Sunday, December 17, 2006

Secretary Rice takes the bait

Rice raises concerns over GCC Nuclear Plans: Washington: US Secretary of State Condoleezza Rice said yesterday she wanted to know more about Gulf states' plans to study nuclear power and questioned why Saudi Arabia, the world's largest oil producer, might need atomic energy.

Was it just a few days ago that I opined: The worst outcome for those in the west who wish for continued domination of the Middle East is a unified whole. If the GCC takes Iran's view on nukes, and begins to actively question Israel's nuclear arsenal, the game gets a whole lot more complicated.

Well the GCC has taken Iran's view- they too wish to harness the power of nuclear energy, which Iranian President Ahmadinejad is only to eager to share, and Secretary Rice has, sadly, taken the bait- a choice which recalls the words of Mark Twain: it is better to remain silent and have people suspect you are a fool, than open your mouth and remove all doubt.

If this GCC desire for nuclear technology flows from earlier Iranian overtures it was a political masterstroke. So long as Iran was the outlier in the region the US had room to maneuver. But if the whole region is tarred with the same brush, the room to maneuver shrinks.

Why, the GCC states might be wondering, should India or Israel have access to nuclear technology but not us? Now, if a military attack is launched against Iran's nuclear installations, will the GCC states not wonder if they are next. I think we will regret not talking to Iran when we had the chance prior to the invasion of Iraq, when they were willing to negotiate a grand bargain.

Perhaps this is why a critique of this policy choice- this road not taken, is, according to this article, considered a matter of national security.

This hard headed, bull in a china shop approach to diplomacy is just not making us many friends these days.

Russia extends her tentacles

Two articles from today's press caught my attention:

Cuba renews old ties with Russia: In his first major policy initiative since assuming power, Gen. Raúl Castro signed a far-reaching military-aid agreement with Russia. In September, Russian Prime Minister Mikhail Fradkov, visited Cuba and signed an economic-aid pact providing Castro with $350 million in credits to upgrade Cuba's armed forces, including the acquisition of Russian transportation equipment, air-navigation systems, industrial goods for the energy sector and financing of future Russian investments in Cuba, among other projects. Fradkov met with Raúl Castro in a climate described as ''cordial and friendly'' by the Cuban press.

This accord with the Russians rounds out Cuba's international alliances with key strategic countries. They include Venezuela, China and Iran. Whether the Russian deal was in the making prior to Fidel Castro's surgery or developed as a more recent initiative, it reaffirms Raúl's long-standing admiration and support for Soviet policies in the past and for Russian policies in the present.

Russia creates political dialogue mechanism with Mercosur: Russia and member states of the South American Common Market (Mercosur) signed on Friday a memorandum of understanding to create a political and cooperation dialogue mechanism.

This mechanism is aimed at increasing political, economic, technical and cultural consultations between Russia and the South American block.

Russian Foreign Affairs Minister Sergei Lavrov and his counterparts from the Mercosur member states -- Brazil, Paraguay, Uruguay and Venezuela -- and its associates, Bolivia and Chile, signed the document in Brasilia, capital of Brazil.

If I was using a comic strip as a medium for expressing my view I might have a picture of Putin looking at a map of the Americas saying, "Monroe who?"

While the current administration has been trying to extend US influence in the Middle East, and by most accounts, doing the opposite, Russia and China have been outflanking their efforts in Africa and the Americas. It is as if the more we try to extend our dominion the more we lose what we have, which tends to be the way of power over men- it accrues fastest and most durably when you don't try to gain it- when the choice is freely made.

I've been getting a few emails (please use the comments section) about my "championing" of Russia's cause so I'd like to set the record straight.

To use an ice hockey metaphor, it is not "championing" the opposing team to notice that they have scored more goals than your team has in the first two periods of play. Often such recognition acts as a motivating force. Acting as if you are winning when you are not fosters complacency.

I wish corporate heads hadn't accepted the notion that the End of History was at hand when the Soviet Union imploded, for we are now reaping the harvest sown by the imposition of unfair PSAs. Recognizing the effects of unwise choices is, at least as I view the world, how one learns. If the US wishes to regain its status it needs to avoid such errors and remember that capitalism works best when win-win deals are structured.

I experience no joy watching Russia and China rise to fill the vacuum of honest broker created by our imperial misadventure in Iraq. But it would be silly to not recognize their rise, the context and choices that allowed it to happen, and the eventual effects on the lives of those around me.

Thursday, December 14, 2006

If China and Russia agree to sanctions, are they on our side?

There is no instance of a country having benefited from prolonged warfare. Sun-Tzu The Art of War

In the martial arts, Judo (Gentle Way) and Jujutsu (Gentle Art) the main principle is to use your opponent's strength against him. Let him charge at you while you give way and then trip him up or flip him over.

Russian President, Vladimir Putin, is an avid student of Judo, and has been since 14 years of age. His administration, as evidenced most recently by the turnabout on Royal Shell over Sakhalin-2 seems quite judo-esque in its behavior.

They wait, allowing the enemy to charge in and get off balance and then, flip him; in that specific case, using environmental concerns sure to make life tough for Shell, arguing in the contrary, back in the US.

I wonder if the recent ground giving on Iranian sanctions in the UN might be more of the same.

Had the US been able to move into Iran quickly following the rapid dismantling of Saddam's regime, they would have done so with rested troops and reasonable strong domestic support. Whether this would have mattered in the long run, I don't know, but conditions were best for US success in such a venture in 2004.

At this point, however, the troops are tired and domestic support for further military adventures is waning. As the opening quote reminds, prolonged warfare saps a country's strength, something Russia's leaders learned in Afghanistan. For a student of Judo, now is the time to get your opponent to rush in- he's tired, he's flailing and he needs a quick victory.

Interestingly, the Iranian President is doing his best to rile people up with the Holocaust Conference. It is as if he is daring the US and/or Israel to attack. Whether this is just coincidence or more, I don't know. Sometimes even stupidity can work out.

I, for one, hope the temptation is resisted. I'm not a fan of War but if you are going to do it, stick with the wisdom of the Powell Doctrine; make sure you can act with overwhelming force and have the people back home on your side. If you don't have that, it is best to wait until you do. Better to not fight at all than to fight and lose.

The problem, of course, is hubris- a hubris, mind you, that, according to this article, leads people to "cook the books" on military games, a hubris that won't allow one to even contemplate whether the enemy might be goading you on.

The Chinese military and political establishments are well versed in the wisdom of Sun-Tzu and the Russian President is a Judo expert. Why, under those conditions, are we acting like a bull at a bull fight, happy every time our opponents give us a red flag to charge at, unaware that it might hide swords. John Bolton might be happy China and Russia get on our side with sanctions that can act as a cover for an attack, but who is really zooming whom.

In Laying PLans in The Art of War, Sun Tzu writes: If your opponent is of choleric temper, seek to irritate him. Pretend to be weak, that he may grow arrogant.

I'm, of course, just speculating here, the end result of an active imagination and lots of time spent reading history from a non-triumphal standpoint.

I just can't shake, having read quite a few Greek Tragedies, how the end result of hubris is almost always a self-inflicted blow, an easily avoidable mistake.

Tuesday, December 12, 2006

A slippery double standard hampers Globalization

The financial media in the west is all atwitter at Russia's recent "seizure", to quote The Guardian, of the Sakhalin-2 LNG (Liquefied Natural Gas) project, reportedly the largest in the world. Spokesmen for Royal Dutch Shell, the company apparently getting frozen out by the Russian government, via state controlled corporation, Gazprom, warned Russia, the world was watching.

The world is watching. That sounds a bit like what I tell my 5 year old son from time to time when he's about to do something he shouldn't- I'm watching you.

The Russian government, assuming I've interpreted the comment correctly, is not supposed to concern itself with energy security, or try to use its power to craft deals the way it wishes.

That's a good one.

I wonder where Royal Dutch Shell was when Yeltsin was dissolving Parliament and, against the will of some, writing a new Constitution which facilitated much more extensive privatization of formerly state-run industries? Waiting in line to get a piece of the pie, of course,

The Sakhalin-22 PSA, which has been called a Production non-Sharing Agreement, was signed in 1994, when Yeltsin's economic liberalization program was in full swing and the Oligarchs were making money hand over fist. The terms of the agreement include the following quite unique features for an investment contract of this type.


1) At first, ALL proceeds from oil and gas sales (apart from a small royalty) are treated as ‘cost oil’, until both the capital investment AND an IRR (internal rate of return) of 17.5% (a comfortable profit) for SEIC have been received.
2) Once costs and the 17.5% return have been received by SEIC, the Russian Party receives 10% of the hydrocarbons for the following two years.
3) After those two years, the Russian Party receives 50% of the hydrocarbons until SEIC has received a 24% IRR (a large rate of profits).
4) Only after that 24% IRR has been obtained does the mechanism shift to its final sharing of 70% of hydrocarbons to the Russian party.

Given that the Russian government was only going to get paid after all project costs were recouped, one can imagine why they were a bit miffed to learn that MMMMS, the Royal Dutch Shell-led consortium, was raising the expected cost of the project from the original US$12B to US$22B. That's US$10B more worth of LNG that needs to be sold before the Russian government gets a ruble.

The world may be watching Russia now, but Russia was watching Royal Dutch Shell the whole time. And they are not pleased. Thus the new found fear of environmental damage.

Do I think Russia is "playing fair" in this game? No, but then I also don't think MMMMS was playing fair with Russia in the early 90s. As the Russian state has reformed and strengthened under Putin, turnabout, it seems, is fair play.

The aspect of the press coverage of this issue that is least useful, in my view, aside from the lack of history which makes it possible, is the sense of amazement at the Russian government's response.

Consider the following excerpt from a letter to President Bush on the proposed, but terminated deal for Chinese controlled CNOOC to buy Unocal, from US Representative Joe Barton, then Chairman of the House Committee on Energy and Commerce:

U.S. national energy security depends on sufficient energy supplies to support U.S. and global economic growth. But those supplies are threatened by China's aggressive tactics to lock up energy supplies around the world that are largely dedicated for their own use. China has used its state-owned oil companies to advance this strategy, by buying up energy assets around the world without regard to human rights and environmental protection, in countries such as Sudan and Iran. And unlike other companies, these resources are not available to the global market.

CNOOC's bid to acquire Unocal is simply the latest, and most significant, step in this strategy. If approved, the transaction would put vital oil assets in the Gulf of Mexico and Alaska directly into the hands of a company controlled by the government of China. This would be directly contrary to the goal of enhanced energy independence embodied in H.R. 6 as passed by the House.

One of the premises behind globalization is that the national origins of any corporation should not matter. What is supposed to matter is efficiency at delivering product to consumers and profit to share holders. Pure corporate competition.

Yet, as the Unocal and Dubai Ports deal demonstrate this isn't the case for the biggest promoter of Globalization, the US. The US is, rightly in my view, concerned about losing control of strategic resources.

And we are not alone in that concern. National governments around the world are reacting, once again, to fears of loss of control- to fears that the strong will bleed the weak. Intra-nationally in the US in particular, the middle class is becoming as disenchanted with unchecked corporatism as many national governments are.

As ex-US Treasury Secretary Summers recently opined in the FT:

In the past, real wages and corporate profitability have moved together – increasing during economic expansions and when the US became more competitive, declining in recessions and when it encountered significant competitive threats. The unique feature of the current expansion is the divergence between the fortunes of capital and the fortunes of labour. While workers normally receive about three-quarters of corporate income, with the remainder going to profits and interest, the Economic Policy Institute has calculated that, since 2001, labour has received only about one-quarter of the increase in corporate income, as real wages have failed to keep pace with productivity growth.

The same corporations that want
to off-load invesment risk onto the Russian government are the same corporations that have increased the income gap in the US.

Mr. Summers continues:

These economic and political trends are and should be of great concern to the business community as well as to policymakers. They have led to populist policy proposals that cut against the grain of the market system by, for example, limiting free trade agreements, restricting outsourcing or limiting the ability of successful companies to expand.

After calling for a return to a more progressive tax system, noting some of the effects of corporate tax shelters and transfer pricing (the shifting of profits to low tax states and costs to high tax states) on smaller businesses and the common man, Mr. Summers suggests:

Much more can done in a range of areas, from disclosure of executive compensation, to ensuring that the government leverages the volume of its purchases, to making financing of education at every level more equitable, to making sure that businesses continue to take responsibility for their workers’ healthcare costs.

I, for one, am not sanguine about the prospects of a voluntary quick shift in commercial corporate mind-set. Mr. Summers calls for fairness will likely go as unheeded as President Hoover's calls for Volunteerism when the last experiment in Globalization run aground.

If history is a guide, that means, after a period of economic decline and growing popular resentment of corporations, that we can expect a shift back to more state controls on corporations and towards greater national self-sufficiency.

And that might not be such a bad thing.

Monday, December 11, 2006

Divide and conquer hits a snag in the Gulf

BBC: Officials from Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE also urged a peaceful settlement to the crisis over Iran's nuclear programme.

The six Arab states said they were exploring the possibility of creating a shared nuclear programme.

The worst outcome for those in the west who wish for continued domination of the Middle East is a unified whole. If the GCC takes Iran's view on nukes, and begins to actively question Israel's nuclear arsenal, the game gets a whole lot more complicated.

Even Saudi King Abdullah can feel the heat: Our Arab region is besieged by a number of dangers, as if it was a powder keg waiting for a spark to explode.

A new Middle East indeed.

Saturday, December 09, 2006

The irony of War

While reading what seemed to me a heart felt cry of anguish from a man trapped in hell, A Soldier's Story, I came across the passage reproduced below. I wonder if the author intended the irony? For is he not also a victim of deception? Are there not greedy and immoral men who kill for money while pretending to be religious, skillfully manipulating people's anger at each other, on both sides of this war?

Last night the Iraqi Army captured Ibrahim's cell leader and brought the two together in the same small room. For Ibrahim, this was a very traumatic moment, for he saw that the pious Muslim man, whom he followed but had not met, was in fact a 27-year-old tattooed common criminal. Ibrahim began to weep when he realized he had been deceived. A greedy and immoral man who killed for money while pretending to be religious had skillfully manipulated Ibrahim's anger at Americans. Before Ibrahim was turned over to the Iraqi authorities, I saw him teaching soldiers to use their new office computer. He was helping them to type up his own written confession. But Ibrahim's transformation is an anomaly. Such a confluence of peaceful events does not often turn an insurgent away from the insurgency. Most insurgents continue to fight the hated American soldier whom they have never met. Their hope is that the American soldier will just go away.

In Greek mythology, one of the followers of Ares, the God of War, is Oblivion (along with Pain, Panic, and Famine). Many who discover they have been used to commit atrocities will seek it.

Friday, December 08, 2006

From high above the ground: Stephen Roach on Globalization

Picture a bright blue ball just spinning, spinning free
Dizzy with eternity.
Paint it with a skin of sky, brush in some clouds and sea
Call it home for you and me.
A peaceful place or so it looks from space
A closer look reveals the human race.
Full of hope, full of grace, is the human face.
But afraid, we may lay our home to waste.
There's a fear down here we can't forget
Hasn't got a name just yet
Always awake, always around
Singing ashes, ashes all fall down.
John Perry Barlow

I can remember the first time I took a round-the-world business trip: business class seats, corporate charge card, first class accommodations, great meals, drinks in the evening and lots of meetings, passing of business cards and smiling.

It's a great way to do business.

But it's a horrible way to develop views on "the economy."

Ideas like globalization seem great while reading at 30,000ft with a nice cocktail, just served by an attentive stewardess, on the arm of your business class seat. I too was as enthralled with the idea as Stephen Roach seems to be when I was jet setting around.

Consider this passage from his latest report, Global Lessons: Notwithstanding the jet-lag and sleep deprivation, there’s nothing like the sheer exhilaration of peering into the inner sanctum of globalization. The more I travel the world, the less convinced I am that our “win-win” theories do this mega-trend justice. Nor do I believe that we should measure progress on the road to globalization by fixating on the quantitative metrics of surging cross-border flows of trade, capital, and information. In the end, globalization is more about the assimilation of shared values of a still very diverse world.

nothing like the sheer exhilaration of peering into the inner sanctum of globalization. And he's right. For people in his business, he is at the top, like a major league baseball player who just had his name called as a starter in the World Series.

Unlike baseball, however, which seeks only to entertain, these businessmen are, in theory at least, supposed to make the world a better place for the many. Sadly, it seems to me, from reading this and other panegyrics of his on globalization, that the beneficial end result of this incomplete experiment is assumed, which is usually a poor tactic when one is doing something new, and poorer still when it has been tried and failed.

Despite the facts of the last attempt, of which he is aware, Mr. Roach seems somewhat surprised at, in his words: the persistence of “localization” -- nations that remain more caught up in self-interest rather than in the collective benefits of an integrated global economy and world financial markets.

How foolish of national leaders to worry about the people in their nation at the expense of my jet-setting, er, um....I mean, the collective benefits of an integrated global economy.

In my view, these arguments of global utopia seemed more reasonable a century ago, before it had been tried and failed, disastrously. Perhaps he is right, but the only data we have suggests otherwise.

Einstein famously defined insanity as doing the same things and expecting different results. As trade tensions rise, military conflicts emerge and imbalances mount, the current experiment seems to me to be following a familiar path.

Perhaps this is tough to see from high above the ground.

Thursday, December 07, 2006

The heretical oil weapon...then Autarky

One of the firmaments of neo-liberalism is the primacy of markets. The First Commandment of that faith might go something like: Markets are the ultimate arbiters of supply and demand truth and they shall not be toyed with. All shall accept the market price, for it is good.

Those who have seen the curious ways in which currency crises unfold or have read books like Perkins' Confessions of an Economic Hit Man are likely apostates to the faith. Markets and prices (and supply and demand) can be and are manipulated by the powerful.

I'm (hopefully) not writing anything new here.

One reason I bring up neo-liberalism is that it stands as the guiding philosophy behind globalization- the vision of an infallible market that will guide producers and consumers around the world in a wonderful global economic harmony.

Or at least it would if the powers that be could manage to stay in the shadows with their interventions and reasons therefore. But such is not the case.

President Bush recently shared his fear of "extremists and radicals" gaining control of oil and using that as a weapon.

Nawaf Obaid (a recently fired) advisor to the Saudi government suggested that one way to control the rise of Iran was to drive the price of oil down and thus drastically reduce Iran's (and Russia's and Venezuela's to boot) supply of currency. Steve Clemons of TheWashingtonNote has also heard similar rumblings so I guess Mr. Obaid isn't alone is his view, firing or no.

Going back a bit further, some have accused Russia of using natural gas as a weapon against the Ukraine.

These are heretical statements against the guiding philosophy of globalization. If nations are going to use markets and prices against other nations, i.e. engage in overt economic warfare, the whole experiment in once again trying to make the world safe for supra-national corporations will end much like the last one.

The thing about globalization as opposed to more self-sufficient (autarkic) models of political economy is that it leaves nations much more vulnerable to economic warfare in much the same way that a family with a garden, some trees to burn and one income is less vulnerable than a family with 2 computer programmers earning money.

Specialization is only great when your specialty is in demand.

As one who thinks a shift towards greater national, and even regional self-sufficiency (note that I wrote, shift towards, not copy North Korea) might be a good thing, I'm watching these heretical to neo-liberalism statements with some interest. The more talk there is about overt economic warfare, the more obvious a shift back towards some degree of self-sufficiency will become.

ps One other point about overt economic warfare, it doesn't begin and end with oil. Who knows, maybe somebody will get the bright idea to start buying up all the loose Gold in the world, and then see what happens to the US$, the IMF and the major US banks.

Olmert just says ISG

Israel brushes off Iraq report, no to Syria talks
TEL AVIV (Reuters) - Israel's prime minister on Thursday said it was wrong to link the Arab-Israeli conflict with woes in the Middle East and ruled out any immediate talks with Syria despite a U.S. report urging negotiations.

Wednesday, December 06, 2006

ISG Report: a step in the right direction...but what about the oil?

Our country deserves a debate that prizes substance over rhetoric, and a policy that is adequately funded and sustainable. The President and Congress must work together. Our leaders must be candid and forthright with the American people in order to win their support. Iraq Study Group: Letter from the Co-Chairs

"What a novel idea," I thought to myself while reading the above excerpt, "using honesty to win support." And there is quite a bit of forthright discussion about the military situation in Iraq contained in the report, and some of the consequences of failure.

Credit where credit is due, this report seems to me to be a big step in the right direction. Of course, considering the starting point, it didn't take much to move forward.

The "major news" sound bite from Robert Gates' confirmation hearing as Secretary of Defense- We're not winning in Iraq- pretty much sums up the pre-ISG sentiment.

Whoa...we're not winning?

If that sound bite was a surprise to you, you might find the military assessment in the report fairly chilling.

The situation in Iraq is grave and deteriorating
Attacks against U.S., Coalition, and Iraqi security forces are persistent and growing. October 2006 was the deadliest month for U.S. forces since January 2005, with 102 Americans killed. Total attacks in October 2006 averaged 180 per day, up from 70 per day in January 2006. Daily attacks against Iraqi security forces in October were more than double the level in January. Attacks against civilians in October were four times higher than in January. Some 3,000 Iraqi civilians are killed every month.

And the assessment of the oil sector is not much brighter.

Iraq produces around 2.2 million barrels per day, and exports about 1.5 million barrels per day. This is below both prewar production levels and the Iraqi government’s target of 2.5 million barrels per day, and far short of the vast potential of the Iraqi oil sector.

Pleasantly surprised at this turn towards honesty, I took a look at the recommendations and almost fell off my chair.

To put it simply, all key issues in the Middle East—the Arab- Israeli conflict, Iraq, Iran, the need for political and economic reforms, and extremism and terrorism—are inextricably linked.

This view, if adopted, would be a huge shift in US policy. Previous attempts by Middle Eastern governments to link resolution of the several facets of Arab-Israeli discord to other negotiating items have been flatly refused.

Here's the first President Bush on linkage:

On the other question, I simply want to see us avoid what is known as linkage. And I think the American people more clearly see now what I mean by linkage because they watched the `Aziz press conference where the whole question was shifting -- trying to shift the onus away from the aggression and brutality against Kuwait and move it over and try to put the blame on Israel or try to shift the onus to the Palestinian question.

Again, it remains to be seen whether this view will be adopted, but it would be a significant carrot to offer at the negotiating table.

Of course, the Israelis would have to go along, and I wouldn't put my money on that development.

The willingness to discuss linkage and the rather candid assessment of the military situation were the positive aspects of the report, in my view.

On the less than candid, and thus, in my view, negative side, lies the discussion of oil.

The executive summary barely mentions oil, except to note that recommendations have been made. One has to go beyond the summary to discover them.

So I did.

The United States can begin to shape a positive climate for its diplomatic efforts, internationally and within Iraq, through public statements by President Bush that reject the notion that the United States seeks to control Iraq’s oil, or seeks permanent military bases within Iraq. However, the United States could consider a request from Iraq for temporary bases.

Hmmm, this sounds reasonable. The US doesn't want to control Iraq's oil or want permanent military bases.

But wait, earlier in the report I find this statement: Along with this military presence, the United States is building its largest embassy in Baghdad. USAToday described this "massive" embassy: The 104-acre complex — the size of about 80 football fields — will include two office buildings, one of them designed for future use as a school, six apartment buildings, a gym, a pool, a food court and its own power generation and water-treatment plants.

Seems like a permanent base to me. And I'm sure the Iraqi government will be persuaded to ask for a few more temporary bases.

Turning to oil, maybe the US doesn't want to "control" Iraq's oil.

What the US wants is to profit handsomely from oil exports, while a centralized Iraqi Oil company does the work.

The fear expressed in the report is: The politics of oil has the potential to further damage the country’s already fragile efforts to create a unified central government. The Iraqi Constitution leaves the door open for regions to take the lead in developing new oil resources. Article 108 states that “oil and gas are the ownership of all the peoples of Iraq in all the regions and governorates,” while Article 109 tasks the federal government with “the management of oil and gas extracted from current fields.” This language has led to contention over what constitutes a “new” or an “existing” resource, a question that has profound ramifications for the ultimate control of future oil revenue.

Apparently the use of euphemism and misleading language is not under US monopoly.

Senior members of Iraq’s oil industry argue that a national oil company could reduce political tensions by centralizing revenues and reducing regional or local claims to a percentage of the revenue derived from production. However, regional leaders are suspicious and resist this proposal, affirming the rights of local communities to have direct access to the inflow of oil revenue. Kurdish leaders have been particularly aggressive in asserting independent control of their oil assets, signing and implementing investment deals with foreign oil companies in northern Iraq. Shia politicians are also reported to be negotiating oil investment contracts with foreign companies.

Whoa, the natives are going to sign their own oil deals, sidestepping the central government, and by virtue thereof, us. This aggression, to quote the elder President Bush, cannot stand.

Thus Recommendations 28 and 63:

RECOMMENDATION 28: Oil revenue sharing. Oil revenues should accrue to the central government and be shared on the basis of population. No formula that gives control over revenues from future fields to the regions or gives control of oil fields to the regions is compatible with national reconciliation.

The United States should encourage investment in Iraq’s oil sector by the international community and by international energy companies.
• The United States should assist Iraqi leaders to reorganize the national oil industry as a commercial enterprise, in order to enhance efficiency, transparency, and accountability.
• To combat corruption, the U.S. government should urge the Iraqi government to post all oil contracts, volumes, and prices on the Web so that Iraqis and outside observers can track exports and export revenues.
• The United States should support the World Bank’s efforts to ensure that best practices are used in contracting. This support involves providing Iraqi officials with contracting templates and training them in contracting, auditing, and reviewing audits.
• The United States should provide technical assistance to the Ministry of Oil for enhancing maintenance, improving the payments process, managing cash flows, contracting and auditing, and updating professional training programs for management and technical personnel.

Here's a conundrum. If regional leaders in Iraq are already signing deals to develop oil fields, why does the US have to encourage investment in Iraq's oil sector?

I'm also wondering about the meaning of "control" because recommendation 63 seems to me an awful lot like what I would consider to be "control." If providing
technical assistance to the Ministry of Oil for enhancing maintenance, improving the payments process, managing cash flows, contracting and auditing, and updating professional training programs for management and technical personnel isn't control, what is?

A few revealing omissions from the ISG report are:discussion of Production Sharing Agreements or the details of the Paris Club and IMF agreements with Iraq. The need to reach the euphemistic "milestones" was mentioned quite a bit but just what they were was not.

And this is the heart of the matter.

While there were other considerations, the US went into Iraq to gain some degree of control and profit from Iraq's Oil sector. And thus far, this aspect of the adventure has been a failure.

The only group who wanted central control of Iraqi oil were the Sunni, who were overthrown. If the Shia and/or the Kurds start signing contracts and exporting "new discovery" oil while the US imposed Central Government in Iraq is stuck doling out revenues from "existing" oil fields, this war will indeed, be, as Ret. General Odom has opined, the greatest strategic disaster in US history.

Some might wonder what I think the market impact of this will be.

I don't know, is my best guess.

But if pressed I think any relief over steps in the right direction will be short lived.

Having thrown out the issue of linkage, the Israelis will have to get on board or the plan will look as stillborn as Sec. of State Rice's New Middle East.

Moreover, it looks to me that the US is negotiating from a position of weakness, and that is a tough position in the great game. Additionally, the lack of forthrightness on the oil issue suggests to me that the prize is still desired.

The only way I can see the United States emerging from this fiasco without its tail between its legs is to give up on squeezing profits from the oil sector. If we can reproduce the sensabilities that led to the formation of Saudi Aramco, we just might be able to stay and play. If we try to impose and steal I think we are doomed in the region for a few generations.

All of which reminds me of the wisdom of the Powell Doctrine, which, paraphrased, means, don't start a fight unless you KNOW you can win and win big.

Tuesday, December 05, 2006

Archimedes and the carry trade

I'm in the midst of reading the works of Peter Dale Scott- a most enjoyable experience as the depth of the research is matched by the quality of the prose. Thus I'll take the easy way out today and present an internet exchange on carry trades and leverage some might find interesting.

Give me a lever long enough and a fulcrum on which to place it, and I shall move the world. Archimedes

A friend of mine recently expressed his concern over the prevalence of carry trades, and their reputed effects, in the FX and interest rate markets.

I responded that the problem, in my view, wasn't the carry trades themselves but the leverage used therein.

After a bit of to-ing and fro-ing, my friend asked: When the BOJ sets rates at 0% and the FOMC sets them at, say, 5%, doesn't this ultimately cause a net creation of credit into the system (albeit temporarily) which sets up an arbitrage system guaranteed (engineered) for those with access to that rate differential?

To which I responded: Yen and the US$ are two different currencies. They represent two very different sets of assets and liabilities. Selling Yen and buying US$s carries substantial risks: 1) inflation in the US is far higher (another way of saying that real rates are not so far apart as the nominal difference suggests) 2) the c/a position is reversed. If the currency market began to fear, say, capital controls, the Yen would rise very quickly vs. the US$.

This sense of "free money" via the carry trade, was, in my view, what tore the GBP out of the ERM in 1992. (It was also a prominent feature of the Asian crisis, when people sold YEN or even US$s to earn much higher Thai or Indonesian rates) Just as today, when investors are sure that the BoJ won't allow the Yen to strengthen too much, allow the US$ to fall too much, or that in such an event THEY COULD HEDGE (the flaw in the Black Scholes option pricing formula) investors in the early 90s were sure that the BoE and BBK would keep the GBP/DEM cross rate within the ERM band. Thus one sold DEM and bought GBP to earn the carry, assured that THE EXCHANGE RATE WOULD NOT MOVE ADVERSELY AGAINST THE POSITION.

In the event this view proved false. GBP were not DEM.

Today's currency carry trade investors will discover the same truth. YEN are not US$.

These trades, by the way, are not creators of credit. Credit can be created when banks that fund, say, hedge funds, allow them to trade with leverage, which was my original point.

Do you keep all your cash as cash? or do you look to place it in vehicles that provide more income? Thus you might sell cash, and buy a CD, or a bond, or even a foreign currency CD or Bond, hoping to earn the greater carry but not suffer the risk of investing in a different instrument. Thus you might have "carry trades" in your portfolio. But you do it without leverage, which allows you to keep a much cooler head.

Imagine trying to trade Gold with leverage of say 20 to 1. As we both know, it isn't fun to watch Gold lose 20%-30%, but at 20-1, 5% is death. Thus the craziness when rallies start to fade and roll over.

The problem arises when an LTCM has US$2B under management and US$100B in positions, lent them by banks, most of which seeks to arbitrage what they perceive to be "free money". Thus a 5% move in the underlying position, like the YEN/US$ exchange rate, wipes them out. A 20% move starts to make the banks who allowed the leverage, nervous, which is, in part, where the "contagion effect" comes from.

In most currency crises I've witnessed the problem was leverage; within the banking system itself, and/or the wider financial sector. Leverage always starts out by damping volatility only to increase it dramatically when unwound, as it must, so long as man confuses himself.

My guess is that you are imputing to the phrase "carry trade" a far wider range of events than the true meaning of the phrase denotes. A great many writers in the financial press do the same thing, which may be where your sense of the phrase arose.

But your "radar" for bad smelling things seems quite intact. Just as the equity mania smelled bad, (and was made far worse because of leverage) and the housing mania smelled bad (and was made far worse because of leverage-10% down is 10-1) so too do some of the cross currency carry trades smell bad. These trades are bad news, because there are no free lunches, at high leverage, they often cause crises.

On the plus side, such crises are when we get our pay day for owning hard currency.

I wonder if Archimedes ever imagined the world that would eventually be moved was the financial world.