Archive for February 2010


The German Crisis of 1931 (Pt. 1 of 4)

This is the first part of chapter 5, which discusses 1931.  First I’d like to make a few comments on this amusing video.  My favorite line is when Joe Biden prays to God.   I didn’t know that politicians talk to God in the same dishonest way they talk to voters.  Bloggers on the right and on the left who think the other party is a bunch of lying weasels are half right.  They are a bunch of lying weasels.  But so is their own party, which they somehow overlook.  Above the fray independents have the right attitude toward most politicians of both parties—contempt.
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Poetic License

I know that I promised to stop blogging again.  But when Krugman says something like this:

One of the curious things about economic debate in the later Bush years was the conviction among many on the right that there wasn’t a bubble in housing, but that there was one in oil.

We now know the truth about housing. But what about oil?

Oil prices did spike to triple-digit levels in early 2008, then drop sharply. But think about the fact that right now, with the world economy still seriously depressed, oil is at $80 a barrel. This suggests to me that high oil prices are largely caused by fundamentals.

How can I resist?  So what’s wrong with Krugman’s assertion?  Nothing at all.  You would expect the price of highly cyclical assets like oil or commercial real estate to fall by 40% to 50% in the deepest recession since the Great Depression.  Indeed I made an almost identical argument about both assets in several posts, noting that their prices did not start falling in mid-2006 when housing began decline, but rather in the second half of 2008, when NGDP started falling.

But there’s just one problem; I have a long memory and I seem to recall Krugman making exactly the opposite argument 6 weeks ago in this post on commercial real estate.  Actually, the US recession is worse than the world downturn, so ceteris paribus CRE prices should have fallen further.  On the other hand oil prices are somewhat more volatile in response to demand shifts.  So they fell by roughly equal amounts, as you might have expected.

Why the post title?  Just yesterday Krugman called himself a poet.  In fairness, he was half-joking, and he actually is brilliant at using metaphors to get to the intuition behind economic arguments.  As far as spotting bubbles, however, he’s not so brilliant.  Like most people he calls price patterns bubbles when he can’t explain them in terms of fundamentals.  BTW, what would Hayek think if he came back today and found so many people who confidently knew when markets were overpriced?  Why do we even need markets?  If it so obvious what the correct price is, let’s bring back Soviet-style central planning.  (On the other hand, even the Soviets couldn’t have done much worse than some of our bankers.)

OK, back to my book.

Zero fiscal multiplier: European version

It’s not just the Fed, check out this article from Business Week:

Short-term rates for borrowing in euros in the forwards market are the cheapest relative to loans in dollars since September. The 50 percent collapse in that spread this month signals investors are betting the European Central Bank will keep its target interest rate at a record low, sacrificing euro strength to prevent deficit cutting by debt-laden economies in the region from stymieing growth.

OK all you Keynesian macro modelers; raise your hand if you included the likely central bank reaction function in your fiscal multiplier estimates.

That’s what I thought.

What caused the slump of 1930? (Pt. 4 of 4)

There was no single cause of the Great Depression, rather there was a cause (or causes) of the initial slump, and then another series of events that caused the Depression to deepen in mid-1931.  Below I summarize my views on what caused the initial slump.  But first I’d like to link to three good posts written by liberals (or perhaps I should say 2 liberals and an alleged liberal, as Robert Wright has doubts about Mickey Kaus.)
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Hoover, Hitler, and the Bank of the United States (The slump of 1930, pt. 3 of 4)

It’s days like today that I regret giving up blogging.  What’s bad for my 401k, and bad for America, and bad for Europe, and bad for Asia, is great news for my blog.  I could have done the following sort of post:

1.  Well it least it’s all out in the open now

About a year ago Krugman dismissed the notion that fiscal stimulus might fail because of being offset by monetary policy.  He said something to the effect that Bernanke would never do such a thing.  I have been arguing for many months that the Fed is doing exactly that.  That all this talk about exit strategies and refusal to offset past deflation with higher inflation, is equivalent to a tight money policy.  As Woodford and Eggertsson keep saying, what matters for today’s AD is expectations of future monetary policy.  But for some reason my arguments fell of deaf ears.  For some strange reason most economists insist on viewing the nominal short term rate as the indicator of monetary policy.  The Fed wasn’t “doing anything,” so how could they be tightening policy?

Well at least it is all out in the open now.  The Fed raised the discount rate and within minutes the S&P futures plunged 9 points.  Here’s the reaction last night in Asia:

LONDON (AP) — World markets fell Friday after the U.S. Federal Reserve unexpectedly raised interest rates for emergency bank loans, triggering fears that regular borrowing costs could also move higher soon, slowing the recovery in the world’s largest economy.

.   .   .

Earlier in Asia, Hong Kong’s Hang Seng stock index led decliners, diving 528.13, or 2.6 percent, to 19,894.02 while Japan’s Nikkei 225 stock average dropped 212.11, or 2.1 percent, to 10,123.58.

“As the dollar strengthens, we see less appetite for riskier assets such as Asian stocks.” said Jit Soon Lim, head of equity research for Southeast Asia for Nomura in Singapore. “We’re bullish on the region’s economic growth, but bearish on risk.”

“As the dollar strengthens”   Why that must be wonderful news for Europe!  After all, the zero-sum game economists keep telling us that we would be helped by a stronger yuan, so why shouldn’t Europe be helped by a stronger dollar (and yuan by implication)?  Odd that the European markets didn’t rise on the news.

When I arm wrestle with my 10-year old daughter I start out with a fairly limp wrist, and then gradually increase the pressure as I feel her pushing harder.  Our two hands remain motionless over the table, my pressure exactly calibrated to offset hers.  She gets frustrated, and I can’t blame her.  And I can’t blame Obama if he is feeling frustrated right now.  The Fed has a nominal target in mind, and dog-gone-it they are going to do whatever it takes to prevent the economy from overshooting that nominal target.  The harder Obama and Congress push, the harder they’ll push back.

Anyone still think that a second stimulus bill would help?

Update:  I forget to mention the last time the Fed raised the discount rate after 24 months of steady job loses—October 1931.  Bernanke is an expert on that event, it might be nice for someone to dig up what he had to say about it.

2.  The invincible markets hypothesis

Then there is talk (here and here) of a new type of inefficient markets hypothesis; Rajiv Sethi calls it the invincible market hypothesis.  I don’t buy it, nor do I think the more famous anti-EMH types would either.  The claim is that markets are efficient, but they are also so irrational that there is no way for investors to take advantage of that fact.  This implies that the gap between actual price and fundamental value doesn’t tend to close over time, but rather follows a sort of random walk, drifting off toward infinity.

As far as anti-EMH theories go, I prefer the views of people like Shiller.  He argues that markets are somewhat inefficient, but also partly efficient.  Thus if fundamentals suggest the P/E should be 15, when it falls below 10 you should allocate more of your portfolio to stocks, and if it is above 25 you should put more into bonds.  After all, stocks always tend to drift back toward the average P/E in the long run.  So Shiller claims his theory does allow you to do better than buy and hold.  I don’t think Shiller’s right about the EMH, but I do agree with him that if the anti-EMH position is correct, it must have investment implications.  If not, then the anti-EMH model would be worthless, and should be ignored.  BTW, Sethi argues Shiller might be right in the long run, but may be wrong in the short run.  I don’t buy that distinction.  If Shiller’s right then the anti-EMH position has useful investment implications, even for short term investors, and markets aren’t “invincible.”

Here’s part three of my chapter on the first year of the Depression, looking at the three big shocks of 1930:

4.f  The June 1930 Stock Market Crash

We have already seen that the 1929 tariff debate may have had an adverse impact on stock prices.  In 1930 the tariff debate re-emerged with even greater intensity, and this time the impact on stock and commodity markets was unmistakable.  By mid-1930 fears of political paralysis in Washington were replaced with worries about the international repercussions of the enactment of a higher tariff.  And now there was evidence that investors were concerned about not just the potential impact of Smoot-Hawley on trade, but also on the prospects for monetary cooperation.
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