The Power and the Money

Stating the obvious about the tariffs on Mexico

I am union-bound to say this, I suppose. The Mexican tariffs are stupid.

First, they will not achieve their stated goal, which is to get Mexico to stop Central Americans from arriving at the U.S. border. Consider what the Mexican government is currently doing:

1. Inviting Central Americans to stay in Mexico. The problem there has been that the Trump administration does not believe that Central Americans will stay in Mexico. Rather, it believes that legalizing their presence in Mexico only makes it easier to get to the border. Under pressure, the Mexican government suspended its visa program after 13,000 applied. But Mexico has allowed Central Americans to apply for asylum from Mexico, as the Trump administration wanted. 
2. Arresting and repatriating Central Americans: 29,660 in the first two months of 2019, about the same as the 29,239 average for those months in 2016, 2017, and 2018. President Trump actually thanked AMLO for this just last month. Through May, Mexico has detained 72,410 migrants and deported 53,371. That is less than the 340,944 Central Americans the CBP detained so far this year, but it is a substantial number. It is far from clear that Mexico could do better given the limited resources available to the Mexican government. 

Second, if the administration sticks to the plan, it will be an own-goal for President Trump. The tariffs on China are bad enough, but companies can adapt and the economy is strong enough to withstand them. Moreover, they are politically popular. Tariffs on Mexico are a different story. These are tariffs that will mess with supply chains. Alonso de Gortari (Princeton) recently calculated that 30% of the headline value of Mexican manufacturing exports to the U.S. consists American exports to Mexico. So they not only hits American consumers, they punch American producers as well. Plus, President Trump can kiss goodbye any chance of ratifying the USMCA. There are cheaper ways to keep immigration on the front burner for 2020, which I presume to be the political goal. 

Third, the tariffs benefit China by taking Mexico off the table as a potential site. Manufacturing has been moving to Mexico from China for years now. The trade war would have accelerated that, at least a little. It is a good thing for America to have industry move next door. But now, well, not so much.

Finally, here is something that is not a problem for this administration: the loss of any credibility as a negotiating partner. Yes, China and Europe will take notice of how the U.S. told Mexico that all it had to do was renegotiate NAFTA but then turned around and screwed it anyway. But that is a feature, not a bug. The current administration intends to impose tariffs forever. Sure, the President will tack back and forth according to political pressures, temporary advantages, and his own strange ego. But the goal is clear, as we reported back in October 2018. Blowing up your credibility just makes it all that much easier to insure that you cannot win the trade wars that you start. 

I have to admit, however, that I think the administration is going to back down on this one. The logic of point (2) above is pretty clear. So put that down as a prediction ... albeit not one that I am particularly confident in. 

Dictatorship rising

In 2011, John Quiggin hypothesized that we were on the verge of eliminating old fashioned tyranny, “in the historical sense of absolute rule by an individual who has seized power, rather than acquiring it by inheritance or election.” 

I can understand his optimism. In the below photo, I am standing atop an abandoned monument to the absolute dictatorship of Enver Hoxha in Albania. There are a lot of former dictatorships in the world.  

But ...

In 2011, in response to a post by John Quiggin, Doug Muir pointed out that there were still quite a few dictatorships left. We defined dictators as (1) a solitary leader, who (2) wields tremendous personal power, and (3) rules in a generally illiberal manner, and (4) will not leave office or surrender power unless compelled by force majeure, and (5) is not a traditional monarch. So we do not include Arab monarchies (like Saudi Arabia), collective one-party states (like Vietnam), illiberal democracies (like Hungary), elected governments formally limited by unelected bodies (like Iran), or military juntas (of which there seem to be none at this moment.) 

Still, back in 2011, you could see a pattern. The New World was free of dictators outside Cuba. Every other dictatorship other than Syria was either in post-colonial Africa or the post-imperial Soviet space. And the Syrian dictatorship, many thought, was not going to be with us for much longer. 

Another but ...

Today that pattern no long exists. Dictatorship is everywhere. Consider the countries that were dictatorships in 2011 and are still dictatorships in 2018: Angola, Azerbaijan, Belarus, Cambodia, Cameroon, Chad, Congo Republic, D.R. Congo, Cuba, Djibouti, Equatorial Guinea, Eritrea, Ethiopia, Gambia, Kazakhstan, North Korea, Rwanda, Sudan, Syria, Tajikistan, Turkmenistan, Uganda, and Uzbekistan.

The only two three countries to leave are Gambia, Zimbabwe and South Sudan ... the latter by dint of falling into prolonged civil war. (In comments, J.H. pointed out that Gambia is no longer a dictatorship.)

What about newcomers? Well, we have Fiji, Maldives, Nicaragua and Tanzania, and Togo ... plus Egypt, Russia, Turkey and Venezuela. It seems as though China has joined them and Honduras is making a play after the incumbent got the Supreme Court to nonsensically overrule the constitution and then blatantly stole an election. 

In total we have six small newcomers and five major ones. Only two are in sub-Saharan Africa. Two have nuclear weapons.

The world is still more peaceful than ever before. But inasmuch as you believe that said peace is due to the spread of democracy, we may have some frightening years ahead.

I would like to be wrong. Please tell me that I am wrong.

NAFTA, trade costs, and the difficulty of economic divorce

Market access can have a big impact even when the numbers are small. For example, extending normal trading relations to China did not dramatically increase access to the U.S. market. But it did increase certainty: previously, China’s access was subject to annual Congressional votes. Remove that uncertainty, and poof, suddenly firms were willing to make long-term investments aimed at the American market. (The paper on this topic is here.) 

The importance of permanence is why giant fluctuations in exchange rates should not be expected to have the same effects as small changes in tariffs. Exchange rates rise and fall subject to unpredictable economic forces. Tariff rates stay the same subject only to politics. Gabriel Mathy made that point here. 

So what about ending NAFTA? Would it undo economic integration between the U.S. and Mexico? 

Quite likely not.

Wait, what? Why would an end to NAFTA not benefit China and other low-wage manufacturers in Asia?

Well, simply put, they are too far away from America. In 2014, according to the Bureau of Transportation Statistics (see Table 10 and Table 11), the average container imported from Mexico carried goods worth $52,921. According to J.P. Morgan, the average cost of moving that container from Mexico was about $1,800. (The World Bank says $1,499, but that includes maritime and non-NAFTA shipments.)

So that is a cost  of roughly 3.4% ... compared to 15% from China. (The number of containers from China comes from the Maritime Administration; the value is from the Bureau of Transportation Statistics.)

This is back-of-the-envelope, but very little of the stuff that Mexico exports to the U.S. is set to move to Asia, Europe, or South America if NAFTA falls apart. Mexico is too close and its labor costs are too low.

Still, a NAFTA collapse could move production back to the USA, no? After all, it is not like U.S.-made goods don’t need to be transported to market. They do. Domestic truck and rail shipments came to $8.8 trillion in 2007. (To prevent link rot: BTS, National Transportation Statistics, Table 1-58: Freight Activity in the United States: 1993, 1997, 2002, 2007 and 2012. I used 2007 because 2012 trucking freight rate data is not available.) The total cost of moving all that stuff came to $262 billion. That comes to an average freight cost of about 3.0%. In other words, and not unexpectedly, the cost of moving goods around inside the United States is roughly equal to the cost of moving them from northern Mexico to the United States. So one would expect a rise in tariffs from zero back up to 3% to have an impact. 

But tariffs and transport costs are not the only trade costs! Total trade costs come to the difference in the markup between the factory gate and the final consumer between domestic goods and imported goods. When Dennis Novy (Warwick) used that approach (albeit indirectly) he found that NAFTA reduced the total trade cost from about 70% to around 33%. (Page 10)

How did that happen? The intuition is as follows. Signing NAFTA cut U.S. tariff rates from 3% to zero. Companies then established cross-border value chains. Those chains were not easy to set up, but once they were in place, it became far cheaper to export. Think of it this way: the first autoparts factory to open up in San Luis Potosí needed to figure out everything about selling to the United States. The fifteenth had a much easier time. Thus, NAFTA caused trade costs to drop by way more than the fall in tariffs.

The flip side of that, however, is that much of the fall in trade costs is not reversible. Abolishing NAFTA, therefore, might have remarkably little effect, taking trade costs up from 33% to 36%. Abolishing NAFTA plus a 20% border adjustment tax will reduce Mexican incomes (via depreciation) but would also have remarkably little effect on trade volumes. 

It would take a straight-up tariff in the 20%+ range to seriously undo integration in any reasonable time period, at least for manufacturing. And even then the impact would be slower and smaller than we think. In fact, most of the impact would come in the form of European cars becoming suddenly competitive in the American market. 

Agriculture would be a different story. I will discuss more if there is interest. 

What does “bias” mean?

The Washington Post publicizes a lot of good political science these days. (Thank you, Mr. Bezos!) They recently ran a column entitled, “Americans aren’t biased against Latino immigration. Here’s what they actually fear.” 

Short version: Morris Levy (USC) and Matthew Wright (American) surveyed a bunch of white Californians about their attitude towards immigration. They humanized their questions by asking the respondents about a particular individual, either a Mexican immigrant named “Juan,”  a Chinese immigrant named “Yuan,” or a German immigrant named “Johan.” In addition, half of all respondents were told that the immigrant they read about had lived in the United States for two years. The other half were also told that Juan/Yuan/Johan speaks English and has worked steadily as a waiter.

Here is what they found:

In other words, when there was no information about the immigrant, more white Californians supported legalization when thinking about somebody from Europe or China than from Mexico. But if they were told that the immigrant worked and spoke English, the gap disappeared.

The authors then conclude, “Discrimination against Latinos may grow not from hostility against an ethnic ‘outgroup,’ but rather stereotypes about whether they will contribute to the United States or become a burden.”

It’s a neat result, but I don’t understand the conclusion. They find that when told a male immigrant has assimilated, white Californians don’t care about his ethnic background. But they also find that without any information, Californians assume that Mexicans are much less likely to assimilate than other immigrants. They conclude that people stereotype Mexican immigrants as less educated and more likely to become a public burden. 

That is possible. But there is another explanation. They found that white people in California don’t consider Mexicans impossible to assimilate. But their results are consistent with the hypothesis that white people consider Mexicans to be intrinsically harder for the American melting pot to melt. 

Wouldn’t that make them an ethnic outgroup?

Ghost Fleet #5½: Why post now?

 Well, Foreign Policy just reminded me that people in the Pentagon are taking this book very, very seriously.

Sigh.

Ghost Fleet #5: A matter of tone

 This series has not been forgotten; other things have simply intervened. We still owe posts on the implausibility of the naval technology, the outright impossibility of the space battles, and the ridiculousness of the tactics used by the Hawaii occupation and resulting insurgency. 

Right now, a short post on tone. 

One problem for all books presenting a villain is how to get into that sweet spot where the villain is competent enough to be frightening, but not so competent as to become caricature. Some readers don’t mind caricature, of course. But Ghost Fleet bills itself as plausible, so it has to hit that sweet spot or fail.

In terms of what the Chinese actually do in the book (and ignoring the technical flaws) the authors more-or-less accomplish their goal. The Chinese of Ghost Fleet are improbably but plausibly competent, and such competence is required for the plot. The book suffered more from making their American opponents implausibly incompetent, at least at the beginning, rather than making the Chinese superhuman. 

That said, there are ways to make competence seem like just that, normal old competence, rather than silly steely Nietzschean power-willing. The book did okay on the substance (ignoring its technical impossibilities) while failing in tone. It tossed in throwaway lines about the Chinese Directorate’s super competence for absolutely no reason — well, no reason other than playing on the implicit prejudices of readers primed to fear China in order to make them more scared of the villain. 

And that was a major disappointment, especially since I believe that the authors were convinced that they were doing the opposite. 

Observatorio Argentino 31: China is not a superpower

 OK, I am only hearing about this now, which is a little embarrassing: but last month the Argentine Naval Division (its coast guard) sunk a Chinese fishing vessel that was encroaching on the Argentine exclusive economic zone (EEZ). 

One might have thought that China would use its putative economic might to demand apologies or compensation or something. After all, the country regularly buys U.N. votes and threatens the neighbors. But in this case, pretty much nothing. The captured Chinese weren’t even sent home until April 10th. 

In the words of the Argentine ambassador, “It is very clear that this was a police matter and has nothing to do with diplomatic issues.” 

It may be that China is merely speaking softly while carrying a big stick. But its behavior elsewhere makes me doubt that. Rather, its stick ain’t that big.

How big is the threat that oil exports will be seized in a Venezuelan default?

 It is pretty clear that oil exports could be attached if PDVSA defaulted on its bonds. It would work as follows. PDVSA would sell oil to a refinery in the United States. Creditors would sue. The refinery would still get the oil, but a U.S. court would attach its payment to PDVSA and transfer it to the creditors. PDVSA, therefore, would get nothing from its exports.

If the Venezuelan government defaulted, however, the legality would get a bit dicier. It is possible that American courts would “pierce the corporate veil” and conclude that PDVSA is an instrumentality of the Bolivarian Republic, but that is not certain. Still, it is the way many investors and lawyers (inclduing myself) would bet. 

So in theory sovereign default would lead to a fall in oil prices, as exporting countries with state-owned companies cast around for alternative markets.

In practice, however, the courts are slow and (as mentioned above) the legalities are far from certain. It is quite possible that a defaulting country would merrily continue selling oil while its buyers merrily continued buying. After all, the buyers might not care. They would still get the oil; what do they care if the seller wouldn’t get its money?

But the seller would still want its money. It would likely therefore sell to middlemen who would demand a discount and then resell the oil at some legal risk to themselves. In other words, the price of oil exports would certainly go down.

The empirical question, however, given all the legal uncertainties, is how quickly it would go down. It is quite plausible that the export price of a country’s oil would not be affected by default for months or years.

Well, Ecuador provides a nice test of that question!

Let me walk you through the data. This is going to be a little chart heavy, so I ask readers to comment if it is ever unclear or you lose the chain of the argument.

Ecuadorean oil generally trades a discount to the WTI benchmark price. That is because its oil is heavier than WTI and needs to travel from Ecuadorean fields to (mostly) Californian refineries. The below chart shows the percentage discount on Ecuadorean oil between the start of 2006 and the end of 2009. It shows a very steep fall in November 2008.

That seems convincing, until you add a control. Mexico also exports heavy oil to the United States. Its discount on WTI also widened in November 2008, although Mexico did not default.

Still, the increase in the discount on Ecuadorean oil was greater than the discount on Mexican oil. Might that have something to do with the default? Certainly! But to be sure of that, you need to also account for the fact that Ecuador and Mexico sell into two different geographic markets. Ecuadorean oil goes primarily to refineries in California, whereas Mexican oil goes overwhelmingly to the Gulf Coast of the United States. The price of crude oil can vary by several dollars per barrel between the two locations, given transport costs and varying demand conditions. 

The below chart, therefore, compared the export price of the two countries’ blends to the price paid by refineries in California and the Gulf Coast (60% in Texas), respectively. Once you account for the fact that the price of oil in California fell more than the price of oil on the Gulf Coast, then the oil price dynamics in the two countries look pretty similar between 2006 and the end of 2008. This chart compares the price received by the exporting countries and the price paid by their primary customers:

 

The dynamics look similar when you express the discounts in dollar terms, rather than as percentages of the sale price. The stark increases in November 2008 go away completely, as artifacts of the general fall in oil prices. Mexican crude is a bit more volatile in the lead-up to November, but otherwise looks similar to Ecuadorean:

It is true that Mexican oil recovered faster than Ecuadorean oil. In fact, after January ‘09, Pemex managed to sell its oil for roughly the average price paid by all Gulf Coast refineries, elimating a long-standing discount. PetroEcuador also managed to improve its position relative to the pre-crisis era, but it took rather longer. 

I do not know what happened in the Gulf Coast oil market. There are two hypotheses to explain the Ecuadorean recovery, however. One is that the Ecuador announced the form of its default in mid-2009 — a form brilliantly and perfectly designed to leave creditors without legal recourse. Freed of fears of attachment, therefore, the discount fell.

The other is that May is around when PetroEcuador began selling its oil to state-owned Chinese middlemen at a significant premium. The discount on Ecuadorean oil fell because Chinese companies absorbed it. 

It is still possible, of course, that without the default Ecuadorean oil prices would have bounced back in January 2009 like Mexican ones and without the need to involve the People’s Republic of China. But there is no direct evidence for that story.

The next thing to do would be to nail down an explanation for the disappearance of the Mexican discount in January 2009. If an explanation for that can be found that Ecuador could not possibly have replicated, then the hypothesis that the Ecuadorean default affected the export price of its oil is likely incorrect. On the other hand, if the strategy employed by Pemex was one that Ecuador was prevented from using because it was in default, then the default cost Ecuador.

To be frank, my prior is that whatever happened to Mexican oil in January 2009 was likely idiosyncratic. I doubt that Ecuador suffered in oil markets for its big sovereign default.

Now, this is not to say that default would be costless for Venezuela. It could prove very costly! Eventually, Venezuelan receivables would probably be attached; sooner if PDVSA debt goes into default rather than Venezuelan sovereign debt. But in both cases Venezuela could continue to sell oil.

In short, the evidence from the Ecuadorean default of 2008 is not completely clear-cut ... but the preponderance of the evidence seems to be that any fall in oil prices will take some time to manifest.

Sources tell me that Venezuelan ministers fervently believe that default will lead to cut off in immediate oil exports, or at least a drastic fall in realized oil prices. I suspect that they are wrong ... but it is a good thing for creditors that they do not know that they are wrong.

Nail, coffin, Nicaragua Canal

 I am still annoyed that one of my ... uh, not childhood, no, “pre-midlife”? “Early adult”? ... heroes endorsed the Drumpfster. So I will write an unrelated blog post instead.

In the past week, there have been a few news stories which have reduced the odds of a Nicaragua Canal from slim to “Not unless President Eleven goes full Drumpf.” 

First, China published what was accurately called “shocking trade data.” Add that to record capital flight, and the case for blowing part of the current account surplus on a giant prestige project in Nicaragua goes away.

Second, the New York Times published a way overblown article about renewed Contra violence in Nicaragua. Now, the headline is overblown: Nicaragua is not facing a serious insurgency. (To be fair, when you read the article, it is pretty clear that nothing is going on.) But it should remind everyone that the people displaced to build the Red Canal could turn violent if not properly compensated.

Finally, it looks as though cargo ships may not be getting any bigger. If that is right, then what little commercial rationale the Red Canal may have had goes away. (It didn’t have much.)

Kind of disappointing, but there you have it.

Trump on his website

 I cannot believe I actually did this. But I did. I went to his website and looked at his policy proposals.

On immigration, well, there is less than I would have expected. Nothing about mass deportation, only a bit about deporting more criminals. (Right now, ICE does not have the budgetary authority to deport all criminals after their sentences.) Some blather about repealing the 14th Amendment. Surprisingly, neither DACA nor DAPA appear. But there is a call for a wall ... and a clear statement that a Trump administration will wreck relations with Mexico all the way down to pulling out of NAFTA in order to pay for it. Expect a President Trump to destroy our southern relations. Which would be a shame, because right now Mexican governments of all stripe pretty much do whatever the United States needs them to do. 

On trade, he seems to be calling for a trade war with China. Except ... uh ... can he start one? He can declare China a currency manipulator. After which, well, lets go to the relevant part of the Omnibus Trade Act of 1988:

“If the Secretary considers that such manipulation is occurring with respect to countries that (1) have material global current account surpluses; and (2) have significant bilateral trade surpluses with the United States, the Secretary of the Treasury shall take action to initiate negotiations with such foreign countries on an expedited basis, in the International Monetary Fund or bilaterally, for the purpose of ensuring that such countries regularly and promptly adjust the rate of exchange between their currencies and the United States dollar to permit effective balance of payments adjustments and to eliminate the unfair advantage. The Secretary shall not be required to initiate negotiations in cases where such negotiations would have a serious detrimental impact on vital national economic and security interests; in such cases, the Secretary shall inform the chairman and the ranking minority member of the Committee on Banking, Housing, and Urban Affairs of the Senate and of the Committee on Banking, Finance and Urban Affairs of the House of Representatives of his determination.”

Got that? The law will allow the Trump administration to ... start negotiations. Which is, to be fair, all he calls for on the website. 

There is also a fun bit where Trump contradicts himself within two sentences: “The U.S. Trade Representative recently filed yet another complaint with the WTO accusing China of cheating on our trade agreements by subsidizing its exports. The Trump administration will not wait for an international body to tell us what we already know. To gain negotiating leverage, we will pursue the WTO case and aggressively highlight and expose these subsidies.”

In other words, the Trump administration will not wait for an international body. Rather, it will pursue a case against China in an international body. Yes, tough indeed.

On taxes, it is all crazy. But that’s the GOP for you these days.

The whole thing is a little crazy, but I was expecting more. In other words, Trump has got a lot of room to walk back a lot of things once he gets the nomination ... with one exception: blowing up our relations with Mexico.

I concur with Carlos in comments.

Anyway, none of this is relevant for the Democrats, because the way to go after Trump is mockery. Pure, unending mockery. 

Fleet ghosting, or an American war on China?

 Recently, there has been some worry that a Chinese government facing internal challenges might choose to aggravate external conflicts. These worries are plausible, but it strikes me that it is far more likely that an American president might provoke a conflict with China than the reverse. After all, a war with China would be primarily at sea and in the air. It would provide the United States with clear victory conditions. And it is one that (as of right now) the United States would win.

So might an American president be tempted? Realistically, any scenario would need to fill several requirements:

1. No cognitive dissonance. I do not believe in a Reichstag fire scenario. Any series of provocative responses by an American president would have to be ones that she or he could justify in their own head. Which also means that they would be justifiable in the eyes of much of the public;
2. Provide electoral advantage. The lessons from George H.W. Bush are useful here. He came out of an amazing overwhelming victory in a popular war and still went on to lose in November of the subsequent year;
3. Retain East Asian support. Any series of American provocations against China would need to keep Japan, South Korea, Taiwan, the Philippines and (to a lesser extent) Vietnam on side at every stage. Lose them and you likely lose (2) as well;
4. Provide advantage short of war. Given the geopolitical circumstances, no single American action would lead to war. It would result from a cascading series of American actions and reactions. Each individual American action, however, would have to fill all of the above requirements, should the Chinese government not take the bait. In other words, the U.S. administration would need to believe that it would come out ahead regardless of the Chinese countermove.

One question, of course, is whether a short naval war with China would have adverse economic impacts on the United States. The answer to that question is surprisingly unclear. Chinese demand for U.S. bonds is irrelevant, given that we borrow in our own currency. A decline the U.S. dollar could be good for the American economy. Most Chinese imports are replaceable, certainly in the short run. The long-run consequences would not be good, but the assumption here is that the American administration is not worrying about the long run.

The question for you, then: what are the circumstances under which an American president might deliberately try to provoke a war with the People’s Republic of China?

Read this first.

Nicaragua Canal still not happening

 Commentator Marc points out that HKND has now announced that it will postpone serious work on the Canal Rojo for another year. I have been saying for a while that this project is not going to happen unless the Chinese government makes a big and hard-to-hide financial commitment to the project. Right now, with China flirting with recession, such commitment seems further away than ever. 

Ghost Fleet #3: Cyberwar is symmetric

 One of the most disappointing things about Ghost Fleet was the dog that didn’t bark: the massive immeidate American cyber-counterattack against China. It’s one thing to write an exaggerated warning against a threat that you believe your country is neglecting. It’s quite another to ignore the loud and massive preparations for cyberwar that the United States has already made — and that those very authors have reported upon extensively. It was weird; weird enough to remove much of our ability to enjoy the book.

One thing that the authors get completely right is that much of any future cyberwar will be fought using malicious programs that are pre-positioned inside hardware. Trojaned electronics are a very real concern. It is entirely conceivable that in a future conflict, the Chinese government could do serious damage to the American civilian infrastructure. Moreover, with the advent of the “internet of things” such an attack — when combined with the more “traditional” operations described in our last post — such an attack would consist of a serious Weapon of Mass Annoyance, as toilets seized up and heating systems went haywire. To their credit, the authors evocatively show just such effects: a home front dealing with unfixable automated refrigerators.

Unfortunately, the authors jumped (a lot of sharks) far away from the great fictional war classics like Red Army or Arc Light or The War in 2020. They moved out of the realm of the plausible. Let’s start with the idea that the Chinese could install Trojan horses in most of our military systems. They couldn’t. There seems to be a fundamental misunderstanding on how some of this works. Adding a modification to a chip is a pretty profound process. It is highly likely to add glitches that would be easily detected. It would likely add significant time to delivery as well … and sudden additional delays for manufacturing a relatively generic chip would catch people’s attention.

Field-programmable gate arrays (FPGAs) are even less susceptible to Trojan horses. (Elsewhere, the authors of Ghost Fleet have pointed out in ominous tones that two-thirds of all the U.S. military’s field-programmable chips are made in China and Taiwan. We’ll ignore the fact that Taiwan is not in fact a part of China but an ally of the United States and pretend that all the key chips come from the People’s Republic.) FPGAs are not where you need to worry about Trojan horses because FPGAs are blank slates: the customers can put whatever programs they want on the chips. There is no way for the manufacturer to know what the customer (whether the U.S. Air Force or Intel) plans to put on the chips.

Remember, in order to subvert a program, a hacker must have an understanding of a program. But there is no way to know what program will be placed on a FPGA. Furthermore, many FPGAs allow for a program to be permanently loaded —  written once, read many –  such that any attempt at overwriting with a new subverted program would be impossible.*

Moreover, the United States has a trusted foundries program administered by the National Security Agency to make chips for the military. (Bizarrely, the authors have the trusted foundries play a key role in the successful U.S. counteroffensive.) Now, the trusted foundries do not make the United States invulnerable. But it does make a breakdown on the scale depicted in Ghost Fleet very hard to believe. The worst case scenario is an attack allowing for the crashing of the software through understanding the hardware —  garnered through espionage.

Recovering from a cyberattack based on Trojaned electronics would “merely” require resetting the software. The scare quotes are because such a reset would be far from simple and would take a substantial amount of time. During a battle, such an attack could be catastrophic. We believed in the U.S. defeat during the initial offensive. (Save perhaps the actual invasion of Hawaii: more on that later.) But over the course of a war, the problem is entirely addressable, and the U.S. should have gotten a handle on the issue much faster than it did in the book.

But to be fair, while the scale of the attack may have been hard to believe, but it was not impossible to believe. Yes, the details were wrong, but the United States could in fact get punched in the nose as hard as it was in the opening battles of a future war.

What was impossible to believe was that the United States would not strike back, hard. The U.S. is already training offensive cyberteams. And this is the latest part of a long-standing program — viz the fact that the only documented cyberattacks in the history of the world have come from the Israel and the United States. Hooah, indeed.

As for Trojan Horses hidden in hardware, the Chinese have far more to fear than we do. They don’t know what they are manufacturing! It’s far more likely the U.S. is slipping in something into their chips than vice versa. Not because the U.S. is miraculous, but because we are doing the design. Chinese firms, for the chips made there, do the manufacture. It’s easier for us to verify that a design is what we think it is than it is for them to verify that a design does what they think it does.

Now, perhaps the United States isn’t installing Trojan horses in Chinese electronics. We’re perfectly willing to accept that as a premise. (Even if it’s improbable.) And we are willing to accept that the Chinese could inflict enough damage on American systems as to allow them to win a naval campaign in the Pacific. What we’re not willing to accept is that the United States would be unable to strike back against Chinese infrastructure.

A realistic counter strike would cripple the Chinese in a manner in parallel to the United States. Those same fridges taken out in the U.S. are likely to be taken down in China. The irony of the Chinese situation is with their modern infrastructure, they are likely to have far more of their critical infrastructure taken down in a cyberwar scenario. The analog systems of yesteryear are completely immune to the hacking of digital systems. Digital upgrades will be very uneven in the U.S. They will be almost ubiquitous in China. The Chinese could pummel the United States. The United States would equally pummel the Chinese in a cyberwar. The authors highlighted Los Angeles and the problems with fridges, a metropolitan area currently of 13 million people. What happens when Beijing’s 21 million can’t store food either?

A realistic scenario for cyberwarfare would be the race of the cripples: compromised systems on both sides will cripple each side’s military and homefront in unexpected ways. Both sides would go into battle with their equipment malfunctioning. Both sides would find some of their premier weapons unusable. No one has a monopoly on cyberwar. As of 2015, the U.S. has a significant lead, despite what the authors imply. It is certainly possible that the U.S. would lose that lead by 2024, but it is simply impossible that America would lose the ability to strike back.

The revelations about Stuxnet and the Equation Group have made it clear that the United States has adapted its Cold War approach to nuclear warfare to the new world of cyberwar. During the Cold War, it was theoretically possible to defend against nuclear weapons on a large scale. (Using nuclear tipped interceptors, for example.) But the costs — and there were many! — were deemed too large.

Instead, American war planners adopted an approach that worked surprisingly well: mutually assured destruction (MAD). If a power launches nuclear weapons against the U.S., then the U.S. will literally destroy them in response.

The U.S. could construct an economy invulnerable to cyberattack, but that would slow progress in development of computers and the internet to a crawl. Moreover, it would require civilian discipline unprecedented outside of the two World Wars: does your grandmother always update her computer? Or your uncle his phone? Your child her tablet? Or your husband his new smart thermostat?

Rather than attempt the impossible, the U.S. has applied MAD to cyberwarfare: China unleashes cybernetic hell on the U.S. and the U.S. will unleash it in turn on China.

Finally, there is no way that a cyberwar on this scale wouldn’t go global. The authors themselves have noted in other venues how Stuxnet spread to systems far outside Iran. The same would happen with Chinese and American cyberweapons unleashed in a Third World War. To some extent, that’s a minor point: why should the reader of a good WW3 yarn care whether municipal sewers and automated metros in Lyon are going haywire? They shouldn’t. But the rest of the world will be affected and they will be angry … and in a scenario where China strikes first, they will be angry at China. Maybe America’s NATO allies would refuse to invoke Article 5. (We’ll get to whether that is believable in a later post.) But there is no way on God’s green Earth that they would pretend as though nothing has happened.

In short: the scale of the effect of the initial cyberattack on the U.S. is believable, even if the depictions of how it was carried out make no sense. But it is improbable. And it is completely impossible that the U.S. wouldn’t strike back. We can believe a Chinese victory in the first phase of the war. But one of on the scale depicted was laughably silly and the lack of an American counterstrike was ludicrous fantasy.

And so, once again, our disbelief was desuspended. If you can’t believe the scenario is possible, then what’s the point? These guys know enough to have done much Much MUCH better.​

Ghost Fleet #2: Cyberwar is boring

 Neuromancer set the template for fictional depictions of hacking: colorful icons swooping through cyberspace in a glorified videogame. Sometimes the depiction is a little more sedate, but only a little: hackers frantically banging at keyboards as they break enemy defenses. Films like Swordfish or Hackers and many, many others make it seem rather glamorous, even visual. 

Ghost Fleet falls right into that trap early on. Page 41: 

“The young hacker focused on her attack, navigating the malware packet through the DIA networks while fighting back the desire to brush a bead of sweat off her nose with her gloved hands. The Pentagon’s autonomous network defenses, sensing the slight anomalies of her network streams, tried to identify and contain her attack. But this was where the integration of woman and machine triumphed above mere ‘big data.’ Hu was already two steps ahead, building systems components and then tearing them down before the data could be integrated enough for the DIA computers to see them as threats. Her left arm coiled and sprung, her fingers outstretched. Then the right did the same, this time a misdirect, steering the defense code to shut down further external access, essentially tricking the programs into focusing on locking the doors of a burning house, but leading a small ember on the outside for them to stamp on, so they’d think the fire was out.”

Needless to say, this is not how hacking works. 

Hacking comes in two major flavors. The first is the all-out assault. The second is the stealthy compromise.

The Distributed Denial of Service (DDOS) attack is a prime example for the all-out assault. A large number of software bots are surreptitiously placed on computers all over the world, usually by getting someone to click on an infected link or attachment. The software then automatically downloads itself and send reports into a controller server (itself likely another hacked system). The number of bots can range up to the hundreds of thousands and be directed by a small handful of servers. When the attack is launched, all those computers fire off requests in such volumes to cause the receiving computers to lock up. This is somewhat like having several hundred 5-year-olds ask questions of one person at the same time.

A variation on this is a massive port scan: using the same botnet, hackers can check all the different places software listens to for communication. The bots will then try to crash the software listening on that port, hopefully getting the system to cough up another entryway in response, like a username or password. The botnet is effectively looking in all the computer’s pockets for a hole from which it can swipe the key. Again, the hacker “merely” pulls the trigger after aiming the botnet. You could, I suppose, have a scene of the hackers feverishly writing the code before they launch the attack. But nobody is going to be sitting in a room swooping through 3-D displays. No typing, no visuals.

Then there is the stealthy attack. The special forces to the DDOS tank army. The classic is stealing access to passwords, preferably from a network administrator. The attacker then moves through the network slowly and carefully. The problem with this method is lots of places log their access and strange places often get flagged. If it happens too often, they lock accounts. That is part of the reason why many sites require periodic password changes.

The problem with this model — the hacker working hands on — is that it’s far more traceable and slow. Better is to compromise a system and let a bot go to work. In fact, far better is to let a bot just plain do all the work. It’s faster and safer.

The most common bot for this is the infamous “malware”: viruses, worms, Trojan horses, etc. The single most famous example of malware that went above-and-beyond was Stuxnet. The authors of Stuxnet didn’t sit and click or wave their hands in real time as they manuevered their way into the Iranian nuclear facilities. They had someone pop in a USB drive and the rest was automated. 

This makes it tremendously unsexy. The Stuxnet infection took a significant amount of time before it compromised the systems at the Iranian nuclear enrichment facility. And once it was in, there was no way to know if it had worked until the U.S. received human intelligence that the centrifuges it targeted had actually broken. The infected Iranian facility wasn’t hooked up to the internet, but even if had been, it would have been very, very dangerous to report back. Communications can be intercepted.

Now, the Chinese hacker is working in nine years in the future. Why couldn’t she use virtual reality to hack systems in 2024? Well, maybe she would write code using a V.R. headset and virtual keyboard, although I’m unclear as to why. But she wouldn’t interact with the cyberattacks once they were underway. That would just result in detection once the communications were intercepted. Moreover, the time it would have taken to send back data about what was happening and send back the response could be up to ten seconds on the round trip. Add another ten seconds for her reaction time. That is a lot of time for the DIA to realize something is wrong and start shutting the doors. 

The authors talk about her and her bots trumping Big Data. It’s a nice buzzword, but it is totally meaningless in this context. Big Data might have been used as a way to train the DIA’s intrusion detection system to recognize which data flow patterns are normal activity and which might indicate an attack. But I have no idea what it would mean for the Chinese hacker to be “building systems components and then tearing them down.” As a description of cyberwarfare, it’s not even wrong; it’s meaningless. 

In summary, the hacking in Ghost Fleet is derived from the silver screen, not the reality of today. It also is highly unlikely to be what comes about in ten years. 

Now, to be fair, these scenes are just window-dressing. There is, in fact, a scene on page 37 in which a Venezuelan refugee accidentally infects U.S. defense systems in a realistic way. (Although I have to admit I have some doubts that you could actually copy malware onto a security badge — the article cited in their footnotes does not describe anything like the scene.) But there are much more serious problems with the way the cyberwar develops in Ghost Fleet, which we will get to in later installments.

Comments and criticisms very welcome!

Ghost Fleet #1: That’s a really dumb way to attack the Panama Canal

 On page 55-56, the Chinese attack the Panama Canal by smashing a giant container ship into the locks. “Two ships ahead, the Xianghumen, a Chinese-flagged freighter, had turned on its engines. This was craziness. What was Xianghumen’s captain thinking, speeding up inside the transit zone? The canal master was screaming over the radio for the Xianghumen to acknowledge and stop. But there was no reply.”

After the Chinese freighter crashes into the locks, “crushing the doors inward,” a Filipino sailor watching it happen thinks : “[He] wasn’t sure how long it would take the Chinese companies that ran the Panama Canal Zone to fix this mess, but their investment had clearly gone down the tubes.”

This was the second moment where I was yanked out of the book, because the scenario is impossible on multiple levels.

The first problem is that ships are not allowed to enter Panama Canal waters under the control of their captains. A Panamanian pilot takes full control. The Xianghumen would have to start its kamikaze run several miles away from the locks, which would making smashing into them a pretty impressive feat of navigation. Moreover, it would give the game away hours before it crashed. The Canal Authority would mobilize tugboats to push the ship away. 

Now, the story is set in 2024. So maybe the Chinese ship has some sort of ghost computer system that can seize control back from the pilot and start its run close to the locks. Still, there will be plenty of warning; ships do not accelerate quickly. 

But that brings us to the second problem: it is goddamned hard to get to the locks. Look at the above picture. Better still, look at this video, which shows a ship clonking into the side of the canal as it approaches the locks:

How in the name of God is a kamikaze vessel supposed to navigate that entrance? Even now, ships cannot safely transit without being hooked up to those locomotives that you can see in the video. 

Finally, we should point out that the Panama Canal has three separate lock systems. You would need three kamikaze vessels to crash simultaneously. That kills your robot scenario, since the Panama Canal Authority does the scheduling. Be hard to make sure that you have three ships in the right places at the right time. 

The scene is just fantastically silly.

If the Chinese really want to knock the Panama Canal out of action, then they should send a commando team to blow the Gatún dam. (Or just hit the damn thing with cruise missiles, as was pointed out in comments.) 

And it gets worse, because there is no reason to take out the Panama Canal in a hypothetical war. The Canal cuts the transit time from the Atlantic to the Pacific, but presumably the U.S. Navy will have the initiative in any counterattack. As Carlos Yu and I showed in our book, the Panama Canal had no substantive effect on anything in World War 2 other than the the marginal campaigns in the Aleutians and the timing of the Doolittle Raid. If the Canal had no strategic benefit in World War 2, why would it have one in World War 3? 

The final nail in the coffin of my suspended disbelief was at the end, where the Filipino sailor wonders “how long it would take the Chinese companies that ran the Panama Canal Zone to fix this mess.” Chinese companies do not run the Canal. The Panama Canal Authority runs the Canal. Chinese companies do run some of the port facilities on either side the Canal. But those ports are a different thing.

Ghost Fleet admirably has footnotes, so I checked the ones for this passage. They footnoted   “Chinese companies that ran the Panama Canal Zone” to an article in the Economist. Go read the article. Now come back. You will note that the Chinese interest the article cites is about the possibility of financing a fourth set of locks or building a competing canal in Nicaragua. How did they turn that into Chinese management of the existing canal?

It is a minor plot point, but it planted the skepticism that will blossom in this space over the next few days. 

Vox has a talent for making to me opposed to positions that I support

 Vox headline: “An NYT op-ed argued for making China poorer to make Americans richer. That’s appalling.”

Translation: a New York Times op-ed writer argued that competition from cheap labor hurts some American workers and thinks imposing tariffs might be a good response.

The Vox piece itself is a mish-mash of assertions. For example, it is true that most of the particular poverty in the South has nothing to do with foreign competition. But some of it does, as the author also admits. It is also true that tariffs impose deadweight costs. But the study on tire tariffs cited in the piece contains no error bars. (The methodology itself is also a little weird, assuming for example that tire manufacturers spend none of their income save wages, but leave that be.) The deadweight costs are quite likely negligible. And anyway, in this case, the point of tariffs would be to affect the income distribution inside the United States. 

And then there is the moralization. It is true that imposing tariffs on foreign goods makes foreign exporters poorer. Yes. True. That is decent argument in favor of free trade. It is, in fact, an argument that I agree with. But saying that it is “appalling” to want to impose some marginal costs on the Chinese export sector to gain some marginal benefits for lower-income American workers is an attempt to shut down debate by painting any restraints on trade as immoral. 

Well, now. If you are going to that, I want evidence about the distribution of the impact of U.S. tariffs on Chinese workers and employers. Come on now, if you are going to call something appalling, then you really have to show us the money. 

Ghost Fleet

 Novels about great power war have long held fascination, particularly since the world hasn’t really seen one since the Korean War ended in 1953. Red Storm Rising is well known, as is Red Army and the Third World War. All three dealt with a conventional European war against the Soviet Union during the 1980s. All wrestled with the specter of nuclear weapons and all got most of the technical stuff right. The best of the bunch is Red Army, in part for the characters, and in part because the author dared to have the United States lose.

All of those books, however, took place in what was more-or-less the present at the time they were written. Today, unlike the 1980s, the United States holds near-absolute military superiority. War is still possible, of course ... see, for example, Eric Harry’s Arc Light. It portrays an accidental war between the United States and the Russian Federation in the early 1990s. What makes Arc Light unique is twofold: it gets the politics and economics absolutely and it lets nuclear weapons out of the bottle without destroying the world. (I won’t spoil it by saying how; the book is worth reading. James should take a look at it for this series.) The war depicted was a great power war, of course, but it was accidental and it was not between peers. 

So to consider what a modern great power war between peers might be like we need to move into the future. On this blog, Martin Skold discussed what a near-future great power war might be like. But that excellent discussion was heuristic and only tangentially touched upon operational or technological issues, let alone the politics. (Go read!) 

And now we have Ghost Fleet, by P.W. Singer and August Cole! In it, China and the United States go to war in 2024. (The authors give away the exact year on page 48.) A real, genuine great power war. Both sides refrain from using nuclear weapons (for reasons I find plausible) and the conflict plays out over land, sea and space. It has gotten good reviews and it is a book that we really wanted to like.

But we have read it, and while it is a good gripping read ... we just cannot give it a thumbs up. The reasons are basically technical. The authors appear to get enough issues seriously wrong to make it impossible to keep our disbelief suspended. 

Over the next few days and weeks Will Baird and Noel Maurer will be collaborating on a series of short posts pointing out the problems with the scenario laid out by the authors. We are doing this for three reasons. First, it is a fun bit of procrastination. (The book is well-written and fun to read!) Second, the book has gotten a lot of attention in policy circles ... and if we are right about the flaws, then that is a problem. Finally, we think we might be able to learn something. These posts aren’t intended to pan or fisk the book; rather, we think of them as opening up a conversation. Are we missing something? Do the authors know something we don’t?

We have divided the apparent errors into three types:

1. “That’s Not How It Works” technical problems that affect verisimilitude, but not the main plot.  

2. “That’s Not How It Works” problems that don’t affect the plot, but are so major that they yank you out of the book completely. “WTF moments” is another good term.

3. Serious screw-ups that make whole sections of the book impossible as portrayed.

Watch this space.

Ecuador is still not a colony of China

 Now that the New York Times has breathlessly put Chinese imperialism in Ecuador on the front page of its Sunday edition, I feel like I must point out that China is securing neither physical supplies of Ecuadorean oil nor favorable prices. And it is certainly not earning rents on the money it lends the Ecuadorean government. China may be buying goodwill and it may be buying the rights to develop some of the last untapped conventional oilfields on Earth ... but it is getting neither cheap.

We covered physical shipments back in 2012. Nothing has changed. Most of the molecules pulled out of the ground in Ecuador wind up in Californian refineries.

What about price? The oil might physically end up in California, but most of it passes through Chinese ownership. In theory, that would give the Chinese middlemen monopsony power. In practice, it does not. In fact, the Chinese overpay for the oil.

Up until 2012, the loans-for-oil deals required the Chinese lenders to take Ecuadorean oil in repayment valued at a premium over the WTI price. In December 2012, Ecuador stopped charging a premium for its oil. That sounds like maybe perhaps now the Chinese were finally taking advantage of their position ... but such a conclusion would be wrong. Traditionally, Ecuadorean oil traded at a discount under WTI because it was of low quality and could only be sold to California refineries unless it was shipped through the Panama Canal. In 2012, however, for the first time ever, Ecuadorean crude sold at a premium over WTI around US$4 per barrel. (Californian refineries needed that heavy oil.) The Chinese buyers did not wish to pay a premium over the premium, and so the Ecuadoreans agreed to deliver the oil at the market price.

Maybe the contracts were just folderole? Perhaps canny Chinese traders managed to squeeze out monopsony profits regardless? Well, we can check that. PetroEcuador sells its oil mostly to Chinese buyers. The private companies operating in Ecuador do not. (They technically turn their oil over to the Ecuadorean government for a per-barrel fee, which then sells it back to them, at which point they sell it again at a further markup upon which they pay taxes.) The prices at which PetroEcuador and the private companies sell their oil is publicly available. And what do those prices tell us?

The blue line shows the difference between the price charged by PetroEcuador (which sells to the Chinese) and the price charged by the private producers. PetroEcuador generally receives more money per barrel. In fact, PetroEcuador managed to take advantage of a spike in Californian prices in early 2011 that passed the other producers right by.

The red line shows the difference between the price received by PetroEcuador and the landed price of oil in California, which is the relevant market. It shows no trend: the increase in oil sales to Chinese middlemen does not drive up the spread between the price paid by Californian refineries and the price received by PetroEcuador. (The spread does increase at the end of 2014; that is an effect of the general oil price crash, as all Ecuadorean producers tried to keep up their market share.) 

OK, then. The oil is still going to California and the Ecuadoreans are receiving a good price. So maybe the Chinese are charging extortionate interest on their loans? It certainly could be. But again, that is easy to check. 

How do the terms on the Chinese loans stack up against those offered by private creditors? The red bars show the lending rate on the Chinese loans. The blue bars show the yield on Ecuador’s 2015 bond at the time the loans were made. In every case, the red line is below the blue line. The last loan, from the Chinese Ex-Im Bank, uses Ecuador’s new issue due in 2024 as a benchmark ... which brings home just how incredibly cheap that last loan happens to be. 

The New York Times article mentions “steep interest payments” on the Chinese loans. I have no idea what they are talking about.

The Times article also states, “Along with taking the bulk of oil exports, the Chinese companies also collect $25 to $50 in fees from Ecuador for each barrel they pump.”

What it does not tell you is that said fee is in fact a triumph of Ecuadorean resource nationalism. Remember how private oil producers (Chinese and Western) in Ecuador turn over their production to the government and then buy it back? Well, that fee is what the government pays them for their oil. The difference between that and the market price is pure rent for the Ecuadorean state. It is the exact opposite of imperial exploitation. (The contracts are quite clever; the newest ones give the companies a higher price if they reduce costs.) The government also takes 70% of the profit on oil sales. (Page 178.) 

The article’s phrasing, however, makes it seem as though Chinese companies take the oil for free and then charge a fee on top of that. Very misleading.

The article also says, “China’s terms are putting countries in precarious positions.” But that doesn’t make any sense! The terms of the loans are great for the borrowers. Falling oil prices are what is putting Ecuador in a precarious position. As for China’s ability to threaten trade or other sanctions should Ecuador default ... well, tell that to the Argentines or the Greeks. Western creditors, public and private, are also pretty good at that sort of thing. (I wrote a book about it!) 

Ditto the way that China forces the recipients of its finances to buy its products and contract with its companies. My co-blogger knows more about development aid than I ever will, but from what I saw on the ground in Afghanistan and Africa that sort of thing seems to be the rule ... even if it is technically disallowed. (Doug?) And I must also admit that while the anecdotes about Chinese labor and environmental practices are quite telling, I also doubt that they are much worse than the Western record. (Setty?)

Finally, love it or hate it, the Refinería del Pacífico is a purely Ecuadorean idea. If it turns out to be a bad one (I suspect it is) then perhaps one could blame the Chinese for going along Ecuadorean desires. But the refinery is not a boneheadedly stupid idea. There are real reasons to support it; opponents (like myself) are making a judgment based on the risk of failure; reasonable people can disagree about whether the potential reward is worth the risk. Moreover, most of the debt for the refinery will be effectively collateralized. Many of the losses will fall on Chinese banks.

The above, I think, is the opposite of imperialism. Ecuador sold the refinery idea to China and looks as though it might get the Chinese to put up most of the money and take on most of the risks. 

If this is a Chinese empire, it makes the American empire look well-run and logical. Which is saying a lot.

Ortega agonistes

 Daniel Ortega is one of the animating forces behind the Nicaragua Canal. I always doubted that he believed the Canal would be built, but I did think that he expected his Chinese partners to go ahead with the subprojects. 

Well, Ortega just fired a shot across HKND’s bow. Exactly one week ago, President Ma Ying-jeou of Taiwan visited Managua. The two presidents of course met. And now it has leaked that President Ortega asked President Ma for Taiwanese official support in building a $500 million deepwater port at Monkey Point, Nicaragua, on the Caribbean coast. 

Monkey Point is less than four miles from the proposed end of the Canal Rojo. In the stunned words of an opposition legislator, Edmundo Jarquín, “What person, with a minimum of common sense, thinks it is possible to build two deepwater ports less than six kilometers apart?” 

Well, nobody. I have only two points. First, the Monkey Point project has been percolating for a while. A Brazilian company rejected it three years ago. But the Nicaraguan government did not: last year, it put out for tenders on a design study for a highway to Monkey Point. Ortega was not talking off the top of this head; Hugo Chávez, he is not.

Second, the whole thing is a message aimed at HKND: get serious about building something, or lose your concessions, constitutional amendment notwithstanding. But this message is not new. I have my doubts about whether the Gran Canal will ever be built. The Ma-Ortega meeting is probably not a sign that Daniel Ortega shares them. Although he should.

When in doubt, a Nicaragua Canal update

 Not terribly much to report. The much ballyhooed access road is indeed under construction, so dirt is flying. But as a project the road is nothing, and as far as we can tell here at TPTM the money so far is coming from Venezuela via the Petrocaribe program. HKND, the company behind the project, says that the environmental impact statements will be coming out at the end of May. Apparently the company ran the statement past a group of academics at Florida International University last month, and those academics had some “doubts.”

The other big news, from yesterday, is that the head of the Panama Canal Authority, Jorge Quijano (pictured here) claimed the following: “I just came from China and builders told me that no state company is interested in financing the project.” But Mr. Quijano is self-interested. I have no doubt that he is telling the truth about what Chinese construction executives told him ... but I have rather more doubt that said executives really know Beijing’s thoughts on the matter. Heck, I doubt that Beijing knows Beijing’s thoughts on the matter. 

Weirdly, when asked about the matter, the spokesperson for Nicaragua’s official canal commission claimed, after some harrumphing, “That is, even this week we got German investors, and in the next few days I will travelling to the United States and the whole world is interested in investing in Nicaragua.”

No word on who these German investors were.

For what it is worth, Quijano thinks that a fourth set of locks big enough to accomodate the newest container ships could be built within 15 years for $17 billion. If that estimate is correct, I can’t see how in the name of God anyone can expect HKND to build the Nicaragua Canal in only five.

In short, our official position remains unchanged: as cool as it would be, this project is not going to happen unless the Chinese government gets involved directly.

Is Venezuela financing the Nicaragua Canal?

 It looks as if Managua may be losing patience with HKND over the delays in starting the canal. According to source from within Albanisa, the company that handles Venezuelan aid and investment to Nicaragua, “We are hoping they [the Chinese] will release the money to compensate landowners in the canal route, but so far they have only made excuses and want the government to provide the funds.” The source went on to allege that Albanisa has been financing HKND’s operations thus far. “My understanding is that the government already told HKND that they should stop using Albanisa funds and now invest their own money.”

That is triply interesting. Albanisa is 49%-owned by Nicaragua’s state oil company (Petronic) and 51% owned by PDVSA. Petronic buys oil from PDVSA at market rates, financed via Petrocaribe. Petronic then resells the oil and hands over the resulting revenue to Albanisa. 50% of the money goes back to PDVSA, while the remainder is split between a social fund administered by the Bolivarian Alliance and Albanisa itself. In other words, Albanisa and the social fund are financed by cheap loans from Venezuela. (The details can be found here, an English interview with the then-head of Petronic.)

Albanisa then uses that revenue to finance investment projects. (Details here.) The flow is around $400 million per year; as of June 2014 the company had received a total of $3.1 billion. Given that all the activity so far has consisted of some rather desultory roads around Brito, it is certainly plausible that Albanisa is financing everything. 

The story has three implications. (1) Venezuela has been keeping the project moving forward, at least indirectly; (2) HKND is having real trouble finding investors; and (3) Managua is having second thoughts.

I would have thought that HKND would be able to get going on the free trade zone; after all, they will need it. But it seems as though they are having trouble getting even the funds to start that. Maybe Beijing does not think this is such a good idea after all.

I am not succeeding in convincing myself about the value of the Nicaragua Canal

 Somehow I doubt that China will replace its imports from Europe and the Middle East with imports from the east coast of the Americas. I also doubt that in any realistic scenario export channels to the east coast of the United States (where Nicaragua and Suez really are substitutes) would be disrupted  enough to make it worth the cost. 

But who knows? Like I said, the only way this thing gets built is if China backs it with sovereign wealth. Maybe they will risk it.

The Nicaragua Canal as insurance against major war

 In line with our post speculating about reasons for the Chinese government to back a Nicaragua Canals, comes a thesis by an Argentine air force colonel that tries to quantify the costs to world trade from interdicting various naval choke points. Since he lacked actual point-to-point trade volumes, he was forced to estimate volumes based on data from country-to-country trade flows. I am not clear what sorts of biases that introduces. He also assumed a cost per ton-mile of 0.2¢, which is rather low. (See page 18.)

That said, his estimate of the annual cost from closing the straits of Malacca, Sunda and Lombok (e.g., a complete blockade of all traffic through Indonesian waters) comes to about $10.5 billion. Shutting down the Bab-el Mandeb (the strait between Djibouti and Yemen) would cost about $13.4 billion. It is not clear what percentage of that would fall on Chinese consumers, producers or shippers. 

Let’s pull a number out of the sky and say that half the cost would fall on China one-way-or-another. Is a $50 billion canal in Nicaragua worth it as insurance? 30-year U.S. treasuries are yielding about 2.6%. Assuming that the canal comes in at cost and hits its projections it should be able to earn that through 2045. In that sense, maybe building it would have no opportunity cost, assuming that the money would have been otherwise plonked into American federal debt. The Gran Canal is still a terrible business proposition, but it would make cheap insurance against a possible $5.2 billion loss if Indonesia goes up in flames or some terrible conflict erupts across the Indian Ocean.

Only ... there is still no sign of official Chinese backing for the Canal Rojo!

All of these recent posts are attempts to make a convincing argument that my assessment is wrong and the Chinese government really will go all-in and build the thing with official money.

Am I succeeding?

Three reasons to build the Red Canal

 I do not think the Canal Rojo will be built. It makes no commercial sense. Most independent observers concur. Here, for example, is an article from the South China Morning Post, in which Andy Lane arrives at the same conclusion using different data. Mr. Lane has another good analysis here which doesn’t quite pan the project, but certainly leads towards skepticism.

All that said, I would like it to be built! Simply because it would be cool. But that will only happen if the government of the People’s Republic of China wants it to happen.*

So why might the government of the People’s Republic of China want it to happen?

Well, consider what China might gain from a Nicaragua Canal. Right now, it is nearly a wash between using Panama and using Suez from the East Coast of the U.S. to southern Chinese ports. Using Suez, however, also means going through the South China Sea. Most scenarios in which the South China Sea was closed to shipping would likely also involve fighting around the First Island Chain ... but not all. (An Indonesian collapse? A war with India?) And there are multiple scenarios in which Suez might be closed. A Nicaraguan Canal would provide an insurance route for cargoes to and from the east coasts of North America and Brazil. 

The problem? An expanded Panama Canal would do the same thing at lower cost. Remember: there is no way on God’s green earth that China could use the Nicaragua Canal in a situation in which Panama was closed to it. In addition, there would be political benefits to financing a second Panama Canal expansion over building a Nicaragua Canal. Financing a fourth set of Panamanian locks would set off some huffing among the usual suspects here in America, but serious observers (e.g., most plausible U.S. administrations) would be reassured by the fact that a Panama expansion would fall under the rubric of the Neutrality Treaty. Which means a greatly reduced chance of antagonizing Washington. Moreover, another Panama Canal expansion would be uncontentious in Panama ... the same cannot be said of the Gran Canal project in Nicaragua. In other words, all the security gains at less financial cost and less political risk.

In fact, Chinese companies in August of last year broached the possibility of financing a new Panamanian expansion. 

There is a second possible reason to build a Nicaragua Canal. Note that Lane does not think that the new canal will lead to price competition with Panama. His logic, however, assumes that the Nicaragua Canal is run as a business. Perhaps China does not plan to run the Canal Rojo as a money-making operation at all. Rather, it could  run it as a piece of necessary public infrastructure, operating at cost. In that scenario, a price war with the Panama Canal leading to HKND’s  bankruptcy would be a feature, not a bug. 

The problem with the second reason? Well, for China to want to do that, it would need to believe that the rates charged by the Panama Canal are a significant drag on commerce. There is not a lot of evidence for that proposition. Would reducing canal tariffs really cause Chinese consumers to buy much more raw material from the east coast of South America or prompt Chinese producers to sell many more goods to the east coast of North America? I have my doubts.

Moreover, how would China insure that its commerce captured the lion’s share of the gains from the Nicaragua Canal? As Carlos Yu and I showed in our book, when the United States tried to give preference to its own ships in the Panama Canal in 1912, British pressure forced the country to change tack. The only reason that the benefits of the Panama Canal went overwhelmingly to the United States during its first 25 years was that the Panama Canal overwhelmingly carried domestic traffic. Maybe China will be able to get away with favoring its commerce over other nations, but I doubt that too. Or maybe geography implies that most of the ships using a low-cost Nicaragua Canal will be carrying Chinese commerce. Maybe ... it would be a hell of a $50 billion bet. 

That leaves you with a third possibility: the project would be the 2020s equivalent of the 1960s landing on the Moon. China would be metaphorically planting its flag on the American continent. Sure, the U.S. Navy would remain in complete control of the sea lanes and the People’s Republic would have no sovereignty. But the opening of the Canal Rojo would trumpet the end of America’s informal empire more than anything ...

... other than the actual end of America’s informal empire. Which will not (inasmuch as it survives) be altered in a any substantive way by this project. As stated above, the U.S. Navy will still control the Western Hemisphere. Moreover, I do not see how building this project would win China diplomatic gains in Latin America worth the $50 billion cost. Perhaps I underestimate the power of symbolism?

In short, the Chinese state would obtain at least three advantages from the construction of a money-losing Nicaragua Canal:** 

1. Insurance against disruptions in Suez, the Indian Ocean, the straits of Malacca, or the South China Sea (although this insurance could be obtained more cheaply using Panama);
2. The chance to drive transit rates down to their operating cost;
3. Prestige.

Are those advantages enough for the Chinese government to lend billions of billions of dollars to an entreprise that will likely go bankrupt? 

A way to make the Nicaragua Canal profitable

 I have been tinkering with my mickey-mouse financial model for the Nicaragua Canal. 

There is one way to make the Nicaragua Canal look like a decent investment: assume that it comes in on-time and on-budget (which we did) hits all its transit targets (which we did) and that the ships are all sized at the maximum possible (which we did) but also that the Nicaragua Canal will be able to raise average tolls at the same 6.8% rate that the Panama Canal has managed since the 1999 handover. If you believe that is possible, then you can manage a positive 6.1% return through 2030 and a respectable 12.2% return through 2040; breakeven happens in 2027.

Do I believe that is possible? No. Do I believe that equity investors would accept that return? No. Do I believe that with enough debt equity investors might be persuaded to that they could get an acceptable return? Uh ... maybe.

We come back to that whole government-involvement thing. The Nicaragua Canal will need a lot o low-cost debt to be viable even under the most heroic assumption. The project only flies if Beijing decides that it wants it to and is willing to back that up with government money. A whole lot of government money.

Stephen Kaplan is just down the metaphorical hall. I should ask him if he thinks the Chinese government would want to back this ... and if so, why. One colleague of mine suggested “colonization” as a goal of its own. Me, I don’t think the Chinese government thinks that way, at least not in this hemisphere. So I am back to thinking that this project isn’t going to happen.

I have no special insight into Chinese strategic thought. I have heard that it might be about secure access to Venezuelan oil or Trinidadian natural gas, but if I were in the Chinese leadership I would not think building the Canal Rojo a sensible way to attain that goal. Is there any Chinese strategic question to which the Nicaragua Canal is the answer? 

The Nicaragua Canal still makes no business sense, now with numbers

 The Nicaragua Canal project is a little crazy. I’ve been canoodling around with some numbers and I just can’t make it work.

The project is estimated to cost $50 billion. According to HKND, the Red Canal will have an average bottom width of 280 meters. (Page 5.) That is only enough for one-way traffic. (Page 8.) Given the amount of time that it will take ships to pass through the two three-chambered locks, that means about 14 transits per day. (Page 72.) That is reasonable. 14 transits per day means 103 minutes for a ship to transit one set of locks. (Only one ship can through the locks at once, but there can be a ship in both the Brito and Camilo locks at the same time.) The new Panama Canal lock chambers are designed to take about ten minutes to fill or empty; call it an hour then for each transit, plus 40 minutes to enter and leave.  

OK, then. In 2020, HKND expects 3,576 transits, rising to 4,138 by 2030. (Also page 72.) That’s about a third of the roughly 12,000 recorded by the Panama Canal. So it is certainly a plausible number.

In 2012, the Panama Canal collected approximately $160,000 in tolls per transit, or $5.67 per ton. (Eight dollars for container ships, around five for reefers, and roughly four for tankers and dry bulk.) The new Nicaragua Canal is intended to handle ships of up to 18,000 TEU; ships on the current Panama Canal is limited to around 5,000. (The expansion will take that up to 13,000.)

If you ever wondered what a Panamax container ship looked like going through the Miraflores locks, well there’s one right behind me in the picture up there. That’s a ship, not a warehouse. Yes, the current locks are a tight fit.

Now imagine one three times the size.

So let’s calculate a ridiculous upper bound for the Nicaragua Canal. Assume that all the container vessels are at the maximum size for the new passageway. At the current rates charged by the Panama Canal, that’s $1.4 million per container transit. Then assume that all other vessels (save tankers) are equivalently oversized. That gets you about $500,000 per dry bulk transit and $1.1 million for vehicle carriers. We’ll further assume that all the “other” vessels in the HKND report are vehicle carriers. For crude oil, imagine that everything is a ULCC with almost 7× the capacity of a Panamax tanker. Ditto the LNG ships. Refined products, on the other hand, are currently shipped in Panamax-sized vessels, so even in this silly projection we’ll leave them the same. 

And opex? Well, huh. I’ll take current Panama Canal costs and divide ‘em by the ratio of projected Nicaragua Canal traffic to current Panama Canal traffic. That does not, of course, make sense, but it is a lower bound. (And one that comes to $75,000 for each of the Nicaragua Canal’s projected 3700 permanent employees; a ridiculous number by any standard.)

What do we get? A real internal rate of return through 2030 of negative 1.8%. If you take it out to 2040, then you can eke out 4.1%. A steely investor willing to bet against global war, the Singularity, and the chance that climate change will open the Northwest Passage could get 5.6% through 2050.

If this thing gets built, it will not be to generate profits for shareholders. Rather, it will be because the Chinese government sees some sort of security benefit. But other than, I dunno, access to the natural gas that the United States is not going to export in large amounts I could not tell you what that might be. 

3-D printed houses are not ready for prime time

 Courtesy of Will Baird, I learn that a company in China is breathlessly promoting its 3-D printed houses. A revolution! The future is here! Not robots, but the next best thing.

Or not. There are some numbers in the second link. At first you’ll see a claim of $4,800 for a 2,100 square foot house. That is ... hard to believe. It is also contradicted later on in the same article, where they claim a total construction cost of $161,000. So the $4,800 is probably the cost of the printed construction materials.

$4,800 is not a dramatic decrease in materials cost. In South Florida, your typical concrete construction costs about $6 per square foot of living space. (That is not the cost of the poured concrete; it’s the cost of the concrete needed for the walls in a house of that size.) That comes to about $12,000 in total. Now, $4,800 is less than $12,000, but it isn’t clear how much of that reduction is due to the technology and how much is due to other things. Consider that in California, concrete walls cost about $11 per square foot of interior space: almost twice their Floridian cost! Building codes matter a lot. I suspect that a Miami builder could halve their costs if they built to Shanghai standards.

The article reports a “total cost” of $161,000 further down, which is a far-from-revolutionary $74 per square foot. And it isn’t clear if that’s the total construction cost or just the cost of the printing materials when you make the correct all-in calculation, although given cheap labor in China I would guess the former.

I think this is either a publicity stunt or a marginal improvement. Maybe both.

Chinese beneficence towards Venezuela runs out ... maybe

 The increasing impenetrability of Venezuelan statistics is well known. What I find annoying above all is the way the Oil Ministry quotes oil prices. Rather than give the average price fetched by Venezuelan crude, they include the prices of the refined products that PDVSA exports. (Venezuela is a net importer of refined products, but it does export some.) 

That makes it hard to understand what happened in the oil market in 2011-13.

Venezuelan crude is heavier and therefore costlier to refine. It generally therefore traded at a discount compared to West Texas Intermediate. (WTI is a generally-used benchmark for North  American domestic crude.) In mid-2011, however, that changed: for the next two years the “Cesta Venezolana” fetched a premium. Sometime in the middle of 2013, things then returned to normal.

So what happened? I do not know for sure. (Is Francisco Monaldi out there?) But I have a hypothesis.

The hypothesis is not that the price of refined exports spiked enough to drive up the price of the Cesta Venezolana. Refined prices did spike in the United States. But gross volumes of Venezuelan refined exports faded to near nothing. (In fact, Venezuela started importing significant quantities of American gasoline and other products around 2010.) Refined product exports are not big enough to explain the massive fall in the discount on the Cesta Venezolana. 

Another possibility is that heavy crude began to command a premium in the United States. After all, domestic production was skyrocketing, and that production was of light crudes. At the same time, Venezuelan exports to the United States continued their decline. (As did, for other reasons, Mexican exports.) American refineries in the Gulf region are optimized for heavy crudes. So maybe they began paying more for all heavy crudes. The Canadians could not enjoy that premium because it cost so much to move their stuff to the coast, but the Venezuelans could sit back and look pretty.

Still, there is something unsatisfying with that story. Venezuelan exports to the United States had been falling for some time. There was no sudden shift. It seems unlikely that the American demand for Venezuelan crude suddenly spiked. 

On the other hand, it seems more possible that the non-American demand for Venezuelan crude suddenly spiked. 2011 was around the time that Hugo Chávez’s policy of redirecting exports to China began bearing fruit. There are reasons to believe that Venezuelan oil fetched higher prices in China than in the United States. Chinese refineries indexed to Brent, not WTI, and Brent enjoyed a premium over WTI at that time. In fact, when you add the WTI-Brent discount to the graph of the WTI-Cesta Venezolana discount, the correlation is hard to miss. 

The hypothesis is the following. The Venezuelan government deliberately redirected exports to China, where they fetched a higher price than in the United States. (This does not include the cost of the new refineries in China that the Bolivarian Republic, in effect, financed.) For a time, that gave Venezuelan crude a significant price premium. The current ~$10 gap between Brent and the Cesta Venezolana is within historic margins, albeit on the high side. It does seem as though the Chinese may have adopted a less-favorable pricing policy.

Of course, given recent market movements, the Venezuelan government has other things to worry about as far as oil prices are concerned. The disappearance in the premium is only an insult added to injury. I wish I could make out what prices President Maduro is looking at in this graph ...

Boz misses the true imperialism of the Chinese deal in Nicaragua

 This would be a comment on this post at Bloggings by Boz, but goddammit there’s no way to comment over there! What up with that, Boz?

Anyway, Boz writes:  “For the Chinese investors behind this canal, one of the biggest fears may be the final line of Tim Johnson's article yesterday: ‘Said Liberal congressman Pedro Joaquin Chamorro, “The canal concession will be overturned by future democratic governments.”’”

Would it will be so easy. For as we pointed out here, Nicaragua has signed away its sovereign immunity in the concession agreements. I doubt that the more extreme renunciation will stand in foreign courts ... but the Chinese won’t even need that to hold future Nicaragua over a barrel.

I suppose that the United States probably could arrange things to help the Nicaraguans escape the deal. Maybe. Perhaps. Uh huh. 

Meanwhile, y’all can listen to me bloviate about why I don’t think the Nicaragua Canal will happen on the BBC World Service. 

Mexico will still get high-speed rail very soon

 Recently the Mexican government cancelled and then annulled a $3.8 billion contract with a consortium led by the China Railway Construction Corporation (CRCC) to build a high-speed train between Mexico City and Querétaro. The reason was that the consortium included Constructora Teya, a company with close ties to President Peña ... including financing an expensive house for his wife. More to the point, Alstom, Siemens and Bombardier all complained that they did not have time to submit bids. 

But don’t worry! New bids will be solicited over the next six months. CRCC will bid. The Chinese government appears to be a little upset, but they’ll live. 

The China in Latin America blog worries that China has a long memory for these sorts of slights. I am not as worried. There has never been any intimation that the China-Mexico relationship is about anything other than business. As political risk goes, this is minor. And if turns out that the Canadians, French or Germans can provide a better product, then Mexico should go with them. In short, I am not worried.

And the train is a good idea. Unlike the Argentine tren bala, this train has the traffic to support it (and actual studies to show it) and it will be a commercial operation. Moreover, it can be extended further to Guadalajara, a much bigger city than anywhere the Argentine high speed train might have gone. 

The Nicaragua Canal is still unlikely

 This blog was confident that the Nicaragua Canal would not be built because it makes no business sense. That is still our position. That said, it is increasingly likely that construction is about to start on ... something. We would still bet against that something being the Gran Zanja.

First, the financing. Where will it come from? HKND used to strenuously deny that there would be any Chinese official involvement with the project. But the business plan still does not make sense and private sources are unlikely to come through. Now, however, HKND is saying that the Chinese state is willing to put up the money. “Mr. Wang is looking at this issue intensely and working with Chinese state businesses that will have a small amount of participation in this project and will finance a great part of this project. And then we have to go out into the international markets once we are ready to.”  

If Beijing has decided that the People’s Republic has decided that a Nicaragua Canal, then one of the biggest arguments why it will never happen goes away.

But we do not know if the Chinese government has made that decision! For what it is worth, the Costa Rican government directly asked Chinese representatives about the PRC’s official position. How did the Chinese respond? “They have told us on two occasions that as of today there is no endorsement. We do not know if in the future China will be interested in participating. That is a sovereign decision, but we believe that the proper stringencies will be complied with.” 

Second, construction is due to begin on December 22nd. But don’t get too excited. The first works will consist of “auxiliary roads and port construction, not the ditch.” Other announcements have omitted the port construction; it looks like the work might be just sixty miles of macadamized roads. Even HKND admits that the December 22nd date is symbolic.  

We will know when the effort gets seriously underway. HKND officials met with representatives of the Nicaraguan farm sector. Michael Healy, the head of the farmowners’ federation, reported that “they are talking about demand for 37.5 tons of rice, 25 tons of vegetables and 12½ tons of beef, pork and chicken, per day.” [Italics ours.] The request led the agriculturalists to suspect that HKND intended to bring about 50,000 of their own workers, because “The Chinese didn’t ask for a single pound of beans or corn, which it seems are not part of the Chinese diet.” 

It is worth noting that while Nicaragua can probably provide the meat, it would need to import most of the rice and a lot of the vegetables. 

In short, a serious effort will see massive imports of food and construction materials, as well as mass hiring of Nicaraguans and the arrival of thousands (if not tens of thousands) of Chinese workers. It won’t start on a dime. 

Third, there is a lot of opposition in Nicaragua, not least because the new law says that landowners will be compensated at the cadastral value of their land, not the market value. The Changjiang Institute has been conducting surveys around Rivas, and the Chinese surveyors have needed police and military protection. And you can add to the opposition to mass expropriations three other things: (a) opposition to the potential arrival of thousands of Chinese workers; (b) opposition to the Panama-Canal-Zone-like 500-meter security zone on either side of the canal; and (c) general opposition to the renunciation of Nicaraguan security. It is not clear that the domestic politics of the project will hold up.

We return to our initial conclusion: the Nicaragua Canal is about the side projects. Look at this presentation. The side projects are much more developed than the Canal. (The map above shows the port complex on the Pacific, which will in effect be a Chinese charter city.) HKND is enveloped in a web of weird related companies that seem perfectly designed to channel profits to Nicaraguan politicians but not so much for raising $50 billion. 

In short, while it is possible that Beijing might throw its weight behind the Gran Zanja (also sometimes evocatively called the Canal Rojo) we remain skeptical.

A lesson for China from Australian history?

 If ever there was a country less likely to provide useful lessons for China, it is Australia. Australia has always been underpopulated. It is practically the platonic ideal of a settler colony, having wiped out the locals far more thoroughly than its American counterparts. The settlers brought British institutions with them and then improved them: in humanity’s slow move towards democracy and the rule-of-law, Oz has always been on the forefront.

But there is one thing that past Australia shared with future China: a huge imbalance of men over women!

There has been a lot of blather about China’s sex-imbalance, most recently in the Washington Post. In the words of our co-blogger, Doug Muir: 

I’ve been reading variants of that article since well back in the Clinton administration. Is anyone aware of any hard evidence linking skewed sex ratios to a more aggressive foreign policy? Because AFAIK there is none, which makes these articles Just So stories justifying another round of yellow peril pearl-clutching.

I note that China’s oldest sex-skewed cohorts are in their thirties now. So far, the major effects seem to be a rise in prostitution and a lot more time spent on the internet. Both negative social consequences to be sure, but a long way from the Tong Wars and “virile” foreign policy these two dopes are going on about.

So what did an unbalanced sex ratio do in Australia? Well, Pauline Grosjean and Rose Khattar of the University of New South Wales decided to take a look! Their findings:

We document the implications of missing women in the short and long run. We exploit a natural historical experiment, which sent large numbers of male convicts and far fewer female convicts to Australia in the 18th and 19th century. In areas with higher gender imbalance, women historically married more, worked less, and were less likely to occupy high-rank occupations. Today, people living in those areas have more conservative attitudes towards women working and women are still less likely to have high-ranking occupations. We document the role of vertical cultural transmission and of homogamy in the marriage market in sustaining cultural persistence. Conservative gender norms may have been beneficial historically, but are no longer necessarily so. Historical gender imbalance is associated with an aggregate income loss estimated at $800 per year, per person. Our results are robust to a wide array of geographic, historical and present-day controls, including migration and state fixed effects, and to instrumenting the overall sex ratio by the sex ratio among convicts.

In other words, the historical evidence does not point to a future of gang warfare and foreign adventurism. Rather, China will be more traditional, more married, and slightly poorer than it would have been otherwise. And if the lessons from the West and Latin America hold, the result of that will also counterintuitively be a much lower birthrate than in more gender-equal countries.

China in 2050? A big giant Queensland! But with robots. 

This is not as sexy as a Venezuelan-style crime wave combined with an invasion of Siberia, or whatever. But it has the advantage of being grounded in this thing we historians call evidence. 

PDVSA is probably not losing money on its sales to China

A few months ago, we mentioned Venezuela’s success in reorienting its oil sales from the United States to the People’s Republic. We lauded the move, since American refineries on the Gulf were (and are) experiencing oil gluts.

Early last month, however, a group of Venezuelan oil analysts called Subaeshi (their Twitter account is here) argued that PDVSA had incurred a terrible opportunity cost from this policy. So I took a look at it.

Unless I am missing something, they are wrong. PDVSA is not incurring huge opportunity costs by selling to China instead of the United States.

On slide 13, they assume that sales to China earn only 10% of the WTI price because of “shipping and insurance costs and debt-repayment obligations”  against 85% in the U.S. because of only “shipping and insurance costs.”

Huh?

PDVSA receives less cash when the oil is delivered simply because its Chinese customers have pre-paid for it.

The analysis makes no sense. A cash-flow analysis would book the loan revenue when the loan was made rather than when the oil was delivered. An income analysis would book the income when the account payable (the loan) was extinguished. (Simple version of the latter: the loan would raise PDVSA’s cash (an asset) and the loan (a liability) by the same amount. Delivery of the oil would then extinguish the loan liability, generating income.)

Inasmuch as PDVSA loses money on sales to China relative to America, it is a function of higher transport costs, the interest rate on the loans, and any price discounts granted the Chinese buyers. Caribbean freight rates are about $1.35 per barrel (some OPEC data); since there is no data on shipping rates from the Caribbean to China, let’s double it for an opportunity cost of $1.35. (That’s actually kind of silly, since there is no real relationship between spot rates and distance: see page 55.) The interest rate on Chinese loans is around 3.4%; so call it 0.9% for a nine-month gap between borrowing and payback ... or 85¢ per barrel.

Total cost: $2.20 per barrel. It would not be unheard of for a supplier to offer discounts of up to $2 per barrel to regular buyers. Call it $4.20, then. Not huge, not chump change.

But there is the possibility that PDVSA gets a much higher price in China. Venezuela’s Merey blend generally tracks WTI. (See page 6 at OPEC’s December Monthly Report and page 27 at OPEC’s 2012 annual report. Maya from Mexico generally trades at a larger discount.) But WTI is still cheaper than Brent: $14.21 per barrel in November; $10.97 now.

And China benchmarks to Brent, not WTI. It is illegal to export crude from the United States; only Americans can buy at WTI.

It is possible that Venezuelan crude trades at less, because it is heavy. But it would have to trade at $10.97 − $4.20 = $6.77 less for PDVSA to be losing money on this deal. That does not seem likely.

In short: the Subaeshi analysis seems fundamentally flawed. I will of course change my mind with new data, but right now the Venezuelan turn to China seems like good business, even if done for the wrong reason.

POSTSCRIPT: Looks like the indispensable Setty got to this issue first.

Much ado about nothing: China and the Caribbean

The Inter-American Dialogue just published a new report on Chinese investment in the Caribbean. And what did it find? Nothing!

Seriously, nothing. There is nothing to be seen here. The headline number for the stock of Chinese FDI in 2011 was $469 million. This is not a whole lot, even considering the small size of the Caribbean economy. Moreover, the geographic distribution shows there is even less to this than meets the eye.

Investment in the Bahamas and Barbados totalled $1.6m and $3.1m respectively; this is the equivalent of a couple very nice beach houses. (And significantly down in both places.) In Trinidad, perhaps the Caribbean’s most important economy, and certainly the one with the greatest growth prospects, China has invested a risible $900,000.

In Jamaica, China has more significant investment: $39 million and rising fast. The Jamaican government got out of the sugar business in 2011, selling three sugar factories and leasing 30,000 hectares of cane fields to Complant International. Complant then began a four-year investment program to put about $156 million into improvements in fields and factories, plus a new refinery to process 200,000 tons of raw sugar per annum.

How has that been working out? Not too well. First, it got hit with a drought. Then it got slammed by a fall in the Jamaican dollar. (Jamaica, unlike the rest of the West Indies, floats its currency. See the previous post.) Adding insult to injury, the company purchased $160 million in new plant and equipment ... of which an astounding $28 million was promptly stolen. Complant then fired 132 guards on July 31, 2013 ... only to face a sympathy strike by the rest of the workforce. The strike was resolved, but the Jamaican sugar industry is still in trouble, and the company is now in trouble over a decision to terminate the credit-support facility to its sugar-cane suppliers.

Another big rise has been in St. Vincent, from $6m to $36m between 2003 and 2010. I have not been able to find out what that was about, and I should note here that St. Vincent still recognizes Taipei as the official capital of all China.

Two-thirds of Chinese investment in the Caribbean is in Cuba and Guyana, with the bulk of the rest in Suriname. Cuba is, well, Cuba. The Guyanese investments are in bauxite, where the Bosai Minerals Group purchased 70 percent stake of Omai Bauxite Mining (the remainder staying in the hands of the Guyanese government). The Surinamese investments are in palm oil. Neither in Guyana nor in Surinam have Chinese investments lead to great leaps in output or productivity; Guyana is in a mining boom, but the lead is not Chinese.

There is more debt invesment (for example the giant Baha Mar complex in the Bahamas is on track, although the China Ex-Im Bank never seems to have taken an equity stake) but other than the Bahamian mega-resort none of it is economy-changing.

In other words, China has a presence in the Caribbean, but it is concentrated in a few countries, not particularly successful, and a harbinger of nothing other than the fact that Chinese banks and companies have dollars to burn.

The real meaning of Sky City

A Chinese company wants to build the world’s tallest skyscraper. As a result, there has been a lot of discussion about the “skyscraper index.” Does the groundbreaking on Sky City mean that the Chinese economy is about collapse? Is the world economy at risk?

Maybe. It could. I am on-record as a medium-term China bear. But that is really not what Sky City means. No, the real meaning of Sky City is the same as the meaning of the locks on the Panama Canal expansion: China’s manufacturing model has reached its limits.

What do the Panama Canal expansion locks have to do with Chinese manufacturing. Well, below you can see a video of the Panama locks being loaded onto the ships that will take them to Panama; they should arrive next month.

You got it: the locks are being built in Italy. Not China. In fact, very little of the equipment for the expansion is coming from China. Engineers on the project told me that Chinese work was cheaper, but they judged it too shoddy and unreliable.

And ... the developers of the Sky City project refuse to use Chinese steel because it is not safe. They will get the steel from Luxembourg instead. (I bet few readers knew that Luxembourg is a historic center of steel production.)

Moreover, the building looks to be mightily unpleasant inside. (I cannot help but think of this great movie.) I also cannot help but think of the infamous skyscraper slum of Caracas.

The upshot is that something is broken at the heart of China’s manufacturing model, at least as it concerns high-performance large-scale capital goods. If nothing else, Sky City exemplifies that concern.

The peak oil people were three-quarters correct

Noah Smith says what I said back in May 2012. My words then: “The peak oil people seem to have been half-right. Technology has enabled the world to maintain oil production, and the truth is average production looks set to expand. But technology has not enabled the world to maintain production without using increasingly expensive techniques.”

(More here about U.S. production.)

Anyway, there is another sense in which the peak oil people were half-right: oil production is not going to rise quickly enough to meet demand. (I think that makes them three-quarters right = 1 − half-wrong × half-wrong.) Current projections have Chinese demand increasing through 2030 at around 2.7% per year. (See page 16.)

The problem is that represents a drastic decline from current growth rates, which averaged 7.2% over the last decade. Considering that Chinese consumption is still only an eighth of the U.S. level per capita (hell, it is a fourth of Germany’s and half of Cuba’s oil consumption) you do not need to assume very rapid Chinese economic growth to outstrip those projections.

We might discover enough oil to meet the high demand projections (although I doubt it) but only at much higher prices.

So either somebody quickly commercializes alternative means to power vehicles on a very large scale or we will be paying a lot more for oil. After all, higher prices are how you limit Chinese consumption growth to 2.7% per year absent economic catastrophe ...

I support the revelation of the NSA programs; I do not support Edward Snowden

The Edward Snowden saga has confused me. He decided to reveal information about NSA surveillance. He revealed that information in a piecemeal and confusing way. He decided to surface in Hong Kong. Hong Kong is sovereign Chinese territory: we are supposed to believe that Chinese intelligence did not get any information from him while he was there. He then travelled to the Russian Federation. Once the U.S. began extradition proceedings in Hong Kong he might not have had any other options but Russia ... but nonetheless that is where he wound up.

Glenn Greenwald just told me on national television that Russian agents have not had any interactions with Mr. Snowden (or copied his data by other means) because they “want him gone.” I have immense trouble believing that.

The NSA surveillance programs are complicated things that deserve to be brought to light and debated. I am glad that Snowden revealed what he revealed. We now need to debate them. An American court of law seems not a bad place to have that debate. A braver man than Mr. Snowden would have risked going to court, as did Daniel Ellsberg. No?

Still, one can imagine why he would want to remain outside the American criminal justice system. But why then did he not surface in one of the Bolivarian nations in Latin America? Going to Hong Kong seems entirely mysterious unless Mr. Snowden intended to pass information to the Chinese government. And it was not hard to know that Hong Kong has an extradition agreement with the United States.

It is possible that Snowden wants to end up in Russia. It is not unreasonable to think that in Latin America he would not be safe from be vulnerable to apprehension by U.S. agents. But going to Russia, I would think, means giving Vladimir Putin all the information that he has. Am I wrong to assume that?

I am glad that Mr. Snowden revealed what he revealed. And I am gratified that the revelations have moved American public opinion despite Mr. Snowden’s odd decisions. But until new information is revealed, the man himself has not got my sympathy.

Successful Chavista initiative

Five years ago, I was skeptical of Hugo Chávez’s plans to reorient Venezuela’s oil exports from the United States to the People’s Republic. But it looks like he did it. Considering that U.S. demand for Venezuelan oil is set to plunge what with Canada (regardless of Keystone) and domestic production, it seems like a prescient move.

It wasn’t easy to reorient sales. China needed to build the downstream refining capacity to process Venezuelan crude. Venezuela’s production is very sour. (Data from Eni’s 2012 Oil & Gas Review.) To refine high-sulphur oil, you need refineries with cokers. In 2007, only 2.5% of China’s refining capacity had the necessary machinery. Moreover, it was all already in use: new crude from Venezuela had noplace to go besides the United States.

As a result, when Venezuela started signing the loans-for-oil deals with China, the Chinese oil companies mostly sent the crude along to the United States. The below figures show PDVSA’s sales to Chinese buyers and the amount of physical petroleum products that arrived on Chinese soil from Venezuela. Note the difference? Chinese companies took possession of Venezuelan oil in Venezuela ... and then shipped it to the United States. As late as 2010 (when I saw the 2009 figures) it looked like Chinese companies were going to stick to shipping Venezuelan oil north to the Imperio but not really take much of the stuff east to the PRC. Moreover, a lot of what it did take was used to make asphalt, considering how hard it was to process. Not exactly a strategic necessity.

	PDVSA sales to China	Chinese imports from Venezuela	Difference
2006	97,000	84,000	13%
2007	95,000	82,000	14%
2008	321,000	129,000	60%
2009	370,000	105,000	72%
2010	178,000	151,000	15%
2011	319,000	230,000	28%
2012	451,000	367,500	19%

Source: Informe de Gestión Anual de Petróleos de Venezuela S.A. (PDVSA), 2006-2012; “Zhongguo shiyou he tianranqi jin chukou zhuangkuang fenxi [Analysis of Chinese Oil and Natural Gas Imports and Exports],” in Zhongguo shiyou jingji, March 2012. The standard accounting measure for oil is in thousands of barrels per day equivalent, but China measures imports in millions of metric tons. The industry standard of 20,000 b/d equivalent to 1 million metric tons was used for the conversion. 2012 data is from Platts: http://blogs.platts.com/2013/05/21/venz-numbers and page 93 of the audited PDVSA financial statements.

It no longer looks that way. Chinese companies are still not taking all Venezuelan crude and products back to China, but the resale percentage has crashed. Last May 2012, PetroChina and PDVSA started construction on a $9.4 billion refinery capable of processing 402,000 barrels per day (bpd). PDVSA is supposed to pay 40% of the cost ... funded via a loan from China. (See page 9 at the link.)

(In fact, the Chinese refinery-upgrading began back in 2008.)

PDVSA has also been beefing up its tanker fleet. In March, it added four tankers with a combined capacity of 2.9 million barrels, taking its fleet up to 18 vessels. The company is purchasing enough new ships to take its fleet up to 46 and supposedly will move 40% of production in its own fleet.

That last will take a little while to achieve. Venezuelan tankers travel to China by via the Cape of Good Hope (really!) with a travel time around 55 days at sea, roughly 65 days total. Call it 130 days round-trip. That means a tanker can make 2.8 round-trips per year. At 750,000 barrels per tanker per trip, PDVSA needs about 64 Aframax tankers just to carry its current exports. The new Sino-Venezuelan refinery includes VLCC berths, but that still means 24 supertankers. New, that would run PDVSA about $2.9 billion.

Does buying the tankers make sense? Lease rates bounce around all over the map, but a VLCC is now running around $12,00 per day, so 24 tankers would cost $40 million per year ... only a hair under 4% of the capital cost. Now, $12,000 is close to an all-time low. (Prices in fact touched $4,000 earlier this year.) PDVSA currently can borrow around 6.5% (the minimum LIBOR is usually 2% in PDVSA contracts) which implies that buying ships makes sense if you think that lease rates will go above $21,000 ... a price not only well within historic norms, but on the low-end of rates over the past decade.

So, yes, at first glance buying tankers makes sense; it is not just a vanity project.

In short, Hugo succeeded in convincing the Chinese to reorient the diet of their refining facilities around Venezuelan oil, redirected the oil to go there, and began to construct the fleet needed to get it their at a competitive rate. And if use the same data another way, it is not hard to show that a pipeline through Colombia makes sense. (Link to Tom O’Donnell’s great blog.)

The only problem, of course, is that Venezuelan product is flat and domestic consumption is rising. So there is only so much oil that can be redirected from the U.S. to the People’s Republic. And all those loans from China will have to be paid back. But that shouldn’t to take away from what seem to have been a pretty good move, carried out well.

Even if it is almost certainly a case of doing the right thing for the wrong reasons.

Does HKND really want to build the Nicaragua Canal? Probably not.

There is some evidence that HKND does not intend to build the canal across Nicaragua. At the very least, they are prepared to walk away from that commitment at the drop of a hat. (The “Casa de los Pueblos” in the below photo is where HKND and President Ortega signed the framework agreement on June 14.)

I just again read over the framework agreement, and it separates the entire project into nine subprojects:

1.  Airport;
2.  Associated infrastructure;
3.  Caribbean Free Trade Zone;
4.  Caribbean port;
5. “Dry Canal,” e.g. railroad;
6.  Pacific Free Trade Zone;
7.  Pacific port;
8.  Pipeline;
9. “Wet Canal,” e.g., the canal.

But clause 15.1 allows the Sponsor (i.e., HKND) to walk away from any of the subprojects at its own discretion.

If in respect to a sub-project, at any time prior to closing the finance for said sub-project, the relevant Sponsor determines by its sole discretion that such sub-project is not viable (for commercial, technical, legal, political or other reasons) or that the sub-project should not be completed or operated, in such case, the Sponsor has the right to terminate the concession for such sub-project and all rights, benefits and obligations under this Agreement with respect to such sub-project.

The chart on page 21 of the agreement makes it clear that there is no special penalty for declaring a sub-project inviable and walking away.

In other words, HKND could develop, say, the railroad and free trade zones, or the airport and pipeline, or just the railroad, or just the free trade zones, or whatever ... with all the amazing protections and concessions that I discussed in this post.

You could see a de facto pair of HKND-run charter city ports (depending on the specific FTZ legislation; all we know right now is that they will be tax-exempt and operation outside Nicaragua’s tariff wall) with a railroad and pipeline connecting them. That might make commercial sense as a project; I can especially imagine the pipeline getting use for Venezuelan and Brazilian shipments.

But I do not think that HKND really intends to build a canal. Oh, I am sure that they might try if the financing showed up ... but I don’t think that they will try very hard.

China claims Okinawa!

OK, not really. But this story in the New York Times was a bit jaw-dropping.

Me, I’m still ambivalent about the whole giving-it-back-to-Japan thing. It would have made a great state. (The honorable Senator Keiko Itokazu, one of the few Democrats from this usually Republican state and vital legislative ally of her fellow Mormon, Harry Reid. C’mon, you can see it.) At the very least, a compact of free association with an Okinawa Republic. But it was not meant to be.

So I can’t call the Chinese who want the Ryukyus to become an independent state under Chinese suzerainty completely crazy. (After all, an Okinawa Republic with a CFA is nothing more than “an independent state under American suzerainty.”) And it would have the additional benefit of pushing the American strategic perimeter away from China.

But I find it hard to take random non-official Chinese claims seriously enough to warrant a page 4 story in the what is still America’s paper of record. Slow news day? Or am I missing something about the seriousness of what looks from the outside to be random noise?

Neocolonialism in Nicaragua?

So I got my hands on the memorandum of understanding, the deed of cooperation, and the framework agreement for the proposed Nicaragua Canal. All I can say is ... wow. It is somewhat, uh, lopsided.

Thus my political doubts about the proposal. This is such a stunningly bad deal for Nicaragua that I have trouble imagining it lasting. But then again, Mr. Ortega has run the place tolerably well and is riding high in the polls. His party has total control over the National Assembly and the next election is not until 2016. So maybe he can get it through, although something about this statue in downtown Managua gives me doubts.

On to the deed of cooperation! First thing, it establishes free trade zones at both ends under the control of the concessionaire. It is supposed include an international airport, or if that doesn’t happen, control over an expansion of an existing one.

Second, the concessionaire gets “title to all real and personal property to be transferred by the Authority on behalf of Nicaragua free and clear of all liens or other encumbrances.”

So far, this is not bad, although it might sound it. This is just standard for big private infrastructure contracts, including the promise of the “relocation and resettlement of any people and/or communities currently situated in areas to be utilized by or in connection with the Project.”

Third, the concession period is 100 years.

Whoa, what? The news reports say 50. True. But right there, on page 5:

Nicaragua shall grant ProjectCo the right to use and receive any and all economic benefits arising from the Canal and the Associated Infrastructure (including without limitation the exclusive right to collect tolls, tariffs and fees from the shipping and freight utilizing the Canal and any party utilizing the Associated Infrastructure) for the period starting upon the date hereof and ending on the date which is fifty (50) years after the commencement of operation of the Canal, which initial term shall be automatically and without any additional consideration from or costs to the NewCos or the Sponsor extended thereafter for an additional fifty (50) year period in the event that ProjectCo provides a written notice to the Authority at least six months prior to the expiration of the initial concessional period.

ProjectCo is a special purpose vehicle (formed under the laws of any country) to operate the Canal. The Sponsor is the HKND Group. The Authority is a semi-autonomous arm of the Nicaraguan state established by Law 800. NewCos refers to both ProjectCo and the holding company that will own the shares, e.g. HoldCo.

Let us continue. Anything else?

The Authority and Nicaragua shall grant protections and safeguards to each of the Sponsor, HoldCo and ProjectCo against any changes in law (including, without limitation, tax, corporate and real estate laws of the Republic of Nicaragua) law enforcement, environmental standards, consents, decrees, policy and regulations and any court order, decrees or judgments.

And:

The Sponsor and each NewCo shall each enjoy exemption from Nicaraguan corporate and income taxes and exemption for themselves, their affiliates and financing sources and the Project from all charges, fees, withholdings and assessments and any other taxes and duties.

But how can HKND be sure that a future Nicaragua government won’t change the rules? Well, they are planning for the year 2113, so maybe they will just send in a robot army. But that seems like a long-shot. So instead they promise to give HKND the protection of Nicaragua’s bilateral investment treaties. See the above clause where the NewCos could incorporate where they like? That means they get to pick the best one of Nicaragua’s treaties, which you can find here.

And that brings in the power of ICSID. Already Nicaragua would be risking Chinese retaliation. (Qianru Song and Rodrigo Wagner have argued that China worries little about expropriation because it stands ready to use harsh economic sanctions against violators.) But now it would risk huge legal knots from every country that had signed the New York or Washington conventions.

So far, we have that the Nicaraguan government gives HKND full property rights over the Canal for 100 years, including title to all property, plus a form of extraterritorial privilege in the free trade zones. Plus full tax exemptions and recourse to international law to make sure that nothing but nothing changes between now and 2113 ... actually, a bit longer, since that 100-year clock starts ticking when the Nicaragua Canal starts operation, estimated by proponents as eleven years after construction starts.

(So call it 2124, when the robotic ships will be carrying ... what? Raw materials for 3-D printers now that the war between Russia and Nunavut has shut down the Northwest Passage? I kid, but the point is that there is something fundamentally ridiculous about a 100-year concession.)

What does Nicaragua get in return? Well, it gets $10 million per year from the start of operations. They are also get a 1% initial stake in the business, but any dividends are deducted from that $10 million. A second 1% stake is to be used by the Sponsor for “philanthropic purposes in order to support social and economic development in Nicaragua and/or in the name of the citizens of the Republic of Nicaragua throughout the world.”

Nicaragua’s stake is set to grow by 10% every decade. So in year 11 of operation, it jumps from 1% to 10%. In year 21, it grows to 20%. And so on, until year 101, where it peaks at 99%, with the rest going to those “philanthropic purposes.”

The framework agreement adds a few wrinkles to the deed of cooperation. It has a few provisions that could be interpreted as giving HKND the right to set up its own security service. It also insures that arbitrations will occur in London, and that is important because London has some of the most powerful laws to use against international entities. (Arbitral decisions are first enforced in the country where the tribunal was held.) And it makes it clear that HKND can bring in whatever workers it needs to construct and operate the canal.

Finally, the framework agreement contains the most forceful renunciation of sovereign immunity that I have ever seen:

[The Republic of Nicaragua] waives to the maximum extent possible whatever sovereign immunity that it might possess, whether before an arbitral tribunal or procedure, judgment, jurisdiction, adjudication or enforcement action, including the waiver of any sovereign immunity for itself (including, should it be applicable, its ministries, departments, agencies and independent organizations carrying out governmental functions) and whatever of its properties, whether its own or any other agency, regardless of the commercial or non-commercial nature, function or purpose of such property. These assets shall include any bank account belonging to the Party [e.g., Nicaragua] whether under the name of a diplomatic mission or something else.

This all seems very familiar. I mean, there is no reference to a zone ... uh, except the free trade zones, and that’s different, right? ... and I don’t think that Nicaragua will be adopting the yuan or changing its constitution to allow Chinese intervention ... but wow.

For what it’s worth, that $10 million is more than the $5.4 million (in 2012 dollars) that Panama received from the U.S. under the Hay-Bunau Varilla Treaty. But this is set up to insure that Nicaragua will enjoy very little benefit from the canal until its second decade of operation, and even then the returns will be slight unless it turns out to be phenominally profitable.

Putting aside the problems with the business case (you can read HKND’s version here), I am not sure how you sell this contract to the Nicaraguan people. But perhaps President Ortega is popular enough and has a big enough majority that he does not have to.

Finally, two useful links. Here is a good news backgrounder by El País. Here is an invaluable run-down of the Chinese actors and the legislative background at Margaret Myers’ always invaluable China and Latin America blog.

Mexico is gaining jobs, not wages, part 2

Part 1 is here.

Part 2 is based on a stunning report from Bank of America: nominal dollar wages in Mexico are now lower than in China. (Hat tip: Beyond Brics. But note that we here at TPTM called it first!)

This is a great thing for China, obviously, and it has benefits for Mexico. It means that “nearshoring” will continue, as Mexico gains competitiveness against China. In fact, Mexico became competitive back in 2008, right after the big depreciation in the peso. The below chart shows Alix Partners’ decomposition of the landed costs (i.e., wholesale cost for U.S. sales) for five representative goods. In 2005, China was cheaper than Mexico; by 2008, that was no longer true.

But is it a good thing for Mexico? I am less certain. A boom based on nearshoring and continuing low wages ($2.50 an hour from BofA; $4.53 from the BLS) is a good thing for investors and the resulting employment boom is a good thing for Mexicans, but it does not presage much future growth. (In addition, the gains from the good news are already priced into the markets; ship-sailed if you’re looking for easy returns.)

Mexico is a solid middle-income democracy with a serious (but not existential) organized crime problem. It has made amazing strides in eliminating unnecessary volatility. The country works. But looking over the recent hype it’s attracting (see here and here and here.) I feel a little like Chris Rock. “You’re supposed to have a democracy! You’re supposed to have a middle class! You’re supposed to have factories! What do you want, a cookie?”

In other words, Mexico is performing just as you would expect a stable middle-income country with substantial long-term problems to perform. The expectations of super-returns and blather about Aztec Pumas (or whatever) is just hoping for a cookie.

P.S. Noah Smith expects rising demand for Mexican manufactures to raise wages. (You should all read his blog! It is a very good blog.) His error is simple: the demand for Mexican manufactures is extremely elastic, because Mexico is not the only country in the world.

P.P.S. No, I have not started to follow Twitter feeds. I hate that thing even more than Facebook.

Randy McDonald reviews a science fiction novel

I was pleasantly surprised by John J. Lumpkin’s first novel, Through Struggle, The Stars. I’m normally wary of the sub-genre of military science fiction. Many of the more recent titles that I’ve seen appear on bookshelves aren’t very good books at all, titles written by their generally right-wing American authors who were much less interested in the art of writing than they were in creating crude nationalist propaganda. The need for a jihad against Muslims, the amusing fatal decadence inherent in the French (or, more broadly, Europeans), the underhanded cunning of the Chinese, the need for the simpler and more martial mores of the past to replace an immoral liberalism — all these tacks have featured too prominently in too many milSF books I’ve picked up for me to feel comfortable with the genre. To the author’s credit, he did a very good job of avoiding this pitfalls of milSF.

Through Struggle, The Stars is set in the starfaring future of 2139, decades after the development and deployment of technologies capable of creating stable wormholes between points in space light-years apart and antimatter-fueled starships capable of transporting wormhole terminuses to distant planetary systems made interstellar travel possible, and after a devastating asteroid impact on Earth gave every countrry capable of mounting interstellar colonization efforts the incentive to do so. Colonies from dozens of different powers are scattered among the nearby stars, different countries’ colonies clustering in different areas. China and Japan, apparently the dominant powers on Earth, are also prominent players beyond the Solar System. Of late, these countries have begun to drift towards war. In this dynamic, unsteady environment, newly commissioned American cadet Neil Mercer joins the United States Space Force and catches himself up in the various maneuverings of the United States as it and its leadership bring the United States and its allies into the Sino-Japanese conflict.

To my relief, no one is propagandizing for any country in this novel. Each of the actual and potential combatants have their good sides, but each also has their own flaws. Lumpkin has written a novel where China is probably the biggest power in the world, but it isn’t an obviously evil or threatening polity. Military fiction novels where the parties in a conflict are complex are inherently more interesting than ones where contrived conflict is created between Good Guys and the Evil Ones, if only because it makes it possible to sympathize with characters on all side that aren’t sockpuppets. Lumpkin deserves to be praised for his even-handedness.

Some of my fellow reviewers have pointed out that the world of 2139 is a world where not much seems to have changed since the early 21st century, politically and otherwise. China is an oligarchy with an expansive sphere of influence on Earth; Britain is an independent American ally outside of an integrated Europe where France seems to be a major player; countries in the global South like Brazil, India, and Mexico seem to be present only in passing, although Iran does make an interesting appearance. Culturally, too, the world of 2139 seems almost too recognizable and contemporary, a certain Hispanicization of the United States aside. These likely anachronisms did stand out to me, although they didn’t prevent my enjoyment of the novel.

I also liked the attention that Lumpkin gave to his material universe. Different worlds are not perfectly Earth-like, the colonization of distant exoplanets is a costly venture that isn’t universally successful, and attention has been given to the import of the location of different stars in different places. The planetography of some of the worlds visited is paid attention, and the nature of life on sai; he even gives multiiple explanations for Fermi’s paradox. (One of these explanations lies at the root of the Sino-Japanese conflict and the United States’ involvement in sai.)

The novel is definitely a good first novel, and a worthy one. I’d give it 3.5 stars out of 5. The novel’s website points to it being the first novel in a projected series, The Human Reach. I look forward to seeing followups, and to seeing this and other novels on the series on bookshelves. Well done.

I bought my copy of Through Struggle, The Stars from Smashwords for $US 2.99, but the novel is also available from Amazon and other online retailers.

Another review of a science fiction novel

Carlos Yu here.

Through Struggle, the Stars
A Human Reach Novel
By John J. Lumpkin
Copyright 2011 John J. Lumpkin
Smashwords Edition

The important things out of the way first: Through Struggle, the Stars is a solid, readable first novel. I would read this novel’s sequel, and I would consider reading an unrelated novel by this author. It’s well-paced and has moments of genuine dramatic tension, a B in a world without grade inflation.

Through Struggle, the Stars is military science fiction without being military pulp science fiction. It’s not a dumb adventure novel of the kind where your IQ points are used for target practice by the writer, and it doesn’t read like someone else’s fetish porn. Quite frankly, this is probably why it hasn’t found a publisher yet. The story is jingo-neutral, or close to it.

Lumpkin has put some thought into each of his set pieces and how they fit into the overall plot of the book. The space combat is realistic in that ships radiate energy like real physical objects, they move with very low accelerations, and they are very vulnerable to hypervelocity impacts. Lasers in space and as a form of artillery have important roles. Lumpkin abides by the constraints of his imaginary wormhole technology, and he uses the local stellar neighborhood as his playground. It’s not totally rigorous, but he’s put in some work.

There is a nagging problem with inconsistency in the setting, however. I’m not sure whether this would be picked up by the general science fiction reader, should such a person exist, but it jarred me. Simply put, the timescales are off. A social setting that would not be a bad extrapolation of today’s demographics in 2050 is given a date of 2139. Future institutions are immediately recognizable. Technological progress outside of the space applications sector has moved very, very slowly —there are no flashy advances in automation or genetic engineering, for example. Despite Japan  becoming a major power once again through its first mover advantage in space technology, economic convergence between the richer nations and the poorer nations has stopped. At the same time, interstellar colonies on previously barely habitable worlds somehow have reached populations in the millions and have been settled for decades, and there is significant commerce. Many nations have colonies.

This mismatch in timescales is a shame, because each part of Lumpkin’s universe feels realistic enough. If anything, his setting feels a little too contemporary — a scene involving a Mercedes and a brawl in a casino parking lot comes to mind.

The politics of colonization motivate the background of the plot — true terra nullius, there are no aliens so far in this setting. There is a worldwide belief in the necessity of developing colonies off-Earth to maintain cultural and biological survival due to the horrible effects of a near-future asteroid impact. This belief has merged with a resurgent nationalism. Policymakers also believe that wars between superpowers can escalate incrementally, perhaps because of the excellent defensive countermeasures in this setting, but I wonder if Lumpkin has in the back of his mind what happens when the conditions for deterrence through mutually assured destruction no longer apply.

The characterization in Through Struggle, the Stars was, for want of a better word, adequate. The soldiers are more fully realized than the intelligence agents. I didn’t believe in the motivations of the two principal Chinese agents, but it wasn’t because of “characterization through ethnic stereotype,” and they are presented as outliers. People die, and I am pretty sure that Lumpkin has read Tobias Wolff’s short story, “Bullet in the Brain.” (Go read it. It’s short.)

Through Struggle, the Stars is an emotionally cool book. It lacks some of the quirky outsider energy of classic science fiction, but it also lacks the same undercurrents of dogmatism and score-settling. This book is not about saving the world with a single grand gesture, or flipping the table over to reveal the rot underneath; it’s about conflicted people in the military and the intelligence services at a particular point in geopolitical history. I enjoyed how the Big Secret turned out not to have very much effect, although it is conceptually important.

I’m more than happy to answer any questions.

A review of a science fiction novel

A friend of mine, James Nicoll, asked me and a few other mutual amigos to review a self-published science fiction novel: Through Struggle, The Stars, by John Lumpkin. Somewhat reluctantly, I downloaded and read it. To my surprise, I enjoyed the read while remaining unconvinced by the scenario. I will also put up my friends reviews (all written separately). Here (with one change) is mine:

Through Struggle, The Stars is much better than a self-published novel has any right to be. It’s a tale of a war in the year 2140 between China and Japan, told through the eyes of a new officer in the United States Space Force. The USSF — which has inexplicably adopted naval ranks and conventions despite the name — exists to defend both the terrestrial United States and its interstellar colonies. The setting is hard science fiction, in the sense that the only gimme is a system of wormholes to allow interstellar travel. No aliens; space vessels rotate for gravity; and while they use fusion engines that we have no idea how to build the accelerations involved are tiny. The politics aren’t self-evidently silly and the populations of the colony worlds are sensibly low. In fact, it reads like the kind of novel that I tried to write as a teenager, only well-crafted.

From the tone of the above paragraph, I’m sure that you can guess that my overall review is going to be negative. Since the book has a lot of positive qualities, let me start with them. First and foremost, I kept reading! I am not the sort of person who finishes every book he starts. In fact, I finish only a small minority of them. Most of my reading is work-related nonfiction and thus mostly skimmed. As for novels, I’m a high-friction reader: the moment I have to work to maintain my attention, my reading speed drops quickly — and it takes very little to get me to quit. This novel I did not quit. That is an extremely good thing. 

Second, I very much liked how the majority of the American characters had Spanish last names. Finally, somebody who thinks about demographics! I also liked that they threw in Spanish catch-phrases, but just as that: catch phrases. That is exactly how Spanish survives after several generations. We learn (from a Senate vote) that the United States has at least 52 states by 2140 and the author opens the possibility that Cuba might be one of them. Normally, that would get my “silly future cliché” alert up, but the allusion is simply that one enlisted USSF person has Havana for a home town. That would be possible today. While I do not believe that Cuba will ever become part of the United States it is supremely easy to believe that the country will continue to have a “special relationship” with the mainland, up to and including free migration. So the throwaway line didn’t desuspend my disbelief — after all, add Puerto Rico and the District of Columbia and you’ve got 52 right there.

The characters were believable, if somewhat clichéd. Actually, “clichéd” isn’t the right word. They were believable enough for me to care about them (and therefore keep reading) but they weren’t distinct enough for me to really remember any details. The one exception was a Chinese gangster-turned-intelligence-agent, and he stuck with me because I didn’t really ever believe in him. He wasn’t a cliché by any means; he just seemed too much like an agent of the plot, a character created by “The Narrative” rather than a real person who naturally found himself involved with the other people in the book. (The phrase in quotes is a reference to Scalzi’s Redshirts.)

The politics were well-handled … but lacking. First, the portrayal of China as a quasi-democracy felt wrong. Such regimes first appeared in Latin America in the late-nineteenth century; they quickly collapsed (via coups or civil wars) or turned into full-on dictatorships. That pattern continued through the 20th century with a third wrinkle: several of the quasi-democracies turned quickly into real democracies. Mexico’s second dictatorship-in-drag collapsed in the 1990s; even in Turkey today, the “deep state” seems to be on its last legs. It strained my belief to think that China would be ruled by a century-old corrupt oligarchy 130 years from now. (A newly-minted corrupt oligarchy would be a different story.)

Second, the politics of the war were given disappointingly short shrift. It is indisputable that major inter-state war has gone into serious decline since 1945. It strikes me as very plausible that it could see a comeback. The novel provides a necessary condition: powerful directed-energy weapons make it at least plausible that politicians would believe that they could control the ladder of escalation. (The prevalence of robotic and precision weapons had a similar effect.) Logically, therefore, the war began as a limited conflict fought at sea and in space; one can imagine future audiences cheering on such a contest.

The problem is that there was something very pro forma about the backdrop. There is an interesting question about whether industrialized interstate war (limited or not) is possible in a modern democratic environment. Can modern democratic politicians capitalize on violence? Would modern audiences countenance unleashing death in their names for anything less than national survival? These questions are unaddressed. When the author reveals the reason the American president maneuvered the U.S. into the war, it comes as an anticlimax. (It depends on the FTL McGuffin.) There were some references to U.S. domestic opposition, but mostly in the context of “ethnic Chinese” congressmen objecting to a war with the madre patria. (Which is, I have to say, a silly idea — in a world where China has been rich for a century, there will be no discernable Chinese-American community have been little net immigration from China for at least as long. The descendents of past and current immigrants will have long since assimilated; second-generation outmarriage among Chinese-Americans currently tops 50%.) There is a subplot involving a Taiwanese independence movement that strained credibility. In short, the politics never became unbelievable — but they were underexplored.

Which brings me to the killer problem: the book read like it took place in 2012, 2030 on the outside. It was simply unbelievable as a depiction of life in 2140. The ground combat scenes, for example, read like they happened last week. (The main characters were a little too composed during the fighting, but that’s a different issue.) Sure, there were exoskeletons and lasers from space, but that felt like window-dressing. Nothing about microdrones, intelligent robotic “pack animals,” self-guided ammunition ... the tactics of ground combat were basically unchanged.

The same problem afflicted the rest of the book. There were passing mentions of self-driving vehicles, advanced drones, machine translation, advanced 3-D printing, computer interfaces implanted in people’s eyeballs and “the best genes that money could buy,” but none of that had any appreciable effect on the course of the action or the social background in which the characters operated. The author failed completely at giving the impression that the book took place in the future. Now, it is possible that the author is correct that by 2140 automation will advance, sensor technology improve, cyborgization continue, 3-D printing mature and gene modification become common among the rich ... yet with daily life remaining about the same as in 2012. (Along with military organizations, ground combat and democratic politics.) That is possible! And hell, as a small-c conservative, I would very much like it to be true. But it’s a tall order, and a writer who wants to keep my disbelief suspended needs to make the case. The author of this book does not even try.

As a coda, I had three other quibbles. First, while the space combat scenes seemed well thought through, I did have to wonder what all those people on board the ships were actually doing. Even if our 22nd-century space navies decide to keep human commanders in the loop rather than entrusting it all to the AI’s, one would think that the ships would operate with tiny stripped-down crews and lots of maintenance robots. If that’s wrong, I want to know why.

Second, the dynamics of space colonization didn’t make much sense, at least not on the surface. There wasn’t much commerce, so the motivation seemed to be non-economic. The few colonies we saw were not rich places, so there was some indication that the author realized the problem, but it wasn’t explicit. Nothing caused me to recoil, but I couldn’t shake the feeling that something didn’t make sense about the scenario.

Lastly, there were a few dumb throwaways. A reference to helium-3 mining on the Moon. Ugh. A reference to asteroid mining. Slightly more plausible for a few rare elements, but double-ugh as something needed to power Earth industry. And then there was a major lacuna for a book about geopolitics: a bit about coastal protections for major cities was the only reference to global warming.

In short, the book succeeded as a yarn. But it failed as science fiction. Props for the Spanish last names, thinking through the dynamics of orbital combat, and avoiding (most) clichés. But minus for essentially writing “2012 in Space!” rather than something about the year 2140.

I would read other works by the author; he shows a lot of promise. I’m not sure that I would read other works set in the same universe, though. None of my objections require him to rewrite his background — just explore it in greater depth. The end result, however, won’t look much like the “2012 in Space” that we saw. Maybe Charlie Stross would let him bounce ideas around?

Comments welcome on any and all of the topics raised above.

Some headlines should be accompanied by exclamation points!!!!

Today I read in the Financial Times, “Philippines backs rearming of Japan.”

My reaction was, “Philippines backs rearming of Japan!!!”

When China gets a Philippine official to state “We would welcome that very much,” in reference to having Japan ditch the pacifist clause in its constitution, then you know that the People’s Republic has completely botched its diplomacy. (The Philippines is a country that still remembers the Japanese occupation, albeit not near as vividly as China or Korea.)

I currently believe that the United States is still what preserves the peace in East Asia. China is being aggressive. The Chinese public (at least portions of it) seems to have some militaristic tendencies. (Click the link for the pictures.) So it is not hard to imagine a Chinese government trying for a splendid little war with the Philippines or Vietnam. Nor is the converse impossible: since Japan currently hold naval superiority, Japanese politicians might try to goad the big fellow into a similarly splendid little Sino-Japanese naval war. 

It is not just China. Don’t forget the stunningly hostile South Korean reaction to Japanese possession of the Dokdo (aka Takeshima) islands.

I know, Steven Pinker tells us that we live in a less violent age. And he is right! But still ... sometimes a weird whiff of 1914 drifts over from East Asia. And it seems like the offshore balancing of the United States is what keeps the smell of gas from igniting.

Anyway, to bring it back full circle, when the Philippines calls for Japanese rearmament, then China’s attempt to assert its claim over the potentially energy-rich (and strategically located) South China Sea has now officially backfired.

Ecuador is not a colony of China

Since its big default on its foreign debt (which I should really write about, it was ingenious) Ecuador has made a lot of oil-for-loans deals with China. The FT reported that Ecuador sold oil at $14-$15 per barrel. Felix Salmon wrote a post entitled “How Ecuador sold itself to China.” Neat stuff.

But exaggerated. The Bolivarians in Quito have not sold their sovereignty to China. Here’s the deal. The China Development Bank (CDB) loans money to Ecuador. Petroecuador repays by shipping oil to China. The Chinese pay for the oil at market prices. The money is deposited in the CDB, which withdraws 21% of the revenue to repay the loan. China has made three of these loans, at fairly cheap interest rates: 7.25% for the first , 6% for the second and 6.9% for the third, at a time when Ecuador basically could not borrow and paid 8.45% on its outstanding issues.

OK, so no Chinese empire ... but is China freeing Ecuador from dependence on the United States? (We will ignore that whole dollarization thing.) Not really. There are some reports that the country is now exporting all its crude to China and Latin America. The official figures for the first half of 2012, however, tell a different story. By value, 59% of oil exports went to the United States; another 11% went to Chile and 10% to Peru. Only 2% worth (or $137 million) went to China. Ditto, imports of refined products from the U.S. of A. came to 55% of Ecuadorian petroleum imports; an additional 8% came from Panama. Only 5% came from Venezuela and nothing from China. Ecuadorian crude isn’t the best quality, but it’s good enough for Chinese refineries ... except they do not seem to really want it.*

(A useful resume of different oil blends is here: scroll to Table 1.)

OK, then. Unless something drastically changes, Ecuador is going to pay Occidental. Maybe not for a while, but it will pay. And China does not have a colony across the Pacific, fun as it is to imagine such a thing.

I should mention that the international courts thing runs both ways. Maybe Ecuador will pay Occidental with assets taken from Chevron ...

* UPDATE: I imagine that Petroecuador is swapping its oil for oil from other sources to send to China. PDVSA does this all the time, so it would not be unprecedented, and it would explain why the Central Bank reports almost no crude exports to the PRC despite the loan deals.

Mexico is gaining jobs, not wages

In 2009, in the wake of rapid inflation, Chinese unit labor costs were 72% of Mexico’s. (See page 19 at the link.) By early 2010, Chinese unit labor costs had risen to 86% of the Mexican level, and Mexico started to export cars to China. For some goods, landed costs (i.e., the cost of manufacturing and moving to the mainland U.S.) are much cheaper in Mexico than in China.

If you only look at the Chinese side, there seems little prospect of these trends turning around. China is experiencing bad labor shortages. Moreover, China has an inflation problem (the strategies described in this post seem to be hitting their limit) and its low inflation of 3% is not much lower than Mexico’s higher-than-expected 3.9%. Meanwhile, the peso is falling, while the yuan is likely to head nowhere but up. (If that turns out to be wrong, expect bad political consequences.)

On the other hand, if you look at the Mexican side, the reason Mexico is gaining competitiveness is that wages are flat. And flat at a low level. The good news is that Mexico is seeing rapid employment growth (see chart below) but Mexico no longer has endless millions of peasants to pull into the cities. Job growth is a good thing, of course, but it can go only go on for so long. (Mexico rebased its employment measures in 2010; thus the two indices.)

Translation: this is good news for Mexico, but it is a one-time thing. Without productivity growth, either within industries or by shifting into new products, Mexico wll remain relatively poor.

Implication: if the U.S. economy ever picks up again, so will emigration.

Omission: the effect of violence and extortion. The jury is out.

Delta Airlines provides perspective on the CNOOC-Unocal controversy

 In 2005, the China National Offshore Oil Corporation (CNOOC, pronounced “See-knock” by Americans) made an offer for Unocal. The political reaction at home was ferocious. The opposition came from three sources:

1. Fear of technology transfer. CNOOC might be able to acquire new techniques and abilities from its subsidiary. This is a reasonable fear in general, but not in the specific. Unocal was not really on the technical frontier ... and even had it been, all the evidence is that in the oil industry the benefits of propietary technology flow to the shareholders, not the citizenry. In that sense, then, China might have done the U.S. a favor by liberating whatever technical secrets Unocal might have possessed;
2. Fear of foreign control over American assets. This objection never made much sense, as Bernard Guerrero pointed out here. CNOOC assets in the United States fall under the jurisdiction of the American government, and should the U.S. and China ever go to war (even a cold one) the U.S. government can and will easily do to Chinese assets what it did to German ones during World War One;
3. Fear of foreign control over foreign assets. This was Paul Krugman’s objection to the deal. His worry was that the Chinese government might choose to keep oil from, say, Central Asia off the world market. That would drive a wedge between Chinese oil prices and world prices, damaging the rest of the world. The incorrect objection to this reasoning involved putting words in Krugman’s mouth, and assuming that he was discussing only military confrontations. The correct objection to this reasoning was simple: the Chinese government would incur a large opportunity cost from such a policy. Rather than sending cheap oil home, China could sell it overseas and pocket the difference. So absent the ignition of Cold War Two, what would be the point?

That last counterargument was very convincing. You can follow a microcosm of the debate at Crooked Timber. There is a wrinkle involving pipeline construction (short version: U.S. consumers have an interest in preventing China from building pipelines into Central Asia, just as we have an interest in preventing Canada from building them to the Pacific) but it is both minor and irrelevant to the CNOOC-Unocal controversy, simply because China was going to build those pipelines regardless.

End of argument? I would have thought so, but today I read that Delta Airlines was doing something interesting:

Delta Air Lines said on Monday that it had agreed to buy a refinery near Philadelphia from ConocoPhillips to offset the risk of higher jet fuel prices ... Richard H. Anderson, Delta’s chief executive, said the investment was a modest one, equivalent to the list price of a new wide-body plane like a Boeing 777. The company estimated that it would reduce its annual fuel expense by $300 million, once the refinery was refurbished and operating again. To achieve similar fuel savings, Delta would have to buy 60 new-generation narrow-body planes like the Boeing 737, a capital investment that would total $2.5 billion.

Huh! It looks like Delta Airlines has decided to do exactly what the economic theory predicted that China would not do. After all, there is an opportunity cost to locking up refined products: instead of selling them cheap to itself, Delta could sell it expensive to others. Moreover, it turns out that Delta isn’t alone. BP is also involved. The reason is simply that refineries cannot product only one product: you always wind up with other byproducts. So Delta will need to swap those other products for jet fuel. It could, of course, sell them and buy jet fuel on the open market, but that’s not what Delta has chosen to do:

Delta said it had also struck a three-year agreement with BP to supply crude oil to the refinery. As part of the deal, the details of which were not released, Delta said it would exchange gasoline, diesel and other petroleum products produced at the refinery for jet fuel from other sources like BP and Phillips 66. Combined with the jet fuel produced at Trainer, Delta said these deals would provide 80 percent of its fuel needs in the United States.

Delta has decided that it makes more sense for it to buy a refinery and sell fuel to itself at less than the market price than it does for it to buy a refinery and sell fuel to other people for the market price, pocketing the returns. Similarly, if the above description is accurate, then BP has also decided that it makes more sense for it to swap jet fuel for other products at less than the relative price it could receive from making that swap on the open market.

This is, it would seem, to be exactly the sort of behavior that people are worried that the Chinese government might engage in on a much larger scale. Two questions, then. First, is Delta making a fundamental mistake? (Many analysts think so.) Second, if it is in fact good for Delta, why wouldn’t it be good for China?

A question for the readership

 How can the fact that Repsol was on the border of selling its stake to Sinopec be reconciled with the fact that it was contractually obligated to buy back the Eskenazi’s stake at $38 per share?