Streetwise Professor

September 20, 2019

Back to the Fed Future, or You Had One Job

In the Gilded Age, American financial crises (“panics,” in the lexicon of the day) tended to occur in the fall. Agriculture played a predominant role in the economy, and marketing of the new crop in the fall led to a spike in the demand for cash and credit. In that era, however, the supply of cash and credit was not particularly elastic, and these demand spikes sometimes turned into panics when supply did not (or could not) respond accordingly.

The entire point of the Fed, which was created in the aftermath of one of these fall panics (the Panic of 1907, which occurred in October), was to make currency supply more elastic and thereby reduce the potential for panics. In essence, the Fed had one job: lender of last resort to ensure a match of supply and demand for currency/credit, when the latter was quite volatile.

This week’s repospasm is redolent of those bygone days. Now, the spikes in demand for liquidity are not driven by the crop cycle, but by the tax and corporate reporting cycles. But they recur, and several have occurred in the autumn, or on the cusp thereof (this being the last week of summer).

One of my mantras in teaching about commodities is that spreads price bottlenecks. Bottlenecks can occur in the financial markets too. The periodic spikes in repo rates–not just this week, but in December, and March–relative to other short term rates scream “bottleneck.” Many candidates have been offered, but regardless of the ultimate source of the clog in the plumbing, the evidence from the repo market is that there are indeed clogs, and they recur periodically.

The Fed’s rather belated and stumbling response suggests that it is not fully prepared to respond to these bottlenecks, despite the fact that their regularity suggests that the clogs are chronic. As the saying goes, “you had one job . . . ” and the Fed fell down on this one.

And maybe the problem is that the Fed no longer just has one job, and it has shunted the job that was the reason for its creation to the back of the priority list. Nowadays, the Fed has statutory obligations to control employment and inflation, and views its main job as managing aggregate demand, rather than tending to the financial system’s plumbing.

This is concerning, as dislocations in short-term funding markets can destabilize the system. These markets are systemically important, and failure to ensure their smooth operation can result in crises–panics–that undermine the ability of the Fed to perform its prioritized macroeconomic management task.

One of the salutary developments post-crisis has been the reduced reliance of banks and investment banks on flighty short-term funding. The repo markets are far smaller than they were pre-2008, and the unsecured interbank market has all but disappeared (representing only about .3 percent of bank assets, as compared to around 6 percent in 2006). But this is not to say that these markets are unimportant, or that bottlenecks in these markets cannot have systemic consequences. For the want of a nail . . . .

Moreover, the post-crisis restructuring of the financial system and financial regulation has created new potential sources of liquidity shocks, namely a supersizing of potential demands for liquidity to pay variation margin. When you have a market shock (e.g., the oil price shock) occurring simultaneously with the other sources of increased demand for liquidity, the bottlenecks can have very perverse consequences. We should be thankful that the shock wasn’t a Big One, like October, 1987.

Hopefully this week’s tumult will rejuvenate the Fed’s focus on mitigating bottlenecks in funding markets. Maybe the Fed doesn’t have just one job now, but this is an important job and is one that it should be able to do in a fairly routine fashion. After all, that job is what it was created to perform. So perform it.

September 17, 2019

Funding Market Tremors: Today May Not Have Been “The Big One,” But It Was Bad Enough

The primary reason for my deep skepticism about the wisdom of clearing mandates was liquidity risk. As I said repeatedly, in order to reduce counterparty risk, clearing necessarily increased liquidity risk through the variation margining mechanism. Further, it was–and is–my opinion that liquidity risk is a far graver systemic concern that counterparty risk.

A major liquidity event has occurred in the last couple of days: rates in the repurchase market–the major source of short term funding for vast amounts of trading activity–shot up to levels (around 5 percent) nearly double the Fed’s target ceiling for that rate. Some trades took place at far higher rates than that (e.g., 9.25 percent).

Market participants have advanced several explanations, including big cash demands due to corporate tax payments coming due. Izabella Kaminska at FTAlphavile offered this provocative alternative, which resonates with my clearing story: the large price movements in oil and fixed income markets in the aftermath of the attack on the Saudi resulted in large margin calls in futures and cleared OTC markets that increased stresses on the funding markets.

To which one might say: I sure as hell hope that’s not it, because although there was a lot of price action yesterday, it wasn’t The Big One. (The fact that Fred Sanford’s palpitations occurred because he couldn’t get his hands on cash makes that bit particularly apropos!)

I did some quick back-of-the-envelope calculations. WTI and Brent variation margin flows (futures and options) were on the order of $35 billion. Treasuries on CME maybe $10 billion. S&P futures, about $1 billion. About $2 billion on Eurodollar futures.

The Eurodollar numbers can help give a rough idea of margin flows on cleared interest rate swaps. Eurodollar futures open interest is about $12 trillion. Cleared OTC notional volume (not just USD, but all IRS) is around $80 trillion. But $1mm in notional of a 5 year swap is equivalent to 20 Eurodollar futures with notional amount of $20 trillion. So, as a rough estimate, variation margin flows in the cleared IRS market are on the order of 100x for Eurodollars. That represents a non-trivial $200 billion.

Yes, there are potentials for offsets, so these numbers are not additive. For example, a firm might have offsetting positions in EDF and cleared IRS. Or be short oil and long Treasuries. But variation margin flows on the order of $300 billion are not unrealistic. And since market moves were relatively large yesterday, that represents an increment over the typical day.

So we are talking real money, which could certainly contribute to an increased demand for liquidity. But again, yesterday was not remotely a truly epic day that one could readily imagine happening.

A couple of points deserve emphasis. The first is that perhaps it was coincidence or bad luck, but the big variation margin flows coincided with other sources of increased demand for liquidity. But hey, stuff happens, and sometimes stuff happens all at once. The system has to be able to withstand such simultaneous stuff.

The second is related, and very concerning. The spikes in rates observed periodically in the repo market (not just here, but notoriously in China) suggest that this market can go non-linear. Thus, even if the increased funding needs caused by the post Abqaiq fallout wasn’t The Big One, in a non-linear market, even modest increases in funding needs can have huge impacts on funding costs.

This highlights another concern: inter-market feedback. A shock in one market (e.g., crude) puts stress on the funding market that leads to spikes in repo rates. But these spikes can feedback into prices in other markets. For example, if the inability to fund positions causes fire sales that cause big price moves that cause big variation margin flows which put further stress on the funding markets.

Yeah. This is what I was talking about.

Today’s events nicely illustrate another concern I raised years ago. Clearing/margining make markets more tightly coupled: the need to meet margin calls within hours increases the potential stress on the funding markets. As I tell my classes, unlike in the pre-Frankendodd days, there is no “fuck you” option when your counterparty calls for margin. You don’t pay, you are in default.

This tight coupling makes the market more vulnerable to operational failings. On Black Monday, 1987, for example, the FedWire went down a couple of times and this contributed to the chaos and the potential for catastrophic failure.

And guess what? There was a (Fed-related!) operational problem today. The NY Fed announced that it would hold a repo operation to supply $75 billion of liquidity . . . then had to cancel it due to “technical difficulties.”

I hate it when that happens! But that’s exactly the point: It happens. And the corollary is: when it happens, it happens at the worst time.

The WSJ article also contains other sobering information. Specifically, post-crisis regulatory “reforms” have made the funding markets more rigid/less-flexible and supple. This would tend to exacerbate non-linearities in the market.

We’re from the government and we’re here to help you! The law of unintended (but predictable) consequences strikes again.

Hopefully things will normalize quickly. But the events of the last two days should be a serious wake-up call. The funding markets going non-linear is the biggest systemic risk. By far. And to the extent that regulatory changes–such as mandated clearing–have increased the potential for demand surges in those markets, and have reduced the ability of those markets to respond to those surges, in their attempt to reduce systemic risks, they have increased them.

I have often been asked what would cause the next financial crisis. My answer has always been: the regulations intended to prevent a recurrence of the last one. Today may be a case in point.

September 14, 2019

Bakkt in the (Crypto) Saddle

ICE is on the verge of launching Bitcoin futures. The official start date is 23 September.

The ICE contract is distinctive in a couple of ways.

First, it is a delivery settled contract. Indeed, this feature is what made the ICE product so long in coming. The exchange had to set up a depository, the Bakkt Warehouse. This required careful infrastructure design and jumping through regulatory hoops to establish the Bakkt Trust Company, and get approval from the NY Department of Financial Services.

Second, the structure of the contracts offered is similar to that of the London Metal Exchange. There are daily contracts extending 70 days into the future, as well as more conventional monthly contracts. (LME offers daily contracts going out three months, then 3-, 15-, and 27-month contracts). The daily contracts settle two days after expiration, again similar to LME.

The whole initiative is quite fascinating, as it represents a dual competitive strategy: Bakkt is simultaneously competing in the futures space (against CME in particular), and against spot crypto exchanges.

What are its prospects? I would have to say that Bakkt is a better mousetrap.

It certainly offers many advantages as a spot platform over the plethora of existing Bitcoin/crypto exchanges. These advantages include ICE’s reputation, the creation of a warehouse with substantial capital backing, and regulatory protections. Here is a case in which regulation can be a feature, not a bug.

Furthermore, for decades–over a quarter-century, in fact–I have argued that physical delivery is a far superior mechanism for price discovery and ensuring convergence than cash settlement. The myriad issues that were uncovered in natural gas when rocks were overturned in the post-Enron era, the chronic controversies over Platts windows, and the IBORs have demonstrated the frailty, and vulnerability to manipulation of cash settlement mechanisms.

Crypto is somewhat different–or at least, has the potential to be–because the CME’s cash settlement mechanism is based off prices determined on several BTC exchanges, in much the same way as the S&P500 settlement mechanism is based on prices determined at centralized auction markets.

But the crypto exchanges are not the NYSE or Nasdaq. They are a rather dodgy lot, and there is some evidence of manipulation and inflated volumes on these exchanges.

It’s also something of a puzzle that so many crypto exchanges survive. The centripetal forces of liquidity tend to cause trading in a particular instrument to gravitate to a single platform. The fact that this hasn’t happened in crypto is anomalous, and suggests that normal economic forces are not operating in this market. This raises some concerns.

Bakkt potentially represents a double-barrel threat to CME. Not only is it competing in futures, if it attracts a considerable amount of spot trading activity (due to a superior trading, clearing, settlement and custodial platform, reputational capital, and regulatory safeguards) this will undermine the reliability of CME’s cash settlement mechanism by attracting volume away from the markets CME uses to determine final settlement prices. This could make these market prices less reliable, and more subject to manipulation. Indeed, some–and maybe all–of these exchanges could disappear if ICE’s cash market dominates. CME would be up a creek then.

That said, one of the lessons of inter-exchange competition is that the best mousetrap doesn’t always win. In particular, CME has already established liquidity in the futures market, and as even as formidable competitor as Eurex found out in Treasuries in the early-oughties, it is difficult to induce a shift of liquidity to a competitor.

There are differences between crypto and other more traditional financial products (cash and derivatives) that may make that liquidity-based first mover advantage less decisive. For one thing, as I noted earlier, heretofore cash crypto has proved an exception to the winner-takes-all rule. Maybe the same will hold true for crypto futures: since I don’t understand why cash has been an exception to the rule, I’d be reluctant to say that futures won’t be (although CBOE’s exit suggests it might). For another, the complementarity between cash and futures in this case (which ICE is cleverly exploiting in its LME-like contract structure) could prove decisive. If ICE can get traction in the fragmented cash market, that would bode well for its prospects in futures.

Entry into a derivatives or cash market in competition with an incumbent is always a highly leveraged bet. Odds are that you fail, but if you win it can prove enormously lucrative. That’s essentially the bet that ICE is taking in BTC.

The ICE/Bakkt initiative will prove to be a fascinating case study in inter-exchange competition. Crypto is sufficiently distinctive, and the double-barrel ICE initiative sufficiently innovative, that the traditional betting form (go with the incumbent) could well fail. I will watch with interest.

August 27, 2019

“HE’S FULL OF SHIT”: You Read It Here First

Filed under: Climate Change,Economics,Tesla — cpirrong @ 5:50 pm

Three guesses as to who “he” is. First two don’t count.

Vanity Fair has a long article, with a title starting with the quote in the title of this post, showing that Elon Musk’s solar roof in particular, and its solar business in general, is a fraud. The article also shows that Elon engineered Tesla’s purchase of Solar City to prevent it from going belly up, and thereby torpedoing Elon’s reputation as a genius.

Which is exactly what I said on the very day the deal was announced three years ago.

I’ve been calling BS on Elon since May, 2013. Nice to see people are finally catching up.

August 20, 2019

The 1619 Project: An Idiotic–and Evil–Monocausal Theory of Everything

Filed under: Economics,History,Politics — cpirrong @ 7:45 pm

Over the weekend, the New York Times released its “1619 Project” amidst great fanfare. The organizing theme of the essays is that America’s true founding dates to the arrival of the first African slaves to Virginia in 1619, and that everything–and I mean everything–in the United States today not only reflects the legacy of slavery, but is tainted, warped, and twisted by it. America is evil because it was founded in the original sin of slavery, and nothing that has transpired since can remove that sin.

When reading these pieces, at great risk to my mental health (what I don’t do for you!), the famous 1741 sermon by Puritan preacher Oliver Edwards came to mind:

The God that holds you over the pit of hell, much as one holds a spider or some loathsome insect over the fire, abhors you, and is dreadfully provoked. His wrath towards you burns like fire; he looks upon you as worthy of nothing else but to be cast into the fire. He is of purer eyes than to bear you in his sight; you are ten thousand times as abominable in his eyes as the most hateful, venomous serpent is in ours. 

You have offended him infinitely more than ever a stubborn rebel did his prince, and yet it is nothing but his hand that holds you from falling into the fire every moment. It is to be ascribed to nothing else that you did not got to hell the last night; that you were suffered to awake again in this world, after you closed your eyes to sleep. And there is no other reason to be given why you have not dropped into hell since you arose in the morning, but that God’s hand has held you up. There is no other reason to be given why you have not gone to hell since you have sat here in the house of God provoking his pure eye by your sinful, wicked manner of attending his solemn worship. Yea, there is nothing else that is to be given as a reason why you do not this very moment drop down into hell. 

In place of God, just insert “the New York Times” or The Woke, and you will understand the contempt in which they hold you. In their eyes you are forever tainted by the original sin of slavery, and predestined (except for an elect) to burn in hell for eternity. And there’s nothing you can do about it.

Make America Great Again? Not only was it never great, it was–and is–irretrievably damned.

Enemy of the people? Well, I can say they are enemy of me, and probably enemy of you too.

As for the exposition in the articles themselves, I can best characterize them as farrago of fallacies, logical and historical. The unifying principle of the essays is something akin to “Six Degrees From Kevin Bacon”: Six Degrees From Slavery, if you will. Pick any aspect of American life–any single one, I dare you–and the 1619 authors tie it to slavery.

It’s actually worse than that. Rather than just pointing out (strained) parallels, they attribute causation: slavery caused everything bad in American life. And since America is pretty bad, it pretty much caused everything.

Monocausal theories are the province of cranks and idiots, and this collection of applications of the monocausal theory du jour is no exception. Take the most simplistic, tendentious class-warfare-is-everything Marxist, and he would appear to be a sophisticated and subtle thinker compared to this lot.

I’ll just take a few examples. I’ll focus on the essay by Princeton sociologist Matthew Desmond, titled “In order to understand the brutality of American capitalism, you have to start on the plantation.” I focus on this primarily because it is allegedly about economics, but also because Dr. Desmond is whiter than chalk on Wonder Bread, so by hammering on him I immunize myself to some degree from the cheap-shot ad hominem “you’re a racist!” substitute for argument. Though I’m sure I’ll get that, nonetheless. (For the record–go ahead, IDGAF.)

Dr. Desmond gives himself away with the title, no? “Brutality of American capitalism.” Nope, no preconceptions there. He’s not writing from an extreme leftist perspective, nosiree.

And Desmond picks up speed from there, quoting Martin Shkreli as if he is some exemplar of American capitalism. (If so, Matty, why is Marty in jail?)

Desmond attempts to bolster his case by contrasting some meaningless statistics for the US and other countries. So for example, according to the OECD the US is far worse than say, Brazil or Mexico at regulating temporary work.

How many Americans are swimming to get to Brazil or Mexico, Dr. Desmond? The concept of “revealed preference” mean anything to you?

Also, Brazil had slavery–for over two decades longer than the US in fact. How come that didn’t prevent it from adopting such “progressive” labor laws?

Desmond emphasizes that the US comes out far behind Iceland in terms of unionization, which is supposedly a much more humane economy. At the risk of spoiling later surprises, is Desmond aware that the Vikings were notorious slavers? That some of the Icelandic population descends from slaves (seized from Ireland, mainly)?

So how come the Vikings weren’t forever tainted by their original sin of slavery?

Along these lines, I should note that the Danes, whom I am sure Dr. Desmond considers far superior to Americans, with a far more humane economic system (just ask Bernie Sanders), participated in the Transatlantic slave trade from 1671 to 1803, and that brutal plantation slavery existed in the Danish West Indies until the mid-19th century. Why didn’t a brutal Danish capitalism grow out of brutal Danish plantations?

Insofar as unionization is concerned, it is well-known that union representation in the US has declined inexorably since reaching a peak of around 33 percent (with relatively few in public sector unions) in the 1950s (to around 13 percent today, with public sector unions representing about half of union members in 2018). So did slavery vault over the 1940s-1950s, do a Simone Biles-esque triple double, and land in the 2000s? (Similar observations can be made about other supposed “legacies of slavery,” such as high rates of black out-of-wedlock births and low rates of marriage, which were comparable to whites’ prior to the 1960s.)

The bulk of Desmond’s screed consists of just-so stories showing that pathologies and misfortunes of modern American life trace back directly to slavery. My favorite–mortgages and financial crisis. You see, slaves were collateral in mortgages extended by greedy New York bankers. There was a credit boom in the South in the 1820s and 1830s, fueled in large part by mortgages with human collateral. The boom collapsed with the Panic of 1837.

Just like 2008!–only replacing “slaves” with “houses.” Per Desmond: “C.D.O.s were the grandchildren of mortgage-backed securities based on the inflated value of enslaved people sold in the 1820s and 1830s. Each product created massive fortunes for the few before blowing up the economy.”

As if there have not been other financial crises in other countries with totally different histories that have resulted from a collapse of credit. Indeed, this a hardy perennial of financial history.

Which can bring us back to Desmond’s beloved Iceland, which had a debt-fueled financial crisis that was arguably the worst in the word in 2008. Remember the joke from that year?: “What’s the capital of Iceland? Oh, about twenty bucks.”

Just how the hell does Iceland’s implosion have anything to do with American chattel slavery? And if it doesn’t, how can Desmond claims some sort of necessary causal link between a financial crisis during the slave era (which, by the way, was followed by many other US financial crises in the non-slave era) to a financial crisis 143 years after the 13th Amendment?

And as for mortgages, they’ve been around since Roman times (as the Spanish word for mortgage, hipoteca, indicates, that also being the Roman word for this kind of debt, which also lives on in English as “hypothecate”).

Ridiculous, I know. Oh, but there’s more!

Accounting. Seriously. Slave owners depreciated slaves in their plantation accounts:

They quantified capital costs on their land, tools and enslaved workforces, applying Affleck’s recommended interest rate. Perhaps most remarkable, they also developed ways to calculate depreciation, a
breakthrough in modern management procedures, by assessing the market value of enslaved workers over their life spans. Values generally peaked between the prime ages of 20 and 40 but were individually adjusted up or down based on sex, strength and temperament: people reduced to data points. (Emphasis added.)

Uhm, slave owners didn’t “develop ways to calculate depreciation,” they applied a long standing concept to their capital in slaves. It is horrific that humans were viewed as capital, but this did not spur the development of a universal accounting concept: the concept has been around since people figured stuff wore out. And it is ridiculous for him to say that “scientific accounting” was developed on plantations: it was developed long before, starting with the Renaissance Italians, and plantation owners found it useful. As did Boston merchants and Manchester mill operators and on and on and on.

Desmond also focuses on the meticulous monitoring of slave laborers, and sees it as the forerunner of “unremitting workplace supervision” in the modern American economy. Put aside for the moment that workplace supervision today is at its most unremitting outside of the United States (can you say “Foxconn,” Matt? How the hell does that relate to US slavery?). What the hell do you think Marx and Engels kept going on about when describing the horrors of the English factory system? Manchester mill operators would never have figured out without American plantation slavery?

I could go on. And on. And on. But you get the idea. Desmond observes X (a bad thing) in the modern American economy. He observes something sorta kinda like X in the slave economy. He asserts that sorta X developed sui generis in the slave economy, and then asserts that the slave economy sorta X caused the modern economy X.

Every part of this “reasoning” is false. The plantation economy developed little if anything in the nature of economic practice: it adapted things that long pre-dated it. It did so (and I’m reifying here to simplify the exposition) because these practices tended to increase output and efficiency. These practices were adopted and adapted in myriad other settings for the exact same reason. There is no causal arrow from plantation practices to modern corporate “capitalism.” Both reflected and reflect underlying economic forces and institutional innovations that have occurred and evolved for millennia.

Desmond’s piece–and all of the others in the 1619 Project–are the Fallacy of the Undistributed Middle, writ large. Plantations did X. Modern corporations do something like X. Therefore modern corporations are functionally identical to plantations.

No.

So if you are considering getting economic insight from an Ivy League sociology professor who writes for the NYT, take my advice: find a crackhead instead.

Another piece in the series, Khalil Gibran Muhammad’s on sugar, presents similar just-so stories. Here the kicker is that Americans are obese because they eat too much sugar, which wouldn’t have ever happened absent slavery. Yes, Americans–and pretty much everybody in the world–has a sweet tooth, and once upon a time that appetite was fed by slavery. But the sweet tooth is a universal human attribute that has been been satisfied in ever increasing amounts long after the demise of slavery. Americans didn’t get really fat until well over a century after the demise of slavery, and then, ironically, a sugar substitute (high fructose corn syrup) made attractive by protectionist policies that raised the price of sugar and reduced sugar consumption, is far more culpable.

Again, the causal arrow between slavery and bad stuff happening today is a figment of the 1619 Project’s fervid imagination.

I also await with bated breath Mr. Muhammad’s explication of the pernicious effects of Muslim slavery. (Which continues to this day, by the way, including–I kid you not–in Iceland.)

Here’s another one. Tiya Miles tells us that “New York City’s phenomenal economic consolidation came as a result of its dominance in the Southern cotton trade, facilitated by the construction of the Erie Canal.” Ms. Miles attributes this conclusion to historian David Quigley, but without citation so I cannot check whether she characterizes him correctly, or evaluate his reasoning. All I can say is that any connection between the cotton trade and the Erie canal must have been extremely indirect, and indeed, the Erie Canal undermined the South’s power by spurring the growth of the Northwest. Southern states were generally opposed to “internal improvements” like the Canal, which they believed benefited primarily Northern states, and were funded by tariffs that the South paid disproportionately (precisely because tariffs are a tax on trade, and the cotton export trade was the largest in the US). Further, although there was a triangular trade in which cotton was exported via New York and other Northern ports, New Orleans was a major cotton exporting point and capital center . . . until the Civil War. That is what really juiced the NY cotton trade, as illustrated by the fact that the New York Cotton Exchange did not come into existence until 1870.

One last monstrosity. The piece by the series editor, Nikole Hannah-Jones, contains this gem of anti-history:

Conveniently left out of our founding mythology is the fact that one of the primary reasons the colonists decided to declare their independence from Britain was because they wanted to protect the institution of slavery. By 1776, Britain had grown deeply conflicted over its role in the barbaric institution . . . In London, there were growing calls to abolish the slave trade. This would have upended the economy of the colonies.

She concludes that the colonies “believed that independence was required to ensure that slavery would continue.”

Bullshit from beginning to end. Where to begin?

For one thing, the anti-slavery movement in the UK was hardly a major force in the 1770s. To the extent it existed, it was limited almost exclusively to Quakers–hardly the pillars of the British establishment. The Committee for the Abolition of the Slave Trade did not begin until 1787–the year the US Constitution was written. The Constitution contemplated the elimination of the slave trade in 1808, and the law banning the importation of slaves to the US was passed in March, 1807–the exact same month the British law banning the trade was passed. The British Anti-Slavery Society, which aimed at abolition, did not begin until 1823, and Britain did not abolish slavery until 1833.

So if the British threat to abolish slavery was so threatening to the American colonists, they sure as hell took their time getting around to it. The crown’s grave threat to American slavery is completely a figment of Ms. Hannah-Jones’ imagination.

Further, rather than being the hotheads of rebellion, the southern colonies resisted it because they feared it threatened slavery. Jefferson’s original draft of the Declaration of Independence contained strong language listing slavery as one of Britain’s sins against America that justified rebellion:

He has waged cruel war against human nature itself, violating its most sacred rights of life and liberty in the persons of a distant people who never offended him, captivating & carrying them into slavery in another hemisphere or to incur miserable death in their transportation thither.  This piratical warfare, the opprobrium of infidel powers, is the warfare of the Christian King of Great Britain.  Determined to keep open a market where Men should be bought & sold, he has prostituted his negative for suppressing every legislative attempt to prohibit or restrain this execrable commerce.  And that this assemblage of horrors might want no fact of distinguished die, he is now exciting those very people to rise in arms among us, and to purchase that liberty of which he has deprived them, by murdering the people on whom he has obtruded them: thus paying off former crimes committed again the Liberties of one people, with crimes which he urges them to commit against the lives of another.

The southerners insisted that this be removed from the draft, and it was. The slaveholding elements in Philadelphia, and throughout the revolutionary period, were fearful that their northern brethren would eliminate slavery. The first fifty-odd years of United States political history revolved around Southern insistence on institutional and political protections of slavery against Northern attempts to undermine it or strangle it.

The Revolution happened not because of slavery, but in spite of it.

This would all be bad enough if it was just the province of humanities and X-studies departments at universities. But it is part of a political agenda by the most important media outlet in the United States, and arguably the world. Further, the NYT is flogging the issue of race–and deliberately stoking racial tensions–as part of a deliberate political strategy to unseat Trump, and vanquish the deplorables.

Don’t believe me? Believe the NYT’s editor, and his “news” room staff, the transcript of whose “town hall meeting” was leaked. In it, editor Dan Baquet admitted that the NYT had built its newsroom around the Russia collusion story in order to bring down Trump. When Mueller imploded, Baquet and the wokerati realized that their strategy had come a cropper, and they needed a replacement. Fast.

So what did they seize upon: race, racism, and white nationalism. The 1619 Project is just a facet of what will be a 24/7 effort by the New York Times (no doubt aided by its allies and fellow travelers) to paint the United States as a racist nation led by a racist president who must be destroyed, and his supporters banished from civic life.

This is, for lack of a better word, evil. Yes, slavery was horrible. The nation has struggled with the legacy of slavery, and race relations are strained at best. But it is for precisely that reason that inflammatory–and utterly illogical and counterfactual–campaigns like the 1619 Project are wrong, divisive, and destructive. All the more so when the true objective behind this campaign is venally political.

And that is the original sin of the 1619 Project.

The main solace I can take is that this will persuade only those who are already on the left. It will not move those in the middle towards the left, and indeed may drive many of the mushy the other way. The Project reeks of the same condescension–and hatred, actually–that made Trump, and made his win possible.

Put differently, when your counter to Make America Great Again is America and Americans Are Irredeemably Awful, don’t be surprised if a strong majority of Americans rise up and kick you right in the ass.

August 6, 2019

Do What I Say or I’ll Blow the Yuan’s Brains All Over This Town: Not a Credible Threat

Filed under: China,Economics,Politics — cpirrong @ 6:14 pm

The recent market tumult was precipitated by Trump’s announcement of new tariffs on China. But the effect of Trump’s action on the markets paled in comparison to the response to China’s retort: allowing the yuan to breach 7/USD. Today the market recovered some, because the yuan appreciated.

A couple of points. First of all, the yuan’s do-si-do demonstrates that it is a managed/controlled currency. Whether you call it a manipulated currency is a matter of semantics. It is not primarily moving in response to market forces, but instead to the dictates of the (laughably mis-named) People’s Bank of China, and hence to the whims of the CCP and Xi.

Second, and more importantly, although the move past 7 was clearly a threat by China to wage a currency war in response to Trump’s tariff gambits (and the market took it as such), this threat is not credible. It reminds me of this classic, but no doubt politically incorrect, scene from Blazing Saddles: “Drop it, or I’ll blow the yuan’s brains all over this town.”*

The threat is not credible, because like Cleavon Little’s cranium in Blazing Saddles, China would be hurt most if it carried through on the threat. Yes, a depreciating yuan would favor Chinese exports and offset (for a while, anyways) the effect of tariffs. But a weak yuan would wreak havoc on many Chinese firms that have borrowed in dollars. Given the dodgy state of the Chinese banking system, this could readily metastasize into a full-blown financial and/or currency crisis. It would also spark inflation and totally undermine the stated (but largely unrealized) goal of moving China towards a consumer-driven economy.

There are no doubt many (perhaps even a majority) in the US (and the West generally) who will be as stupid as the townspeople of Rock Ridge. I doubt Trump is one of them. Or if he is, I doubt he would lay down his guns: he’d be happy to see Xi pull the trigger. So I expect him to call the bluff.

One last thing. Framing the US-Chinese relationship in terms of “trade war” is stupidity befitting Governor Le Petomane. Trade is just one front in a far broader great power contest between a revisionist power and the status quo power. After decades of complacency, interrupted by spasms of romanticism, the US recognizes China as its primary strategic competitor and threat. The contest is being joined on many fronts, analogous to the Cold War. The main distinctions are that China is not nearly the same nuclear threat that the USSR was back in the day, but China is far more formidable economically than the USSR ever was. Hence there is an economic dimension to this competition that was largely lacking 1945-1991.

Trade is not the war. Trade is a weapon in a larger war.

*In fact, most of Blazing Saddles is beyond the pale today. There is no way it could be made in 2019. This is a sad testament on the utter inability of our alleged elite to see past the superficialities in order to grasp the true message of Brooks’ classic film. As a result, IDGAF if anyone gets the vapors over my reference to the most politically incorrect scene in a very politically incorrect–but brilliant–movie.

August 4, 2019

Pork Wednesday: A Tale of Gilded Age LaSalle Street, With a Heavy Dose of Irony

Filed under: Commodities,Derivatives,Economics,Exchanges — cpirrong @ 7:05 pm

On Friday, someone tweeted a picture of the front page of the Chicago Tribune from 126 years prior–2 August, 1893. It depicts the trading floor of the Chicago Board of Trade when a pork corner collapsed:

Actually, two corners collapsed on that day: the one in pork, and another in lard. The “provisions” markets (as the futures in pork and its products were called) had been successfully cornered repeatedly in the year running up to August, but the corners failed in August because the Panic of 1893 (which began in May of that year) weakened demand and made it impossible to sustain prices. From 31 July to 2 August, the price of pork futures fell from $19.25/barrel to $10.50, and lard fell from 9 cents/lb. to 5.9 cents/lb. The pork price fell $9 in 30 minutes.

The night prior to the collapse, the cornerers (notably John Cudahy, of the Cudahy family of meat packers) tried to hammer out an agreement with their bankers to secure financing to fund the deal, but Cudahy’s brother Michael (who ran the family packing establishment) refused to sign. Lacking the ability to fund their positions, the cornerers had to sell, and prices collapsed. (A la Silver Thursday when the Hunt Brothers ran out of money and had to sell. So perhaps this event should be called Pork Wednesday.)

I have spent a good deal of my professional career studying manipulation, so I find these things of academic interest. They are also fascinating from a historical perspective. Not only was this front page news in Chicago, it was front page news around the country: this paper from Omaha is just one example. This is not surprising, given the importance of agriculture in the economy at the time. Agriculture was the biggest industry and employer in the country, and food represented the largest share of consumption, so the vicissitudes of trading on the CBOT and the New York Cotton Exchange were of deep interest to most Americans. Events like those of 2 August, 1893 were a major impetus behind efforts to regulate (or ban) futures trading. These efforts failed until the post-WWI agricultural depression.

And look how big the pork pit was! It would give the 1990s-era T-bond and T-note pits a run for their money.

Further, the ag futures markets were of such economic importance at the time that they created systemic risks. The collapse of the pork and lard corner, occurring in particular as it did when banks were under suspicion due to the Panic, and when there was no deposit insurance or lender of last resort, caused runs on several banks in Chicago due to fears that they had extended credit to the cornerers or one of the four brokerage firms that failed due to the collapse, and hence were insolvent. Two prominent private banks run by Jews failed. The owner of one, Herman Scheffner, committed suicide by drowning himself in Lake Michigan. The owner of the other, Lazarus Silverman, had staved off a run at the onset of the Panic in May, but could not secure funding in New York in August, and suspended payments on 3 August. The failure of these banks, and the heavy withdrawals at others, contributed to a decline in economic activity in Chicago and the Midwest and exacerbated the prolonged depression that gripped the country from 1893 to 1897.

Lazarus Silverman’s story is of particular interest to me, in part due to a family connection (by marriage) and in part due to the compelling nature of the story itself. Silverman had immigrated from Bavaria before the Civil War, and started a business as a bank note broker which developed into one of the premier private banks in Chicago. His bank on Dearborn Street was quite the edifice:

He advised Senator John Sherman on monetary questions, and was a major financier of the development of iron ore in the Mesabi Range. An early investor in Chicago real estate, he was one of the giants of the Chicago financial community during the Gilded Age.

Although his assets exceeded the liabilities of the failed bank, it could not avoid bankruptcy. Nonetheless, due to his great stature and respect in the community, he was basically allowed to serve as his own bankruptcy trustee. Even though the bank’s debts were discharged in bankruptcy and he was therefore under no legal obligation to do so, he spent the remainder of his life repaying its unsecured creditors. After the failure, he conducted his real estate business out a building he had commissioned and whichA now houses the Standard Club.

I have often wondered if Silverman ever pondered the irony that he, a devout Jew who would not conduct business on Saturday (despite the fact that was a working day back then), whose business had survived the Civil War, the Chicago Fire, and the Panic of 1873, was brought low by the collapse of a corner in pork and lard.

August 3, 2019

Renewables Are Expensive Because You Can’t Stick ‘Em Where the Sun Don’t Shine (or the Wind Don’t Blow)

Filed under: Climate Change,Economics,Energy,Politics,Regulation — cpirrong @ 4:45 pm

I’m sure you’ve read articles claiming that the cost of renewables electricity generation is approaching that (or even lower than) the cost of traditional thermal generation. I am deeply skeptical of these claims even when evaluated on their own terms (which focus on generation costs alone), but find them particularly misleading because they ignore other costs attributable to the facts that renewables are intermittent and diffuse, and that the siting of renewables generation is sharply constrained because they are energy limited resources; the distribution of energy is dictated by nature; and typically is not closely related to the distribution of load.

In other words, renewables are costly because you can’t stick them where the sun don’t shine (or the wind don’t blow).

Case in point: Australia. As even Bloomberg (a tiresome renewables fanzine) reports:

Australia’s financing of cleaner power is slowing because the country’s aging grid isn’t being upgraded quick enough to accept new, intermittent generation and transport it efficiently to demand centers.

Although Bloomberg attempts to blame an old, creaky transmission system, this is misleading in the extreme. It would be far cheaper to upgrade Australia’s transmission system to accommodate thermal generation than it will be to build transmission to increase the fraction of generation coming from renewables.

This is true for at least a couple of reasons.

First, the energy-limited nature of renewables means that you have to site them where the energy is available–sunny or windy places. This imposes a constraint on the location of generation resources that is not relevant for thermal generation. With traditional fossil-fueled generation, you have more flexibility in trading off transmission costs with generation costs (including the cost of brining fuel to plants) than is the case with wind. This flexibility means that all else (notably the spatial distribution of load) equal, transmission costs are lower with thermal generation than renewable power.

Second, the intermittent and inherently more volatile nature of renewables generation increases the variance in the spatial distribution of generation. This variability in the spatial distribution of generation necessarily requires more transmission capacity per unit of load. This, in turn implies a lower average rate of utilization of transmission resources.

The basic idea here can be illustrated relatively simply. Consider a system with two generation resources. One is highly volatile (e.g., a renewable resource). The other is controllable. There is one load location. The transmission capacity from the volatile location to load must be high enough to carry the power when output is high (because the energy input is high due to the vicissitudes of sun or wind). The transmission capacity from the location with controllable generation must also be high enough to transmit enough power to fill the gap left when the renewable output is low.

Note that when renewable output is high, controllable output will be low and the transmission lines from the latter will operate at low capacity. When renewable output is low, the lines serving it will be operating at low capacity.

It’s possible to expand the example to include multiple variable, energy limited, but imperfectly correlated renewables resources, but the outcome is the same. You need more transmission capacity to deal with the spatial volatility in generation, and given load, higher capacity translates into lower average capacity utilization.

Thus, the problem that Australia is confronting isn’t a function of an old grid: it arises from the fact that increased reliance on renewables requires investment in new transmission capacity even in a system where transmission is optimized relative to (thermal) generation and load.

The need to maintain relatively underutilized transmission capacity to deal with the inherent volatility of renewables generation is mirrored by the need to maintain underutilized thermal generation capacity:

While new clean energy projects struggle to gain access to a congested grid, aging coal and gas-fired generators are being kept running for longer to maintain system stability. AGL Energy Ltd. said Friday it would delay the planned closure of its Liddell and Torrens A plants, both around 50 years old, to help the national energy market cope with peak summer demand, which has seen blackouts in parts of southeastern Australia in recent years.

Who knew?

Yet the renewables industry/lobby continues to flog the dogma that they will inevitably be more efficient:

Despite the challenges facing the industry, it’s not all doom and gloom. A number of coal-fired plants will be retired over the next decade and they will only be replaced by the cheapest cost of energy, which is renewables, Clean Energy Finance Corp. Chief Executive Ian Learmonth said in an interview.
“I’m hoping once some of these issues around the grid and regulations are settled that we’ll see another significant uptick in the renewable energy pipeline,” he said.

What costs is Mr. Learmonth including in his assertion that renewables are the “cheapest” source of energy? His statement that settling “issues around the grid” will lead to increased renewables investment suggests that he is ignoring crucial costs, because settling these issues doesn’t come for free.

It’s not as if the transmission issue is unique to Australia. It is present in every locale that has force-fed renewables. Germany is a prominent example. Wind energy is abundant in the North Sea, but believe it or not, there aren’t a lot of electricity consumers there (despite my ardent wish that Merkel and her ilk get into the sea). Major sources of load are in central and southern Germany, so bringing North Sea wind power to load requires massive transmission investments, which inevitably are not just costly, but politically difficult (Der NIMBY, anyone?). These difficulties inflate the cost.

Renewables boosterism operates in an atmosphere of serious unreality because it consistently glosses over–or ignores altogether–the costs arising from intermittency, diffusiveness, the energy-limited nature of wind and solar, and the caprices of nature that cause a mismatch between where the energy exists and where it is needed. When these facts are considered, sticking renewables where the sun don’t shine makes perfect sense.

July 21, 2019

Zip It, Fritz

Filed under: Economics,History,Military,Politics — cpirrong @ 5:59 pm

File this under “We didn’t bomb them enough.” (Maybe I should create a new category for easy reference.)

Item One: Angela Merkel expressed “solidarity” with Ocasio-Cortez, Omar, Tlaiba, and Pressley. She then proceeded to pontificate on her views of what makes America strong.

Item Two: The CEO of Siemens called Trump “the face of racism and exclusion.“

To which I say: mind you own goddam business, Fritz.

Merkel has obviously let all the post-November 2016 bologna about her being the new leader of the free world go to her head. In fact, she is merely the de facto leader of the 4th Reich (who recently succeeded in installing her puppet as de jure leader), and one who has pigheadedly stuck to immigration policies that many Germans strenuously oppose: this no doubt explains her haste to chime in on an issue that is related to America’s immigration debate.

As for Siemens: where to begin? This company’s history is so sordid that its CEO (a successor to a long line of corruptocrats, and an accomplice to mass murder) should not dare to cast aspersions on anyone for anything.

Siemens was deeply enmeshed in the Nazi war economy. Its attempted justification for its conduct makes appalling reading. It attempts to distance itself from its role by claiming it didn’t make things that actually blew up, like bombs and such. It only made electronics. Which of course were vital to a technologically advanced war (e.g., vital components of V1 and V2 rockets, which did in fact blow up, causing thousands of civilian deaths).

It admits to using forced labor, but its description is extremely sanitized, and incomplete. This sentence is rich: “The fact that Siemens allowed people to work against their will during a time when the company was an integral part of the wartime economy of the national socialistic rogue regime is something that the company’s current top management and employees deeply regret.”

Allowed people to work against their will? That sentence is an oxymoron, and a disgusting one at that. And the description of the actual extent of forced labor, and the nature of the forced labor, does not do justice to the malignity of the company’s conduct, and its complicity in the Nazi regime’s atrocities. It talks benignly about moving production facilities due to Allied bombing, but manages to neglect mentioning that it operated these facilities at numerous death camps, including: Auschwitz, Buchenwald, Flossenberg, Gross Rosen, Mauthausen, Neuengamme, Ravensbruck, & Sachsenhausen.

The whole presentation is so dishonest as to make it utterly worthless as an apology, or even an acknowledgement.

That’s in the past, you might say. Well, post-WWII, the company hasn’t utilized forced labor, but has engaged in what is likely the most pervasive pattern of corruption of any large company anywhere in the world. Google “Siemens corruption” and the suggested search terms list a slew of countries: Argentina, Greece, Nigeria, Russia, China. It has paid billions in fines.

Like other German companies, it rushed to do business in Iran (the country that has pledged to finish the job German started), only to state regretfully that the Bad Orange Man made it impossible to continue to do so.

And, of course, Merkel holds Siemens in the highest standing.

Merkel’s and Siemens’ opinions about US politics and US society are gratuitously offered, and worth less. And considering the source, they have no business lecturing others. So zip it, Fritz.

July 11, 2019

Putin Stands Aloof While Rosneft and Transneft Duke It Out

Filed under: Economics,Energy,Politics,Russia — cpirrong @ 6:50 pm

Totalitarian and authoritarian regimes are noted for their vicious internecine battles between the lords of various economic fiefdoms: Nazi Germany presents a classic example (and perhaps a good thing too, because these battles crippled German war industry). Not-quite-totalitarian Russia is seeing such a battle today, over the fallout from the Druzhba pipeline fiasco. Pipeline operator Transneft and oil producer and refiner Rosneft are at it hammer and tong over the issue:

Russian state-owned pipeline monopoly Transneft launched a broadside at Rosneft on Monday, publicly criticising the oil producer for dragging its feet over oil quality controls and making unsubstantiated damages claims.
Transneft said that Rosneft had been unwilling to help resolve a contaminated oil crisis in the Russian Druzhba export pipeline which began in late April and that the oil producer was seeking compensation from it without any grounds.
Rosneft did not immediately responded to a request for comment.

For his part, Putin is steering clear:

The dispute between Rosneft and Transneft (TRNF_p.MM) is not a matter for Russian President Vladimir Putin to intervene in because it is a corporate matter, Kremlin spokesman Dmitry Peskov said on Wednesday.

As if Putin never got involved in corporate matters before. Hell, this is supposed to be his job. As I have pointed out for well over a decade, Putin’s primary function in the Russian “natural state” has been to be the balancer, the adjudicator of conflicts within the Russian economic elite, and the distributor of rents among them.

So why is he standing aloof? His power has eroded to the point that he can’t dictate or even negotiate a settlement? Or does he actually quite like economic titans bashing out each other’s brains, thereby distracting them from scheming against him?

I’m guessing the latter. After some more weeks or even months of Tokarev and Sechin bashing one another, he’ll swoop in and graciously broker a solution.

An aside on Transneft’s criticism of Rosneft dragging its feet on “oil quality controls.” To me that is an implicit accusation that the massive contamination wasn’t caused by a handful of mopes currently enjoying the hospitality of a Russian prison, but was the result of something Rosneft did (or didn’t do). Given the volumes involved, that’s quite plausible.

And if true, it would make Sechin’s demand for compensation, and his praise for the operators of Rosneft’s German refinery, truly awesome examples of chutzpah. But we all know that chutzpah is one thing Sechin is expert at. Or should I say the one thing?

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