Top of the Pops
A quick note on yesterday’s long column. On the back of the napkin calculation on foreign ownership, I included foreign bond ownership as though it were securities so the figure is much, much lower than just under 8% (probably more like 2ish%). But it is important to flag that foreigners aren’t buying US Treasuries much anymore in net terms and are moving into Chinese bond issuances for return, a dynamic that poses similar issues in terms of macroeconomic management, but very different ones for internal credit risks linked to financial asset values. My apologies.
US oil output is finally recovering from its low base as prices remain higher overall despite having fallen off pre-OPEC+ meeting highs. Per the latest EIA release, output is up 500,000 barrels a day in the last month putting a little more pressure on OPEC+’s pricing calculus. Rigs are climbing and even more importantly rig efficiency is now at all-time highs after drillers spent last year gaming out how to best generate more positive cashflow to return money to Wall Street (h/t to Rory Johnson at Commodity Context):
Platts is expecting another 360,000 barrels a day to come onstream this year and 940,000 next year at US shale plays. Even if they’ve reached peak productivity, that’s a decent chunk of the remaining OPEC+ output cuts. The losses from hedging will eventually ease and the big uptick in efficiency makes the relative cost of drilling another well lower, also rendering traditional metrics like drilled but uncompleted wells not quite as helpful for assessing the direction of travel in terms of net output. Seems like the market’s misunderstanding the significance of shale once again. It doesn’t have to grow past 2019 to derail the tenuous pricing balance built into Russian and Saudi targets. It just has to chip away at any supply shortfall while the bump in developed market demand slows — US gasoline stocks unexpectedly rose yesterday, for instance, and developed markets are likelier to sink public money into activity that ends up destroying future demand than most emerging markets.
What’s going on?
Here’s some food for thought — a poll conducted by the University “Synergy” (I’m looking into the background more too) found that 45.1% of Russians want the state to manage inflation by using price control measures similar to those in the USSR. 20.1% support direct price-setting for goods in stores. 96.2% have noticed rising food prices. Setting aside that these kinds of polls can be a bit pushy and it’s not like many of these people necessarily understand the internal dynamics and problems with a Soviet-style system for price management, it does suggest that the government won’t necessarily lose public support over its various market interventions despite their general ineffectiveness. Right now, Levada polling shows slightly more people aren’t happy with government action than happy with it (50% vs. 47%):
I’m curious to see how this social dynamic plays out with business lobbies. If the public is fine seeing the state slap business around and blame it for these problems and public dissatisfaction with falling or stagnant incomes mounts amid higher inflation, the political incentive is to slap business around. The investment pressure campaign speaks to that problem. The more they do so, the more likely they are to reinforce stagnation without some sort of demand stimulus or else rising investment could create competition between sectors and further bid up prices. In other words, the Kremlin and political technologists have built a political coalition that can justify mismanagement as much as it rewards competence.
In positive news, Russia’s GDP consensus forecasts are trending upwards for 2021-2022. In bad news, the composition of growth might not be as rosy past the burst from US stimulus and reopening(s). The question is will real wages and real incomes keep pace with price increases since the positive indicators for demand have been debt-led and concentrated among those who’re better off and investment indicators are still riding the short-term bump from the annual February-March peak in the budget cycle and the recovery in oil prices. The following is % annual growth:
The restrictions on travel are actually propping up growth — in an open borders scenario, Russian tourism outflows cost the balance of payments $15-20 billion (1.1-1.48. trillion rubles) most of which could otherwise be spent domestically. The new consensus for 2021 around 3.5% is 0.3% from MinEkonomiki’s recent upwards revision, and I suspect the consensus is as positive as it is because of the imbalances within the Russian economy — the current COVID wave and potential further waves until the population achieves collective immunity have a much larger impact on domestic goods and services demand whereas exports, many of whom are still seeing higher prices, will keep going strong.
This is more off the beaten path than usual but a great intervew from Novaya Gazeta on the work done by Earthsight uncovering Russia’s largest illegal logging operation in Irkutsk oblast’ and common illegal practices. 15,000 hectares of forest were illegally logged under the guise of a “sanitation harvest” — when loggers take down strips of forest to ward off insects and disease that might spread — and then sold to IKEA. Effectively, loggers regularly get around logging bans with local prosecutors and authorities by claiming it’s all done in the name of maintaining the health of forests. Whereas deforestation globally is primarily a result of agricultural enterprises for the production of beef, palm oil, and soy, BCG and the World Wildlife Fund found in a study that in Russia it’s forest fires and illegal logging that are to blame. Irkutsk oblast’ has accounted for about 12% of forests slated for sanitation harvests in the last decade, with that figure rising to 17% in some years. Translation: loggers and the network around former regional minister for the forestry complex Sergei Sheverdu were cutting deals in violation of competition requirements — firms bid to “rent” state-owned land for cutting and clearing and are supposed to be completely transparent — and loggers never even bothered to bring in a forest pathologist to determine whether or not a sanitation harvest was necessary. Topping it off, the fines assessed for violations are far, far smaller than the value of the timber felled, perpetuating the cycle of land misuse. I grabbed this because it’s a good example of not only how institutional dysfunction and capture by business interests exploiting rents from public property — not at all an exclusively Russian phenomenon — interact with the incentives in a political economy built around the export of natural resources in a system where the state and individuals simultaneously act to extract maximal value for themselves. If they finally launch the state timber export monopolist, then the state will be contracting volumes of timber to sell abroad from individuals exploiting the state forestry ministry and regional authorities. It’s a fantastic example of the ouroboros logic of really-existing state capitalism in Russia, especially when commodity prices rise.
The lack of demand for Russian sovereign debt continues. Coverage continues to blame US sanctions and the expectation of key rate hikes — I’m sympathetic to the latter point but find the invocation of the former needs more nuance mostly state banks that were buying from abroad anyway. Non-residents just sold off another $4.5 billion in Russian bonds, but 85% of those were corporate which suggests that it’s about the Russian economy — Congress isn’t talking sanctions and the White House would need another trigger to justify more action. Yesterday, MinFin offered 40 billion rubles ($538 million) worth of OFZs and only 14.2 billion rubles ($191.28 million) were snapped up. Non-residents have completely abandoned the primary market, hence my comment about state banks. The inability to use deficit financing parallels the beginning of cuts to expanded social spending and support linked to last year’s spending surge. Health spending has been cut 13% despite the current wave, the social budget has been cut 4.8% YTD, and regional transfers are down with the biggest winners are big infrastructure projects thanks to a roughy 500 billion ruble ($6.73 billion) increase in spending on the national economy. But overall, MinFin’s talk of a budget surplus for 2022 has gone from rhetoric to action at precisely the moment the state has to spend money to convince resident investors and non-resident investors alike to actually buy its sovereign debt. Incoming rate hikes and high inflation are definitely scaring off interest, but both could have been better managed with a larger state stimulus spend doing stuff like buying commodities at the beginning of the crisis to form state reserves that could then be released over time or, like China did, buying oil cheap and then releasing or else reselling it as prices. Wholesale benzine prices are now at historic highs because of the effects of tax reform efforts to encourage refinery modernization coupled with imbalances in supply availability and occasional incentives to export — the damping mechanism helps refiners or vertically-integrated firms financially, but isn’t great at making sure enough fuel is available. The next rate hike will probably draw more interest in, we just don’t know if and when inflation’s peaking yet.
COVID Status Report
25,293 new cases and another record 791 deaths were recorded in the last day. Based on the breakdown of reported deaths now shown by RBK to distinguish Moscow and St. Petersburg from the rest of Russia, the overall infection rates are likely worse than official data suggests unless Delta is actually deadlier than other variants:
Red = Russia Black = Moscow Purple = St. Petersburg
Based on the official data, the R is estimated at 1.08, which isn’t crazy. But the case fatality rate keeps climbing — in late December/early January it was in the range of 1.7-1.8%, climbed further, and now has reached 2.47% which I think implies a higher rate of infection for the whole time, though the current surge would be terrible for anyone older who isn’t vaccinated. Pilots are now lobbying to have access to foreign vaccines to help manage the health protocol issues that inevitably arise as borders are opened and quarantine and vaccination measures finalized to try and bring back tourism in Europe and elsewhere. Promoters are pushing for “COVID-free” concerts using QR-codes, vaccination certificates, or negative PCR tests within 3 days of the event to let people in. These adaptations will probably help push up vaccinations. Waiting for more on how the rollout of foreign vaccines goes.
Dude, where’s my carbon tax?
Finally, after months of bad punditry and the slog of political projections and constant hopes for better, we have a roughly agreed $3.5 trillion Democratic reconciliation bill to pair with the $579 billion bipartisan “hard” infrastructure bill. It seems that the European experiment sorting out a Carbon Border Adjustment Mechanism (CBAM) has finally rubbed off on the American policy conversation. Thanks to Rachel Ziemba catching and posting on Twitter, I saw the New York Times’ writeup of Democratic plans that included a vital new policy mechanism: an import tariff (or tax) for goods from countries that lack sufficiently aggressive climate change policies. As Rachel noted:
We don’t yet know what the final US policy specifically aims to achieve, only that it’s called a “polluter import fee.” It’s easier for Democrats to rally around an external carbon pricing mechanism than a domestic carbon tax for a variety of fairly straightforward political reasons, as well as the legacy of Trump’s trade wars and the Left’s parallel efforts to torpedo the Trans-Pacific Partnership and its Trans-Atlantic cousin TTIP. Let’s start with jobs — manufacturing is still the 5th largest employer by sector in the US proving jobs for 11.9 million people. Consider the political map as well. I mocked up the following using NAM’s data to show % share of Gross Regional Product for states and 2020 employment, focusing on politically vital states for Democrats to win seats in and for the 2024 presidential election with significant industrial sectors. I used 2020 data despite it being an outlier for employment since politics is always relative and about the latest reference point, not past trends. We’d often see higher relative shares for state output in past years as well as higher employment despite the relative resiliency of goods production last year since US exports took a much larger hit whereas imports were sustained via stimulus effectively:
Any viable path to retaining power in Washington given the Republican Party’s in-built electoral advantage requires more of the union manufacturing vote that went for Trump in 2016 and 2020, many of whom voted for Obama and most of whom are better off economically than many of their neighbors given sectoral wages. These manufacturers didn’t actually benefit from Trump’s tariff wars, but that was also because of a lack of fiscal stimulus and business incentive to reshore supply chains. The current disruptions taking place during reopening as a result of last year and businesses’ struggle to stay afloat over the last 18 months have led many to reconsider the value of sourcing their inputs nationally, thus avoiding the risks from border closures or interruptions to very long supply chains. Trump worsened manufacturing output with the economic policies his administration put in place despite the labor market heating up for lower wage workers by 2019:
That coalition was hoping he’d help, and while many stuck with him in 2020, that was as much a result of the Democratic Party’s cumulative messaging after 2016 blaming white working class voters in key states like Ohio for being racists rather than examining much larger questions of political coalitions built on material interests alongside the observed rise of identity as a focal point for politics. That identity approach can’t adequately explain why in Ohio and Pennsylvania, more union households voted Republican than Democrat despite past support — Trump won 57% of Ohio union households in 2020. They matter again. Using import fees on pollution in concert with a more clearly delineated industrial strategy and business environment that supports businesses thinking hard about supply chain resiliency make sense as Democrats struggle to hold together a voting coalition laden with contradictions facing an unfair electoral map.
As this policy shift moves forward, there’s more scope for Washington and Brussels to coordinate policies. That’s a huge problem for Russian exporters since they can’t rely on the lobbying power of American industry to unintentionally help their cause contesting EU policy shifts. The updated CBAM product list from the European Commission includes aluminum (and alloys), iron, steel, products made from them, fertilizers, cement, and electricity. A MinEkonomiki review of the updated proposal puts annualized export earnings losses at $7.6 billion. That’s not fatal but a lot of money that’s sorely needed for investment purposes. And the problems aren’t just coming from American Democrats cobbling together voters for 2022 and 2024. China’s emissions trading scheme launches tomorrow, covering the 2,225 coal and gas-fired power generating plants across the country. The scheme only applies to the thermal power sector for now, and will be expanded slowly over time when other sectors like steel and nonferrous metals now experimenting with pilot schemes are deemed ready. The current price level from pilot schemes has been a miserly $6.20 a ton, way less than anything seen in Europe. All firms that emitted more than 26,000 tons of CO2 in any single year between 2013-2019 will eventually be added.
There’s little cause to assume Beijing intends to move quickly and jack up carbon prices, nor are Chinese authorities happy with EU carbon tariffs and presumably now the potential for similar mechanisms from the US. The EU and US absorb most of China’s goods exports and the interplay between US trade deficits, legacies of EU austerity, and China’s refusal to accept slower but healthier growth rates will take a hit from these tariffs if applied. We can see now that while China’s domestic economy appears to be slowing down, its exports are rising again and again unbalancing recovery:
In Moscow, there’s still a lack of clarity about the scale of the investments and change in fiscal and regulatory approach needed. The decarbonization strategy will be quite useful when it drops since MinEkonomiki was adamantly against a domestic carbon tax last fall with a carbon trading scheme potentially more aggressive in practice. Indicators are, however, that as pro-inflationary pressures are seen to be easing by the Central Bank, the demand to return to budget surplus is again eating into grand investment plans. MinTrans has slashed its expenditure plans through 2030 from 45-54 trillion rubles ($607.5-729 billion) to 29.3 trillion rubles ($395.6 billion). Every bit of smart infrastructure investment can help ease the strain of emissions reduction. Based on past experience from 2012 when a similar level of spending was announced through 2020, there’s no evidence these plans will be realized no matter how much carbon pressure builds up geopolitically.
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