Author Archives: Yves Smith

The Return of the Trade Cold War?

Yves here. With an active US effort to isolate Russia, which Russia is seeking to undermine (with only limited success so far) in strengthening ties with China and other emerging economies, most analysts have seen the geopolitical struggle in terms of short-term effects, such as on Russia’s and Europe’s growth rates over the next year. At the same time, the Chinese initiative to create a development bank, meant to rival the World Bank, is seen by many as an important step in breaking the dollar hegemony, along with moves by China and Japan to enter into oil contracts denominated in currencies other than the greenback.

As we’ve discussed in previous posts, we believe the frisson over the demise of the dollar as the world’s reserve currency is greatly overdone. As much as the US is abusing its role, particularly in its aggressive use of its influence over the dollar payments system as a weapon, there are simply no viable candidates for replacement on the horizon.

However, this post examines a consequence of US economic aggression against Russia that has not rceived the attention that it merits: that of reducing the amount of international trade, something economists see as a driver of growth. Note that per the Lipsey Lancaster theorem, there is ample reason to doubt the near-religious belief that more open trade is always a good thing. However, sudden restrictions in trade, which is what is taking place with US/European sanctions on Russia and Russia implementing counter-sanctions, is certain to cause short-term dislocations. And as we noted in a recent post, the cordon sanitaire being placed around Russia will led it to operate more as an autarky, which may not necessarily be a negative in the medium to long term.

This post seeks to identify the impact of reduced trade between Russia and Europe. This sort of analysis could become more germane going forward. While a currency rival to the dollar any time soon looks to be far-fetched, ever-more obvious US economic imperialism may lead other countries to strengthen trade ties among themselves to the detriment of the US, or like Russia, to move to greater self-sufficiency as a defensive measure. While economists assume that our current open trade system could never be rolled back, that was the tacit assumption during the last great era of open trade, the period right before World War I. The Great War put that all in rapid reverse gear. While no one expects a violent rupture, we may be in the early stages of seeing fractures developing in the trade system.

Saudi Cut In Oil Price for US May Lead To Price War

Yves here. We pointed out last month that the US was on the list of Saudi targets when it made clear it was not supporting oil prices at a level higher than $80 a barrel. Some readers rejected the idea that Riyadh would launch a price war to undermine the US, when in fact the desert kingdom has been mightily unhappy with US policies in the Middle East for some time (in case you managed to miss it, ISIS started out as Prince Bandar’s private army and odds are high that it continues to get Saudi support).

A major news story today, that the Saudis are letting oil prices drop further, provides more support for our jaundiced assessment last month.

Links 11/5/14

Private Equity Kingpin KKR Threatens Iowa Pension Fund Over FOIA Request

A new story on private equity secrecy by Mark Maremont at the Wall Street Journal started out with a bombshell, that of private equity industry kingpin KKR muscling a public pension fund to deny information requests about its practices:

Why Greenberg May Win the AIG Bailout Trial

Due to the hour, and the fact that I want to work up the argument longer-form over a series of posts, I’ll give only an overview now as to why the popular handicapping on the AIG bailout trial, that the suit is ridiculous and not worthy of attention, is wrong.

While this case by any logic should be ridiculous, the Fed so egregiously overstepped its authority in the way it handled AIG (and for that matter, its other bailouts) that they handed Greenberg a decent legal argument. And to add to the government’s self-inflicted woes, all of its bailout cheerleading also plays straight into Greenberg’s hands.

Probably the biggest relief to the government so far is that the media has virtually ignored the trial. The only major news organization that has a reporter there daily is Bloomberg. Their reporter, Andrew Zajac, concurs with our view (and quoted us) that David Boies, the Greenberg attorney, has decent odds of winning the case. If Boies does prevail, you can expect an Administration-led firestorm of outrage, with the arguments previewed in a Steve Rattner op-ed in the New York Times.

But the grandstanding serves to obscure the legal argument, which when you get past the technicalities, has real significance politically. That is why the officialdom would rather distract the public by hammering on “That ungrateful deadbeat Greenberg. Who is he to want more money when by all rights he should have been wiped out?” If anyone bothered to look at what is really at stake here, it is that the Fed, with the help of the Paulson Treasury, greatly abused its powers. And that matters because as a practical matter, the Fed is unaccountable for its actions.

Links 11/4/14

More Private Equity Fibbing: Marketing Materials Often Exaggerate Returns

I’m a little slow to write this up because private equity abuses are so pervasive as to fall in the “dog bites man” category. But that doesn’t mean that the public at large, or worse, intellectually captured, credulous investors understand that.

One of the latest abuses to come to light is private equity firms effectively lying about their returns in past funds when dialing for dollars for prospective funds. The overview from Reuters, which broke the story last week:

JP Morgan Under Criminal Investigation for Foreign Exchange Trading Abuses

Regulators look to be getting more serious about financial firm misconduct, as witness their new-found willingness to file criminal charges against banks. Not that has happened yet as regards JP Morgan, the US bank with far and away the biggest rap sheet of all US financial firms. But as we’ll discuss, while it is good to see regulators getting tougher with banks, this move still falls in the category of “too little, too late,” particularly since it looks to a last-ditch effort to improve departing attorney general Eric Holder’s file of media clips.

Here is an overview of the JP Morgan investigation from the Wall Street Journal:

Federal Reserve Policy Keeps Fracking Bubble Afloat and That May Change Soon

Yves here. This post highlights an issue that has also been flagged by Wolf Richter, that fracking depends on junk bond financing that has been made unnaturally cheap by the machinations of the Fed. Steve Horn conflates QE with the Fed’s super-low interest rate policy known as ZIRP, when they are distinct, but they have been implemented with the same idea in mind, that of encouraging investors to make riskier investments, particularly riskier loans.

Horn cites sources that suggest that the Fed could start undoing its rock-bottom rates in 2015. Bear in mind that that’s a minority view.

Links 11/1/14

That Shrinking Slice of a Barely Growing Pie: Why the Glorious Economy of Ours Feels so Crummy

ves here. There’s one thing to add to Richter’s useful recap of what the supposedly sparkling 3Q GDP results mean for those of us who live in the real economy. The GDP deflator fell from 2.1% in the second quarter to 1.3% this quarter, so some of the rosiness of the results was due to the swing in the deflator.

Michael Hudson: Europe to Pay for the Whole Mess in Ukraine

Yves here. This discussion with Michael Hudson on RT focuses on the real meaning of the Ukraine-Russia gas deal. One point that Hudson makes that readers might doubt is that Russia loves the US sanctions. I’m not sure “love” is the right word, but there is reason to think they aren’t working out as the US had hoped. First, they’ve greatly increased Putin’s popularity. Even the intelligentsia in Moscow, who were hostile to him, have largely rallied to his side in the face of foreign bullying. Second, the Western press may be overstating the amount of damage done to the economy by the sanctions. Arguably the biggest negative is the fall in the price of oil, which came about growth in Europe and China slowing, and the Saudis announcing that they’d allow the price to reset at a much lower level than most analysts anticipated. But the ruble has been falling, which blunts that effect, but increases the drain on FX reserves as Russia tries to keep it falling too far and will increase inflation. Third, the sanctions have allowed Russia to engage in protection of domestic industries as a retaliatory measure, for instance, blocking many food imports from Europe.

Now all good well-indoctrinated neoliberals will say, “Trade protectionism merely allows domestic producers to become inefficient and uncompetitive.” It’s not so simple. Development economists are increasingly of the view that trade restrictions can help smaller economies develop domestic businesses to the point where they can compete in international markets, while if they foreign firms in, they’ll find it nearly impossible to build any local champions.

A colleague who does business in Russia but has no deep loyalties there, says he sees no signs of negative impact of the sanctions in Moscow (he describes it as now looking like any post World War II European capital). This is confirmed by recent surveys in Russia, so the lack of meaningful impact on Russian citizens isn’t an artifact of his seeing only the better parts of Moscow. Note that the latest EU forecasts anticipate very weak growth this year and next, as opposed to outright recession.

This visitor describes how the sanctions are helping Russian businesses. One of his friends has the Papa Johns franchise. They used to get their cheese from the Netherlands, but those supplies were cut off by the Russian sanctions against Europe. So they had to buy cheese domestically. It was cheaper but not as good. So he is working with the local farmers and cheese-makers to bring the cheese up to the standard of the cheese he used to import. So he expects to eventually have cheese that is lower cost than what he brought in and of comparable quality. And if he succeeded, the cheesemakers will be more competitive in Europe when the sanctions are relaxed.

The shorter version of this story is that Russia has a large enough domestic market and enough resources that unlike Iran, it may be closer to being able to function as an autarky when its imports and exports are restricted. The open question is whether it can go through the pain of a reset, with some serious and painful short-term dislocations, and escape the slow strangulation that the US claims it has imposed.