours of Civil War battlefields (she was a saint to take me on so many): “Nobody ever won a battle, but some people sure lost one.”)

Circumstances are totally different now. The Russians had ample time to dig in extensively, and in particular, sow extensive minefields. It’s a totally different proposition attacking deep, heavily mined defenses than pouncing on the flanks of demoralized, exhausted troops in the open.

The Ukrainians, Zelensky in particular, have been damning the West vitriolically for failure to provide enough of, well, everything. Sorry, but “enough of everything” would really mean deployment of several American heavy divisions, and most importantly, a good chunk of the USAF. American doctrine for attacking prepared defenses involves an extended period of intense air attack to degrade them, followed by assaults by heavy divisions (i.e., divisions other than the 82nd and 101st, and 10th Mountain), supported by continued air attacks and massive artillery.

Not happening in Ukraine. Never was going to happen. Never will happen.

I am a Patton fan, but this quote from the movie is wildly incorrect:

Fixed fortifications, huh? Monuments to the stupidity of man. When mountain ranges and oceans could be overcome anything built by man can be overcome.

As Patton surely knew, history is replete of examples of the power of fixed fortifications. Ironically this statement was made about the fortifications at Metz, which stymied Patton for months. (And it is amusing that in the same film Patton gives a tour of the fortifications of Malta, and describes how the Knights of Malta used them to stop the Turks.)

Given these realities, the Ukrainians have adapted. They are gnawing through some of the minefields (at non-trivial cost), but are also executing WWI-like trench raids to attrit front line units and deep strikes with drones and Western-supplied weapons (notably HIMARS and StormShadow) to undermine Russian logistics.

This has some chance of succeeding–eventually. Chewing a wide enough gap may permit a breakout, with someplace like Tokmak playing the part of St. Lo. Russian reserves and operational mobility are likely inadequate to contain such a breakout–if it can be engineered. With “engineering” being the operative word, because making the gap that could be exploited is first and foremost a combat engineering task.

But nothing will happen quickly, if it happens at all.

In the meantime, both sides are acting like exhausted fighters in a no-holds brawl, with attacks on civilian and infrastructure targets being the equivalent of eye-gouging and ear-biting. The Russian attacks on Ukrainian grain-exporting capacity are the most prominent example of this.

(NB, especially to people like supposed commodities expert Javier Blas. The first thing that pops into the minds of most when attacks on Ukrainian grain-handling infrastructure is wheat. But Ukraine is a much bigger player in corn than wheat.)

And these attacks carry the risk of dramatically escalating the conflict. Today Russia extended its missile attacks westward from Odesa/Odessa to the banks of the Danube, and executed a strike that landed ~100 meters from Romanian territory. That is, Nato territory.

All this raises the question: what’s the point? And I don’t mean the point for Russia and Ukraine, or more particularly their governments. I mean for the interests of the United States.

A strong case can be made that the US has already achieved–courtesy of tens of thousands of Ukrainian lives and tens of billions of American dollars–about all of the conceivable strategic benefits of this war. Courtesy of Putin’s idiocy, Russian military capacity has been (a) dramatically reduced, and (b) shown to have been not that great in the first place. The threat to Europe posed by Russia (which (b) suggests was not that serious in the first place) has been neutered, at the cost of increasing the US’s vulnerability in a more vital theater–Asia. Good strategic thinking should not focus on making the rubble bounce, but should pocket gains in eastern Europe and focus on Asia.

So rather than acceding to Zelensky’s ever greater demands, the message to him should be: take half a loaf, and make a deal. For the sake of your people.

But that is not the attitude of America’s (and most of Europe’s) ruling class. They are monomaniacally focused not just on restoring pre-2014 borders, but crushing Putin and transforming the Russian state. As illustrated by this:

Vladimir Kara-Murza writes: There is only one outcome of this conflict that would be in the interests of the free world, of Ukraine and, ultimately, of the Russian people: resounding defeat for Putin, to be followed by political change in Russia and a Marshall Plan-type international assistance program both to rebuild Ukraine and to help post-Putin Russia build a functioning democracy so that it never again becomes a threat to its own people or its neighbors. That is the only way to make sure Europe can finally become whole, free and at peace — and stay that way.

Sounds great! How is that going to happen, exactly, Vlad baby? Especially the part about “build[ing] a functioning democracy so that it never again becomes a threat to its own people or its neighbors”?

This reminds me of a statement that I saw from China today, about how government policy makers promised to “optimize and adjust policies” in response to the real estate meltdown. Optimization is not a plan–it is an aspiration. Almost to a person the policy establishments in the US and Europe are hooked on a categorically, metaphysically unachievable aspiration and are willing to spend countless lives and dollars in the futile attempt to achieve it.

These people believe in fairy tales. Murderous fairy tales that cannot possibly come true.

In an ironic twist, a war in Europe (not Asia) is now “The wrong war, at the wrong place, at the wrong time, and with the wrong enemy.” (I’m not a big Omar Bradley fan, but he got that one right.) But our policy “elites”–of both parties–are hyper-focused on the wrong war. (Why that is is a story for another, and probably much longer post.)

War and geopolitics require cold-blooded calculations. The cold-blooded calculation for the United States is definitely not to dream of magically transforming a notoriously intractable and autocratic society into Switzerland with nukes. (The possession of nukes in itself making such a transformation wholly fantastical.) It is instead to push for an outcome that satisfies none of the combatants–and indeed infuriates them–and shift focus from eastward to westward. Don’t fight the last war. Prepare for the new one–in order to prevent it.

Saudi Arabia is fussed at the low level of oil prices. So true to form with those unsatisfied with price, they are rounding up the usual suspects. Or in this case, suspect–speculators!

I’m sure you never saw that coming, right?

As the world’s biggest oil producers gather here Sunday to decide on a production plan, the spotlight is on the cartel kingpin’s fixation on Wall Street short sellers. Abdulaziz has lashed out repeatedly this year against traders whose bets can cause prices to fall. Last week he warned them to “watch out,” which some analysts saw as an indication that the Organization of the Petroleum Exporting Countries and its allies may reduce output at their June 4 meeting. A production cut of up to 1 million barrels a day is on the table, delegates said Saturday. 

Claude Rains is beaming, somewhere.

I’m so old that I remember when oil prices were beginning their upward spiral in 2007-8 (peaking in early-July), in an attempt to deflect attention from OPEC and Saudi Arabia, one of Abdulaziz’s predecessors blamed the price rise on speculators too.

Is there anything they can’t do?

Not that I’m conceding that speculators systematically or routinely cause the price of anything to be “too high” or “too low,” but if you do think that they influence price, they should be Abdulaziz’s best buddies. After all, they are net long now and almost always are. (Cf. CFTC Commitment of Traders Reports.)

If the Saudis (and other OPEC+ members) have a beef with anybody, it is with their supposed ally, Russia. Russia had supposedly agreed to cut output in order to maintain prices, but strangely enough, there is no evidence of reductions in Russian supplies reaching the world market, even despite price caps on Russian oil and the fact that they are selling it at a steep discount to non-Russian oil. Perhaps Russia has really cut output, but (a) that doesn’t really boost the world oil price if Russian exports haven’t been cut, and (b) it would mean that Russian domestic consumption is down, which would contradict Moscow’s narrative that the economy is hunky-dory, and relatively unscathed by sanctions.

But I think that the more likely story is that Russia is playing Lucy and the football with OPEC.

Which would be a return to form: see my posts from years ago. And I mean years ago. Apparently Won’t Get Fooled Again isn’t on Abdulaziz’s play list.

The other culprit behind lower oil prices is China: its tepid recovery is weighing on all commodity prices–not just oil. A fact that Abdulaziz should be able to understand.

But it’s much easier to shoot the messenger, and that’s what speculators are now–and almost always are. Venting at them probably makes Abdulaziz feel better, but even if he were to get his way that wouldn’t change the fundamental situation a whit.

Bashing speculators is what people who don’t like the price do. And since there’s always someone who doesn’t like the price (consumers when it’s high, producers when it’s low) bashing speculators has been and will continue to be the longest running show in finance and markets.

The war in Ukraine has pointed out the fact that modern combatants consume massive amounts of munitions. This can only be a surprise to those with short memories, or the ignorant. Hell, Saddam had it figured out. He cached massive stores of shells. His problem was he didn’t have time to use them because the US went through his army like crap through a goose. Twice. But he left behind enough to keep American EODs working OT for months to blow it up . . . and to supply the explosives for numerous IEDs deployed by his “dead-enders” against the American forces occupying Iraq.

Awakened from their post-Cold War reveries by the shock of Russia’s invasion and Chinese truculence, American, European, and Asian politicians have recognized the desperate need to increase their munitions stocks, and to expand their surge capacity to produce in the event of war. That’s good: better late than never. But rather than make everything willy-nilly, to respond to this awareness it is imperative to prioritize munition types–and the weapons used to fire them. This requires an appraisal of strategic priorities and likelihoods.

Ukraine needs primarily artillery shells, 155mm mainly, and lots of them. That’s because it is engaged in a war of attrition on a relatively static front against an enemy that employs artillery en masse. But such ammunition should not be an American priority because such the United States will not fight such a war, short of a major strategic blunder.

The inability of Russia to defeat Ukraine means that the likelihood of a land conflict against that country is low. And regardless, if it does break out, the Europeans should be the one to fight it, and therefore should be looking to their own munition supplies.

China is the United States’ main likely adversary in a major war. But it is highly unlikely that the US would be facing off against China in a major ground war. It would be beyond idiocy for the US to charge into China. It would also be idiocy for the US to deploy major ground forces to Taiwan in the event of an invasion, and risk getting trapped like, say, the British on Crete in 1941.

The most likely theater of a major ground war involving the US would be Korea. However, South Korea has proved to be the least free riding of any American ally, and has built up a credible military and a military industrial base to back it up. (Poland is also pretty much a non-free rider. Funny how countries on a front line take security threats more seriously, isn’t it?) I think South Korea can–and should–take care of itself, especially on the ground, with the US chipping in with air and sea support

Since a strategically sensible US would be unlikely to engage in a shell eating contest a la Ukraine, what should its munitions strategy focus on?

Again, China is the main potential adversary, the one that poses the greatest threat to the US, and the one which has the greatest capability. In the event war breaks out with China, what should US strategy be? That strategy should dictate procurement priorities.

I’ve never been all that fussed by China’s Anti-Access/Area Denial (“AA/AD”) strategy, precisely because it would be strategically insane–and unnecessary–for the US to attempt to contest the area that China wishes to deny access to, namely the South China Sea. In the event of war, the proper US strategy would be to flip the board and implement an AA/AD strategy against China. Specifically, to deny it access to the region beyond its AA/AD zone. That is, don’t try to get in–keep them from getting out. Turn the fortress they believe they’ve constructed into a prison.

This is a strategy akin to classic British sea power strategies, dating back to the 18th century, which relied on blockades against Continental enemies, first France, then Germany. In the wars against the French culminating in the Napoleonic Wars, the blockades were often “close.” In WWI, the blockade was “far.”*

A “far” blockade would work for the US against China because China faces some of the same vulnerabilities as Wilhelmine Germany, namely, a dependence on raw material imports, most notably an inability to feed itself, and sea lines of communication that are very vulnerable to being severed by myriad means.

China is acutely aware of its dependence on food imports, especially animal feed inputs. The “iron rice bowl” is a thing of the past: as China has developed, so has its consumption of mean protein, and its people’s expectation of it. Xi has prioritized making China self-sufficient in food–a sure tell that he realizes the vulnerability. But this will take a long time under the most ideal circumstances, and is unlikely to occur in any event, especially given how China has ravaged its soil and waters in the past decades, and the disaster that generally results when autocrats attempt to force increased agricultural production.

Imposing and maintaining a blockade of China will require primarily submarines, aircraft, and surface vessels armed with long range precision munitions. And also mines. Lots of mines. Mines are a relatively cheap, low casualty risk, highly leveraged way of blockade and area denial. A large fraction of Japanese merchant shipping was sunk by mines laid by subs and aircraft in WWII. The mining of Haiphong in Vietnam was probably more decisive than the Operation Linebacker bombing campaign. Mining the waters around Chinese ports would have a devastating impact.

PGMs will also be vital in deterring any attempt by the Chinese People’s Liberation Army Navy’s (a name that cracks me up) to break out of a US (and Japan, and Australia, etc.) cordon sanitaire around the South China Sea–or destroying it if it tries. They will also be the primary means by which the United States can strike long-range Chinese weapons that pose a threat to the ships of the US and its allies, and the land bases (on Guam, in Japan and in the Philippines) on which they will rely.

The networking of sensors and platforms, and the deployment of offensive weapons on virtually every US Navy platform, will serve to make a US judo move of denying access to an access denier very effective–if it is backed with adequate means. This will require lots of long range, precision munitions to work–so ramping up their production, stocks, and production capacity of such weapons should be the priority.

But although networking platforms and the employment of precision weapons greatly leverages US capabilities to implement this strategy, the fundamental fact is that the US has too few platforms. The USN is now at a mere 297 hulls, and the current Biden budget proposal will shrink that to 291. The Navy has not submitted a shipbuilding proposal, and the brass are pushing to decommission 11 ships. Navy construction capacity is woefully inadequate. The capacity to build the fleet’s backbone–Burke class destroyers–is limited to 2 per year. The DDG(X) is still a pipe dream. The first Constellation class frigate has just been laid down. Most importantly, production of Virginia class submarines (the most potent threat to China, as their absolute freak out over the AUKUS nuke sub deal shows) is limited to two per year, and US submarine construction capacity will be challenged by the necessity of also building new Columbia class SSBNs to replace the aging Ohios.

So it is not just ammunition–it is platforms to fire it from. And on that score the United States is at best treading water, and may actually be slipping under.

Yes. Ukraine is a wake-up call–although one that should have been unnecessary. But just because the Ukrainians are suffering a WWI-esque shell shortage does not mean that the United States should prioritize artillery ammunition to fight a major land war. Adapting capability to likely adversaries and strategies dictates a focus on long range sea- and air-launched anti-ship and land attack weapons, and crucially the means to employ them. Which means more hulls and more airframes.

These take a long time to build. The time is now to start producing the weapons, and to expanding the capacity to produce the things that can deploy them. Right now we are unduly dependent on hoping the Lord looks kindly on our praise (if we would even give it today), because there just isn’t enough of the right kind of ammunition to pass to fight the most likely and most dangerous conflicts.

*This strategy cuts against the US grain. It frequently takes a long time to implement and take effect. In WWI it took 4 years for the British blockade to bring German to the brink of starvation. In the Civil War, the blockade was also extremely important, but also took years to affect the military situation. The strangulation of Japan by US submarines and mines was also decisive, but took a good two years to have a real impact.

In WWII Churchill wanted to employ the classic British strategy against Germany. This drove the Americans (not to mention Stalin) nuts: they wanted to charge onto the Continent ASAP. Strategic patience is not an American virtue. But it will be a necessity if the US does get involved in a shooting war with China. In such a war, time would be on the US’s side, precisely because what has made China powerful has also made it vulnerable.

The embarrassment of this administration is ballooning, as if one could have thought that possible as bloated as it was already. Apparently in a belief that “Trump did it!” is kryptonite to any criticism, some anonymous DoD person told reporters that Chinese balloons had transited continental United States airspace on at least three occasions when the Donald the Dreaded was POTUS.

Virtually everyone in Trump’s national security upper echelons–including people who hate him, like Bolton and Esper–immediately called BS. They all said they were never informed of this. So what are the possibilities?

First, it never happened and this is just somebody making shit up to clean up after Joe. Always a real possibility.

Second, it did happen, and the balloons were detected in real time, but the DoD decided to withhold this information from the commander in chief. That would be a scandal of major proportions. And sad to say, it is believable.

Third, the administration’s elaboration: the previous balloons weren’t detected in real time, but they were uncovered after the fact by the intelligence agencies through some undisclosed means. Although all of these explanations are disturbing in their own way, this would be the worst. It would imply a gaping hole existed in US detection technology. Although the administration claims that THIS TIME they detected the balloon as soon as it passed over the Aleutians, and this suggests that the vulnerability has been addressed, we can’t be sure whether it’s just that NORAD got lucky this time.

There must be a public investigation, by Congress, to determine which of these explanations is the correct one.

With regards to the first explanation. Why did the WaPo rely on a single source for a story like this? Why won’t the Pentagon reveal who made the statement to the reporter? Note that the story–if it was true–would have involved the leak of highly classified information: a crime. If it wasn’t true, a “senior” official is spreading–wait for it–disinformation, supposedly the greatest threat to “our democracy.” Either alternative is unacceptable, and should result in the investigation, termination, and perhaps prosecution of the perpetrator. And he should be identified immediately while these steps are proceeding.

Letting the balloon traipse from Alaska to South Carolina (apparently on a tour of US nuclear facilities) is bad enough for the reasons discussed in my earlier post. But this clumsy attempt to exonerate Biden through whataboutism (“whatabout Trump!!!”) makes things even worse. It reveals the US military and Department of Defense to be incompetent, mendacious, or both.

Biden didn’t say anything either at a shout or a whisper about the balloon in his State of the Union address. He obviously wants this to go away. It can not be allowed to go away. It is a national security embarrassment of the first order, and Austin, Milley, the head of NORAD, and the head(s) of the intelligence agency or agencies that allegedly discovered previous violations of US airspace ex post facto must be hauled in front of Congress for a public grilling.

And then, perhaps, keel hauled.

The carnival of the Chinese balloon transcontinental transit is bringing musical flashbacks, such as this from 1983:

Or going even further back–deep into my childhood:

Groovy, baby.

Seriously though, I am of mixed minds regarding the decision–the Pentagon’s according to Biden–to defer destroying it until it had traversed the US from sea to shining sea. On the one hand, I can perhaps see that there is intelligence value in observing it. On the other, it makes the United States look pathetic before a strutting China.

On balance, I believe the latter consideration substantially outweighs the former. The lame excuse given for not puncturing it with extreme prejudice earlier–that its fall would endanger people on the ground–belies an intelligence collection motive: if that was the reason, just say so! At least that sounds more boss:

And what are the odds of someone on the ground being hurt in Alaska, the Yukon, or even eastern Montana FFS?

And was the benefit to us of the intelligence we collected on the balloon greater than the value of the intelligence the balloon collected on us?

And perceptions are reality. It’s not like this is a new super weapon. Pretty sure we had figured out everything it was doing and capable of doing during the time it was flying over thousands of miles of trackless waste–if we didn’t already know before it breached US airspace over the Aleutians. But the image of a spy balloon flying with impunity over the fruited plain does convey the image of a “pitiful, helpless giant” (to quote Nixon, reading what the just-retired Patrick Buchanan wrote). This is especially true given that there is a pitiful, helpless mental midget holding the position of Commander in Chief.

This reinforces the image of fecklessness that hangs around this administration like a bad smell. And fecklessness encourages recklessness. That is, we have to think about how Xi interprets this, and believe me, he’s not going to believe “we were protecting people on the ground” line for one second.

He may laugh, though.

But after he’s done laughing, he’ll incorporate what he surely perceives as an image of weakness and indecision into his calculus regarding Taiwan and other points of potential conflict.

This raises the question of motive. After all, China has supposedly reined in its “wolf warriors” and was trying to present a more conciliatory face to the US, and the world. Blinken was supposed to meet with the Chinese to help reset relations. (Nod was to remain in the White House.)

One possibility is that this was a test–would the US still proceed with a rapprochement despite a provocation (humiliation, in fact)?

Another possibility–never to be dismissed in one party (but many faction) states–is that elements in the CCP (including, perhaps, aforesaid wolf warriors) wanted to derail any rapprochement, and figured that creating an incident like this was the way to achieve that objective.

Given the opacity of the CCP/Chinese government, it’s hard to say. But under either scenario, the return message should have been: don’t fuck with us. Instead, we sent the message that we are eminently fuckable.

For their part, the Chinese lost their shit when an F-22 FINALLY took down Chairman Xi’s Amazing Flying Machine.* To which we should have replied: fuck you and the balloon you rode in on, commies. Instead, we gave a mealy mouthed, diplomatic reply.

We are in a very fraught period with China. We are trying to recover from “locust years” (as Churchill called them) of military distraction and decay and recover at least a semblance of our former naval and air dominance over China. China is ruled by a megalomaniac with ambitions to crown his achievements by retaking Taiwan. The last thing do do under those circumstances is to convey weakness. And regardless of the true justification for allowing the balloon to traipse over American unhindered, that’s exactly what happened.

The phrase “the balloon went up” means that the situation is very serious. It dates from WWI, when the appearance of a reconnaissance balloon was a harbinger of an artillery barrage incoming. Well, the balloon went up, and to my mind, was brought down far too late.

*The F-22 took down the balloon with an AIM-9X Sidewinder. A testament to how sensitive the heat seeking infrared sensor on that weapon has become. In early versions of Sidewinder it was necessary to get right on the tail of an adversary for the guidance system to be able to pick up the heat signature of the engine. To be able to take down a balloon, which has far less of a heat signature than a MiG’s exhaust, is pretty impressive.

The F-22 pilots used the call signs Frank1 and Frank2, apparently an homage to WWI “Balloon Buster” ace Frank Luke (whom Eddie Rickenbacker called the best pilot in WWI). There is some irony here, though, because it is clear that the current Pentagon leadership is shall we say slightly less aggressive than Lt. Luke.

While working for an FCM in 1987 my main job was to assist S&L and mortgage banker clients manage their interest rate risk. Along with several colleagues I attended a banker’s conference in San Francisco where the firm had a booth and hosted a reception. One of the reception attendees was an S&L president, who happened to be a big bear of a man. During the cocktail chitchat somehow military backgrounds came up, and the S&L guy mentioned he had been a Marine in the Korean War. I asked him: “Were you at Chosin?” His eyes grew wide, and he threw his arms around me in an almost suffocating hug: he was surprised, and deeply grateful, that there was anyone my age who knew of that battle. For even then Korea was known as “the Forgotten War” (indeed Clay Blair’s book by that title came out in that very year).

He then started to talk about his experience. It was sobering listening. But it was evidently cathartic for him.

I write about this today because the epic Battle of the Chosin Reservoir began on 27 November 1950. On that day, the First Marine Division, along with a combat team of the 31st Infantry (US Army), were attacked by swarms of Chinese infantry who had infiltrated south of the Yalu River in the previous weeks. The Americans had moved far north into North Korea after the smashing US victory over the Norks at Inchon, and the subsequent routing of the North Korean Army. The US commander, Douglas MacArthur, had “victory disease”: he believed that the war was all but over, and promised his troops that they would be home by Christmas.

Giddy with success, MacArthur dismissed numerous intelligence reports of Chinese troops massing north of the Yalu, and infiltrating to the south of it. His soldiers and Marines around the Chosin Reservoir paid a huge price for his arrogant indifference when hordes of Chinese attacked in the dark on the night of the 27th, blowing horns and whistles, and beating gongs. The fighting was often at close range, and very often hand to hand.

The UN forces to the west were routed by the Chinese. Their “bugout” was probably the most humiliating experience in American military history. But the troops at Chosin grimly hung on.

The Marines and soldiers straddling the Chosin Reservoir in the east of NK barely withstood the assaults, outnumbered as they were by about 6-to-1. During the day the Chinese would melt into the forests to avoid US airpower, but at night, and for many nights, they resumed their attacks. For the Americans, it was a close run thing.

The Chinese had effectively surrounded the 1st Marines and 31st RCT, and attacked the division headquarters around Hagaru-ri. In the tradition of “every Marine a rifleman,” division commander O.P. Smith armed engineers, cooks, and clerks (“titless WACs,” in the slang of the time) and sent them to the hills overlooking Hagaru-ri to beat off the Chinese attacks. It was a close run thing, but they did.

American airpower was probably the difference. Navy and Marine F4U Corsairs and AD1 Skyraiders provided close air support, napalming, strafing, and rocketing the Chinese whenever the weather allowed.

Smith realized he could not hold out forever, and had to withdraw to the coast. Hence began an anabasis in a different direction, with the Marines and the few soldiers who survived beginning an epic march from the reservoir to Hangnam. An “anabasis” is a march from the coast to the interior, and the Americans did the reverse. Apropos this, when asked about how he felt about retreating, Smith said: “Retreat hell. We’re just attacking in a different direction.”

And indeed they were. Surrounded, they had to fight their way out against a Chinese enemy bent on their utter destruction. Every mile was contested, although as a result of exhaustion and casualties the Chinese resistance ebbed as the Americans trudged south.

But the Chinese were not the American’s only enemy: the weather was too. It was bitter cold, allegedly reaching -50F when the Americans consolidated for a few days around Kot’o-ri. Even when it wasn’t that cold, it was damned cold, with periodic blizzard conditions. So cold that wounds typically froze, which sometimes saved lives.

Even though enemy resistance had devolved mainly to sniping and ambushing, rather than screaming human wave assaults, the survival of the retreating Americans remained in doubt because the Chinese had blown a bridge at Funchilin Pass. Miraculously, Air Force C-119 “Flying Boxcar” transport aircraft dropped pieces of an M-2 “Treadway” mobile bridge which the Marine and Army engineers painstakingly assembled in the brutal weather to permit the breakout to continue. It took two days for the entire column to pass the chokepoint, but they all did.

Soon afterwards, the Americans descended into the plain near the coast where they took off their coats to bask in the 32F warmth. They arrived to the safety of UN lines around Hangnam exactly 2 weeks after their ordeal had begun.

About 30,000 Americans, British, and South Koreans were involved in the battle. 18,000 were casualties, including around 2,500 dead, 5,000 wounded, 5,000 missing (disproportionately among the 31st RCT) and 7,400 non-battle casualties, mainly from frostbite. Chinese losses are unknown, but are widely estimated to number around 60,000–including Mao’s eldest son. Several Chinese corps were effectively destroyed.

The Americans brought off most of their wounded (although many wounded from the 31st RCT became POWs), and many of their dead, following the tradition of the United States Marines.

The survivors of the attack in the other direction were evacuated by sea–along with more than 10,000 North Korean refugees. Thus ended one of the most amazing feats in American military history, a true seizing of a sort of victory from the jaws of devastating defeat.

Those who survived were known as the Chosin Few. Almost all are gone now–the youngest would be around 90. I was fortunate to have met, albeit briefly, one of them. He was gratified by my remembering what he and what his comrades suffered, and what they achieved, and I write this to do what I can to keep that memory alive even though almost all of them have passed.

Semper Fi.

While writing the post on European electricity prices, I was wondering about the drivers. How much due to fuel prices? How much due to capacity constraints? Risk premia?

Spreads, specifically spark and dark spreads, are the best way to assess these issues. Spark spreads are the difference between the price of electricity and the cost of natural gas necessary to generate it. And no, dark spreads are not the odds that Europe will shiver in the dark this winter–though I’m sure that you can find a bookie that will quote that for you!: a dark spread is the difference between the price of power and the cost of coal required to generate it. In essence, spark and dark spreads tell you the gross margin of generators, and the value of generation capacity. High spreads indicate that capacity is highly utilized: low spreads that capacity constraints are not a maor issue.

Sparks and darks depend on the efficiency of generators, which can vary. Efficiency is measured by a “heat rate” which is the number of mmBTU necessary to generate a MWh of electricity. Efficiency can be converted into a percentage by dividing the BTU content of electricity (3,412,000).

Electricity is a highly “spatial” commodity, with variations across geographic locations due to the geographic distribution of generation and load, and the transmission system (and the potential for constraints thereon). Moreover, since electricity cannot be stored economically (although hydro does provide an element of storability) forward prices for delivery of power at different dates can differ dramatically.

Looking at sparks and darks in Europe reveals some very interesting patterns. For example, comparing the UK with Germany reveals that German day ahead “clean” sparks (which also adjust for carbon costs) are negative for relatively low efficiency (~45 percent) units, and modestly positive (~€35) for higher efficiency (~50 percent) generators. In contrast, UK day ahead sparks are much higher–around €200.

Another example of “identify the bottleneck.” The driver of high spot power prices in Germany is not limitations on generating capacity–it is the high fuel prices. (Presumably the lower efficiency units are offline in Germany now, as their gross margin is negative.) Conversely, generation capacity limits are evidently much more binding in the UK.

But if you look at forward prices, the story is different. Quarter ahead clean sparks in Germany are around €200, while in the UK they are over €300. Two quarter ahead (the depth of winter) are almost €600 in Germany and a mere €300 or so in the UK. (All figures for 50 percent efficiency units).

These suggests that capacity will be an issue in both countries, but especially Germany. Way to go, Germany! Relying on solar in a country with long nights ain’t looking so good, is it?

The wide sparks also undermine attempts to blame it all on Putin. Yes, high gas prices/gas scarcity courtesy of Vova is contributing to high power prices, but that’s not the entire story. Though to be fair, more gas generating capacity wouldn’t help that much if they become energy limited resources due to a lack of Russian gas.

The high forward prices may also reflect a high risk premium. My academic work from the 2000s showed that there is an “upward bias” in electricity forward prices. That is, forward prices are above–and often substantially above–expected future spot prices. My interpretation was that this reflects “spikeaphobia”: power prices can spike up, but they are supported by a floor. This means that being caught short is much riskier than being long. This creates an imbalance between long hedging (to protect against price spikes) and short hedging (to protect against price declines that are likely to be far smaller than upward spikes). This creates “hedging pressure” on the long side: if speculative capital to absorb this imbalance is constrained, this hedging pressure drives up forward prices relative to expected spot prices.

The imbalance is likely exacerbated by the fact that there are large fuel price spike risks too. Moreover, the price and liquidity risks that speculators absorbing the imbalances must shoulder is likely raising the cost of speculative capital in electricity trading, meaning that there is both a demand pull and cost push driving the risk premium. Thus, I conjecture that some portion–perhaps a hefty portion–of the large spark spreads for German and the UK is risk premium. (Back in the days I started to estimate the risk premium in the US markets in the late-90s, the risk premium was as much as 50 percent of the forward price. That decline substantially over the next decade to about 10 percent for summer peak as the electricity markets became more “financialized.” Financialization, by the way, is usually a pejorative, which drives me nuts. Financialization typically reduces the cost of hedging.).

In the aftermath of the mooting of EU proposals to intervene massively in electricity markets, especially through price controls, forward power prices have plummeted: the above figures are from before the collapse. Price controls would impact both the expected spot price and the risk premium–because they take the spikes out of the price. However, as I noted in my prior post, this is not good news: if prices cannot clear the market, rationing will.

Dark sparks also tell a fascinating story. They are HUGE. The German dark spark for 2 quarters ahead (Jan-Mar) is over €1000, and the UK dark spread is over €600. In other words, it’s good to own a coal plant! By the way, these are clean darks, so they take into account the cost of carbon. Meaning that the market is sending a signal that the value of coal generation–even taking into account carbon–is very high. This no doubt explains why despite massive green and renewable rhetoric in China, the Chinese are building coal capacity hand over fist. It also points out the insanity of European policies to eliminate coal generation. Even if you believe in the dangers of carbon, the way to deal with that is to price it, rather than to dictate generation technology.

To give some perspective, the above figures imply that a 500MW coal plant in Germany was anticipated to produce €870 million in value in 23Q3 (24 hours/day x .80 operating rate x 91 days/quarter x 500 MW x €1000/MW). That’s more than the cost of a plant. Even if you cut that in half to take into account today’s power price collapse, it’s a huge number.

Think about that for a minute.

In sum, spreads tell fascinating stories about what is happening in the European electricity market, and in particular the roles of input prices and capacity constraints and risk premia in driving the historically high prices. But perhaps the most fascinating story they tell is the high price that Europe is paying to kill coal.

The “Inflation Reduction Act” became Joe Biden’s climate and health care bill.

The narrative pivots are truly amazing to watch.

The deeper you dig into the details, the worse it looks. The supersizing of the IRS is one example. And if you believe that the massive expansion in “enforcement” (representing fully half of the $87 billion in increased expenditure) won’t be directed at schlubs like you, well, you’re a schlub and a sucker. The IRS, like federal law enforcement generally, goes after the easy targets. The people without the resources to defend themselves. And given the rampant politicization of all federal bureaucracies with any enforcement powers, if you are an easy and leveraged target. Get some money, damage the deplorables.

As to the climate aspect, it is a massive boondoggle of subsidies of inefficient technologies. We are constantly told (just read Bloomberg, if you can stomach it) that renewables are becoming so so so efficient. OK. Then why do they need massive subsidies to displace putatively inefficient fossil fuels?

And is there any evidence that our Solons have contemplated the systemic impacts of their intervention? In particular, how encouraging electrification generally, and the supply of electricity with renewables, will affect the reliability and indeed the stability of the grid? Of energy supply generally?

Or as another example, have they thought a nanosecond about the environmental and geopolitical consequences of this intervention into the extremely complex energy supply system? I’ve gone on at length before about the environmentally destructive effects of allegedly “green” policies. In a nutshell: mining ain’t green.

I’ve also discussed the geopolitical aspects, specifically the inevitable conflict over mineral resources vital for batteries and electrification generally. This conflict will be with China in particular, and will occur primarily in Africa and South America.

When I originally raised this issue, I received a lot of pushback. Whatever. Just watch. The Scramble for Africa Part Deux is already underway (with Russia as well as China contending with the US).

This benign summary of US policy towards Sub-Saharan Africa conceals more than it reveals. It acknowledges that Africa has 30 percent of the “critical minerals that power our modern world.” It says “[t]he United States will assist African countries to more transparently [sic] leverage their natural resources, including energy resources and critical minerals, for sustainable development while helping to strengthen supply chains that are diverse, open, and predictable.”

Just how is that supposed to work, exactly, in competition with the Chinese (and Russians) who are all about “assisting” rather non-transparently (through bribery and force) African nations exploit their natural resources in ways that are anything but “sustainable,” “diverse,” or “open”? (They are altogether predictable though.)

The logic is inexorable. Western nations hell-bent on the “energy transition” will increase dramatically the demand for resources in poorly governed or ungoverned regions of the world. Given that property rights in these regions are weak (and often non-existent) the competition will not be mediated through markets, but through force and fraud.

Meaning that the unintended–but inevitable–consequence of the compelled transformation of energy supply will be conflict in wretchedly poor areas that will make 19th century British and French struggles in Africa look like child’s play.

Put differently, virtue signaling policies in the West will create massive rents in countries with weak institutions that are especially prone to the most vicious forms of rent seeking. That will work out swell!

Case in point: the looming battle in the Lithium Triangle:

Similar setbacks are occurring around the so-called Lithium Triangle, which overlaps parts of Chile, Bolivia and Argentina. Production has suffered at the hands of leftist governments angling for greater control over the mineral and a bigger share of profits, as well as from environmental concerns and greater activism by local Andean communities who fear being left out while outsiders get rich.

And it’s not just lithium. It’s copper too. And rare earths, and nickel, and on and on.

In other words, we are about to witness the “resource curse” on meth. Massive rent seeking struggles in weak polities, all due to the whims of western elites in the thrall of a theory–and divorced from reality.

And for what? Even if the theory is correct, the impact of things like the “Inflation Reduction Act” on global climate will be virtually immeasurable, in the 100ths of a degree F at most, and perhaps in the 10000s of a degree.

In other words, the intended consequences of this act, and others like it, will be virtually nonexistent, while the unintended consequences will be dire. “Died of a theory” will be literally true–especially for those unfortunate enough to be living atop the resources the demand for which will be stimulated greatly by western elites mesmerized by that theory.