Vindication?

Bob Murphy is too kind, suggesting in a new post that today’s events provide vindication for my views.  It’s true that I’ve been saying for some time now that the Fed should not raise rates, and that this is now becoming the conventional wisdom.  It’s true that I’ve been saying that low interest rates and low inflation are the new normal of the 21st century, and the bond market is coming around to that view as well.  But Bob is really being too kind, singling out a promise that was not at all difficult to fulfill.  He quotes this non-prediction from 9 days ago:

I’m a bit more optimistic [about the Chinese economy], as I think the reform process will continue. They’ll avoid the middle-income trap. But they haven’t yet even reached the trap—a lot more growth is ahead. If you want to know when that day of reckoning will finally arrive in China, don’t come here looking for answers. I will miss the collapse, blinded by the EMH, just as I missed every other dramatic economic shock in my entire lifetime. My predictions are boring, and always the same:

“More of the same ahead”

My predictions are usually right, but they get no respect, and don’t deserve any.

Yes, my claim that my Chinese predictions deserve no respect has clearly been vindicated.  It’s easy to claim that asset prices follow a random walk and can’t be predicted; even a kindergartner could do so.  Let me return the favor with a few comments on the bubble-mongers of the world, both real and phony:

1.  If you are real bubble-monger and predicted the Chinese stock market collapse and shorted the Hong Kong market and got rich, then I offer you my congratulations.

2.  If (like me) you failed to predict the collapse, then I offer you my sympathy.

3.  If you are a phony bubble-monger who predicted the China crash, but did not get rich shorting the Hong Kong market, then I have contempt for you.

I think that pretty much covers all the bases.

PS.  Unfortunately in this day and age I must add on a “just kidding” disclaimer.  (Jokes are no laughing matter.)  I actually have contempt for no one and sympathy for everyone.

PPS.  The views of Ben Bernanke pre-Fed were very different from the actions of the Fed under his leadership.  The views of Janet Yellen pre-Fed were very different from the actions of the Fed under her leadership.  I have no idea what Larry Summer’s actions would be if he were currently chair of the Fed.

PPPS.  A brief comment on TIPS spreads.  There is one factor that leads TIPS spreads to underestimate inflation expectations—conventional bonds have more liquidity, and this reduces their yield relative to TIPS.  There are two factors that lead to the TIPS spreads overestimating inflation expectations, the fact that they are indexed to the CPI and not the Fed’s preferred PCE, and the fact that TIPS bond principal only indexes upward over the life of the bond, not downward (during deflation).

PPPPS.  I have a new Econlog post.

PPPPPS.  My claim about not having contempt for anyone is only true about 1% of the time, when I reach Robin Hanson/Scott Alexander/Scott Aaronson/Tyler Cowen/Bryan Caplan/Razib Khan/Miles Kimball levels of dispassionateness.  The other 99% of the time I’m closer to Donald Trump, and hate almost everyone.  But I was in a good mood when I wrote the first PS.

Thinking out loud

Always dangerous to speculate when the market is changing minute by minute, but a few observations:

1.  Over at Econlog I did a post earlier this morning, suggesting that the China slowdown is reducing the Wicksellian equilibrium global interest rate.  Since central banks foolishly target interest rates rather than NGDP, this makes monetary policy more contractionary.

2.  Why does this seem to affect foreign markets more than the US market?  One possibility that that economies like Germany and Japan are more exposed to a global slowdown, as manufacturing exports are a bigger part of their economies. But that suggests the yen and euro should be falling against the dollar, whereas they are actually appreciating strongly.  Indeed the appreciation is so strong that one could easily attribute much of the recent stock market decline in Europe and Japan to their strengthening currencies.  Now of course I always say “never reason from a price change,” so let me emphasize that I am implicitly assuming the stronger yen and euro reflect tighter money, not surging growth expectations in Europe and Japan.  I don’t think anyone in their right mind believes global growth prospects have been rapidly improving in the last week, especially when you look at commodity and stock prices.

3.  The falling TIPS spreads and real interest rates suggest that AD expectations are falling in the US, but not anywhere near to recession levels.  After all, did anyone expect a recession last time the S&P was at this level?  Obviously not.  The tighter money in Europe and Japan suggests those economies will be hit harder than the US.

4.  If Europe and Japan are facing tighter money than the US, why would that be? Probably because markets think it would be easier for the Fed to at least partially offset this shock, via a delay in the interest rate increase.  Areas already at the zero bound would have to be more creative, and history has shown that central banks tend to be slower to react at the zero bound, especially when there are sudden and unanticipated shocks like this.  (It’s easier to offset anticipated shocks, like 2013’s fiscal austerity.)

This is all very speculative, and I don’t have a lot of confidence on my analysis. And as always, I don’t forecast asset prices, I merely try to ascertain what the market is forecasting.  Unfortunately the Hypermind market is still not very efficient.  It opened this morning at 3.6%, which was actually up slightly in the past few days.  I don’t think that reflects actual NGDP expectations.  Last I looked it was down to 3.4%, but of course efficient markets respond immediately to shocks.  This tells me that while the market is a nice demonstration project, there is no substitute for a very deep and liquid NGDP prediction market subsidized by Uncle Sam.  If it’s not the biggest $100 bill on the sidewalk, it’s right up there.

One other point.  I’m much more concerned by falling TIPS spreads and falling 30-year bond yields, than I am by falling equity prices.  Stocks often show large price breaks, without there being any change in the business cycle.

PS.  I agree with Lars Christensen’s analysis (except the part about China not becoming the biggest economy.  We face this problem because they already are the biggest.)  I think Lars is right about the two key mistakes being the Chinese yuan/dollar peg and Yellen’s tight money policy.

Nick Rowe’s wisdom, New Keynesianism vs. NeoFisherism, and Fed incompetence, all explained in one 7 minute bicycle video

Here it is.

HT:  Tyler Cowen

Fed policy is bankrupt

With each passing year it becomes more and more obvious that the current Federal Reserve policy regime is finished, and that a new regime will be needed.

The existing regime at the Fed relies on using interest rate control to steer monetary policy.  But they are also reluctant to cut nominal rates below zero.  That means that in a world of low real interest rates (which describes the world of the 21st century) the Fed will not be able to use monetary policy during recessions, if they maintain a low inflation target.

There are several possible solutions.  One solution (favored by Krugman and Blanchard) is to raise the inflation target to 4%.  Another possible solution is NGDPLT. Or NGDP futures targeting. But whatever the Fed decides, one thing is clear—the current policy regime is bankrupt.  The Fed hasn’t yet figured this out, but I suspect that at some level the markets have.  Not that market participants necessarily agree with my specific MM intellectual framework, but rather that they see the failure of the current regime.

I’m told that lots of market participants think low inflation is now a structural characteristic of the global economy, and cite all sorts of factors like cheap imports. Of course that’s nonsense, inflation is never a structural problem, it’s a policy choice. I think what they are actually intuiting is that the Fed is wrong—under the current policy regime we will have very low inflation for as far as the eye can see. And we are seeing that in the bond market.

Today the 30-year TIPS spread fell to 1.71%, a record low.  The 30-year bond yield is 2.74%.  At those rates the Fed won’t be able to use the short term nominal interest rate as a policy instrument during recessions.  The markets are telling the Fed that its policy regime no longer works.  Is the Fed listening?

Update:  The 30-year TIPS spread is not a record low, I relied on a FRED time series that only went back a few years.

Japan prediction from 2011, revisited

Back in 2011 most experts claimed there was nothing the Japanese could do to boost NGDP.  It was believed they were stuck in a liquidity trap.  Then in 2012 candidate Abe announced that he would implement a more expansionary monetary policy, including a 2% inflation target.  I suggested the policy would help, although they’d fall short of 2% inflation.  Mark Sadowski has a post showing the path of inflation.  (When Abenomics was announced in November 2012 the Nikkei was around 8700 and the yen at less than 80 to the dollar.)

Screen Shot 2015-08-20 at 11.34.31 AM

Mark also generously quoted from a 2011 post of mine that I’d forgotten about.

Just to be clear, it is quite possible (likely in my view) that Japan could get another 2% of RGDP by switching to a 3% NGDP target.  But it would be a one-time gain, as their labor market got less rigid.  Unemployment might fall to 2% or 3%, but trend growth shouldn’t change.

In fact, RGDP growth was 2.4% in the first year of Abenomics, and has been roughly zero since.  Recall that zero is the new trend growth for Japan, due to their rapidly falling working age population. Yes, I was a bit lucky, but as Napoleon once said “give me lucky generals.”  (or something vaguely like that, probably in French, not English.)

Marcus Nunes has a new post that quotes from the recent FOMC meeting:

There was push back against hesitating. A number of officials argued that a rate increase could convey confidence to the world about the economic outlook and that the Fed needed to move in acknowledgment of the progress the economy had already made toward normalcy.

Yes, tighter money from the Fed is just what global markets are looking for right now, to regain confidence.

You can’t make this stuff up.  While traveling I saw a story that the new President of the Dallas Fed is going to be a management professor.

PS.  I have a new post at Econlog.