Archive for June 2016


Teebs was right

So the man who just last weekend was the odds on favorite to be the next PM is out.  Someone going under the moniker “Teebs” saw it coming 5 days ago, and left these prescient remarks in the comment section of the Guardian:

If Boris Johnson looked downbeat yesterday, that is because he realises that he has lost.

Perhaps many Brexiters do not realise it yet, but they have actually lost, and it is all down to one man: David Cameron.

With one fell swoop yesterday at 9:15 am, Cameron effectively annulled the referendum result, and simultaneously destroyed the political careers of Boris Johnson, Michael Gove and leading Brexiters who cost him so much anguish, not to mention his premiership.


Throughout the campaign, Cameron had repeatedly said that a vote for leave would lead to triggering Article 50 straight away. Whether implicitly or explicitly, the image was clear: he would be giving that notice under Article 50 the morning after a vote to leave. Whether that was scaremongering or not is a bit moot now but, in the midst of the sentimental nautical references of his speech yesterday, he quietly abandoned that position and handed the responsibility over to his successor.

And as the day wore on, the enormity of that step started to sink in: the markets, Sterling, Scotland, the Irish border, the Gibraltar border, the frontier at Calais, the need to continue compliance with all EU regulations for a free market, re-issuing passports, Brits abroad, EU citizens in Britain, the mountain of legislation to be torn up and rewritten … the list grew and grew.

The referendum result is not binding. It is advisory. Parliament is not bound to commit itself in that same direction.

The Conservative party election that Cameron triggered will now have one question looming over it: will you, if elected as party leader, trigger the notice under Article 50?

Who will want to have the responsibility of all those ramifications and consequences on his/her head and shoulders?

Boris Johnson knew this yesterday, when he emerged subdued from his home and was even more subdued at the press conference. He has been out-maneouvered and check-mated.

If he runs for leadership of the party, and then fails to follow through on triggering Article 50, then he is finished. If he does not run and effectively abandons the field, then he is finished. If he runs, wins and pulls the UK out of the EU, then it will all be over – Scotland will break away, there will be upheaval in Ireland, a recession … broken trade agreements. Then he is also finished. Boris Johnson knows all of this. When he acts like the dumb blond it is just that: an act.

The Brexit leaders now have a result that they cannot use. For them, leadership of the Tory party has become a poison chalice.

When Boris Johnson said there was no need to trigger Article 50 straight away, what he really meant to say was “never”. When Michael Gove went on and on about “informal negotiations” … why? why not the formal ones straight away? … he also meant not triggering the formal departure. They both know what a formal demarche would mean: an irreversible step that neither of them is prepared to take.

All that remains is for someone to have the guts to stand up and say that Brexit is unachievable in reality without an enormous amount of pain and destruction, that cannot be borne. And David Cameron has put the onus of making that statement on the heads of the people who led the Brexit campaign.

The Brexit shock and its aftershocks

I just spent some time looking at stock market reactions around the world, over the past three trading days.  I’m too lazy to compute all the exact numbers, but I’ll give you a rough sense of what I found:

1.  The FTSE100 is down less than almost any other market, but I originally misinterpreted this fact.  It’s dominated by large multinationals that benefit from the lower pound.  Vaidas Urba suggested looking at the FTSE250, which focuses on domestic British companies.  There we see a drop of around 10%.  Think of that as one bomb going off—the “British economic chaos bomb”.

2.  The German and French markets are down by about 8%.  Think of those as representing the heart of the eurozone.  The PIGS seem to be down about 13%. So the Brexit explosion detonated another blast in southern Europe, which we might call the “potential eurocrisis bomb”.  The 8% declines in Germany and France represent fallout damage from these two bombs.  The UK is not directly impacted by the euro bomb, and that explains why it suffered only slightly more than Germany and France.

3.  Sweden and Denmark are outside the eurozone, and declined by 4% to 6%.  This is collateral damage from generalized European risk.

4.  At a global level, you tend to see declines of around 3%, say in the range of 2% to 4% in places like the US, Canada, Australia, Korea, Hong Kong, etc.  So that’s collateral damage to the global economy.

5.  China actually went up, but they tend to follow their own drummer.

6.  Japan is down about 6%, and fell especially sharply last Friday.  I see this as a third bomb.  As the first two bombs detonated, there was a flight to safe havens, and for some reason I don’t understand very well the yen is considered a safe haven.  So the yen appreciated strongly and the “strong yen bomb” drove Japanese stocks down by more than other non-European markets.

7.  The FTSE250 did especially poorly on Monday (compared to other markets), which fits my political chaos theory, as the media portrayed the British government as being clueless about how to handle the situation.  Things were a bit better on Tuesday.

A few points I’d like to emphasize.  This general market pattern was somewhat predictable, conditional on the vote (which of course was not well predicted.)  In other words, prior to the Brexit vote, we’d seen markets rise on optimism that “Remain” would win, and so it was possible to clearly see how investors thought a Brexit vote would affect various markets.  The size of the declines (after the results were announced) were not really a surprise, given that markets had rallied strongly on small increases in the probably that Brexit would fail.  We knew this was a really big deal.

The second point is that I think it’s useful to view market reactions in terms of one bomb triggering another, albeit often for very different reasons. The hit to Greek stocks occurred for very different reasons from the hit to Japanese stocks.  Outside of the UK, this was an almost purely monetary story, and commenters tell me that even within the UK, markets rallied strongly on a statement of support by (BOE head) Mark Carney.  So I still think at a non-British level this is an essentially a monetary story, and within the UK it is mostly real, but partly monetary.

This article claims that almost all experts agree that this is basically a British problem:

Experts agree: When the dust settles, there will be a clear main victim of Brexit

After the Brexit vote, economists agree that the UK economy is going down.

Just to be clear, I think that is certainly a possible outcome—recession in Britain and no recession elsewhere.  But I also think we need to take these stock market reactions more seriously.  Even with the recoveries today, eurozone markets are down sharply from Thursday’s close; declines almost comparable to the UK (FTSE250), or (in the case of the PIGS) even steeper.  The markets are telling us that there are big risks for all of Europe, and non-trivial (but modest) risks for the global economy.

Because the shock to the UK is more of a real shock, perhaps the damage there is more unavoidable.  In that sense I agree with the article.  But if the eurozone damage is more uncertain (a crisis may or may not occur) the size of the stock price decline suggests that if a crisis does occur, it could well be worse that the recession that might hit the UK.  The 8% German/French stock price decline could represent a 1 in 5 chance of 30% or 35% declines, if a eurozone domino effect develops.  So we should not be complacent and assume that this is just a UK problem; the rest of Europe needs to take this very seriously.  Right now, almost no plausible amount of monetary stimulus from the ECB would be excessive.  It’s pedal to the metal time.

Fed stimulus would also help.  Perhaps a statement by Yellen that the Fed is ready to move very aggressively to address any global problems that could also impact aggregate demand in the US.

Let’s improve the way we report exchange rate movements

This post is motivated by recent headlines suggesting that the Chinese yuan has depreciated in recent days.  Here’s an example:

China’s yuan weakens to 5-1/2 low as tolerates depreciation

This headline is completely inaccurate; the Chinese yuan has been appreciating in recent days.  So that’s one problem I’d like to fix.  I’d like to see the media start reporting accurate data on exchange rates, so that we know what is actually happening to them.  Not inaccurate information, which leads to bad public policy decisions.

Another problem with the reporting of exchange rates is that it’s often done in a very confusing table, where sometimes a bigger number means the exchange rate has appreciated, and sometimes a bigger number means depreciation.  Most of us now know that a bigger number means a weaker yen and a stronger euro, but who can keep straight the Canadian and Australian dollar, which are also not reported in a consistent fashion?  I also get confused by exchange rates that are very close to one, like the Swiss franc:

Screen Shot 2016-06-28 at 10.23.26 AMMy proposal would solve both of these problems in one fell swoop.  I propose that Bloomberg, or some similar company, create a table of currency indices.  Thus instead of reporting exchange rates against the dollar, they would be reported against a weighted index of the 10 or 20 most important currencies.  The numbers would all start at 100 on January 1st, 2017, and then proceed from there.  For all currencies a bigger number would mean currency appreciation, and vice versa.

Let’s take the recent example of the Chinese yuan.  Why did Reuters wrongly report a depreciation appreciation in the yuan?  Because the number of yuan required to buy one US dollar rose by about 1% in the days after Brexit, from 6.58 to 6.65.  Notice how confusing that is—a bigger number means depreciation, not appreciation.  But it gets worse.  The dollar appreciated strongly against almost all currencies, up around 2% against the euro, Canadian dollar and Australian dollar.  It fell slightly against the yen, but soared against the pound.  So 2% is a ballpark figure for dollar appreciation.  But that means the Chinese yuan actually appreciated by about 1% after Brexit, as it fell against the dollar by less than the dollar rose against other currencies.

Initially I’d like to see a separate table reported, similar to the one above, along side the old method.   Each trade-weighted exchange rate would be reported as “US$ index” or “yuan index” or “euro index” or “yen index”, and in every case a bigger number would mean currency appreciation. You’d never have the problem of the media reporting that a currency had depreciated, when it actually appreciated.

After a few years people would start to migrate to the new and better way of reporting exchange rates, just as they gradually migrated from the Dow to the S&P500, as a benchmark for the stock market.  I’d like to see them continue to report the old table with exchange rate vis-a-vis the home currency, as a benefit to tourists, but without the daily change.  Changes in the exchange rate would only be reported on the index table.

PS.  I suggest that a committee of interested parties, perhaps including the top business media outlets, sit down and agree on a set of countries to be used to construct the various exchange rate index numbers, so that there is consistency from one media outlet to another.

PPS.  Why doesn’t the market solve this problem?  Perhaps the combination of inertia and network externalities requires a “nudge” to move us to a better system.

Sliding back to the gold standard?

When the Bank of International Settlements was created in 1930, it was hoped that it would provide a progressive voice on monetary policy, pushing back against the passivity of the Fed and the Bank of France.  Commenter Emerich directed me to a new report out by the BIS.  I don’t know what sort of term to apply, but it certainly is not “progressive”:

For monetary policy, the key is to rebalance the evaluation of risks in the current global stance. The exceptionally accommodative policies in place are reaching their limits. The balance between benefits and costs has been deteriorating (Chapter IV). In some cases, market participants have begun to question whether further easing can be effective, not least as its impact on confidence is increasingly uncertain. Individual incremental steps become less compelling once the growing distance from normality comes into focus. Hence, accumulated risks and the need to regain monetary space could be assigned greater weight in policy decisions. In practice, and with due regard to country specific circumstances, this means seizing available opportunities by paying greater attention to the costs of extreme policy settings and to the risks of normalising too late and too gradually. This is especially important for large jurisdictions with international currencies, as they set the tone for monetary policy in the rest of the world.

Translation:  The Fed needs to raise interest rates so that it will have more “monetary space” to cut them in the future, when monetary stimulus is once again needed.  Of course this is a very basic error.  Monetary space results from the gap between the Wicksellian equilibrium nominal rate and the effective lower bound (zero or slightly below).  If central banks tighten monetary policy then the Wicksellian equilibrium rate will decline, even if actual market rates increase, thus reducing monetary space.  Indeed back in 2011, the ECB did exactly what the BIS wants the Fed to do, and ended up with far less “monetary space”.

Let’s look at the next paragraph in detail:

Such a policy shift relies on a number of prerequisites. First: a more critical evaluation of what monetary policy can credibly do.

Translation:  The BIS wrongly thinks that monetary policy might be unable to boost demand.

Second: full use of the flexibility in current frameworks to allow temporary but possibly persistent deviations of inflation from targets, depending on the factors behind the shortfall.

The BIS understands that its recommendation might cause the Fed to fall short of its policy targets, but is OK with that.

Third: recognising the risk of overestimating both the costs of mildly falling prices and the likelihood of destabilising downward spirals.

The BIS doesn’t see it as a major problem if the central bank falls short of its target, as long as we don’t face a deflationary spiral.  What the BIS doesn’t understand is that falling short will lead to precisely the ultra-low rates and bloated balance sheets that the BIS abhors.  Furthermore, not hitting your target reduces policy credibility, making monetary policy more difficult to implement in the future.

Fourth: a firm and steady hand – after so many years of exceptional accommodation and growing financial market dependence on central banks, the road ahead is bound to be bumpy.

The BIS understands that the markets will scream bloody murder if the Fed adopts the BIS’s advice, but it wants the Fed to ignore those screams and keep a steady hand on the tiller as they steer toward higher and higher interest rates.  In fact, the market screams would be rational forecasts of economic disaster ahead, and should not be ignored by the Fed.

Last: a communication strategy that is consistent with the above and thus avoids the risk of talking down the economy. Given the road already travelled, the challenges involved are great, but they are not insurmountable.

The BIS thinks the “road already travelled” has been ultra-easy money, whereas it’s actually been tight money.  The BIS thinks that an upbeat communication strategy by the Fed, i.e. communicating that raising rates is desirable because the economy would otherwise overheat, will reassure the markets.  In fact, the markets will assume the Fed is delusional, and asset prices will decline sharply as a result.  Fortunately, the Fed is very unlikely to accept the BIS’s advice.

Later in the report the BIS suggests that we are approaching something like the old gold standard:

More generally, there are natural limits to the process – to how far interest rates can be pushed into negative territory, central bank balance sheets expanded, spreads compressed and asset prices boosted. And there are limits to how far spending can be brought forward from the future. As these limits are approached, the marginal effect of policy tends to decline, and any side effects – whether strictly economic or of a political economy nature – tend to rise. This is why central banks have been closely monitoring these side effects, such as the impact on risk-taking, market functioning and financial institutions’ profitability.

I don’t see those limits, but let’s say I’m wrong.  In that case the solution is to adopt a higher inflation target, or NGDPLT, so that monetary policy does not become impotent.  But the BIS also appears to oppose those ideas.  Rather they seem to want to return to the world of the gold standard. Not literally, of course, but in the sense that they are willing to live with a policy regime where the effectiveness of monetary policy is greatly reduced.

The BIS of 2016 holds views that are striking similar to the conservative central bankers of 1930, which the BIS was created to push back against. Their primary focus seems to be using monetary policy to push back against financial bubbles.

If the Fed were to follow their approach right now the entire world would be in a deep depression within 6 months.  Instead, the Fed should do the opposite.  I’d like to see them cut rates by 50 basis points today, by eliminating IOR.  The global economy (NGDP expectations) needs a shot in the arm.

For instance, Brian Donohue recently pointed out that the dividend yield on the S&P500 (2.20%) is now almost has high as the 30 year T-bond yield (2.28%).

And the Fed is still worried about inflation.

PS.  The last few days would have been a wonderful time to have a highly liquid and subsidized NGDP futures market. And yet I don’t even see other economists calling for it.  Another failure of the economics profession.

Off Topic:  Gideon Rachman has a very good post on Brexit.

The New Trump (likes Muslims, Mexicans and trade deals)

No, this is not from The Onion:

Presumptive Republican presidential nominee Donald Trump said on Saturday that he wouldn’t characterize his immigration policies as including “mass deportations,” drawing a sharp retort from the campaign of Democrat Hillary Clinton.

Trump, in an interview at his golf course in Aberdeenshire, Scotland, said that rather than a blanket ban on Muslims coming to the U.S., a position he took in late 2015, he’d focus on those from countries with links to terrorists. The Republican also said he would start from scratch on the sweeping Trans-Pacific Partnership trade pact.

Trump said his immigration policies would have “heart,” suggesting he may be shifting tone to transition into general-election mode after the bruising primary season.

“President Obama has mass deported vast numbers of people — the most ever, and it’s never reported. I think people are going to find that I have not only the best policies, but I will have the biggest heart of anybody,” Trump said.

Pressed on whether he would issue “mass deportations,” Trump answered: “No, I would not call it mass deportations.”

I’m sure my neo-Nazi commenters will be thrilled to learn that on immigration Trump will have an even bigger heart than Obama. It’s a pity that the Supreme Court doesn’t have a heart as big as Trump’s.  So which illegals will he deport?

Trump, 70, continued eating fish and chips at his golf course’s clubhouse before adding: “We are going to get rid of a lot of bad dudes who are here,” he said. “That I can tell you.”

I’d guess that even Bryan Caplan could support that.  And exactly which Muslims will Trump stop from coming into the country?

Earlier Saturday, Trump told reporters that he’d seek to restrict people from unspecified “terrorist countries” from entering the U.S. It marked a shift from a news release on Dec. 7 saying that, if elected, Trump wanted “a total and complete shutdown of Muslims entering the United States.”

There were an estimated 1.6 billion Muslims in the world as of 2010, or about 23 percent of the world’s population, according to the Pew Research Center.

‘Specific’ Countries

“I want terrorists out. I want people that have bad thoughts out.

Perhaps he’ll have the INS develop a new form for immigrants to fill out.  Check one of the three boxes:

1.  Terrorist _____

2.  Person with bad thoughts _______

3.  Good Muslim _______

And he’s suddenly a fan of trade deals that steal jobs from America’s blue color workers, he just wants them one country at a time:

On the TPP, the trade agreement signed this year by 12 Pacific Rim countries, Trump said he would prefer bilateral talks.

‘So Complicated’

“I like the idea of making deals with individual countries. They put in these vast number of countries and it gets so complicated and it’s more than 6,000 pages,” Trump said.

From the beginning, I’ve said that Trump’s words mean nothing, it’s just like the babble coming out of the mouth of a baby.  What continues to amaze me is that his fans seem to think that he’s one of them.  Are they in for a big surprise!

If elected, Trump may well try to bend over backwards to prove he’s not a racist, and end up loosening our immigrations laws so much that immigration increases. Or he may not.

Since he claims that his heart is bigger than Hillary’s, he may spend even more on social programs, or he may not.  If you are Republican that plans to vote for Trump as a way of stopping Hillary, this is exactly what you are voting for:

Screen Shot 2016-06-26 at 1.19.04 PMHT:  Tom Brown