Monday, October 10, 2011

Thoughts on Europe

Honestly, I am too busy with more important matters to write much on Europe, through my recent perusal of the Economist on the eurozone crisis could provide sufficient material for another post criticizing the Economist.

John Cochrane's opinion piece summarizes my views best. However, I wish to write them in my words.

On the policy front, I can not help but think that the problem boils down to:

  1. No credibility that Greece will be able to pay its bills, and hence an inevitability of default;
  2. Greece can not inflate its way out because it has no control over monetary policy (I'm shedding tears that they default on a payment plan via inflation... not really);
  3. Eurozone banks that loaded up on Greek bonds because of the tempting yields and no need to hold capital against those bonds per Basel II capital requirements now are caught with their pants down because they do not have a capital buffer for defaults (honestly, doesn't that sound like the regulators giving a subsidy to eurozone nations by incentivizing banks to buy government debt, creating an artificial demand that reduces the interest rate those sovereign nations needed to pay to issue their debt?);
  4. Funnily enough, no one has mentioned the insurance companies, but they likely hold government bonds too. They likely have some capital to charge off against, but they will still be affected.
  5. "Those who do not remember history are doomed to repeat it," or This Time is Different syndrome: 2000-2007 was abnormal insofar as there was a paucity of sovereign defaults. We're really regressing to the mean, which was inevitable because of the stupidity/corruptness of politicians
  6. Unlike prior default periods, because people suffered from This Time is Different syndrome and the regulators made matters much worse by not requiring any capital be set aside to back purchases of government bonds, the financial system is much more exposed to systemic risk, ironically the thing regulators are supposed to prevent.

There is probably more to it, but that is what I am able to discern.

I can not help but analogize this to the United States and California though. Why? Let's say that California had an excruciating amount of debt which it could not service. Naturally, it can not inflate its way out because it uses the U.S. dollar for its currency as part of its currency union with the rest of the United States. Naturally banks and insurance companies across the U.S. will have some Californian bonds in their liquidity portfolios or insurance float, and hence a Californian default will eat into their capital and hurt them.

But the U.S. dollar itself won't be hurt by a Californian default - it will still be used in the currency union. California can still pay its debts in U.S. dollars as long as their government enacts austerity measures. If it does not, California can restructure and continue paying in U.S. dollars, but at higher rates.

So the U.S. dollar would not necessarily be threatened by a Californian default. But it would likely be if California was bailed out, because nationalizing Californian debt would add to inflationary pressures on the U.S. dollar since the federal debt would go up.

That to me is the Greek situation - a Greek default will be painful because the regulators created systemic risk. However, the euro itself, the currency, would not be threatened by this systemic risk unless a bailout occurred because of the added inflationary pressure of "Europeanizing" this debt.

So ultimately, my thoughts are that the government was instrumental in creating this mess. To believe that they can fix the system when their prior fixes destabilized the system is to continue to run an experiment proving the definition of insanity.

N.B. I sincerely hope that the Slovakian parliament can not reach a compromise on endorsement of expanding the eurozone bailout fund. Besides the fact that it is highly irresponsible of Europe to expect poor Eastern European nations to bailout a wealthier neighbor who could not control its spending, I clearly think a bailout will be worse for the system than letting the default occur, the banks which have bad assets to be hit, and people needing to learn the hard way that "this time is not different."

Of course, I'm not a European, so why should I care?

Stupid Environmentalists...

Over the past year, I've become quite interested in the Canadian oil sector. I find the revolution in North American energy in general to be intriguing: fracking of shale gas resulting in a potential new normal of low prices for natural gas; the Alberta oil sands, and steam assisted gravity drainage (a friendlier extraction process for oil from the sands than current strip mining); and revisitation of light oil reservoirs with new technologies that can extract more oil from them than in the past (for example, some companies, like Crescent Point, believe that rather than a 5% oil recovery factor from reservoirs, new technology could lead them to have a 25-30% recovery factor).

I would think that with high oil prices, people in the United States would welcome such developments, since the majority of that oil will come here. Canada does not have the access built to ship that oil or the bitumen for processing, to Asia yet.

Of course, that does not account for the nutters in the environmentalist movement (actually, I consider them all to be rather inconsistent and illogical, but they have a right to free speech, so I get to enjoy the stupid gems that come out of their mouths).

For example, from the FT (full article):

Erich Pica, president of Friends of the Earth US, one of many environmentalist groups opposed to oil sands development, says: “Whether to approve this pipeline [Keystone XL, which will transport bitumen from Alberta, Canada, to the Gulf of Mexico, since Canada does not have enough refining capacity for the bitumen production expansion that is occurring] is the most important environmental decision President Obama will make before the election.

“If he sides with greedy oil companies instead of people and the climate, he will essentially be urging a huge part of his base to sit out the election.’’


First, those greedy oil companies:
  1. What's wrong with making a profit? That profit means that people value what oil companies produce.
  2. Oil companies are composed of people. They aren't magical entities of robots. So when you say "greedy oil company," do you stop to think of the insult to the hard working oil field workers, engineers, and yes, executives, that are producing a product that people want?
  3. Do they think of the people backing these oil companies, including hedge, mutual and pension funds? What about individual investors? In all likelihood, some of these environmentalists or their connections have a financial dependence on these companies doing well for their retirement portfolios to perform well. I suppose environmentalists are welcome to shoot themselves in the feet.
Next, the people:
  1. If oil companies are making a profit, that means that people want or need their product. So, to restrict access to that product means that the U.S. may have shortages of that product, driving up oil prices. Is that really friendly to the U.S. populace?
  2. There is no credible alternative for transportation, be it the short commute (or 2 hours, for me), or the college road trip, other than oil and natural gas (if you have a CNG vehicle). Even the electric cars coming on to the market in 2012 will have a capacity of 100-120 miles per charge. The technology has a long way to go. And if they think oil companies are deliberately slowing down electric technology development (which some environmentalists probably do think), they're even more idiots than I thought.
  3. Oil and natural gas are used for more than transportation. Other goods, such as fertilizer (we need to eat, after all) and plastics depend on those inputs. Depriving the U.S. of incremental Canadian oil would raise the prices for these other goods, both directly via higher input prices and indirectly via higher transportation costs. Is it really people-friendly to advocate that people be forced to spend more money to buy their basic necessities? 
  4. Again on transportation, if oil prices in the U.S. are higher due to less supply from Canada and a harder time getting supply from elsewhere (or maybe Canada sells to Asia, and then Asia turns around and sells back to the U.S., which certainly adds to the cost), then leisure for the U.S. populace became more expensive. You wanted to fly to Tahoe to ski? That'll be $100 more dollars per airplane ticket, thank you very much. If that's people-friendly, then I'm scared to know what's people-unfriendly.
Finally, the climate:
  1. Let's think about this. Canada is a developed nation with a sound rule of law, and respect for the environment, even in the corporate world. Do people really think that the Canadian government would let oil sands development occur without funds set aside to restore the land after the reserves are extracted? Maybe environmentalists do, but in that case, they are guilty of ignorance: according to Jeff Sundquist, CAD$1 billion in bonds have been posted to ensure environmental reclamation.
  2. Oil extraction in other countries we rely on, such as Nigeria, is a lot less friendly. If we do not get oil from Canada, our demand is likely not going to go down, so we'll need to get it elsewhere. Maybe we'll demand more then from other nations with laxer environmental standards, and inadvertently contribute to environmental destruction there? Wouldn't that be climate unfriendly? File that under the law of unintended consequences.
In my opinion, incremental Canadian oil will find its way to market, one way or another. Maybe it'll go to Asia. Maybe to the U.S. through a circuitous route. But it would be a damn shame to let environmentalists dictate our energy policy, as it seems they can not answer the question, "And then what?"