Streetwise Professor

Apparently Gazprom’s Alexei Miller didn’t get Putin’s memo on spot markets as the cure to all your commodity contracting ills:

Addressing the annual European Business Congress in France for the first time since 2008 – when he predicted oil prices would soar to $250 per barrel – Mr Miller said sales had recovered in the first few months of 2010, “but the month of May has seen the positive trend reversed. As we see, financial turmoil in the eurozone has started to affect energy markets”.

Swiping at those pressing for linkage to spot prices, Mr Miller said this price could soon rise as demand recovered, while Gazprom’s long term contracts offered greater stability.

“In several cases we have agreed to take into account the spot market component,” he said. “But please note: when in a couple of years the market bounces back, do not ask us to revert to previous price practices.”

Tying gas prices to oil made some sense when (a) these things were closer substitutes, and (b) there was absolutely no spot market in gas, but a well-developed oil spot market.  The case, on transaction cost grounds, for utilizing oil as a pricing benchmark for European gas is far, far weaker when there is a growing (organically) spot market for gas in Europe.

Miller is, surprise, surprise, talking his rather large, and underperforming, book.  With weak demand and surging supply for gas, the relation between gas values and oil prices is far weaker than it was only a couple of years ago.  Miller wants to live in the past, and keep on pricing like it’s 2007.  But it’s not, and it’s not likely to be for a long, long time.  Demand looks to be weak for an extended period, especially given Europe’s current economic ferment, and the supply situation has been turned upside down by shale gas and its concomitant effects on LNG flows.  Oil and gas have diverged, and not in a way that is favorable to Gazprom.  Miller way want to hold back the tide, but the pressures on the existing pricing mechanism are likely to grow over time, and rapidly.

Perhaps recognizing this, Miller tries to rain on the shale parade:

In his speech, Mr Miller also sought to dispel what he said were “myths” that a recent surge of LNG and the rapid development of shale gas in the US could threaten Gazprom’s position on global markets.

Citing high investment requirements for developing shale gas deposits and “low output at wellheads”, Mr Miller said shale gas could only serve as a replacement for the depletion of local traditional gas production. “There are no reasons to crown it and elevate it to the throne,” he said.

Hmm.  Then why is Gazprom moving into shale?  And more importantly: the markets apparently think quite differently.

And speaking of “depletion of local traditional gas production”: where is Gazprom going to replace its depleting local traditional gas production?

Is the Hobgoblin of little minds, according to Emerson.  And if you want a pitch-perfect illustration of the kind of mind Emerson was disparaging, I present Obama:

“Some of the same folks who have been hollering and saying ‘do something’ are the same folks who, just two or three months ago, were suggesting that government needs to stop doing so much,” Obama said. “Some of the same people who are saying the president needs to show leadership and solve this problem are some of the same folks who, just a few months ago, were saying this guy is trying to engineer a takeover of our society through the federal government that is going to restrict our freedoms.”

I mean, really.  Does this guy have the slightest clue?

When I complain when my waiter brings me a bowl of melted ice cream, am I guilty of an unpardonable inconsistency because I had earlier griped when he brought me a bowl of ice cold soup?  Because, of course, if I like warm soup consistency demands that I must therefore like my ice cream warm too, right?

Hardly.  The waiter screwed up twice.  He served the thing that should be cold hot and the thing that should be hot cold.  No tip for you, pal.  (And the absence of tipping might explain why service in France is so often has much in common with the performance of government small and large in the US.)

This is not rocket science, or advanced logic.

Government has some functions to perform, and some things it should keep its damn paws off of.  Just because people rightly point out that the government under Obama’s “leadership” has vastly expanded its reach beyond the things it can–or should–do, does not mean that they cannot with perfect intellectual consistency criticize the same “leader” when he, and the executive branch for which he is responsible, fail miserably to carry out their legitimate functions.   The people who do this have it exactly right–just as in the case of my hypothetical of the clueless–and tipless–waiter.

There is so much to say about the appalling response of the administration to the spill, but I’ll just limit myself to one: the fiasco over the report of experts that the administration used to justify a ban on drilling.  Except that experts never signed, never agreed to, and in fact object to, the paragraphs in the report that recommended the ban.

Am I imagining things, but didn’t Obama and many of his supporters excoriate the Bush administration for politicizing science?  Didn’t they pledge, sanctimoniously, that this administration would respect the independence of science, and restore it to its proper place in public policy?

What is this, if not an outrageous politicization of science, using extremely dishonest means–putting new, political opinions over the signatures of members of the National Academy of Engineering, opinions that the members never saw and in fact have criticized?

The politicization really isn’t a surprise from a gang dominated by Chicago pols. Nor should the smallness of Obama’s mind be surprising.  I am still mystified at the gushing encomiums to his intelligence.  What is the evidence for it?  None that I have seen over the past nearly three years since he catapulted to prominence in the primaries.  In his response to the criticism of his failures of doing too much in some things and too little in others, he has more in common with Homer Simpson than Einstein.  And Emerson had him pegged 169 years ago.

Last August, I wrote a post titled “Not Tall Enough to Regulate” in which I skewered CFTC Commissioner Bart Chilton.  He was very peeved.  He’s not going to be any happier about this post, because he hasn’t changed his mind, nor have I.

This weekend’s WSJ has a semi-fawning story on Chilton, focusing on his advocacy of position limits–and the endorsement thereof in the House and Senate bills currently in conference.  The article gives Chilton an opportunity to explain his position.  His utter failure to do so, which implicitly implicates the entire position limits initiative both at the CFTC and in Congress, speaks volumes about the intellectual bankruptcy of the pro-limits side.

Here’s what the article says (emphasis added):

The volatile summer of 2008, when $145-a-barrel oil led to $4-a-gallon prices at the pump, was the pivotal moment for the Midwesterner. Mr. Chilton says he largely ignores prices, but the surging cost of oil changed his mind. “I’ve seen nobody who can justify $147 [a barrel for crude oil]. It doesn’t mean the massive passives are the sole culprit. I think they’re having an impact. As regulators, it’s our job to be asking these questions,” he says. Mr. Chilton pushed the CFTC to propose position limits that would prevent traders from having a large concentration in energy contracts for four of the most highly traded commodities at the center of the global energy market.

“Position limits that are reasonable,” Mr. Chilton says, “would end the possibility of large concentrations in individual markets that could inordinately influence price.”

. . . .

In July 2008, the CFTC staff issued a report saying that financial traders weren’t driving oil prices higher. Mr. Chilton was infuriated and publicly called the report “deeply flawed.” Today, he charges the report was “political” and done to appease Republicans.

Mr. [Dr.] Harris says, “There was no political pressure from any party. We looked but we couldn’t find any smoking gun. There were a lot of people working hard to find out what was going on. We had dedicated economists and their reputation was more important than political pressure.”

Possibility.  Could.  I think.  A refusal to take seriously empirical evidence, or to critique it rigorously, and a complete failure to provide any of his own.  Ad hominem accusations of politicization when competent economists–which Chilton certainly is not–did not give the answer he wanted.  (This is particularly rich from a political lifer who owes his position to long service as a Senate staffer.)

This is the basis for major policy changes that could have serious effects on the market?

I have a piece on position limits coming out in Regulation titled “No Theory?  No Evidence?  No Problem!”  That’s Chilton (and to a large extent, Gensler, and most of the Senate) in a nutshell.  Any cogent–or even coherent–theory of how speculators are influencing prices?  No.  In particular, any cogent/coherent theory of how passive traders–buy and hold traders so beloved in securities markets–cause prices to increase 100 percent in a period of months?  Surely you jest.  Any empirical evidence to support the claims that speculation and/or passive traders have distorted prices?  See above slander of CFTC economists, along with the CFTC position limit NOPR, for illustrations of the “we don’t got to show you no steekin’ evidence” attitude of Chilton et al.  He just “thinks” it’s “possibly” true–that’s enough, dontcha know.

Here’s a guy who has never been in the markets, and who has never seriously studied markets (“he largely ignores prices”), declaring that prices are somehow wrong.  He wants to restrict the market in order protect against the theoretical possibility (and a theoretically ungrounded theoretical possibility at that), but does not give serious consideration to the far more realistic and likely deleterious effects of the limits on liquidity, hedging, and price discovery.  His justification for the “crowding out” provisions are particularly inane, and not based on any serious economics analysis.

As I point out in the Regulation piece, markets aggregate massive amounts of dispersed information, so it is impossible to explain–“justify”–exactly why prices are what they are.  If it were possible, we wouldn’t need markets to discover prices. That’s why debates over speculation never end: you can’t prove or disprove that the price was right.  Bob Barker doesn’t give you the answer just before going to commercial.

But we know that people spend tremendous time and resources to develop information about values–arguably too much time and resources–and that through trading decisions, this information is embedded in prices.  Moreover, since prices guide the allocation of resources, distortions in prices should result in distortions in quantities–something which (as I point out in the Regulation piece)  were not observed in the commodity price boom and bust.  Commodities are different than say, internet stocks: they are consumed and produced every minute of every day, and distortions in prices will distort those decisions–and such distortions are noticeable.  And if speculators are overpaying–they’ll end up owning the stuff.  None of that happened, and Chilton and others have failed even to acknowledge the issue, let alone confront it.

There should be a pretty high bar to overturn the operation of markets.  Any such action should be based on serious economic reasoning and sound empirical evidence.  And no, deep musings during guitar picking sessions or boat trips to restaurants don’t count.

Due to my involvement in energy issues, many folks have asked me for my reactions to the oil spill disaster in the Gulf.  Obviously the implications of the event will be seismic, but remain to be fully grasped.  Here are some initial thoughts.

I certainly do not blame the administration for failing to stop the leak, and I definitely shudder at the prospect of it “taking charge” of the efforts to stem the flow.  The government has neither the expertise nor the resources to do it.

Where I do find the government generally, and the administration particularly, culpable is in the containment efforts, if “efforts” can be used to describe what has transpired (and is transpiring) in the Gulf.  Contingency plans (e.g., burning in situ) were not implemented, and were apparently not resourced, and hence could not have been implemented.  I wish that I could say that lacking a feasible plan, the government has been scrambling.  But “scrambling” hardly describes the business as usual, bureaucratic, check the boxes behavior of the EPA, the Coast Guard, and the Corps of Engineers.  That is an outrage, and a tragedy.

What about Obama?  Well, he has acted perfectly to form.

A detached talker, rather than a doer or leader.  “Plug the damn hole” brings to mind an old Steve Martin routine.  It also brings to mind a stock joke about economists (or academics generally): When trapped on the top floor of a burning 100 story building, all about are panicking except the economist (academic).  When asked why he is so calm, the economist (academic) replies: “We just assume a 100 story ladder.”

A man disturbingly lacking in affect.  (Obama’s emotions appear to run the gamut from smug to annoyance to pique.)   In his disastrous press conference, Obama made George H. W. Bush’s “Message: I care” look like an example of deep empathy .  (I don’t have to identify which of Mr. Transparency’s press conferences, because he has held so few that there is no possibility of confusion.)

And hyperpartisan.  Given the criticism of the above two things, Obama turned to his old standbys, partisan attack and knocking down straw men and letting no good crisis go to waste.  In his has-to-be-read-to-be-believed speech yesterday, Obama turned the spill into a political bludgeon, blaming the spill on the Republicans and a mythical era of ideological hostility to regulation that rendered the government helpless.  He is using the event to flog his cap & trade proposals.  (The adoption of which, ironically, would undermine his desire—stated in the same speech—to create jobs.)  Post-partisan, my foot.  (I leave other body parts to your imagination.)

Look, things like the explosion of the platform and the subsequent leak are complicated events that almost always involve the unforeseen conjunction of myriad factors, decisions, errors, and bad luck.  To boil it down to a simplistic narrative is deeply dishonest; even if there is a kernel of truth to the narrative, that won’t be known fully until after a thorough examination of the entire event, if ever.  The narrative is also incomplete, because it overlooks myriad other government interventions, notably those that restrict drilling in less daunting environments.  Then to use that dishonest and incomplete narrative to advance grandiose and dubious policies, and as a stick to beat his political opponents, is manipulative and opportunistic, and anything but constructive.

The spill is an epochal event, environmentally, economically, and politically.  Now is not the time for political score settling and agenda advancement.  Obama’s actions may appeal to his base, but I strongly suspect that they will instead further alienate vast swathes of the electorate, including many who supported him out of good will and a hope that he would indeed be a transformative figure that would move the country forward.  They will only feed the country’s deep cynicism, especially so given Obama’s campaign pose of an idealist fighting cynicism—which may well be the most cynical thing of all.

Roman Abramovich has been one of the favored oligarchs in Putin’s Russia.  But not even Abramovich is untouchable.  The Russian Federal Anti-Monopoly Service has announced an investigation of Abramovich’s Evraz steel company for “high monopoly-like pricing.” Steel consuming firms, notably car maker Avtovaz, railcar and tank manufacturer Uralvagonzavod, and Russian Railways have bridled at recent price rises.  Uralvagonzavod head Oleg Siyenko had taken his complaints to Igor Sechin. Siyenko has also called for export duties on steel (which would increase domestic supplies, thereby reducing prices). This follows FAS support for an export duty on potash due to price rises by Uralkali and Silvinit.

Such government interventions–which almost certainly require Putin’s consent, especially where somebody like Abramovich is involved–are an integral part of the operation of the natural state.  The natural state restricts competition and access in order to provide streams of rents to the rich and powerful, in order to purchase their support for the political order.  (Khodorkovsky’s great strategic error was to use his rents to challenge the status quo.)

This equilibrium is upset if the distribution of rents becomes too skewed.*  In the present instance, a recovering world commodity market has boosted demand for steel and potash.  At the same time, Russian domestic consuming industries have not benefited because they are not competitive internationally and are still suffering from the after effects of the economic crisis.  These shocks have unbalanced the distribution of rents, threatening the equilibrium in the natural state.  Matters are particularly delicate because Avtovaz and other big metal bashers are major employers; their continued financial troubles could threaten the delicate social order, already somewhat unsettled due to the Raspadskaya mine explosion (Raspadskaya being another Abramovich property).

So the government intervenes to maintain the balance and preserve the equilibrium.  This is the way the natural state works.

The use of export duties is particularly interesting.  As the steel and potash examples demonstrate, shocks to world commodity prices are a primary source of threats to the natural state equilibrium.  Some Russian raw material and semi-processed product industries are internationally competitive, and their fortunes wax and wane with the global economy.  (The energy industry is of course in this category, and is subject to export duties that are adjusted regularly, although this is in part done for fiscal reasons since these duties are a major source of government revenue.) In contrast, Russian material consumers are almost entirely dependent on the domestic market.  Thus, global demand shocks that help the raw material firms can have very adverse effects on the domestic consumers, requiring a reset to maintain balance.

This raises questions about whether Russia can really join the World Trade Organization.  WTO membership would constrain its ability to respond to global shocks so as to maintain the political equilibrium.  The natural state cannot tolerate truly open markets as these markets are destabilizing to the status quo.  Russia has indicated its intention to rejoin WTO talks, and Medvedev has expressed hope that the US will support its candidacy.  But given past Russian diffidence about the WTO, and Putin’s dalliance with a trade union of Russia, Belarus, and Kazakhstan, there is considerable doubt as to whether when push comes to shove the country will accede to the constraints that the WTO is likely to impose.

* Sam Peltzman’s famous article presenting a formal theory of regulation is useful in understanding these dynamics.  In Peltzman’s model, skewed profits under competitive conditions lead to regulation as politicians by political support through redistribution.

The previous story about the Russian Chess Federation’s battle with the state may shed some light on the fact that foreign direct investment in Russia fell 17.6 percent in the first quarter of 2010.  And it is not that 2009 was such a great year: FDI in 2009 was down 41 percent over 2008.  So despite the alleged recovery in the Russian economy, FDI is not coming back.  This is problematic for Russia because foreign investment was an important driver of GDP growth in the mid-00s.

Not that I’m surprised.  Given the tenuousness of property rights from the predations of the state, or the whims of those who can wield the coercive powers of the state, it is dangerous to invest directly in Russia; fear, uncertainty, and doubt should be foremost in the mind of any potential foreign investor..  If the Chess Foundation is worth siccing the police on, just think of the incentives to call in the muscle when there’s real money to be made.

Kudrin seems to be whistling past the graveyard:

Finance Minister Alexei Kudrin said in February that FDI might climb to a “pre-crisis level of $60 billion to $70 billion in the next two to three years.”

Given that the 2010 pace is for about $10 billion/year, $60-$70 billion seems way, way out of sight for the medium term.

Although FDI was down, total foreign investment in Russia is up.  This is a mixed blessing, at most, for Russia.  It is not a strong vote of confidence in the Russian economy.  Instead, a good chunk of it is likely hot money playing the carry trade, borrowing abroad at low rates (thanks, Ben and Claude!) and investing in Russia at higher rates.  It’s also a play on energy prices.  But this money can flee as quickly–more quickly, in fact–as it arrives.  Flights to safety, concerns about the effects of the European crisis on energy prices, uncertainty about whether China will try to reduce credit growth and its effect on oil prices, or a million other things, can reverse those flows in a hurry.

Not that Russian officials (some Russian officials) are unaware of this:

Improving the investment climate is a priority to boost the share of long-term direct investment in the total capital flow into Russia, Economic Development Minister Elvira Nabiullina said Thursday.

While speculative capital inflows are “a problem,” Russia will not ban short-term investments and needs instead to “create conditions for attracting direct investment,” she said.

True enough.  But how?  That’s the Russian dilemma.  The substantive changes needed to attract FDI–notably, the creation of at least a simulacrum of a rule of law that would protect investors from expropriation–is a threat to the political equilibrium in the Russian natural state.  Meaning that Russia will not escape Putin’s purgatory any time soon.

Last week the Senate passed the financial “reform” legislation, which now goes to a conference committee that will produce a bill that combines the Senate bill with that passed by the House months ago.  (Ironically, the vote came when I was at a very nice conference on financial regulation hosted by Notre Dame.)

The Senate bill is best measured in pounds rather than pages.  (Pounds of what I’ll leave to your imagination.)  It is comprehensive, and from what I can tell, it is comprehensively wretched.  Stephen Bainbridge, whose opinion I respect a good deal, strenuously objects to the nationalization of corporate governance embedded in some of the bill’s language.  The infamous Lincoln swaps provision, which I’ve written about, is a horror.  It is some kind of sick joke to remake the entire derivatives market–and the banking sector–with a transparently populist ploy heaved up by a rather undistinguished senator (but I repeat myself) from Arkansas in a desperate attempt to stave off a primary challenge.  (Said ploy being incompletely successful, with Blanche Lincoln facing a runoff against her more lefty opponent.  Which probably gives the provision continued life when it should be put out of our misery with all dispatch.  The joke is even sicker when one considers that if current polls are at all accurate, Lincoln will be demolished in the general election.)  The clearing mandate is also a disaster in waiting.

Rather than deconstruct the whole abortion, I’ll focus on a couple of (relatively minor, in the scheme of things) features that illustrate its intellectual incoherence.

The first relates to market manipulation.  Here is a place where Congress could do some good by rewriting the existing law.  As I’ve written extensively over the past 15 plus years, US manipulation law could use a serious overhaul.  I’ve made concrete recommendations, including in a recent article in the Energy Law Journal.

But instead of doing something reasonable, the Senate passed an amendment proposed by the aptly named Senator Cantwell that does the exact opposite of what I recommend in the ELJ piece.  Specifically, apparently lacking the ability to form an original thought, Cantwell and the Senate fire up the copy machine and essentially Xerox the anti-manipulation language in the Securities and Exchange Act.  The amendment (S3348) outlaws “any manipulative device or contrivance.”

Boy, that’s such a big help.  Makes things crystal clear, no?

Look, a major problem with US commodity manipulation law is its complete failure to define what is  manipulative, and to provide courts and commissions with any guidance as to just what kinds of conduct are manipulative, and what tests should be applied to make that determination.  In its attempt to ensure that the law is sufficiently broad to catch everything that could be construed as manipulative, Congress has instead passed language that is so vague that the law can hardly catch anything.  The amendment’s language does nothing to correct that.

Moreover, Cantwell sings paeans to the securities law’s anti-manipulation provisions and precedents, and the effects of previous utilization of similar language in other commodity manipulation laws:

This language in this amendment is patterned after the law that the SEC uses to go after fraud and manipulation; that there can be no manipulative devices or contrivances.

It is a strong and clear [not!] legal standard that allows regulators to successfully go after reckless and manipulative behavior.

This legislation tracks the Securities Act in part because Federal case law is clear that when the Congress uses language identical to that used in another statute, Congress intended for the courts and the Commission to interpret the new authority in a similar manner, and Congress has made sure that its intention is clear.

In the 75 years since the enactment of the Securities and Exchange Act of 1934, a substantial body of case law has developed around the words “manipulative or deceptive devices or contrivances.”

The Supreme Court has compared this body of law to “a judicial oak which has grown from little more than a legislative acorn.” It is worth noting that the courts have held that the SEC’s manipulation authority is not intended to catch sellers who take advantage of the natural market forces of supply and demand, only those who attempt to affect the market or prices by artificial means unrelated to the natural forces of supply and demand.

Mr. President, Congress granted the same antimanipulation authority to the Federal Energy Regulatory Commission in 2005 in the Energy Policy Act. We did this as a result of the Enron market manipulation. I am very proud of this legislation and its ban on manipulation in electricity and natural gas markets. I say that because there was a similar issue of deregulation of energy markets that led to the Federal regulators not doing their job.

Since we have implemented this language in the electricity markets, the Federal Energy Regulatory Commission, since 2005, has used its authority to conduct 135 investigations. Of those 135 investigations, 41 have resulted in settlements involving civil penalties or other monetary remedies totaling over $49 million.

Two investigations brought about enforcement actions against manipulation, one against Amaranth for $291 million—-

The PRESIDING OFFICER (Mr. Udall of Colorado). The Senator has used 5 minutes.

Ms. CANTWELL. Mr. President, I ask unanimous consent for an additional 1 minute.

The PRESIDING OFFICER. Without objection, it is so ordered.

Ms. CANTWELL. The alleged market manipulation brought enforcement action against Amaranth for $291 million in civil penalties and Energy Trading Partners for $167 million in civil penalties. That is just an example of what a statute with teeth and a regulatory entity can do to actually stop manipulation when given that authority.

Sigh.  There are so many things completely wrong with this it isn’t even funny.  Most importantly, the relevance of SEC precedent to commodity market manipulation is a cross between (a) completely non-existent, and (b) actively counterproductive.  Most importantly, as I point out in the ELJ piece, whereas the most important kinds of commodity manipulations are market power manipulations (e.g., corners) most securities manipulations are information/fraud driven.  The canonical securities manipulation is the pump-and-dump, which has nothing whatsoever to do with market power manipulation that should be the first order target of any commodity anti-manipulation measure.  So, the vaunted SEC precedents are worth exactly bupkus.  No, that’s too generous.  They will be actually counterproductive as enforcement attorneys and judges try to pound a market power manipulation peg into a fraud hole.

The ETP case that Cantwell mentions is a perfect example of this.  I was an expert for ETP in this case, and know it intimately; as an aside, Cantwell is less than accurate in her characterization of the outcome of that case, because the government settled for a lot less ($5 million to the government, plus a set aside of $25 million to pay potential settlements in third party lawsuits) than the $167 million figure she cites, and that was a let’s-get-this-behind-us-gift to FERC, which brought the case.  Substantively, the FERC had to twist itself into knots to try to characterize the conduct it found offensive into the “deceptive device or contrivance” category.  FERC’s theories, uhm, evolved, to put it mildly; actually “devolved” would be a better characterization.  At every iteration, I was reminded of Maxwell Smart: “Would you believe?”  (No, actually.)  Rather than being the shining example that Cantwell paints it to be, the ETP case was a perfect example of the fundamental idiocy of trying to export securities law manipulation concepts and precedents to the commodity markets.

Instead of improving manipulation law, the Cantwell amendment will make it worse, as hard as that is to believe.  I don’t know if I’ve ever written a more depressing sentence.

Cantwell focuses on intent.  But that isn’t the only problem with existing commodity manipulation law.  Artificial price and causation have also posed problems too.  But all are eminently fixable through an application of solid economics, as I discuss in more detail in the ELJ piece, and which I demonstrated in my book on manipulation in the mid-90s and my piece on the Ferruzzi squeeze from 2004.

Another poster child for the intellectual bankruptcy of the Senate bill is its provision to empower the CFTC to extend position limits to OTC energy derivatives.  I have pieces forthcoming in Regulation and the Swiss Derivatives Review analyzing speculation and position limits in commodity markets.  The title of the Regulation piece suffices to convey the conclusions: “No Theory?  No Evidence?  No Problem!”  That is, the CFTC’s current proposal to impose position limits is not grounded in an understanding of the economics of commodity markets, and is completely unsupported by empirical evidence.  The same, obviously, is true of the provision in the just passed legislation.  But we’ll get limits nonetheless.

The Senate provision is particularly troubling because it will likely have effects on the Commission’s futures position limits as well as on OTC limits.  Fear of driving trading to the OTC markets restrained the Commission in its setting of the proposed limits, and led some Commissioners to express reservations about the entire effort.  With OTC position limit authority, those constraints and reservations evaporate.  Now the only competitive constraint on the CFTC is the threat of trading moving overseas.  But that threat is less severe than the competitive threat to the domestic OTC market, so it is quite possible that the Commission will impose more onerous restrictions on both exchange-traded and OTC-traded positions now that it has the OTC authority.

At the Notre Dame conference Chester Spatt warned of the unintended consequences of regulation.  Quite so.  And the Senate bill, and whatever comes out of conference, will spawn myriad unintended–but not unpredictable–consequences, most of them quite pernicious.  When the Insane Clown Posse (AKA the United States Congress) is done “reforming” our financial markets we’ll learn to our regret that however flawed our existing system is, it is a far, far better thing than the product of the constructivist irrationality of Dodd, Lincoln, Cantwell, and Frank et al.

Sarah Lynch has a VERY interesting story in today’s WSJ about how CFTC economists could find little evidence that speculation distorted commodity prices, and energy prices in particular.  (I’m quoted towards the end.)

Not that I’m surprised.  Hard to find stuff that don’t exist.

An Aug. 21, 2009 memo written by two agency economists and addressed to Treasury Secretary Timothy Geithner points to an internal CFTC debate over position limits. A CFTC spokesman said Mr. Gensler hadn’t read the memo or sent it to Mr. Geithner.

The memo analyzes the impact a lack of position limits may have had on energy markets after Congress voted in 2000 to replace them with a new and less stringent accountability level regime. Accountability levels are non-binding thresholds that merely trigger additional oversight if exceeded.

According to the memo, New York Mercantile Exchange data from between 2000 and 2009 show that the switch to the new accountability regime in 2001 didn’t change energy-price volatility.

“In our analysis of the impact of position limits, we find little evidence to suggest that changes from a position limit regime to an accountability regime, or changes in the levels of position limits impact price volatility in either energy or agricultural markets,” the CFTC memo states. “Our results are consistent with those found in the existing literature on position limits.”

Again.  No surprise.  In 2004 I did a very extensive study on the effect of the move to an accountability regime on volatility in nat gas at the behest of the Industrial Energy Consumers of America.  I found nothing.  IECA was not pleased.

It is revealing that Gensler allegedly never saw the memo.  Nor did Geithner, to whom it was addressed.  But since Gensler assuredly had his mind made up already (and/or had marching orders from Congress), it probably made no difference.

Here’s the most interesting part of the article:

Other internal emails drafted in August 2009 by the agency’s now Acting Chief Economist James Moser reveal he was concerned about how to craft a position limit rule.

Mr. Moser was at the time the agency’s deputy chief economist and sent an email to CFTC Commissioner Jill Sommers’ staff member expressing his views.

“I think of a position limit as a tool,” he wrote. “That tool needs to be calibrated to the problem it hopes to solve. Because we have no statistical evidence of a problem, we are not able to calibrate the tool to fix the problem.”

I feel your pain, Jim.  What you said is spot on.  But your big mistake is your touching belief that policy should be made on the basis of evidence.  How quaint.  (By the way, you can tell everybody you don’t know me.  I’ll understand.)

Lynch’s story also includes a link to a CFTC report on the effects of speculation and commodity funds on prices.  The study is an extension of earlier CFTC work that had drawn the ire of Commissioner Chilton.  The extended report, which as Lynch says expressed the no-speculative-effect view “more forcefully” never saw the light of day until it was unearthed via a FOIA request.  Go figure.

In its position limit NOPR, CFTC disclaims any need to show that speculation actually has caused unwarranted fluctuations in prices before imposing the limits.  It has to say that, because it’s pretty clear that its economists can’t do so.  But this isn’t about economics.  Its about belief, and politics.  Gary Gensler and Bart Chilton have a fixed belief about speculation and a political agenda to implement.  They’re not about to let something as irrelevant as evidence get in their way.  Hopefully the other commissioners feel differently.

As I am quoted saying in the article, CME and FIA have argued that as a legal matter CFTC must make a finding of speculative impact before imposing limits.  I don’t know if they’re right as a matter of law, but I’m sure we’ll find out soon enough.  And if a judge decides it must, GiGi is going to be in a very, very awkward position.

And doesn’t this story make you feel warm all over at the prospect of handing over vast new powers to the CFTC, especially a Gensler led CFTC?  A cavalier approach about economic logic and evidence about speculation in energy markets is bad enough.  Extending such an approach to oversight of trading and clearing of the vast OTC markets would be infinitely more dangerous.

Russian manufacturing expanded at the most rapid rate in the last two years, with the April PMI registering 52.1 (with anything over 50 indicating growth).  Yes, better than a sharp stick in the eye, but nobody should get too excited: Russia is still a manufacturing underperformer.  The Global PMI was 57.8, the second highest level recorded in history.  The US PMI came in at a robust 60.4.  Germany’s even better, at 61.5.  China’s 55.7.  India’s 57.2.   Brazil was a comparative laggard, at 53.8, as was Japan at 53.5, both of which still lapped Russia.

Russia suffered one of the sharpest declines in manufacturing activity.  It is also experiencing one of the weakest recoveries.  Not exactly an “L”, but definitely not a “V”.  More like a very shallow “U”.

A good deal of this is the result of one of the myriad consequences of the resource curse.  Relatively strong oil prices have bolstered the ruble, and this has hampered the Russian manufacturing recovery.

Russia has been very aggressive at cutting interest rates to try to counter the ruble appreciation and force feed credit to businesses.  Even with this stimulus, however, the manufacturing performance has been lackluster.

The worst appears to be over (unless, as is not outside of the realm of possibility, the metastasizing European fiscal crisis causes another global shock), mais les bons temps ne roule pas en la Russie.

When he first became president, Putin compared Russia’s standard of living with Portugal’s, and promised that Russia would catch up to the small Iberian country by 2015.  Not going to happen.  Unless, that is, the convergence is from above, with Portugal crashing to earth with the other once flying PIIGS, rather than from below, with Russia growing at a much faster rate.

Russia’s economic anschluss in Ukraine is well underway.  First, Putin announced a proposal to merge the nuclear generating assets of the two countries.  Second, yesterday he proposed something even bolder: the merger of Gazprom and Ukrainian gas monopoly Naftogaz Ukrainy.

Gazprom’s Alexi Miller stated the proposal met with an “enthusiastic” response from Ukrainian government officials.  However, Ukrainian President Yakunovich’s spokesman denied that the deal had been discussed.

This would obviously be a major coup for Russia on the political and economic levels.  It would transform Ukraine into a Russian satrapy.  It would reduce the potential for holdups and conflicts like those that culminated in gas shutoffs to Europe in 2006 and 2009.  It would also reduce the need for South Stream in particular, thereby relieving Gazprom of the financial burden of paying for a system that makes sense only as a way of circumventing Ukraine and undermining Ukrainian bargaining power.

One wonders how the Europeans, distracted by Greece and the Greeces to come, will react to this.  One possible reaction is to conclude that this would be a good thing.  It would relieve them of any care about quarrels between far away people of whom they know little.  It would reduce the transactions costs and associated prospect for gas cutoffs inherent in a situation where ownership of highly complementary assets is divided.

But the Europeans should realize that Russian success in Ukraine will not sate its ambitions.  It will only move the scene of tension and potential conflict that much further west.  Insofar as gas is concerned, deal or no, the Europeans should get their act together and encourage development of alternative supplies, whether via new pipelines (a stretch), LNG, or domestic exploitation of shale gas.  (As an aside, isn’t the Russian concern for the impact of shale gas production on the European environment touching?  If only it were matched by a similar concern for Russia’s own environment.)

And yeah, I know saying “Europeans” and “getting their act together” in the same sentence is something of a joke.

In the early days of the blog I wrote a lot about how Putin is a man in a hurry.  In the present instance, he is clearly in a hurry on Ukraine.  It’s not hard to understand why.  He probably recognizes that there is only a short window of opportunity to achieve his ambitions.  Yanukovich’s power is at its apex, and the opposition is demoralized and divided.  But the near riot that accompanied the approval of the Kharkov agreement over the Sevastapol base is a reminder that a large swathe of the Ukrainian public opposes ceding its autonomy to Russia.  Putin no doubt reasonably concludes that it is necessary to move now while the opposition is still disorganized and inchoate.

But this move is so provocative that it could catalyze the revitalization of a more-or-less unified opposition.  If Yakunovich goes along with it, it could revivify Putin’s bogeyman–the Orangist opposition movement.  It clearly puts Yanukovich in a delicate spot, and gives Tymoshenko a powerful issue and a new lease on political life.  A merger would also have a profound effect on the shadowy interests that make obscene money in the dirty gas trade in Ukraine.  Given the influence of these forces (and their money) on Ukrainian politics, they could play a decisive role in the ultimate resolution.

One thing is certain.  The process will not be open, transparent, or clean.  A murky mix of power politics, nationalism, Ukrainian political dysfunction, and money will determine what happens next, and after that.  In these circumstances, it would be foolhardy to predict an outcome.  I do sense (and perhaps it is only wishful thinking) that there is an appreciable probability that this could blow up in Putin’s face as occurred during one of his previous attempts to meddle in Ukrainian politics–the 2004 presidential election.