Substack Library

Glossary

Opening Black Boxes

For most of its inhabitants, the modern world is full of black boxes, devices whose internal workings remain—to different degrees—a mystery to their users.”—Vaclav Smil.

Today, I want to talk about three inter-related black boxes—energy, Russia and the stock market. All three are key components of the modern world, abstract and easier to understand when they don’t work smoothly. It’s a bit like the wind. You can see the impact, not the thing itself, particularly in a storm. European natural gas prices have risen 26 fold, retreating Russian soldiers left a patchwork of freshly dug mass graves in Ukraine and stock markets have lost between 10% and 20%.

Some readers find these events so distressing they prefer to look away. I recommend against that. Now is the time to see how the black boxes actually work. For instance, even as stock prices on average sink, there will be a scramble to buy companies that can reliably provide energy. There has to be. That’s why Warren Buffet asked permission to buy half of a company called Occidental Petroleum. To understand why, you need to pry open the boxes. 

The Energy Black Box

  1. We can’t define what exactly energy is, as Smil notes in books like Energy and Civilization and How the World Really Works. But energy surrounds us. As I write this, there is energy pouring out of my desk light and pulsing through my computer.
  2. Energy separates us from the pre-modern world. Energy application explains why we can feed 8 billion people easier than we could 1 billion. “In two centuries, the human labor to produce a kilogram of American wheat was reduced from 10 minutes to two seconds,” writes Smil. Think tractors, tractor trailers, highways, train tracks, fertilizer and irrigation.
  3. This massive rise in energy use is also (a duh) what is driving global warming. Smil calculates a 1,550 fold increase in the use of fossil fuels in the last 220 years.
  4. We face a paradox, which is that to meet the world’s future energy needs there is no available replacement to the substances whose heat cause droughts, volatile weather and climate migration. We can’t build a clean, natural gas powered jet airplane, for instance. At present, the choice is between a lower standard of living (countries where people walk rather than drive, continue to walk) or a lower standard of living through higher temperatures (think burnt crops and higher food prices).
  5. To be useful, energy needs to be reliable. For a hospital, for instance, to do what it is supposed to do, the ventilators, heart-lung machines and defibrillators need to work every time.
  6. Russia is a key node in a vast global energy infrastructure. Russia, along with Saudi and the US, is one of the top oil producers and is the second largest natural gas producer in the world. Russia has now proven itself an unreliable supplier.
  7. While the US isn’t reliant on Russian energy, Europe and Asia are. By cutting off Europe to retaliate for their support of Ukraine, Russia is forcing Europeans to face another energy paradox. The choice is between a warm home or preventing war crimes. By next year, however, a new non-Russia European energy infrastructure will be more clearly evident, which relates to both what Buffet is doing and the stock market black box.

The Russian Black Box

  1. Geography is destiny. Russia is a huge place with few people. Specifically, it is twice the size of the US with 45% the US population.
  2. Russian genius—Tolstoy, Dostoyevsky, Chekhov, Pasternak—reflects the peculiarities of living in a place that is both European and not. This touches every Russian. A Moscow-based doctor friend of mine described a stint he did as a resident in rural Russia. Between applying modern medicine to rural sick, he watched the head of maintenance attempt to slaughter a pig in the hospital basement. Where a knife failed, a gun succeeded.
  3. Putin is a variation on an ancient Russian theme. He is in the same medieval tradition of a Czar or General Secretary, only he wears Brioni suits, modern and not at once. Under Putin, Russia has slowly become a state that scares both its citizens and neighbors, much as it has over history. Poisoning rivals is palace intrigue. Seizing territory is old-school.
  4. The chief lives, as chiefs often do, increasingly in his own world. He applied his “in his own world” framework to Ukraine, where he promptly collided with a different framework, which is that people in the US and Europe oppose violent land grabs and are willing spend to a lot of money to stop them, as long as Ukrainians do the fighting. So far the US has pumped $7 billion into Ukraine, or 5% of Ukrainian GDP, with nary an objection.
  5. Until the invasion of Ukraine, the top Russia echelon enjoyed a standard of living higher than similar bureaucrats in Washington, D.C. or Brussels. Private planes and helicopters, vineyards in Italy, luxury real estate, multiple lovers were all within their grasp. A level below that, there were lots of Russians who enjoyed a level of wealth and comfort their grandparents could not imagine, as long as they avoided politics. That’s no longer true.
  6. Now Putin is locked into a self-reinforcing cycle. If he admits defeat, he may end up like Romania’s Ceausescu or Italy’s Mussolini. That’s how the game is played in such structures. Stalin’s secret police chief Beria was promptly shot after Stalin died. For sure Putin knows this history.
  7. Putin’s policy repels Russia’s talent. This seems counter productive and it is. Yet, the desire to stay in power can create behavior that is incomprehensible to outsiders. Who detonated last week’s car bomb in Moscow? Like bomb blasts during the Lebanese Civil War (1975-90), it’s almost impossible to know; my Russian contacts immediately suspected the FSB.

Case study on diversification. I know two Russian businessmen. Both are rags to riches stories. When one of them started he literally had a single pair of pants to his name. They both made a lot of money, in part by learning how to operate a business in a system with weak rule of law. One of them took his money and bought commercial real estate in Moscow with a modest amount of debt. The other took his money and bought commerical real estate in the US with no debt. The yield (or rent as a percentage of purchase price) was much lower (less attractive) in the US but rule of law much clearer than in Russia. The businessman who bought the US building thought of it as a hedge against Russia imploding. The other businessman has lost, as far as I can tell, everything. The Russia building has seen its value collapse and the bank refused to roll over his debt, rags to riches to rags.


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