February 19, 2015 4:37 pm

Opec has ceded to the US its power over oil Price
Shale breakthrough will be a more effective market stabiliser, writes Alan Greenspan
Pump jacks are seen at dawn in an oil field over the Monterey Shale formation in California, US©Getty Images
Normal diplomacy probably could not have achieved the geopolitical outcomes that have been produced in the past year by America’s shale oil revolution. Oil prices have more than halved, which — coupled with the collapse of the rouble that stemmed from the turmoil in Ukraine — has gone a long way towards disabling the Russian economy. Cheap oil has weakened Iran’s economy, too, lifting the chances of a realistic nuclear agreement. Finally, oil-rich Venezuela was on the edge of default even before the oil price decline. This amounts to a marked change in the economic and geopolitical landscape, of which the main beneficiaries are the US and its allies.
At the root of the price collapse was the development in the US of techniques for extracting tight oil, mostly from shale deposits, by horizontal drilling and hydraulic fracturing. This reversed the decline in US oil production, adding 3m barrels a day since 2012. As a result, the gap between global production and consumption has widened, precipitating a dramatic rise in US and world inventories and a fall in prices. Saudi Arabia, confronted with an oil supply glut but not wishing to lose market share, abandoned its leadership role as global swing producer and refused to cut production to support prices.

After the oil embargo of the 1970s, Opec wrested oil pricing power from the US. But the shale technology breakthrough is likely to be a far more effective stabiliser of oil prices than the cartel of oil producing countries. Opec is now relinquishing its pricing power. It may never be regained.

The reason is that shale technology is far more flexible. Shale oil wells can come on stream faster than most conventional wells, and drain far more rapidly. More than half of the oil content of shale wells is run off in the first two years of operation, while conventional wells keep producing for 20 years or more. Thus, shale oil output can expand and contract more rapidly than conventional wells.

Unlike the production decisions of a monopolistic Opec, fluctuations in market prices will automatically guide shale expansion and contraction.

Recent oil price declines, of course, have given consumers considerably more purchasing power. Global consumer outlays are up markedly in the current quarter, but this will be partially offset by slowed capital investment in oil-producing countries this year and next. On balance, the impact of the oil price decline on global gross domestic product appears marginally positive.

India, a large crude importer, is among the countries to gain most from falling prices. So is Japan — which has been importing oil to replace the nuclear power capacity that was switched off after the Fukushima disaster in March 2011. China, the US and Europe have also benefited, to a lesser degree.
Brent crude prices fell to $45 a barrel in late January, down from $115 in June last year — though they have recently rebounded, to close to $60. Is this a temporary increase as traders cover their short positions, after which prices will resume their slide? The answer is likely to be found in the inventory statistics. For prices to rise, the gap between consumption and production must close.
So far, the heavy build-up of inventories of crude and petroleum products, and decline in the number of active drilling rigs, has not arrested the growth in US crude output.

A year ago, when prices were high, the conventional wisdom was that, at $60 a barrel, shale oil could not be profitable. Back then, incentives to cut production costs were a low priority; when each barrel was worth more than $100, the most important thing was to get it out of the ground. At today’s prices, cost-cutting is mandatory. We are about to find out whether shale producers, with their backs to the wall, can keep oil investment innovative and profitable.

The writer was chairman of the US Federal Reserve from 1987 to 2006

The Morris Massey Market

I first started working in the financial markets—as a clerk on an options exchange—in November of 1999.

Four months before the top.

So over the first three formative years of my career, stocks only went down, not up. Not only did they go down, but they went down relentlessly. Demoralizing everyone. Extinguishing all hope.

So, for pretty much my entire career, I have had a bearish bias.

Some folks in the financial media will really beat up on the bears. Don’t beat up on me! It’s not my fault. I was born this way.

If you had started trading from 2000-2003, you would probably be like this, too.

Shaped by Your Experiences

When I was eleven or twelve years old, I once rummaged through my mom’s VHS tapes and found something called What You Are Is Where You Were When. Sounded like a mouthful. So I sat in the basement of our tiny house and watched it.

The video was by a guy named Morris Massey, a business consultant/sociologist who made a living doing seminars and selling tapes about his particular brand of social psychology. His view was that you were pretty much a fully formed person by age 21, and you weren’t changing much after that. But who you were at age 21 was a product of your experiences in early childhood, middle childhood, and your teenage years.

It was based on events that happened to you, but also what was going on in culture and politics and sports and current events. For example, World War II had an indelible impact on “The Greatest Generation,” or for a more contemporary example, take the relationship between Millennials and technology.

Judging from the videos, Morris Massey was a pretty compelling guy. He’d get really animated and even angry in some parts as he told stories about what he called “significant emotional events,” things that have such a profound effect on you that they will literally change the course of your life.

I thought this was pretty fascinating stuff. Even at a young age, I was interested in social psychology. I ended up incorporating a large part of Dr. Massey’s message into my own worldview, especially as it pertained to markets.

Staying in Your Comfort Zone

So what kind of trader you are probably depends on what kind of market you started your career in. One of my bosses at Lehman was an options trader back in the ‘90s (and a terrific human being, too). Not only was he generally bullish, he was a natural optimist.

What he liked best was to just buy naked call options on stuff. Why not? It sure worked in the ‘90s. Volatility was underpriced, and markets only went up. Not so much in the 2000s, when markets went sideways and vol was more challenging. But he kept buying naked upside calls—it was what he knew how to do.

People who began their careers right before the crash of 1987 tend to think that a crash is always just around the corner. I have met a few of those guys.

Guys who got rich trading tech stocks in 1996-1999 are still trading tech stocks. Never mind that the world has moved on and we have since had bull markets in things like steel, railroads, chemicals, and emerging markets. They are still punting around profitless dot-coms.

I’m just a bear. I can’t help it. Actually, I try to help it—I try to step outside of my comfort zone and go long every once in a while. Last year, I bought Tesla and a couple of crappy Internet stocks because they were going up. I made a lot of money on that trade, but I hated every minute of it.

So here I find myself again at the crossroads. The market is breaking out to new highs, and I am underinvested. The reality is that I should probably get with the program and buy stocks, because they could go up for 20 years or more.

As you can see from the chart, the stock market can go up for long periods of time between major bear markets. You can look around and find evidence of froth if you look hard enough—I wrote about Silicon Valley last week—but as far as bubbles go, this is junior varsity stuff. However, if you grew up trading in a crash—and then, eight years later, the market crashed again, you tend to see bubbles wherever you look.

Like I said, it’s not my fault.

I think it’s worth pointing out that it’s been long enough since the financial crisis that you have a new generation of traders who have not yet seen a bear market. And they might not, for a long time. Maybe the next major bear market will come in 2030, when all the codgers who lived through the last one are gone. That is usually how it Works.

Cycles of History

Of course, the way to get around ending up as one of Morris Massey’s textbook examples is to really study your history. But that’s laborious. And you can look at old charts, but they don’t tell the whole story.

If you’re 26 years old, how do you really know what it was like in 1999, when the whole country was day-trading tech stocks? You don’t. I’m turning 41 soon, but I really don’t know what it was like in the leveraged buyout (LBO) boom of the late ‘80s. I can read about it, but I will never really understand, not having lived it.

It’s not a coincidence that the Global Financial Crisis happened about 75 years after the Great Depression. Everyone who could have warned us about what was going to happen was dead.
Sure, there is plenty written about the Great Depression in the history books. And plenty of people have read it. But it’s not the same as living it.

Direct participation in the stock market is at all-time lows. All-time lows, even with the market at all-time highs! Think about what will happen to the stock market when everyone decides that it’s safe to get back in the pool.

To the moon, Alice.

Jared Dillian
Editor, The 10th Man

ECB risks crippling political damage if Greece forced to default

If Greece defaulted, the German people would discover instantly that a large sum of money committed without their knowledge and without a vote in the Bundestag had vanished

By Ambrose Evans-Pritchard

8:54PM GMT 18 Feb 2015

Municipal police officers take part in a protest in front of the Greek parliament in Athens

Anybody who thinks the loan package forced on Greece in 2010 was fair treatment should read the protests by every member of the IMF Board from the emerging market nations Photo: Reuters
The political detonating pin for Greek contagion in Europe is an obscure mechanism used by the eurozone's nexus of central banks to settle accounts.
If Greece is forced out of the euro in acrimonious circumstances - a 50/50 risk given the continued refusal of the creditor core to acknowledge their own guilt and strategic errors - the country will not only default on its EMU rescue packages, but also on its "Target2" liabilities to the European Central Bank.
In normal times, Target2 adjustments are routine and self-correcting. They occur automatically as money is shifted around the currency bloc. The US Federal Reserve has a similar internal system to square books across regions. They turn nuclear if monetary union breaks up.
The Target2 "debts" owed by Greece's central bank to the ECB jumped to €49bn in December as capital flight accelerated on fears of a Syriza victory. They may have reached €65bn or €70bn by now.

A Greek default - unavoidable in a Grexit scenario - would crystallize these losses. The German people would discover instantly that a large sum of money committed without their knowledge and without a vote in the Bundestag had vanished.
Events would confirm what citizens already suspect, that they have been lied to by their political class about the true implications of ECB support for southern Europe, and they would strongly suspect that Greece is not the end of it. This would happen at a time when the anti-euro party, Alternative fur Deutschland (AfD), is bursting on to the political scene, breaking into four regional assemblies, a sort of German UKIP nipping at the heels of Angela Merkel.
Hans-Werner Sinn, from Munich's IFO Institute, has become a cult figure in the German press with Gothic warnings that Target2 is a "secret bailout" for the debtor countries, leaving the Bundesbank and German taxpayers on the hook for staggering sums. Great efforts have made to discredit him. His vindication would be doubly powerful.
An identical debate is raging in Holland and Finland. Yet the figures for Germany dwarf the rest. The Target2 claims of the Bundesbank on the ECB system have jumped from €443bn in July to €515bn as of January 31. Most of this is due to capital outflows from Greek banks into German banks, either through direct transfers or indirectly through Switzerland, Cyprus and Britain.
Grexit would detonate the system. "The risks would suddenly become a reality and create a political storm in Germany," said Eric Dor, from the IESEG business school in Lille. "That is the moment when the Bundestag would start to question the whole project of the euro. The risks are huge," he said. 
Mr Dor says a Greek default would reach €287bn if all forms of debt are included: Target2, ECB's holdings of Greek bonds, bilateral loans and loans from the bail-out fund (EFSF).
Markets remain relaxed. Yields on Portuguese, Italian and Spanish debt have been eerily calm. Investors are betting that the ECB could and would contain any fallout as its launches €60bn a month of quantitative easing, simply blanketing the bond markets of EMU crisis states.
This ignores the great unknown. Would the Bundestag or Holland's Tweede Kamer, or any creditor parliament, continue to let their national central banks supply unlimited Target2 credits to Latin bloc states via the ECB nexus once the system had blown up in Greece.

As a practical matter, the ECB itself would be in trouble. Any Target2 losses must be shared, according to the ECB's "capital key". The Bundesbank would take 27pc, the French 20pc, the Italians 18pc and so on, but these are uncharted waters.
"I do not believe that the Germans would allow the Bundesbank or the ECB to carry on with negative capital. They would demand recapitalisation and consider it a direct loss to the German state," said Mr Dor.
If so, Chancellor Merkel would face an ugly moment - avoided until now - of having to go to the Bundestag to request actual money to cover the damage. Other forms of spending would have to be cut to meet budget targets.
Syriza's leader, Alexis Tsipras, holds a stronger hand than supposed, and he is not shy in playing it. His speech to the Greek parliament on Tuesday night was flaming defiance. "We are not taking even one step back from our promises to the Greek people. We will not compromise, and we won't accept an ultimatum,” he said.
"There is a custom that newly-elected governments abandon their election promises. We intend to implement ours, for a change," he said, basking in approval from 82pc of Greek voters.
The new Greek plan to be submitted to Brussels is scarcely different from the proposals already rejected by the EMU finance ministers on Monday. The elemental demand is that there must be no further austerity. This has not changed.
The Eurogroup insists that the primary budget surplus be raised from 1.5pc of GDP in 2014, to 3pc this year and 4.5pc next year. As Nobel economist Paul Krugman says, they want to force a country that is already reeling from six years of depression - with the jobless rate still near 50pc - to triple its surplus for no other purpose than paying off foreign creditors for decades to come.

They are doing to Greece what the Western allies did to a defeated Germany at Versailles in 1919: imposing unpayable and mutually-destructive reparations on a prostrate nation.
The fear of the Northern bloc is that austerity discipline will collapse across southern Europe if Greece wins concessions, but collapse is exactly what is needed for Europe to escape from a debt-deflation trap and prevent a second Lost Decade.

"It has become an ideological battle over austerity. Conservative governments want to ram though their retrenchment policies whatever the cost," says Sven Giegold, a German Green MEP.
Many of the attacks on Syriza are caricature. Athens is not taking on more public workers. It is rehiring 3,500 people "unjustly fired", offset by reductions elsewhere. "On privatisation, the government is utterly undogmatic," said finance minister Yanis Varoufakis.
"We are ready and willing to evaluate each project on its merits alone. Media reports that the Piraeus port privatisation was reversed could not be further from the truth," he told his Eurogroup peers.

What Syriza will not do is carry out a "firesale" of assets at giveaway prices in a crushed market.

Talk of a debt write-off is a red herring. The Greeks are not asking for it. Mr Varoufakis wants a bond switch to "GDP-linkers" tied to future economic growth rates. He would probably settle for lower interest payments by stretching maturities.
The issue that matters is the primary surplus. Do the creditors wish to risk an EMU break-up and all that could follow in order to extract their last pound of flesh regardless of history's verdict?
Anybody who thinks the loan package forced on Greece in 2010 (with the collusion of the Greek elites) was fair treatment should read the protests by every member of the IMF Board from the emerging market nations. With slight variations, all said Greece needed debt relief from the outset, not fresh loans that stored greater problems. All said the bail-out was intended to save foreign banks and the euro itself at a time when there were no EMU defences against contagion, not to save Greece.

"The scale of the fiscal reduction without any monetary policy offset is unprecedented," said Arvind Virmani, India's former representative to the International Monetary Fund, according to leaked minutes. "It is a mammoth burden that the economy could hardly bear. Even if, arguably, the programme is successfully implemented, it could trigger a deflationary spiral of falling prices, falling employment and falling fiscal revenues that could eventually undermine the programme itself." This is exactly what happened.
Jean-Claude Juncker, the European Commission chief, implicitly recognises that Greece has a legitimate moral claim on Europe. He is quietly helping Syriza, just as France is quietly helping to shift the balance in the Eurogroup. The united front against Greece is a negotiating posture. It will fray under pressure.
Whether the EMU powers can resolve their own deep differences before Greece runs out cash - within a week, reports Ekathimerini - is an open question. Francesco Garzarelli, from Goldman Sachs, said he is "more worried" now than at any time since the start of the EMU crisis.

"The risk of a miscalculation in the negotiations remains high and will peak between now and month-end. Should Greece drop out of the single currency, the risk would become systemic. We doubt that even the major markets would be unaffected," he said.
On balance, and with little conviction, my view is that Chancellor Merkel will ultimately overrule the debt collectors and will yield in order to save Germany's 60-year investment in the diplomatic order of post-war Europe. It is a view shared by German eurosceptics such as Gunnar Beck, a legal theorist at London University.
"Germany's leaders can't let Greece leave the euro, and the Greeks know it. They will die in a ditch to defend the euro. This is our Eastern Front, our Battle of Kursk, and I'm afraid to say that it will end in unconditional surrender by Germany," he said.

February 18, 2015 6:58 pm
Keeping Greece in the euro is about far more than money
The price of Athens staying within European order is probably worth paying, writes Marc Chandler
When European leaders talk about Greece they speak the language of economics, no matter what their mother tongue. I am a financial analyst, and I know that language well. Still, it seems to me that the continent’s politicians have chosen the wrong lingua franca. Geopolitics, far more than economics, is what is at stake. The cost of a blunder would be incalculable.
Recall that, as recently as 2013, EU officials were negotiating a trade association deal with Ukraine. No doubt diplomats were aware of the geopolitical ramifications of this endeavour; indeed, ushering Ukraine into the EU was seen in many quarters as a long-term goal. But Brussels, absorbed in the technical complexities of an agreement to open markets, may have taken its eye off the strategic situation.

Russia’s actions in Ukraine would always have been difficult to foresee. But the lens of economics was the wrong one to choose, as diplomats scouted out the lie of the land. This is a mistake that Europe cannot afford to repeat in Greece.

Finance ministers are debating Athens’ demands for a loan that would tide the country over until June, allowing time to negotiate a permanent solution for Greece’s economic woes. The sums involved are large, and the Greek demands raise questions about the monetary and macroeconomic framework of the entire eurozone. They should not be agreed too hastily. But these issues, important though they are, should not blind politicians to Greece’s outsize geopolitical significance.

This is a country that bridges north and south, and east and west, like no other. It forms Nato’s southern tip. And the relationships it enjoys with Russia, Iran, China and others are unique within the alliance. Even if keeping Athens securely inside the European political and security order were to come at a high price, it is one that is likely to be worth paying.

Greece is responsible for securing a large and volatile part of the EU’s external border. This role is only likely to become more important, given the conflicts unfolding in north Africa and the Middle East.

The country’s strategic importance as a gateway to Europe has grown — even as its economy has shrunk by a quarter. It is one of the few eurozone countries that meet their Nato commitment for military spending (because of which, incidentally, it ranks among the most important customers of German and French weapons makers).
Politicians elsewhere in Europe are understandably concerned that their taxpayers will be made to pay for Greece’s past fiscal profligacy. But they should also remember that the country’s valuable contribution to the common defence of Europe goes largely uncompensated.
Events in Ukraine have shaken those in Europe who once took for granted that the postwar territorial settlement would be respected by all its neighbours. In what promises to be a protracted western confrontation with Russia, the geostrategic assets represented by Greece are irreplaceable.

Yet European leaders persist in discussing Greece’s financial position as if its geopolitical allegiances were immutably settled. Events may yet prove them right. But it is a risky bet. It would be a tragedy if a narrow-minded analysis of the situation led them to place that wager accidentally.

If the game of brinkmanship now unfolding between Athens and other European capitals leads to Greece’s leaving the eurozone, the costs will be far more serious than unpaid debts and economic stresses.

Mario Draghi, the president of the European Central Bank, has said he will do everything it takes to save the euro. Europe’s politicians should be willing

to do far more to keep Greece in the euro, and squarely in Europe’s political order.

The writer is global head of currency strategy at Brown Brothers Harriman

Op-Ed Columnist

The Cost of a Decline in Unions

Nicholas Kristof

FEB. 19, 2015