InvestMacro

By Amitrajeet A. Batabyal, Rochester Institute of Technology 

The world as we know it cannot function without oil, giving oil-producing countries an advantage economists call market power. Nations that produce oil are able to set the price, while countries that rely on oil have little choice but to buy it at prices determined by the seller.

While this asymmetry in market power generally favors the seller, in response to the war in Ukraine, a group of global oil buyers are trying to leverage their economic purchasing power to weaken Russia’s strength as a major global oil producer. The European Union and the United States have both imposed bans on the purchase of Russian oil. In solidarity, other nations like Australia and Canada have also decided to not purchase Russian oil anymore.

Now, the G-7 countries – a group of democracies including the United States that try to coordinate global policy – are developing a price cap they hope nations will agree to when paying for Russian oil to further limit Russia’s profits and shrink the income stream that fuels its war with Ukraine. Can a price cap make a difference? And if so, how?

Oil as an economic engine

Given that it is not possible for the world to completely wean itself off Russian oil, the G-7 recently announced that it is planning to cap the price of Russian oil beginning in December 2022. Its goal is to get more nations to join the G-7 price cap scheme.

The economics of a price cap can be quite straightforward. The escalating costs of an apartment in New York, for example, demonstrate how rent control – a price cap policy – protects renters from the rising cost of housing. When the market rental price, which equates the demand for apartments with its supply, is too high, a price cap below the market rental rate ensures that the price of an apartment cannot legally be higher than the cap.

Squeezing Russian oil profits

Led by U.S. Treasury Secretary Janet Yellen, the G-7 nations in July 2022 decided to cap the price of oil sold by Russia, a policy that is planned to go into effect on Dec. 5. Since this cap would be executed in an international setting with different rules and regulations and with nations whose interests are not always aligned, the success of a price cap is not guaranteed. Even so, the leaders of the G-7 agree that a cap policy is needed to decelerate, if not stop, the Russian war machine.

In addition to ensuring Putin’s war funding is reduced, a cap may help preclude an even higher spike of oil prices. The European Union’s sixth sanctions package is set to ban all Russian crude imports by sea – also set to begin Dec. 5, 2022 – and all refined oil products starting on Feb. 5, 2023. Because the world economy will have relatively little time to adjust to these hard cutoff dates, they are likely to lead to enormous oil price hikes that could cause great suffering in the European Union, the United States and other nations.

If capped at the right level – a little above Russia’s cost of producing oil, estimated at US$40 per barrel – and periodically monitored, then Russia will likely act in its own interest and legally sell oil at the capped price. Potential buyers would not run afoul of Western sanctions if oil is purchased at the capped price, helping to limit dramatic upticks in the price. This is how the price cap concept is supposed to work. Yet a few things could go wrong.

Chief among these is the behavior of nations that are not party to the G-7 cap. China and India, for instance, could decide that they will pay no heed to the cap and simply continue to do business with Russia as they have in the recent past.

But economic forces are likely to make China and India behave consistent with the cap policy.

Since oil can always be purchased at the capped price, China and India have an incentive to reduce their oil expenditures by obtaining even larger discounts from Russia to continue to buy its oil. Since Russia is desperate to find markets for its oil, to continue to do business in these large markets, President Vladimir Putin either has to sell his oil at the capped price or at a negotiated discount. Either way, the intention of the cap, to reduce oil revenues flowing to Putin, will be met.

Some nations might be able to undermine the cap because it would be difficult to enforce. Privately held companies in the business of shipping and financing Russian oil may continue to sell oil to buyers. Such entities, because of the risk of running afoul of Western sanctions, are likely to do so after demanding a cut from any oil sales, and this will, once again, have the impact of cutting into Putin’s profits.

Other forces may help maintain a cap

Another consideration for businesses that ignore the cap is that 90% of maritime insurance is based in Britain and the EU. Such firms will not be able to do legal business with Russian entities or those promoting its interests as determined by the international cap enforcement criteria. Based on my research, I believe that not many buyers will continue to do business with Russia when most seaports, ocean shipping lanes and oil tankers are off-limits to Russian oil because of the terms stipulated in the European Union’s sixth sanctions package.

Putin claims that he will not sell Russian oil to nations participating in the cap program. Based on my research, this is difficult to believe given how dependent the Russian economy is on oil revenue.

Russia’s economy is in poor shape. By one measure, its war with Ukraine is costing about $1 billion per day. Such high costs, in concert with Western sanctions, will continue to have an adverse impact on Russia’s economy. To continue his “special military operation” in Ukraine, Putin urgently needs more revenue.

Oil sales are Russia’s principal revenue source. Perhaps the price cap will pressure Russia to choose selling oil over waging war.

About the Author:

Amitrajeet A. Batabyal, Distinguished Professor, Arthur J. Gosnell Professor of Economics, & Interim Head, Department of Sustainability, Rochester Institute of Technology

This article is republished from The Conversation under a Creative Commons license. Read the original article.

By George Prior

The UK government’s humiliating U-turn on the higher tax rate reforms will not be enough to calm turbulent financial markets, warns the CEO of one of the world’s largest financial advisory, asset management and fintech organizations.

The warning from Nigel Green of deVere Group comes as it is reported that the Chancellor, Kwasi Kwarteng, plans to bring forward his medium-term fiscal plan announcement to this month.

The deVere CEO says: “Mr Kwarteng’s bringing forward of the plan to this month rather than November 23 underscores just how badly the so-called mini budget was received by financial markets.

“Having the announcement sooner rather than later is the right thing to do, as the longer the markets wait for proof that the government’s fiscal agenda is sound, the higher the risk of turbulence.

“However, the bringing forward of the announcement and the scrapping of plans to axe the 45p tax rate stinks of desperation.”

He continues: “The forthcoming amendments to the reckless mini budget that we know already are unlikely to calm markets in a significant way.

“Sterling did regain some ground higher against the dollar and gilt yields fell on the scrapping of the 45p rate announcement, but the pound will remain under pressure and high bond yields remain of serious concern.

“Investors’ trust in UK plc has had a hole blown through it.”

Last week, Nigel Green noted that markets now know where the weakness lies. He added: “If they don’t budge, they will have blown up the UK mortgage market, UK pensions, amongst others, and eventually this could spread to impact the wider global financial markets which themselves are sitting on thin ice as liquidity disappears.”

“Prime Minister Liz Truss and her Chancellor Kwasi Kwarteng have created a loop of doom.

He concludes: “There will be some relief that the UK government finally seems to be listening somewhat.

“However, the modified plans do not go nearly far enough to ease markets and regain economic trust and confidence.”

About:

deVere Group is one of the world’s largest independent advisors of specialist global financial solutions to international, local mass affluent, and high-net-worth clients.  It has a network of more than 70 offices across the world, over 80,000 clients and $12bn under advisement.

By Dan Steinbock 

Not so long ago, Brazil’s BRIC economy soared as working people and the poor were able to join the labor force and formal economy. In just years, a “soft coup” and far-right president derailed Lula’s miracle. What next?  

As I am writing this column, Brazil is preparing for its general election on October 2, after the disastrous term of Jair Bolsonaro, the incumbent far-right president and ex- captain, who placed army officers in key cabinet positions.

Elected in exceptional circumstances, Bolsonaro caused exceptional damage in Brazil’s economy and politics, society and military, and ecology.

With more than 156 million registered voters, Brazil is the second largest democracy in the Americas and one of the largest in the world.

But democracy is no assurance that the election outcome will be democratic.

Bolsonaro’s disastrous term

Rolling back protections for indigenous groups and facilitating deforestation, Bolsonaro compounded devastation associated with accelerated climate change.

Under his government, the COVID-19 pandemic effects were downplayed, quarantine measures opposed, and health ministers dismissed. So, the pandemic has killed almost 700,000 Brazilians; more than in India, despite its seven times bigger population.

Seeking re-election, Bolsonaro is facing former president Luiz Inácio Lula da Silva, a veteran trade unionist, who was elected in 2002, reelected in 2006, and left the office as the most popular president in Brazil’s history. In the past six years, he has overcome not just a throat cancer, but the far-right effort to keep him in prison.

Before the election, Bolsonaro, who has never hidden his yearning for a new military junta, made multiple allegations of election fraud. Observers have been quick to condemn such claims as invalid. But widespread concern prevails that false allegations could be exploited to challenge the election outcome, to execute a coup, or both.

After their bitter experience with military dictatorship (1964-85), the last thing Brazilians want is a junta of generals. Their prime concern is the economy and jobs. And that’s why they want Lula back.

Lula’s Boom, Rousseff’s plunge, oligarchs’ coup               

In the early 1990s, Brazil still had a reputation as the world’s champion in “unfulfilled agreements with the IMF.” In 2003 Lula inherited a poor, resigned nation on the verge of an economic implosion. Winning the presidency heading the left-wing Workers’ Party (PT), his primary objective was to stabilize the economy and to lay foundation for the struggle against poverty.

Lula’s economic policies were born under favorable stars. In 2001, China joined the World Trade Organization (WTO). A year later, Lula initiated Brazil’s economic reforms. To modernize, Brazil needed demand for its commodities; to industrialize, China needed commodities.

In the 2010s, Lula refocused policy momentum to the expanding middle class. Now the goal became to provide new opportunities for the upwardly mobile, while ensuring income transfers to the poorest.

During those boom days, Brazil overtook Italy as the world’s seventh-largest economy, while living standards soared by almost 60 percent. In Brazil, these were the days of wine and roses, or caipirinha and orchids.

Brazil led Latin America. China spearheaded Asia. Both shunned President Bush’s unipolar foreign policy; each supported a multipolar view of the world.

Washington had a different take of such developments.

15 lost years

When Dilma Rousseff, Lula’s chief of staff, won presidency in 2012, she hoped to build on Lula’s success. In this quest, she failed, due to the lack of time and wrong priorities, tax policies and spending.

Worse, international environment worked against her. World trade plunged, commodity prices collapsed, China’s growth decelerated and the Fed initiated rate hikes. “Hot money” began to flee leaving behind asset shrinkages, deflation and depreciation.

In Brazil, a narrow economic elite reigns over an unequal economy polarized by class and race. It had always opposed Lula and PT, and it was supported by external forces. According to Wikileaks, the U.S. National Security Agency (NSA) tapped some 30 Brazilian government leaders’ phones (Rousseff, ministers, central bank chief, etc), and corporate giants, including Petrobras, the huge petroleum conglomerate that would play a central role in corruption allegations.

Sparked particularly by such allegations, protests erupted and were fostered by conservative and family-owned media oligopolies. That boosted the center-right opposition of juridical authorities and military leaders, conservative social democrats, Democrats, and PT’s more liberal allies.

In the subsequent “soft coup,” Rousseff was impeached by the Congress in 2016. The economic effects were disastrous. During Lula’s two terms, Brazil enjoyed a historical boom. Though sluggish rather than stagnant, Rousseff’s period was undermined by the coup. Bolsonaro’s economic mismanagement proved disastrous.

Following the coup and Bolsonaro, Brazil’s GDP is now where it was around 2007 or so. 15 years have been lost (Figure).

Brazil’s GDP: Lula (2003-10), Rousseff (2011-16), coup, Bolsonaro (2019-21)

Source: TradingEconomics; World Bank; Difference Group

Biased judges and political ambitions

In 2015 Sérgio Moro gained national attention as one of the lead judges in Operation Car Wash, a criminal investigation into high-profile corruption and bribery scandal involving government officials and business executives. It fueled Rousseff’s impeachment and Lula’s 580-day imprisonment.

Moro, a Harvard-trained judge, had participated in the U.S. State Department’s International Visitor Leadership Program (IVLP). Meanwhile, Brazil’s federal police began broader cooperation with the FBI and CIA.

Moro portrayed himself as untouchable judge with no political ambitions. Yet, afterwards he eagerly joined Bolsonaro’s government as Minister of Justice and Public Security (2019-20), and subsequently the presidential race only to withdraw after his ratings fell.

There was a reason for Moro’s plunge. His “investigations” were prejudicial. Leaked messages exchanged between Moro and prosecutors have led to widespread questioning of his impartiality during the Operation Car Wash hearings.

In June 2021, all cases Moro had brought against Lula were annulled. White House officials admitted that the CIA and other parts of the US intelligence apparatus had been involved in assisting the “War on Corruption,” which jailed Lula and elected Jair Bolsonaro. Even the UN Committee found Moro biased in all cases against Lula.

Toward Lula’s comeback, unless…

In Brazil’s first round of elections, the candidate who receives more than 50% of the total valid votes is elected. If the 50% threshold is not met, the two candidates who receive the most votes participate in a second round of voting on October 30.

All current polls suggest that Lula will win the first round. The projections indicate he could get 45%-48% of the vote, against Bolsonaro’s 30%-36%. Moreover, all current second-round polls suggest Lula’s win by 10% or more.

Then again…

While Washington has urged Brazil to conduct fair elections, Bolsonaro, after his June meeting with President Biden, issued a coded command to the military in which the word “auditable” focused attention on the electronic voting system.

Brazil’s military has a “parallel vote count,” which some consider a risk to democracy. Furthermore, CySource, a controversial Israeli company hired by Brazil’s military, will presumably “supervise” the election against “disinformation.” Meanwhile, Brazilian observers have charged both YouTube and Facebook for pushing pro-Bolsonaro content and supporting coup mongering.

If democratic rules prevail, Lula is likely to make a comeback on October 2, or October 30. If not, current turmoil is just a pale prelude of what’s ahead.

No election is viable without the “consent of the governed” – not even a democracy.

About the Author:

Dan Steinbock is the founder of Difference Group and has served as research director of international business at the India China and America Institute (US) and a visiting fellow at the Shanghai Institutes for International Studies (China) and the EU Centre (Singapore). For more, see http://www.differencegroup.net