The West’s Unilateral Cold War

Sergei Karaganov

The video screen shows the Kinzhal shipborne surface-to-air missile system as Putin delivers an annual address to the Federal Assembly

MOSCOW – Rising tensions between the United Kingdom and Russia are but further proof that Russia and the West, according to no less an authority than Richard N. Haass, President of the Council on Foreign Relations, have entered a “Cold War II”. I tend to disagree.

Yes, Russia’s relations with the United States, and now also with the UK, are worse than in the 1950s, and the chance of a direct conflict is higher than at any time since the 1962 Cuban missile crisis. Given the complexity of today’s strategic nuclear weapons and the systems designed to neutralize them, one cannot rule out the possibility that some actor on either side, or a third party, could provoke escalation.

Making matters worse, communication between US and Russian leaders is all but nonexistent, owing to the lack of trust on both sides. Among Americans, feelings toward Russia verge on something close to hatred, and many in Russia now regard Americans with ill-concealed disdain.

This psychological backdrop to the bilateral relationship truly is worse than during the Cold War. But that does not mean that today’s tensions amount to a sequel. Such a confrontation would require an ideological component that is decidedly lacking on the Russian side.

Russia has no intention of waging another Cold War. Although some degree of confrontation with the US does help President Vladimir Putin unite the public while burnishing Russian elites’ nationalist credentials, Russia is not an ideologically motivated state. What ideology it does have is based in Russian culture and civilization, which it is not interested in exporting.

The Kremlin in fact prefers not to proselytize on Russia’s behalf. Russia’s approach to international affairs has long centered on respect for national interests and sovereignty, and the belief that all peoples and nations should have the freedom to make their own political, economic, and cultural choices. Russia also embraces universal human values such as trust in God, family, and country, as well as self-fulfillment through service to society and nation.

I dream of the possibility that even 2% of the accusations concerning Russian “interference” in the 2016 US election prove true. It would bolster my self-esteem as a Russian, while educating Americans – whose government has long interfered in other countries’ internal affairs – about the dangers of throwing stones from a glass house.

But the problem between Russia and the West is really a problem among Westerners themselves. The US establishment is using the scarecrow of Russian interference to regain its lost political control, particularly in the realm of social media, where a discontented population and maverick politicians have finally found a voice.

But even if American elites do manage to wrest back control, the deeper source of Western angst will remain. For at least the past decade, the world has been witnessing the endgame of the West’s 500-year hegemony. It started in the sixteenth century, when Europe developed better guns and warships and began its imperial expansion. In the following centuries, Europeans would use their economic, cultural, political, and especially military dominance to siphon off the world’s wealth.

For a few decades in the second half of the twentieth century, the West’s dominant position was challenged by the Soviet Union and China. But after the Soviet Union imploded, the US emerged as the sole hegemon, and the world seemed to return to its historic status quo. Soon enough, however, the US overextended itself by plunging into geopolitical misadventures like the invasion of Iraq. And then came the 2008 financial crisis, which exposed the weaknesses of twenty-first-century capitalism.

At the same time, the US has long pursued military superiority. In 2002, it unilaterally abrogated the 1972 Anti-Ballistic Missile Treaty. And, more recently, it has embarked on a massive build-up of conventional forces and a large-scale modernization of its nuclear arsenal.

Still, Russia, China, and the rest of the world won’t allow a return to US hegemony. Putin recently made this clear by unveiling a number of new, cutting-edge strategic weapons systems, as part of what I would call a strategy of “preemptive deterrence.” The message was that the US cannot hope to regain absolute military superiority, even if it decides to bleed itself dry in an arms race, as the Soviet Union did.

Preliminary assessments that my colleagues and I recently carried outsuggest that even if the US decides to wage a unilateral Cold War, its chances against Russia, China, and other emerging powers would not be very good. The balance of military, political, economic, and moral power has simply shifted too far away from the West to be reversed.

Nonetheless, a new Cold War, even if largely one-sided, would be extremely dangerous for humanity. The world’s major powers should concentrate on strengthening international strategic stability through dialogue; reopening channels of communications between militaries; and restoring civility to their interactions. We should also consider establishing more diplomatic, legislative, academic, and educational exchanges. Most of all, though, we must stop demonizing each other.

The world is entering a dangerous period. But if we are wise, we can build a more balanced international system, one in which the major powers will deter one another while cooperating to solve global problems. Smaller countries, meanwhile, will be freer to develop according to their own political, cultural, and economic preferences.

The previous, Western-led system has collapsed. To ensure a peaceful future, we need to start working together to build a new one.
Sergei Karaganov is Dean of the School of International Economics and Foreign Affairs at the National Research University Higher School of Economics in Moscow, and Honorary Chairman of Russia’s Council on Foreign and Defense Policy.

Warning signal on US borrowing costs is a red herring

While a widening in a key spread does not portend doom, other indicators need watching

Bhanu Baweja

Dollar funding for banks is tightening, but not exceptionally so in the context of a rise in yields on government bills

Perhaps because it reflexively takes us back to an unhappier time, there’s a strong sense of disquiet about the rising gap between the dollar Libor rate, at which banks borrow from one another, and the overnight indexed swap (OIS) rate, a gauge of the future Fed Funds.

Having risen 35 basis points over the past six months, this spread, now at 50bp, is about to break through the highest levels recorded during the European peripheral scare of 2011. It has historically been viewed by investors and policymakers alike as a reliable indicator of the health of financial plumbing. But its widening today should not portend the dark spell of the past.

To understand why, it is useful to decompose the Libor-OIS spread into three parts: the Treasury bill (T-bill)-OIS spread, the commercial paper (CP) to T-bill spread, and Libor to CP spread.

At least two-thirds of the move in Libor-OIS has been driven by a widening in the T-bill-OIS spread. Dollar funding for banks is tightening, but not exceptionally so in the context of a rise in yields on government bills, widely considered the risk free rate of the world. T-bill yields have risen particularly sharply since early February, when the US Congress agreed on further fiscal spending. Supply is at play here, not rising credit risk.

The remaining widening in Libor-OIS is explained by the widening in the CP-T-bill spread.

Large corporations fund themselves in this CP market, and their funding became dearer to T-bill rates after US money market reform of 2016. This required the pricing of institutional money market funds investing in CP to move to floating Net Asset Value, shrinking the set of investors who held these instruments. As secured T-bill rates have risen since, unsecured CP rates have climbed with a modestly higher beta. This is a new reality of the market microstructure; again, not a credit issue.

Finally, the spread between Libor rates and CP rates is, if anything, tighter than where it has been in previous Fed hiking cycles. In all, Libor is rising in tandem with T-bill and CP rates, not because financial institutions are becoming more wary of one another.

Signs across different asset classes echo this message. Subordinated debt issued by subinvestment grade financial institutions trades close to its strongest level. US equities are up on the year, with financials outperforming. The premium for funding in dollars, as tracked by the cross-currency basis swaps, barely shows a tremor. US financial conditions remain in the loosest quartile of their distribution of the past 10 years.

So, access to funding isn’t changing, the price of funding is. It isn’t the same thing. The price of funding is changing by design; the Fed is raising rates to keep the US economy from overheating. But, reduced access to funding, especially for able borrowers, would constitute tightening by accident, and must induce the Fed to stop dead in their tracks, and potentially to reverse course. We are very likely to find out at the Fed meeting on Wednesday that isn’t the case.

Does the price of funding not matter at all, then? It most certainly does. It can fundamentally alter market trends. But instead of Libor-OIS widening, which is likely a red herring, we need to focus on the right channels to detect signals of a change in the investment opportunity set.

First, watch the hit from yields to floating rate high yield credit and leveraged loans. We estimate floating rate loans to US borrowers at $2.2tn, nearly half of which have been extended to issuers rated below BB-. Our analysis shows that leveraged loan issuers will remain resilient to the next 75-100bp increase in Fed Funds rates, but could see their interest coverage ratios reaching dangerously low levels beyond that.

Second, watch US growth surprises relative to those in the rest of the world. Widening front end rate interest rate differentials will become more meaningful for currency trends if mirrored in growth differentials. It’s worth paying particular attention to the relative economic cycles of US and China. The EM complex, particularly EM currencies, thus far in a Zen-like calm, may begin to show signs of fatigue if China growth softens against a backdrop of higher US rates. Risks become more elevated as we approach US Trade Representative Office’s report on intellectual property rights.

Third, and perhaps most importantly, watch term premium in the US bond markets. Investors have been worried about the impact of higher rates, but US rates volatility itself hasn’t risen yet, and isn’t likely to unless term premium rises. A change here could mean a sell-off in the US bond hits other assets classes harder and quicker.

Much as one must now prepare for the music stopping, it is important not to overreact when history rhymes for unrelated causes. It’s often said in jest that policy is fully equipped to fight the last crisis. Somehow that’s a reassuring thought today.

Bhanu Baweja is the deputy head of macro strategy at UBS Investment Bank

China uses economic muscle to bring N Korea to negotiating table

Data reveal how Beijing has drastically cut exports of key materials to Pyongyang

James Kynge in London

Kim Jong Un with China's Xi Jinping during the North Korean leader's visit to Beijing this week © AP

China virtually halted exports of petroleum products, coal and other key materials to North Korea in the months leading to this week’s unprecedented summit between Kim Jong Un, the North Korean leader, and his Chinese counterpart Xi Jinping.

The export freeze — revealed in official Chinese data and going much further than the limits stipulated under UN sanctions — shows the extent of Chinese pressure following the ramping up of Pyongyang’s nuclear testing programme. It also suggests that behind Mr Xi’s talk this week of a “profound revolutionary friendship” between the two nations, his government has been playing hard ball with its neighbour.

“China has effectively turned off the petroleum taps flowing into North Korea,” said Alex Wolf, economist at Aberdeen Standard Investments and a former US diplomat in China. “From the data available . . . it appears that the North Korean economy is under a great deal of pressure and this has undoubtedly contributed to North Korea’s change in policy.

“It is Chinese ‘maximum pressure’ that may be bringing a change in North Korean policy.”

Since its September test of a nuclear weapon, North Korea has launched a highly unusual series of diplomatic forays. Mr Kim’s sister, Kim Yo Jung, was dispatched to the Winter Olympics held in South Korea in February. Mr Kim then shocked many by inviting Donald Trump to a summit — an offer that the US president accepted. Following the visit to Beijing this week, North and South Korea announced a historic summit scheduled for later this month.

Debate has swirled over the motivations behind North Korea’s shift in strategy. Some analysts believe that Pyongyang has achieved its nuclear and ballistic missile goals and now wants to negotiate recognition as a nuclear power. Others say that it is seeking detente with South Korea to weaken the US alliance structure. In the US, some attribute Mr Kim’s new approach to pressure from Mr Trump’s White House.

But evidence of a partial Chinese export freeze adds a further perspective. Official Chinese statistics show that the monthly average of refined petroleum exports to North Korea in January and February was 175.2 tons, just 1.3 per cent of the monthly average of 13,552.6 tons shipped in the first half of 2017.

The level of reduction went far beyond the 89 per cent cut in petroleum product exports stipulated by the UN sanctions.

Chinese coal exports to North Korea were also cut to zero in the three months to the end of February, after running at a monthly average of 8,627 tons in the first half of 2017. Exports of steel ran at a monthly average of 257 tons in the first two months of this year, down from a monthly average of 15,110 tons in the first half of 2017.

Shipments of motor vehicles also dried up, with just one unit being exported in the month of February, official Chinese statistics show. Concerns over the accuracy of China’s statistics are common, but analysts said that such consistent and bold drops in export volumes are unlikely to have been the result of official massaging.

It is more likely, analysts said, that Beijing is seeking to remind Pyongyang of the economic leverage it wields over North Korea as Mr Kim prepares his diplomatic forays. A senior Chinese official, speaking anonymously before Mr Kim’s diplomatic flurry, said that Beijing wanted to bring Pyongyang to the negotiating table.

It is important that the US and other countries realise that Pyongyang’s objective is not aggression but to win security guarantees for North Korea, the Chinese official said, adding that North Korea had in the past shown a willingness to negotiate but US inflexibility had precluded progress.

The evidence of China’s strong sanctioning of North Korea stands in contrast to Beijing’s longstanding policy of resisting US pressure for stiffer restrictions on economic engagement with North Korea. In one example, Mr Xi told former US president Barack Obama in 2016 that North Korea had little to lose from sanctions, such was the poverty already in the country.Mr Wolf said: “China wants to play a central role in resolving this crisis, but it wants to do it on its own terms.”

Price Reflexivity - What's It Going To Take For People To Wake Up To The Potential Of Higher Oil Prices For Longer?

by: HFIR

- Market participants are still using lower for longer oil price scenario as a base case.

- We explain why oil prices have to move to a level where the bull thesis can no longer be ignored.

- Our view is that this will happen when WTI reaches $80/bbl, or our upside target for 2018.

- The thinking is that Saudi, knowing full well the depressed sentiment, will shock the market in the second half of 2018 via lower exports.

- This will put upward pressure on Brent, which would widen Brent-WTI spread and result in higher US crude exports.
We are strong believers in the theory of reflexivity. In our opinion, George Soros’s theory of reflexivity is the most important behavior/economic/market theory ever created.
The theory of reflexivity states that market participants do not act on the reality of fundamentals, but the perception of fundamentals. Price itself is the catalyst for positive or negative behaviors.
Pain Capital, a contributor to HFI Research, wrote a piece on this titled, “Knowing When The Trend Is Your Friend, Lessons From Soros.” The write-up was about Soros’s observation on the dollar, and that the dollar was moving not based on fundamentals, but the perception of fundamentals.
Another example that was given by Soros was on the savings and loan crisis in the 80s and how the perception of positive fundamentals fueled a higher price to book ratio for many SNLs, which fueled higher value accretion through share issuances, which fueled even higher share prices. As Soros explained, this is why markets go through boom-bust cycles and never according to the laws of supply and demand or any academic economic theories, and why the markets are never truly efficient.
Taking the theory of reflexivity into heart, we can see how the oil price move from $26 to $60 hardly impacted investors' perception of the oil market fundamentals. This is true because in 2014, WTI was trading over $100/bbl, and we are only at $63/bbl today.
In our view, this is where price reflexivity has to come in. If the theory of reflexivity holds, and if price itself is the catalyst to changing fundamentals rather than fundamentals, then we will need sharply higher oil prices to shake the markets out of the “lower for longer” paralysis.

How high do oil prices have to go to shock the market out of its complacency?
We think oil prices have to move to a level where no one can no longer ignore just how bullish fundamentals are. Our thinking is that it will be when WTI reaches above $80/bbl.
Now, this does not imply that energy stocks will not move higher from $63 to $80/bbl. No, far from it, but for there to be multiple expansions in energy stocks, we need the price reflexivity to shake the consensus out of the complacency. This means that the real move in energy stocks won’t come until the perception of oil changes from one that will be “lower for longer” to a “shortage is coming.”
Why is this perception change so important?
The Barron’s energy roundtable piece really allowed us a glimpse into the minds of market participants. While we had hunches on why energy stocks weren’t moving higher, the roundtable solidified our key assumptions.
The general market sentiment is that US shale will keep oil prices lower for longer, but this theme needs to change to, “we need all the US shale growth we can get because we are headed for a shortage.”
This sentiment change is also vitally important for the Saudis because the Aramco IPO valuation is dependent on investor perception of oil prices in the long term rather than the fundamentals of the company. And as we have highlighted numerous times in the past, the relative performance chart of XLE to SPY overlapped to WTI does not give the Saudis any comfort in the valuation of Aramco:
This is why we believe the Saudis will aim for a shortage in the second half of 2018…
Combining our variant perception take in section 1 of this WCTW and our theory of price reflexivity, we believe that Saudi will aim for a shortage in the second half of 2018. This also aligns with the comment Khalid al-Falih made recently that ROPEC should aim for an overtightening in the oil markets rather than scuttle the deal too early.
How will we see the shortage develop?
The second half of this year is when oil demand will be at its highest. IEA is still forecasting ~1.4 million b/d of oil demand growth in 2018, and despite a track record of perennially underestimating oil demand, the market continues to read and believe IEA’s analysis. This year will be the first year since the global financial crisis that we see global synchronized growth, and our view is that oil demand growth will be 1.9 million b/d with most of the increase coming in the second half of this year.
If Saudi does intend to push the markets into a shortage territory, then we will see Saudi exports move even lower in the second-half of this year. Why? Because Saudi’s domestic demand will increase, which will put more pressure on exports.
Saudi’s latest crude exports came in right around ~7 million b/d, and we have reasons to believe that this will fall to 6.3 to 6.5 million b/d. This decrease of 500k b/d to 700k b/d will put more upward pressure on Brent prices, which will translate into an even higher Brent–WTI spread.
If this forecast turns out to be true, we think US crude exports for the second half of 2018 could average 1.8 million b/d.
This is what US crude storage would look like if US averaged 1.8 million b/d:
And all the while US crude storage falls, US shale production will be on the rise prompting the sentiment shift of, “Look at storage decline even though shale production is on the rise. Are we headed for a shortage?”
This sudden sentiment shift from “US shale will keep oil prices lower for longer” will turn into “we need all the US shale growth we can get.” Simultaneously, the second half of this year is when Permian producers will face issues with takeaway capacity, so we could see well completion growth stall and translate into slower month-over-month production growth. This will further heighten the market’s awareness that we could be headed for a “shortage”.
If a shortage is what we need, then a shortage is what we will get...
Market participants remain complacent over the view that oil prices will stay “lower for longer”. The theory of reflexivity states that the price itself can be the catalyst that changes the perception of fundamentals. In the case of the oil markets, we think oil prices will need to climb above $80/bbl to start making analysts and investors question whether the thesis of “lower for longer” holds any ground.
To make matters worse, we believe that the market needs to change the mindset that “shale will keep prices lower for longer” to “shale is needed for the market to avoid a shortage.”
We believe the underperformance in energy stocks perfectly illustrate the prevailing sentiment bias, and as our section 1 of this report states, most energy investors remain agnostic to oil prices, and all one needs today is a view on oil prices to outperform.
Combining this observation with Saudi’s incentive for a $2 trillion valuation in Aramco, we believe that Saudi will use the excuse of higher domestic oil demand in the second half of 2018 to lower crude exports even more to prompt a shortage in the oil markets. This will then be reflected via higher Brent – WTI spread, which will boost US crude exports higher. In our scenario, if US crude exports average 1.8 million b/d for the second half of 2018, US crude storage will end at the same level as it was in 2014, or when WTI was over $100/bbl.

Is this extreme scenario, what’s needed for the crowd to start believing in “higher for longer” rather than “lower for longer”? We think so, and the theory of reflexivity works both ways. If a shortage is what we need, then a shortage is what we will get.

In Geneva, Extreme Luxury Takes the Floor


The new 2018 Phantom VIII is the first car built on what Rolls-Royce calls its new Architecture of Luxury, a high-strength aluminum chassis. This twin-turbocharged V12 leviathan has a starting price of about $450,000. Credit Martyn Goddard/Corbis, via Getty Images       

Even the most common cars offer the luxury of transportation, providing reliable and quick travel, assuming traffic cooperates. But while many brands will also get you to your destination in luxury, few will glide you there as if you were the queen.
Most people will never ride in a Rolls-Royce or Bentley, the English brands long associated with royalty and extreme wealth, or actually ever see one. But on the floor of the Geneva International Motor Show, the brands will be showing the public what all the fuss is about.
The fuss begins as soon as you sit down in one of these cars. The scent of wood, the lamb’s wool carpet and supple leather fills the interior. Doors shut smoothly, powered of course. Foam filled tires ban noise, as do hundreds of pounds of acoustical material built into the cars.
Rolls-Royce wheel hubs always display the RR logo upright, even in motion. If you find yourself in drizzly London or Seattle, look for the umbrella slot in the door frame when exiting. You’re welcome.

You’ll choose from a dozen or so paint colors, perhaps four interior treatments and a smattering of option packages.
The jump from the luxury level to ultrapremium is a huge financial and emotional leap, filled with decisions. Think building a house with an architect. In this strata, the old chestnut “what money really buys is choice” could not be truer.
In Geneva, the brands plan some surprises.
Rolls will be unveiling a feature that will allow owners to display art in their dashboard, and on the floor will be three different Phantoms. Bentley will be revealing the plug-in Bentayga Hybrid S.U.V. Also on the floor will be a Bentayga V8, Continental GT and the Flying Spur by Mulliner.
The average Bentley sells for $250,000, a Rolls-Royce $375,000. Rolls, which is owned by BMW, offers about 60 leather options and about 30 variations of wood. Ponder over 64 standard paints choices and several dozen custom hues. In total, a library of 44,000 colors are available.
Still on the fence? Shades can be customized.
“Some clients are very decisive when choosing the paint and interior, others can take months,” said Mark Maakestad of Bellevue Bentley-Lamborghini-Rolls-Royce in Washington State.
“Many of these cars are rewards for selling off a company or a milestone in life. They want to get it right.”
It is possible to Lyft to a Rolls showroom and drive off in a Wraith that’s in stock, but customization is what uber luxury is about.   

Thorsten Franck, a product designer for Rolls-Royce, who has done work on the Gallery.                    

The sky’s the limit. Literally. Starlight headliners that recreate the night’s sky with pinpoint lights in the ceiling are standard in a Rolls-Royce Phantom and optional in most others. Astrology buffs can even customize it with the exact mapping of the heavens on the day and place where they were born.
Motorists tend to be happy with real wood trim and stitching on the instrument panel. Phantom VIII owners will soon have the pleasure of gazing upon the Gallery, the new dashboard feature being unveiled in Geneva. It’s a glass panel that arcs fully across the dash, behind which owners can have commissioned art placed.
Have a small Picasso you cannot travel without? This is your ride. Imagine the delight of kindergartners to find their artwork immortalized in Mom’s Phantom instead of the refrigerator. Rolls will connect clients to artists working in ceramics or oil paint if they lack classic art, or children.
Gerry Spahn of Rolls-Royce says a few cars wander into the seven figures when a client’s demands turn exotic. It might mean custom sheet metal.
“Each of our cars is unique with 80 percent of them bespoke historically,” he said. “We had an Asian buyer who wanted 464 diamonds lacquered into the wood interior trim. Silver or gold specks can be embedded in the paint. We had a client specify diamond dust in the paint. 

     The Continental GT will be on the floor of the Geneva motor show.                    

Rolls engineers took two months figuring out the process of keeping the finish smooth.

Matching the paint to a husband’s wedding cummerbund or wife’s signature lipstick is possible. In the Britain, Bentley said that a buyer cut off the salesman’s tie for use as a color swatch, saying it was his perfect exterior color. Interior stitching can be specified to color, length and width. If a buyer’s favorite tree is felled by lightning, its veneer can be installed to keep its memory alive.
Chartreuse door panels with mauve leather seats are possible, but the manufacturer may put its foot down. Jeff Kuhlman, chief communications officer of Bentley Americas, said: “We can do anything, but we don’t do everything. There was a gentleman who wanted ostrich leather seating, and we could provide that. Another wanted snakeskin, but we felt it wasn’t durable enough for our standards.”
Safety and government regulations can also hinder customization. Mr. Kuhlman said an Asian customer requested a glass dashboard enclosure to display his finest whisky. This was rejected because the airbag could have launched the spirits into the front passenger.

Stuart Robinson, a semiretired real estate investor of Snohomish, Wash., said that he and his wife, Jane, fell for a 2017 Rolls-Royce Wraith Black Badge with its striking rear-hinge doors.
“I’m in the garage a couple times a day and walking toward the Wraith, I get the feeling of, oh my gosh, I can’t believe I own it,” Mr. Robinson said. “It just makes me wish for the next dry day to drive it.”