Archive for the Category China


The Chinese stock market crash

I’ve been asked to discuss something that I don’t know much about, the Chinese stock market.  So here goes:

1.  Stock crashes are often predictions of bad times ahead.  Sometimes they are correct (the US in 1929, 2008) and sometimes they are incorrect (1987).  We know from 1987 that stock crashes don’t actually cause economic problems. Roosters don’t cause dawn.  Chinese stocks are still much higher than a year ago, and the Chinese people won’t decide to stop working just because stocks crash.  Indeed they may work even harder.

2.  It’s possible that the Chinese crash is not a prediction of economic distress, but rather just a sort of mass panic.  But the Australian dollar has been falling in sympathy with Chinese equities, which means that in this case it’s not just panic; it’s actual worry about a slowing economy.  (Unless Australian mass hysteria is correlated with Chinese mass hysteria, which I doubt.)

3.  Tyler Cowen often (wisely) points out that lots of things that superficially look stupid actually have good reasons if you look deeper.  Here he speculates as to why the Chinese government might have wanted to prevent a stock market crash.

4.  However even if Tyler is right, in this case the Chinese government probably is being stupid.  The techniques they are using (such as banning the sale of many types of stock) will actually create more panic, and will lead to more sales from that part of the investment community that is still free to sell.  Just as European governments that make it hard to fire workers end up causing higher unemployment, as people are afraid to hire them.

5.  There’s a lesson here for “bubbles.”  Even if you disagree with my view that bubbles are not a useful concept, there is very little evidence that governments can do anything about them.  The Chinese government tried to stop the bubble on the upside, and then more recently tried to stop the price collapse. It tried hard.  It failed miserably.  China will learn from this lesson.

6.  One reason why bubbles are not a useful concept is that it’s hard to tell what the right price should be in any “fundamental” sense.  Some people thought 1987 was a bubble.  After the huge price collapse of late 1987 they said, “I told you so.”  At that point there seemed to be a consensus among experts that prices had gone way too high, and that a correction was inevitable.  In fact, we now know that prices at the peak of the 1987 “bubble” (Dow 2700) were quite reasonable.  (The Dow was 1700 after the crash.)  If you bought at the peak and held stocks for 10 years, or 20 years, or 28 years (up to today) you did fine.  So the experts were wrong.  Thus even after an apparent bubble collapses, it’s really hard to know which price was right, the peak level or the later trough.  In 20 years we’ll have a better idea whether the Shanghai market should now be at 5000 or 3500 3400 (down 100 since I started typing).  Right now no one has a clue, just as no one in 1987 had any idea that the Dow would be at 17,000 today.

7.  I’d rather the Chinese government stay out of the stock market, but this intervention is of trivial importance compared to the bigger changes occurring in China.  I wouldn’t want the US government to spend a trillion dollars on Vanguard index funds, but if they did so it wouldn’t cause much of a problem.  The tiny Norwegian government has almost a trillion dollars in stocks, and it doesn’t seem to have hurt Norway.  There’s a lot of ruin in a nation as big as China, and China should be far more worried that the PBoC will fail to keep NGDP growing at 5% or more, and/or that Premier Li stops the economic reform process that’s been underway for 35 years, than about whether the Chinese government purchases some stocks.

8.  When I first visited China in 1994 almost no one had cars or owned stocks.  I was fascinated by the country, by the urgent moral issue of raising hundreds of millions of people out of abject poverty and misery.  Quite frankly, I find the modern problems of pollution, traffic congestion and stock market crashes to be rather boring.  Even today poverty is a much more urgent problem for China, but overall the situation is dramatically improved.

PS.  Fascinating story from Ambrose Evans-Pritchardmaybe even true.  If so, is a deal still possible?  (This link is better.)

Confirmation bias and bubbles

I’ve done a number of posts pointing out that people are hard-wired to find patterns where they don’t exist.  Studies have shown that people will see “bubbles”, even in data that is generated to follow a random walk.

Now of course just because most people would believe in bubbles even if they did not exist, does not in any way prove that they don’t exist.  Maybe they do.  But we always have to be on guard against cognitive bias.

Bob Murphy had some fun earlier today commenting on a post I did on China.  His post is entitled Chinese Stock Market Crashing”:

Details here. It’s down about 25% in the last two weeks, and 11% in the last two days.

Meanwhile, Scott Sumner is running victory laps, over those broken records who called it a “bubble” but didn’t give the precise timing.

So it sounds like I did a post mocking Chinese stock market bubble theories, and then the market crashed right after my post.  That wouldn’t really prove anything, but even I have to admit it would be pretty funny.  Chalk one up for Bob.

The only problem is it never happened.  My post was put up on June 27th, and when Bob did his post the Chinese market was actually higher than it was when I did my post.

Does this prove anything about the Chinese market?  No, for all I know it might collapse 20% tonight.  Who knows? It’s certainly been extremely volatile in recent weeks.

What it does show is that people are very receptive to data that supports their preconceived bubble theories.  And this is a part of my anti-bubble theory.  I’ve done posts on how the Economist magazine once bragged that it correctly predicted a bunch of housing bubbles, whereas the article it cited was actually totally, spectacularly WRONG about the future course of house prices in a number of countries.  Prices actually rose in markets where they predicted declines.  And yet the Economist put their “successful” prediction into an ad for the magazine. Someday China will have a big crash, and the people who have been predicting it for a long time will say, “I told you so.”  And I’ll say, “Market prices rise and fall, that’s what markets do.”

Economies have booms and recessions.  If talking about bubbles makes you feel good, go for it.  But don’t think it’s telling us anything useful about the world. When prices are high they might crash, or they might go higher.  That’s what history shows.


Off topic

Occasionally I get bored with economics, and would rather talk about something else.  (In any case, there’s not much to say until they do the last minute Greek deal, or not.)  Here are some interesting links that I ran across:

1.  From an article on the poet Charles Simic:

His opposition to any utopian project, including nationalism, which would place a collective interest above the safety of the individual, is unremitting. As Slobodan Milošević was taking power in Serbia, Simic warned early on that he was “bad news,” and for his pains was denounced by Serbian nationalists as a traitor. His answer: “The lyric poet is almost by definition a traitor to his own people.” As he saw it, “sooner or later our tribe always comes to ask us to agree to murder,” which is one good reason he has resisted tribal identification with a passion: “I have more in common with some Patagonian or Chinese lover of Ellington or Emily Dickinson than I have with many of my own people.” Leery of all generalizations, he insists again and again that “only the individual is real.” As the civil war heated up, he found that his appeals to forgiveness and reasonableness were met with total incomprehension and finally hatred.

2.  This quote from Schopenauer reminds me of the internet:

Bad books are an intellectual poison that destroys the spirit. And since most people, instead of reading the best to have come out different periods, limit themselves to reading the latest novelties, writers limit themselves to the current narrow circle of ideas, and the public sink ever deeper into their own mire.

It’s from a delightful book by Enrique Vila-Matas, entitled Bartleby & Co., consisting of nothing but footnotes to a book that was never written. Highly recommended for fans of Borges, Calvino, Walser, Musil and Pessoa.

3.  In the same spirit, Morgan Warstler sent me this quote from Mark Twain:

“Travel is fatal to prejudice, bigotry, and narrow-mindedness, and many of our people need it sorely on these accounts. Broad, wholesome, charitable views of men and things cannot be acquired by vegetating in one little corner of the earth all one’s lifetime.”

And even more so for (imaginative) travel to the past and future.  When I read internet discussions about what “we all should think” about social practice X, I sometimes have the feeling that the writers couldn’t care less about what the public view was 200 years ago, or will be 200 years in the future.  All that matters is the eternal here and now.  The most notable exception is Scott Alexander.  I’d always known that there were math geniuses, physics geniuses, composer geniuses, etc.  But not social science geniuses.  Sure there have been brilliant economists like Irving Fisher, Milton Friedman and J. M. Keynes, or even some of the top bloggers.  But none of them make you say “wow, how did he do that?” Until Mr. Alexander, who seems to have arrived from another planet to enlighten us childlike earthlings.  If he ever forms a new “ism”, you can sign me up.  This recent post is far from his best, but he somehow emerges without a spec of dirt clinging to him, whereas I’d end up covered in “mire.”

4.  Peter Hessler wrote three wonderful books about China.  Here’s an article discussing his amazing popularity in China:

I asked why they read him. After all, they must know China better than a Missourian.

“He shows us a familiar country, but one we never saw before,” said one young man, a twenty-five-year-old engineer named Brian Cheung. “He cares about the lives of ordinary people.”

A tall young man of twenty-nine stood in the background. When the crowd thinned out, he stepped forward and identified himself as an English teacher at a local university.

“I’d like to hear more from him about politics. I feel we need to know more about Liu Xiaobo and Charter 08,” he said of the imprisoned dissident and his manifesto for political change.

“But if his books were about that he wouldn’t be here promoting his books,” I said. “Those kinds of books can’t be published here.”

“I know, I know.” The young man said. “But I still want to know about that too.”

“And yet you’re here.”

“He notices things about China that make us think. He sees a slogan on the wall and describes it, just like that. No commentary. Just the slogan, and when it’s told like that, it seems absurd, laughable, like Kundera’s The Joke. And we think: What are those slogans doing there? They are absurd. And then you start to think: Why?”

When I read The Joke I thought to myself, “what would it be like to live in a society where one’s life could be ruined by a single joke.”  I don’t have to wonder any longer.

5.  And speaking of China, I found this to be an intriguing observation:

But why do I feel that China—and Sinologists—would be better off to relax about the idea that “we have great novels, too”? I feel this because I think that setting up literary civilizations as rivals (although I can understand the insecurities that led Liang Qichao and others to do it) only gets in the way of readers enjoying imaginative works. What does it matter if the author of Chin P’ing Mei might be less than Flaubert? Why should anyone have to feel defensive?

Let me put it the other way around. Novels were not the primary language art in imperial China. Measured by volume, xi, translatable as “drama” or “opera,” would be in first place, and measured by beauty, calligraphy or poetry would be. Should we compare poetry across civilizations? If we do, classical Chinese poetry wins easily. The contest is almost unfair, because, as my students of Chinese language eventually come to see, the fundaments of language are different.

Indo-European languages, with their requirements that tense, number, gender, and part of speech be specified, and with the mandatory word inflections that the specifications entail, and with the extra syllables that the inflections add, just can’t achieve the same purity—a sense of terseness and expanse at the same time—that tenseless, numberless, voiceless, uninflected, and uninflectible Chinese characters can achieve. In a contest, one person has a butterfly net and the other a window screen. Emily Dickinson might have come to be known as the greatest poet in world history if she had written in classical Chinese. Should Westerners feel defensive that this was not the case? Far better just to inherit what we all have done, and leave it there.

Federal revenue in 2013

Jason Smith has a post that points to a very interesting fact about 2013—federal revenue from asset sales soared, primarily due to dividend payments by Fannie Mae and Freddie Mac.  By my calculations the revenue from asset sales increased by about $111 billion, from $53.6 billion in 2012 to $164.7 billion in 2013.  This is certainly a non-trivial portion of the $500 billion in deficit reduction that occurred during 2013, and in my view offers a far better argument than pointing to things like state and local government (which is just as endogenous to the Federal government as private investment.)

I don’t claim to understand the Keynesian model, so I won’t even pretend to comment on the importance of these payments.  Until recently I thought Keynesians viewed deficit reduction done via reduced transfers and higher taxes as being “contractionary.”  You know, the sort of austerity that you see in Greece.  Now I’m not so sure what they think. FWIW, at the time Matt Yglesias thought these GSE dividends were a contractionary “disaster.”

The only problem is that this gusher of federal revenue is actually an economic disaster.

In normal times, government coffers filled with dividends would be good because they could be put to some use. The government could spend that money on building Hyperloops or repairing schools or vaccinating children. Alternatively, the government could do the exact same things it was doing before, but reduce taxes and put more money in working peoples’ hands. But that would require a functioning political system. Today’s gridlocked Congress isn’t doing anything with the money.

Still, under ordinary circumstances the reduced government borrowing that results from a dividend windfall could be useful. A smaller deficit often allows the Federal Reserve to run lower interest rates without sparking inflation. That makes it easier for people to buy houses or for firms to invest in new production. Today, though, the Fed’s preferred measure of inflation is running at its second-lowest level on record, even though short-term interest rates have been at zero for years now.

So the Treasury is earning tons of Fannie/Freddie money. But the profits aren’t letting us spend more, they aren’t letting us tax less, and they aren’t freeing up private investment capital either. They’re doing nothing. It’s as if the money were sitting around as cash in a storage locker somewhere.

PS.  There are all sorts of “Ricardian equivalence” arguments as to why Matt might be wrong—that those payments to the Federal government don’t matter.  But do Keynesians believe in Ricardian equivalence?

PPS.  Yglesias also has an excellent new post on the Chinese stock market:

On the other hand, I should say that when I went to China in 2008 I heard from a lot of smart foreign observers that the country was in the midst of an unsustainable stimulus-driven boom that would surely crash someday soon. Now it’s seven years later, and all the smart foreign observers say China is in the midst of an unsustainable stimulus-driven boom that’s in the midst of collapsing. And since no country goes forever without an economic contraction, surely China really will see its long boom come to an end and the economy fall into recession one of these days. Maybe even tomorrow!

But it’s dangerous to be too confident you know what’s going on. Nobody really predicted the boom that’s unfolded over the past six months, so nobody really knows what the future holds.


Seeing Lu Mountain

Brad DeLong has a post discussing a debate between Paul Krugman and Roger Farmer:

I find myself genuinely split here. When I look at the size of the housing bubble that triggered the Lesser Depression from which we are still suffering, it looks at least an order of magnitude too small to be a key cause. Spending on housing construction rose by 1%-age point of GDP for about three years–that is $500 billion. In 2008-9 real GDP fell relative to trend by 8%–that is $1.2 trillion–and has stayed down by what will by the end of this year be seven years–that is $8.5 trillion. And that is in the U.S. alone. There was a mispricing in financial markets. It lead to the excess expenditure of $500 billion of real physical assets–houses–that were not worth their societal resource cost. And each $1 of investment spending misallocated during the bubble has–so far–caused the creation of $17 of lost Okun gap.

(You can say that bad loans were far in excess of $500 billion. But most of the bad loans were not bad ex ante but only became bad ex post when the financial crisis, the crash, and the Lesser Depression came. You can say that low interest rates and easy credit led a great many who owned already-existing houses to take out loans that were ex ante bad. But that is offset by the fact that the excess houses built had value, just not $500 billion of value. I think those two factors more or less wash each other out. You can say that it was not the financial crisis but the destruction of $8 trillion of wealth revealed to be fictitious as house prices normalized that caused the Lesser Depression. But the creation of that $8 trillion of fictitious wealth had not caused a previous boom of like magnitude.)

To put it bluntly: Paul is wrong because the magnitude of the financial accelerator in this episode cries out for a model of multiple–or a continuous set of–equilibria. And so Roger seems to me to be more-or-less on the right track.

DeLong is certainly right that the housing bust is far too small, but it’s even worse than that.  The vast majority of the housing bust occurred between January 2006 and April 2008, and RGDP actually rose during that period, while the unemployment rate stayed close to 5%.  So it obviously wasn’t the housing bust.  On the other hand you don’t need exotic theories like multiple equilibria—the Great Recession was caused by tight money.  It’s that simple.

Or is it?  Most economists think that explanation is crazy.  They say interest rates were low and the Fed did QE.  They dismiss the Bernanke/Sumner claim that interest rates and the money supply don’t show the stance of monetary policy. Almost no one believes the Bernanke/Sumner claim that NGDP growth and/or inflation are the right way to evaluate the stance of policy.  Heck, even Bernanke no longer believes it.

And even if I convinced them that money was tight they’d ask what caused the tight money, or make philosophically unsupportable distinctions between “errors of omission” and “errors of commission.”

In previous blog posts I’ve pointed out that it’s always been this way.  If in 1932 you had said that tight money caused the Great Depression, most people would have thought you were crazy.  Today that’s the conventional wisdom.  If in the 1970s you’d claimed that easy money caused the Great Inflation, almost everyone except a few monetarists would have said you were crazy.  Now that’s the conventional wisdom.  Even the Fed now thinks that it caused the Great Depression and the Great Inflation.  (Bernanke said, “We did it.”)

The problem is that central banks tend to follow the conventional wisdom of economists.  So when central banks screw up, the conventional wisdom of economists will never blame the central bank (at the time); that would be like blaming themselves. They’ll invent some ad hoc theory about mysterious “shocks.”

The other night at dinner my wife told me that the Chinese sometimes say, “If you cannot see the true shape of Lu Mountain, it’s because you are standing on Lu Mountain.”

In modern conventional macro, most people look at monetary policy from an interest rate perspective.  That means they are part of the problem.  They are looking for causes of the Great Recession, not understanding that they (or more precisely their mode of thinking) are the cause.

Only the small number of economists who observed Mount Lu from other peaks, such as Mount Monetarism or Mount NGDP Expectations, clearly saw the role of central bank policy.  People like Robert Hetzel, David Beckworth, Tim Congdon, etc.

PS.  Before anyone mentions the zero bound, consider two things:

1.  The US was not at the zero bound between December 2007 and December 2008 when the bulk of the NGDP collapse occurred, using monthly NGDP estimates.

2.  Do you personally support having the Fed use a policy instrument that freezes up exactly when you need it most desperately?  Or might the problem be that they’ve chosen the wrong instrument?

PPS.  Yes, not everyone on Mount Monetarism saw the problem, but as far as I know no one on Mount Interest Rate got it right.  Perhaps Mount Interest Rate is Lu Mountain.

PPPS.  To his credit, Brad DeLong thought the Fed should have promised to return NGDP to the old trend line.  If they’d made that promise there would have been no Great Recession, just a little recession and some stagflation.