No news is bad news

The recent Japanese stock market rally and “correction” is almost identical to the US experience of 1933.  During that period FDR was engaged in a policy of depreciating the dollar.  One problem with this policy was that asset prices move on new information.  Thus each day the dollar exchange rate had already factored in the expected depreciation for all of 1933.  FDR could only drive the dollar lower by doing more than expected.  Surprisingly, he was able to do so fairly effectively, partly by pushing much harder than almost anyone expected.  By the time the price of gold had risen from $20.67 to about $28, Keynes said enough is enough, and called for a halt to the policy.  But FDR listed to George Warren, and persevered until he reached $35/oz.

In October 1933 FDR was dissatisfied with the pace of inflation, so he adopted a new technique, called the gold-buying program.  The details are unimportant; the key point is that it gave FDR a way of sending the market signals that he wasn’t satisfied with the pace of dollar depreciation.  Both Abe and FDR faced a similar problem—they needed to send signals to the market that they weren’t satisfied, that they intended to do more than the markets expected.

Here’s where the title of the post comes into play.  Markets knew that FDR would either provide more signals of monetary stimulus, or be silent.  He certainly wasn’t going to call for a stronger dollar.  During the gold-buying program of late 1933, the markets knew that on each day FDR would either raise the official price of gold, or leave it unchanged.  It would not fall.  The EMH predicts that on days where the official price of gold was not raised, news would be viewed as more contractionary than expected, and the free market price of gold would actually fall.  And that’s usually what happened.  (All the details are available in my book, due out later this year.  BTW, the 1933 New York Times commentary on daily movements in the dollar exchange rate were consistent with the EMH; markets moved on more positive than expected policy announcements, not positive policy announcements.

Many pundits are surprised that after rising by 80%, the Japanese stock market fell by 20%.  “There wasn’t much news.”  But that’s exactly the problem (as the NYT understood back in 1933) the EMH predicts that no news will be bad news, when the only two plausible outcomes are further stimulus signals, or nothing.

Yes, I’ve oversimplified slightly; there arguably was some bad news out of Japan, as Lars Christensen pointed out recently.  But the lesson here is still very important.  When a market is rocketing upward under a steady drumbeat of good policy news, even a pause in that drumbeat will cause a market setback.  After all, markets expected the drumbeat to continue, or at least placed a positive probability on that outcome.  When it stops, prices fall.  The markets know that the only two plausible outcomes are Abe calling for a weaker yen, or Abe saying he’s happy where things are right now.  Abe won’t call for a stronger yen, and investors know that.

This is why I’ve been less optimistic about Japan than even some Keynesians like Krugman and Stiglitz.  I regard each day’s level of stock and exchange rate data as the optimal prediction of the long run effect.  And I see that market data indicating modest success, but well short of 2% inflation, at least in 2014.

PS.  The Dow rose about 80% in the first three months of of the 1933 dollar depreciation, then fell 19% in 3 days.  Sound familiar?


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32 Responses to “No news is bad news”

  1. Gravatar of Lars Christensen Lars Christensen
    13. June 2013 at 12:00

    Scott,

    “The Dow rose about 80% in the first three months of of the 1933 dollar depreciation, then fell 19% in 3 days. Sound familiar?”

    I have noted that as well. The reason I haven’t done a post on it was that the sell-off in 1933 wasn’t about fears of the future of monetary policy, but was the fear of what NIRA would do to the US economy. You of course knows that better than anybody else.

    And furthermore, after the initial 80% rally in Dow Jones in 1933 the market was flat until 1935 when NIRA was ruled unconstitutional.

    Anyway, I know you are agree with all this. But there might nonetheless be a lesson from the 1930s. However, to me it is 1937. I have as you read through the New York Times for 1937. It is quite shocking to what extent US policy makers talked about and very clearly feared inflationary pressures. That in my view was a main cause of the 1937 recession. However, it was also notable that the FDR administration imposed further negative supply shocks in 1937. At the moment we are luckily not seeing the combination of monetary tightening and a negative supply shock. We are having a negative demand shock, but ALSO a positive supply shock.

    So I remain fairly optimistic…

    I of course learn all that from you;-)

  2. Gravatar of Geoff Geoff
    13. June 2013 at 12:02

    “FDR could only drive the dollar lower by doing more than expected.”

    Yay Goodhart’s Law.

  3. Gravatar of TravisV TravisV
    13. June 2013 at 12:12

    Here is some AWESOME news from Fed reporter Jon Hilsenrath:

    “Fed Likely to Push Back on Market Expectations of Rate Increase”

    http://blogs.wsj.com/economics/2013/06/13/fed-likely-to-push-back-on-market-expectations-of-rate-increase

    Even with Japan falling, the S&P 500 increased 1.5% today due to Hilsenrath’s story!

  4. Gravatar of Scott N Scott N
    13. June 2013 at 12:26

    Sorry, I’m not buying your no news is bad news theory. The 20% drop in the Nikkei happened because of two things: (1) the BoJ started getting weak in the knees when it saw yields on Japanese bonds start to jump causing it to start saying confusing things and (2) Bernanke and the FOMC started ratcheting up its taper rhetoric (this happened the day before the Nikkei initially crashed 7%).

    I think the biggest problem is that the BoJ has a credibility problem – credibility that it will stick to a 2% Inflation target no matter what. Like an oft slighted girlfriend, the Japanese stock market really wanted to believe this time was different, that this time the BoJ would really live up to its commitment. Unfortunately, as soon as yields on Japanese bonds started to shoot up, the message from the BoJ got very convoluted. The market began to question the BoJ’s commitment. After being bitten so many times in 20 years, I don’t blame the market for selling first and asking questions later.

    As for the Fed, read Jon Hilsenrath’s latest article that came out today. The Fed doesn’t understand two things: (1) bond yields rise when the economy gets better (note that bond yields really took off only when the jobs report surprised to the upside in April and May – basically, it broke a three year trend of crappy jobs reports in April and May; that’s when the recovery became real; the other jobs reports weren’t that surprising) and (2) QE IS THE MONETARY POLICY LEVER not some side program until the Fed gets back to adjusting interest rates, which is what the Fed seems to think.

    The market understands that QE is mainstream monetary policy so any talk of tightening sends the market into a tizzy. The Fed needs to stick with the current level of QE until the economy expands so much that if interest rates weren’t at the zero bound, it would consider raising them. That is when the Fed should begin to taper QE. Instead, the Fed is going to lecture the market about overreacting to the taper (i.e., tightening monetary policy). Fools.

  5. Gravatar of Scott N Scott N
    13. June 2013 at 12:32

    Travis, the problem with Hilsenrath’s piece is that the Fed is speaking out of both sides of its mouth. On the one hand it is saying it will tighten monetary policy by tapering QE, but on the other hand it is saying it will keep interest rates low for forever. If we need more expansionary monetary policy in the form of low interest rates for eternity, then why do we need to tighten monetary policy right now?

    The Fed is basically promising to tighten policy now under the assumption that the economy will take off but then later refuse to tighten as quickly as it would otherwise. The market takes the bird in the hand – tighter policy now – and not the bird in the bush – looser policy if the economy takes off (yeah right; if you believe that I’ve a got a bridge to sell you).

  6. Gravatar of Geoff Geoff
    13. June 2013 at 12:47

    “Let’s be clear. We’ve intentionally blown the biggest government bond bubble in history…We need to be vigilant to the consequences of that bubble deflating more quickly than [we] might otherwise have wanted.” – Andrew Haldane, Executive Director of Financial Stability, Bank of England.

    Now, if we can only get the morons at the Fed (and on this blog) to admit the same thing for the US.

  7. Gravatar of ssumner ssumner
    13. June 2013 at 12:59

    Lars, Those are all good points. I think the recent TIPS/Dow divergence is overrated as an issue–I hope to do a post at some point.

    Travis, Hilsenrath has awesome access.

    Scott, You said;

    “Sorry, I’m not buying your no news is bad news theory. The 20% drop in the Nikkei happened because of two things: (1) the BoJ started getting weak in the knees when it saw yields on Japanese bonds start to jump causing it to start saying confusing things and (2) Bernanke and the FOMC started ratcheting up its taper rhetoric (this happened the day before the Nikkei initially crashed 7%).”

    Reread what I wrote, I agree with Lars that there were other factors as well.

    I like your second comment, I wish the Fed would read it.

  8. Gravatar of J J
    13. June 2013 at 13:45

    Geoff,

    Perhaps you disagree, but I see clear reasons why US bonds are a particularly attractive investment these days. Other government bonds as well as many other investments are much riskier than they were thought to be before the crisis. Is there a bond bubble on top of that?

  9. Gravatar of jknarr jknarr
    13. June 2013 at 13:50

    I view this wanting-low-yields-yet-wanting-to-boost-NGDP back-and-forth in the US and Japan as finally exposing the bald-faced stupidity of credit transmission “easing”.

    Low yields are a symptom of tight money and slow NGDP. Low yields encourage debt formation. Hence, tight money produces debt.

    The Fed and BoJ are finally getting impaled on this utterly bogus low yield/easing misconception — easy money will mean that yields rise, and no amount of central bank whining will change that fact. What Hilsenrath is saying is that money will remain tight — and financial asset prices love tight money.

    And they will have to rewrite the textbooks as a result — Scott’s will be first in line, I am sure. Looking forward to that.

  10. Gravatar of Scott N Scott N
    13. June 2013 at 14:56

    J, I believe the bond bubble Geoff is referring to is the fact that the price of bonds have gone way up. I don’t think it’s a bubble because it is exactly what we should expect when money is tight for a long time (ala Japan). When money is tight and growth grinds to a halt, the market is much more willing to accept low yields on bonds. People who think it is a bubble tend to believe that bond prices went up because of central bank buying but I don’t think that’s the case.

  11. Gravatar of No news is bad news « Economics Info No news is bad news « Economics Info
    13. June 2013 at 15:00

    […] Source […]

  12. Gravatar of jknarr jknarr
    13. June 2013 at 15:12

    There is no bond bubble. Bubbles happen mostly with long-lived, zero-yield assets. Bond mature and trade back to par — you get only your money back.

    Low yields are 100% a product of tight money and slow NGDP. A dropping discount rate, and income scarcity, pushes savers into financial asset bubbles in the hope of present-value-driven capital gains, but by definition, not into bonds.

    The asset side of Fed balance sheet is mostly moot — they buy at market prices that are set by the next-best alternative investment (driven by NGDP cash flow scarcity or abundance).

    The Fed’s liability side — what is provides to the economy, i.e. the unit of money — is desperately important, but reserve growth in the base encourages very little marginal borrowing at the zero bound. By definition, there are few borrowers available if rates have fallen to zero.

  13. Gravatar of Marcos Marcos
    13. June 2013 at 17:08

    David gets radical:

    “A Foolproof Approach to Monetary Policy For Both Fiscalists and Monetarists”

    http://macromarketmusings.blogspot.com/2013/06/a-foolproof-approach-to-monetary-policy.html

  14. Gravatar of J J
    13. June 2013 at 17:53

    Scott N,

    I understand that he sees the high bond prices as a bubble. My point was that there is a rational explanation for such high bond prices. I am wondering why he thinks there is a bubble rather than just rationally high prices. Shouldn’t a bubble entail increasing prices? Once prices stop increasing, a bubble should burst.

  15. Gravatar of J J
    13. June 2013 at 17:53

    The last two sentences were directed towards Geoff.

  16. Gravatar of TallDave TallDave
    13. June 2013 at 18:26

    All the details are available in my book, due out later this year.

    Looking forward to that, hopefully there’s a Kindle version.

  17. Gravatar of Tom Brown Tom Brown
    13. June 2013 at 18:29

    @Marcos,

    Beckworth’s idea also sounds reminiscent of Keen’s “debt jubilee” idea. Hopefully I didn’t ruin it for everyone with that…. forget I said that!… It’s clearly Friedman’s helicopter drop! (What was I thinking?)

  18. Gravatar of Marcos Marcos
    13. June 2013 at 19:29

    Milton Friedman: “Negative income tax”

    http://www.youtube.com/watch?v=zo9ufzIXN3U

  19. Gravatar of JP Koning JP Koning
    13. June 2013 at 19:52

    Maybe Abe needs to have a fireside chat with his fellow Japanese. Meltzer claims that after Roosevelt’s Oct 21st, 1933 chat, wheat prices rose 34% in a day or two.

  20. Gravatar of Robert Robert
    13. June 2013 at 20:30

    The money don’t come from the taxpayer the money is created by the FED and the government give to the households. It has nothing to do with Keen’s “debt jubilee” idea.

  21. Gravatar of Tom Brown Tom Brown
    13. June 2013 at 21:43

    @Robert, You mean taxing eventually I take it… Keen’s idea did allow for deficit spending (I hope!… otherwise it’d be completely pointless!). Beckworth’s idea with the Fed truly does sound MORE radical… more like a straight MMT style “state money” kind of thing. That’s what the MMT folks are always pushing: taxes destroy money, gov spending creates it… etc. In other words a world how they’d like it to be, not how it is. Granted Beckworth is talking about an emergency backup plan which he hopes would never have to be used, but aside from it’s rareness it even sounds more radical than the MMT idea!

  22. Gravatar of Ben J Ben J
    13. June 2013 at 22:04

    Geoff,

    Could you demonstrate the posts where Sumner said the 1970s inflation was caused by rising oil prices? You called him clueless and claimed there were several times he made that statement, a couple of posts back. Just wanting to see if you were going to salvage some credibility.

  23. Gravatar of Michael Michael
    14. June 2013 at 02:39

    Ben J,

    I think Scott has cited the 70s oil shocks as contributing negatively to real growth in the 70s. He absolutely has not argued that 70s oil shocks drove inflation via a “cost-push” mechanism. Perhaps the oil shocks were part of the rationale for the Fed’s loose money policies which led to inflation.

  24. Gravatar of Mikio Kumada Mikio Kumada
    14. June 2013 at 06:01

    Gentlemen,

    The concerns are valid. But within the constraints of the domestic institutional and international framework, as well in the face of ideological resistance, the Bank of Japan under Kuroda is as market monetarist as it can be at this stage.

    Perhaps it is useful to remember than sometimes we march forward by taking “two steps forward, one step back”.

    Japan actually took about four steps forward since late last year, and more recently had to take one step back.

    The reason it had to take one step back, in my view, was that an entire industry (the primary bond dealers), perhaps fearful of the fact that it faces a long-term bond bear market, panicked. There are many vested interests that would like to see the cozy bond bull market continue, and keep things broadly as they are.

    Remember also that the Japan of today is different from the US in the 1930s. Despite all the challenges, it has low unemployment, a very high standard of living, positive real growth, low levels of inequality (though they have risen), and a very high degree of social cohesion.

    The point being: many people feel things are actually quite ok, as they can make a good living under the status quo.

    Under such circumstances, it is actually remarkable how far the BOJ – an old, proud, conservative institution – has come, less than three months since it was subjected to what was in effect a hostile takeover.

    In recent weeks, it may not have responded in an ideal manner from a market monetarist standpoint, but it has only taken one step back out of four it took forward.

    1) It resisted “incremental” measures aimed at lowering nominal bond yields by doubling the duration of loans it extends to banks (to fund JGB purchases).

    2) Neither Abe nor Kuroda have made comments that they wish to lower nominal rates in an environment in which many influential people warn that “Abegeddon” will come if rates rise.

    3) Key advisers, such as Hamada, and officials have said that the BOJ can and will do more if needed, and they have also indicated that the yen could fall further — despite the fact that there is a G7 agreement that doesn’t want Japan to talk down its currency. There is opposition from Germany and South Korean, making it an international issue for Japan to openly say it wants a lower yen.

    So far, I would focus on the positives, such as what has happened so far, including the decline in real interest rates and real wages. The BOJ and Abe need to reclaim some political room to maneuver before they can make another one or two or three steps forward.

    I do not yet think they are going wobbly.

  25. Gravatar of John John
    14. June 2013 at 06:18

    Scott,

    This article in the Wall Street Journal probably makes you wanna “facepalm.”

    http://online.wsj.com/article/SB10001424127887324049504578543732746191690.html

    “If the fall in inflation expectations persisted and deepened, it could cause some Fed officials to argue for continuing their bond-buying program at the current $85 billion-a-month pace for longer than otherwise.”

    Even though I don’t necessarily agree with you about NGDP targeting or fiat money in general, I can see the humor in the fact that the Fed, having a dual mandate to target inflation and unemployment appears certain to miss in the same direction with both measures and decides to “stay the course.”

    I don’t know by what criterion Bernanke is such a good Fed chairman. If he were such a genius, given the above he would be able to change people’s opinions to do what he thought was right.

  26. Gravatar of Ben J Ben J
    14. June 2013 at 06:51

    Michael,

    Yes I agree with you completely, but Geoff was claiming that Sumner has said the opposite in an earlier post. Looking to see if he an example, or if he was just mouthing off, and it’s another example of massive cognitive dissonance.

  27. Gravatar of ssumner ssumner
    14. June 2013 at 08:08

    Thanks Marcos, I do plan a post on that.

    Michael and Ben, I’ve done posts pointing out that NGDP growth averaged about 11% from 1972 to 1982, 3% RGDP and 8% inflation. So the problem was monetary, not oil. Perhaps I mentioned that oil contributed to inflation in 1974–which is true, and Geoff thought that meant the entire 1970s was caused by oil.

    Mikio, Good comment, you are probably right.

    John. Yes, facepalm.

  28. Gravatar of TheMoneyIllusion » Investors fear that the BoJ won’t move and that the Fed will move TheMoneyIllusion » Investors fear that the BoJ won’t move and that the Fed will move
    14. June 2013 at 09:04

    […] I did a post arguing that “no news is bad news” when it comes to the BoJ, as markets know that more action is needed.  Today CNBC has a […]

  29. Gravatar of TheMoneyIllusion » No <b>news</b> is bad <b>news</b> | Radio Slot Network TheMoneyIllusion » No <b>news</b> is bad <b>news</b> | Radio Slot Network
    14. June 2013 at 11:19

    […] TheMoneyIllusion » No <b>news</b> is bad <b>news</b> […]

  30. Gravatar of TallDave TallDave
    14. June 2013 at 11:54

    The reason it had to take one step back, in my view, was that an entire industry (the primary bond dealers), perhaps fearful of the fact that it faces a long-term bond bear market, panicked. There are many vested interests that would like to see the cozy bond bull market continue, and keep things broadly as they are.

    Yeah, that’s unfortunate. Some are arguing that Japan is already in too deep and the rise in rates associated with a strong recovery would destroy so much wealth they’re better off with perpetual near-zero growth, but I think that view is nuts.

  31. Gravatar of Geoff Geoff
    15. June 2013 at 07:00

    J:

    “Perhaps you disagree, but I see clear reasons why US bonds are a particularly attractive investment these days. Other government bonds as well as many other investments are much riskier than they were thought to be before the crisis. Is there a bond bubble on top of that?”

    Risk is priced. If a commercial bond portfolio is riskier, and that risk is priced in, then it’s not actually correct to declare for the whole world’s population that government bonds are “better.”

    If an individual investor wants to expose themselves to the additional risk, and this risk is priced, then it’s not true to say that government bonds are “better” for this person.

    Investments are not only “out there” in the world, they are also tailored to suit the needs and plans of individual actors.

    If you are highly risk averse, then it makes sense to say that government bonds are “better.” But not everyone is highly risk averse.

    Scott N:

    “J, I believe the bond bubble Geoff is referring to is the fact that the price of bonds have gone way up. I don’t think it’s a bubble because it is exactly what we should expect when money is tight for a long time (ala Japan). When money is tight and growth grinds to a halt, the market is much more willing to accept low yields on bonds. People who think it is a bubble tend to believe that bond prices went up because of central bank buying but I don’t think that’s the case.”

    Except money has not been anywhere close to “tight”, if we use the rational standard of all individual actor’s plans, desires, and knowledge, concerning their persons and property, not the irrational standard of state diktat, which is grounded on violence, not reason.

    When money is “tight” according to your standard, yields tend not to stay low for 20 years. For at some point prior, actual time preferences should widen the gap between demand for outputs and demand for inputs, and with “tight” money according to your (irrational) standard, the demand for inputs should have fallen by then, so that the difference between the two demands increases the yields back up.

    No matter how “tight” you believe money to be, it is always the case that central banks inflating into the banking system, which increases the money supply via fractional reserve lending processes, i.e. credit expansion, this puts a downward pressure on rates.

    The problem is not that rates are low in some absolute sense. The problem is that central banks are changing interest rates to be must necessarily be non-market rates by virtue of the Fed’s activity. This difference between markets rates (which are unseen because we don’t have a market in interest rates), and prevailing nominal rates (which are seen because we don’t have a market in interest rates!), that is the source of errors in investment, which require future correction, and the deflation and unemployment that accompanies this (healing, but painful) process of correction.

    We cannot reason from interest rates themselves, because that would ignore the subject matter that determines interest rates, namely, us humans. If rates are low according to some arbitrary absolute standard, be it history, or some ideal, then we are not permitted to conclude that it is caused by some other concept or concepts divorced from humans, such as “tight money”. Humans are the engine, not money. Money is a tool. The only people who know the right tools, are the individuals themselves and for themselves.

    That means what Bernanke believes is the case, or what you believe is the case, or what Dr. Sumner believes is the case, when it comes to how much money there should be, and how much spending there should be, and what interest rates should be, is all your own little mental worlds where you fight imaginary demons and seek imaginary angels. For your worlds are not at all really taking into account other individual’s preferences, plans, goals, and actions, relative to each other.

    You don’t even consider their economic activities relative to each other. If one person is building a bridge, while another is building the bricks, then it doesn’t matter to you if the brick builder’s activity and the bridge builder’s activity is not in coordination. All you look at are the green pieces of paper that exchange hands, and you arbitrarily assert this as primary, even if actually seeking to focus on such exchanges of paper, and acting yourself to get it to what you want, ends up making the discoordination WORSE between the bridge builder and brick builder.

    To you, what matters more is that the bridge builder and brick builder keep acting in both coordination and discoordination, whatever the case may be.

    I fundamentally disagree with your entire economic approach, because I hold coordination as more important than the exchanges of green pieces of paper. And because I hold it as more important, I can know what you cannot know, which is how focusing on the paper exchanges without taking into account coordination, can lead, indeed will likely lead, to counter-productive results that can turn bad situations, if they arise, worse over time.

    We can pretend to believe that Japan is worse off because of their insufficient quantity of paper printing, but that would only ignore the costs that would have resulted from more inflation.

    Let me ask you this, and I hope you give it serious consideration, time, and study: How much of your standard of living do you think is increased by you living at the expense of others through the US dollar fiat system (which is not entirely your fault), and, secondly, how much of your standard of living do you think is decreased by others living at the expense of you through the US dollar fiat system (which may or may not be not entirely their fault)?

    To make this easier, imagine tomorrow that the violence backing the US dollar fiat system, was immediately removed, and you and myself and everyone else, were faced with having to produce and buy in terms of commodities that are promoted or demoted according to a one person one vote type system, where each individual decides for themselves subject to the constraints of preferences of others?

    Who would likely incur the biggest percentage losses and why, and who would likely reap the biggest percentage gains, and why?

  32. Gravatar of Geoff Geoff
    15. June 2013 at 07:01

    Ben J:

    The argument is about stagflation.

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