Archive for August 2015


Bob Murphy on Efficient Markets

Bob Murphy is frustrated, but he’s lashing out at the wrong theory:

I understand the Efficient Markets Hypothesis, and I think it’s a very good way to take a first crack at the markets. The thing that annoys me about many EMH proponents is that they think they are being empirical and scientific, when they often are clearly able to explain any outcome in their framework. Steady growth? Just what EMH predicts. Massive crash? Just what EMH predicts. In practice, the EMH is non-falsifiable, which is ironically the criticism many of its proponents level at others.

The EMH is most certainly “falsifiable.”  It’s been tested in many ways.  Some people even claim that it has been falsified, although I’m not convinced.  In the tests that I think are the most relevant the EMH comes out ahead.  (Stocks respond immediately to news, stocks follow roughly a random walk, indexed funds outperformed managed funds, excess returns are not serially correlated, or not enough to profit from, etc., etc.) I assure you that if stocks responded to news with a 12-hour lag, or were clearly far from being a random walk, even Fama would reject the EMH.  BTW, is ABCT refutable? If so, how?  (I don’t regard refutability as the most important test of a theory–usefulness and coherence are better tests in many fields.)

I think this following passage from Scott is a tad slippery:

Murphy seems to suggest that the fact that Austrian economists were not surprised by the volatility is a point in their favor. But why? Who was surprised? If you had asked me a year ago “Do you expect occasional volatility, up and down?” I would have said yes, and also that I had no idea when that volatility would occur, or in which direction the market would move.

Look, there was nonstop coverage of this on NPR when it happened. They were trotting out all kinds of people, including Austen Goolsbee, to make sure Americans kept their money in Wall Street. I’m not making this up, give me a break.

Monday showed the biggest intraday point swing in history. (Granted, you would want to look at percentage swing for a better comparison, but I can’t find such a ranking.)

And according to this guy’s analysis, by one measure of market volatility-the VVIX-Monday blew the previous record out of the water:

Bob should not rely on NPR for his stock analysis.  And you really should look at percentages, not absolute changes.  He talks like the US just experienced a stock market crash, at a time when the market less than 10% below its all time high! Monday was not a particularly big deal in terms of stock market history.  Yes, the volatility was unusually large by the standards of 2015, but this has been an unusually placid year.  Back in 2008 we had weeks and weeks of non-stop action that was roughly as volatile as Monday.  I’d guess that one could find many hundreds of days throughout stock market history where the stock market fell by as much as it did on Monday.

But let’s say I’m completely wrong, and stocks were historically volatile.  Even then Bob’s wrong, as he completely misunderstood my quote.  By “more of the same” I merely meant the most likely outcome for the market was what we have observed in the past.  There are periods of stability and periods of volatility.  If the S&P is at 2108, and someone asks me where I expect it to be in two weeks, I’d say 2108, or maybe 2109 (to reflect a gradual upward trend.)  But that does NOT mean I actually expect the stock market to equal precisely 2109 in two weeks time.  Rather it reflects the fact that I view it as being equally likely to rise or fall.  I actually think it far more likely that it would be considerably higher or lower than at that specific point estimate.  Bob’s frustrated that I’m not making market forecasts that can be refuted, but that’s because I don’t think it’s possible to forecast the market.

And I feel the same about the business cycle.  The US has recessions every 5 or 10 years, China less often.  We don’t know when the next one is coming.  Usually I’m right, because any given year I say that growth is more likely than a recession, and when the recession actually occurs then I’m wrong.  I was wrong in 2008, as I did not predict a recession in 2007.

Now if last year Bob had said there’d be a crash on August 24, 2015 and it happened, then more power to him.  But as far as I can tell he simply posts “I told you so” blog posts after every minor pull back, before the market again soars to new heights.  Then another modest pullback, and another “I told you so.”  I honestly don’t know what we are to make of all that.  Does the Austrian model provide some key to predicting the stock market?  If not, why talk about stock moves as if they support the model?

If you want to say I’m a broken clock, or that we should wait and see what things look like in three years, etc., that’s fine. But come on, don’t act like predicting “more of the same” two weeks ago is consistent with what just happened.

Bob doesn’t tell his readers that the link is to me discussing the Chinese business cycle, not the US stock market.  Some might even say that’s misleading, as his post implies it applies to the US stock market.  But I won’t complain; I stand by my previous “more of the same” as being a wise prediction, and I’ll apply it to the US, to China, to stocks or business cycles.  Whatever Bob wants.  And if I visit the Sands casino and I predict that the little bouncing ball will land on a red or black, and it ends up on the green 0 or 00, I’ll stand by my prediction that red or black were the most likely outcomes. That I made a wise prediction.

In most areas of life we judge competence by track record.  Doctors, lawyers, engineers, etc.  But that doesn’t work for market forecasters.  Track record tells us nothing about the competence of stock pickers.  It doesn’t tell us whether their future predictions will be better than those with a poor record.  And I think that really frustrates people.  It goes against common sense than past performance is not an indicator of competence. But it just isn’t.  I think that might be why Bob is exasperated by my placid agnosticism.

PS.  Obviously I do know that volatility is serially correlated.  I hope readers don’t think I’m THAT stupid.  Thus it goes without saying that for the Chinese market a “more of the same” prediction two weeks ago implies a prediction of continued high levels of volatility.  Which is what happened.  You may disagree with me, but please don’t assume I’m a complete moron.

Chinese house price bleg

People are always talking about the Chinese house price bubble.  And I have to admit that it was also my impression that Chinese house prices had risen dramatically in recent years.  I was curious to see just how much and checked The Economist’s handy interactive graph.   And I was completely shocked by what I found:

Screen Shot 2015-08-27 at 11.07.24 AM

Yes, this is house prices adjusted for changes in income, but still . . . The ratio of Chinese house prices to income has fallen from 130 in 2000 to 50 today?

I showed 4 other countries for comparison purposes, and they all seemed to be about what I’d expect.  But China?


1.  Is the data in The Economist wrong?  And if so, where can I get the correct data?

2.  If it’s accurate, does this mean China never had the house price bubble that everyone is talking about?

What am I missing here?

PS.  In nominal terms the Chinese prices look more impressive, but considering how much China’s boomed since 2000, I even find the nominal increase to be quite underwhelming—somewhere between the US and the UK.  And don’t mention specific cities, I only care about the overall Chinese housing market, not individual cities.

Screen Shot 2015-08-27 at 11.46.55 AMPS  I have a new post at Econlog.

Still crazy after all these years?

Here’s Alexander Humboldt:

First they ignore it, then they laugh at it, then they say they knew it all along.

In late 2008, I wrote op eds saying that tight money was driving the US into recession. No newspaper was willing to publish them.  Then in early 2009 I started a blog, and people laughed at my claim that money was very tight.  “How can that be, with ultra low rates and all the QE.”  It was difficult to find anyone who agreed with me—until today. Now it looks to me like Paul Krugman agrees with me.  This is from a recent post entitled, “It’s Getting Tighter.”

When thinking about the market madness and its possible real effects, here’s something you “” where by “you” I mean the Fed in particular “” really, really need to keep in mind: the markets have already, in effect, tightened monetary conditions quite a lot.

First of all, if break-evens (the difference between interest rates on ordinary bonds and inflation-protected bonds) are any guide, inflation expectations have fallen sharply:

Why only go back to 2011?  Let’s see what monetary policy was like in late 2008:

Screen Shot 2015-08-26 at 10.58.41 AMNow that’s tight money!

Krugman continues:

Second, while interest rates on Treasuries are down, rates on private securities viewed as even moderately risky are up quite a lot:

So real borrowing costs are up sharply for many private borrowers.

Again, that makes me wonder what real borrowing costs looked like in 2008:

Screen Shot 2015-08-26 at 11.03.12 AM

Now you might argue that this isn’t really tight money.  Good borrowers could still borrow cheaply in 2008.  It was default risk.  Nope, good borrowers couldn’t borrow cheaply, as liquidity had dried up.  How do we know?  While yields on conventional Treasuries fell sharply, the real yield on TIPS soared higher during the second half of 2008.  The 5-year TIPS yield soared from 0.57% to over 4%.  There is no default risk with TIPS, it was purely a liquidity story.  Because of the Fed’s tight money policy, liquidity had dried up:

Screen Shot 2015-08-26 at 11.07.50 AMJust to be clear, real interest rates are not a good indicator of whether money is easy or tight.  But the spike in BBB yields was not just a default risk story; it was also a liquidity story.

Over at Econlog I have a post discussing a related issue, could a quarter point interest rate increase later this year do great harm?

I suppose we attach the label ‘crazy’ to people who believe things that are not socially acceptable and seem irrational.  Now that a Nobel Prize winner is making similar claims, I guess I can’t claim to be crazy any longer.

Some extremely misleading stock market data

Here are the performances of some of the major stock markets over the past year (actually since August 27, 2014):

China (Shanghai):  2209.47 –> 2964.97  Up 34.2%

Japan:  15534.82 –> 17806.70   Up 14.6%

Germany:   9569.71 –> 10,074.66  Up 5.3%

S&P 500:  2000.12 –> 1932.34   Down 3.4%

Hong Kong:  24,918.75 –> 21,404.96  Down 14.1%

Update:  This post was written before the late day selloff.

Regarding the China numbers, I am reminded of the news report, “man drowns in lake that has an average depth of 3 feet.”  But I still think there is some food for thought here.

The Japanese and German numbers are affected by their recent currency depreciation. But Hong Kong is pegged to the dollar, while China has only depreciated about 4%.  I find those numbers to be kind of surprising.  For instance, the Hong Kong market has recently tracked China fairly closely, but has fallen by a smaller percentage.  Today it actually rose slightly, while China fell another 7%. But over 12 months Hong Kong has done far worse.  Why?

Tyler Cowen says he believes “China is in for a very bad recession.”  That’s certainly possible, and the recent data out of China is certainly consistent with that claim.  But the recent data out of China is also consistent with the claim that they will not have any recession, indeed they’ll have strong growth by the standards of almost any country other than China.

Suppose the Chinese stock market had not fallen from about 5000 to about 3000. Suppose it had fallen from about 6000 to about 2000.  That is, suppose that instead of losing a bit over 40% of its value, the Chinese stock market had lost two thirds of its value.  And suppose that while this was occurring all the production data out of China was looking horrific. Suppose international trade was in free fall, and the global financial system was imploding.

Actually you don’t have to suppose, that’s what things looked like in China at the beginning of 2009.  And China’s actual GDP growth rate in 2009?


Now of course that was below trend growth, and China’s trend rate has slowed considerably in recent years, as almost everyone expected.

My guess is that there is a 20% chance that Tyler is right, and an 80% chance that 2015-16 will be another 2009, with China growing at below trend, but enough to avoid recession.

Unfortunately we lack a China RGDP growth prediction market.  That would tell us whether I got my probabilities right.  (Of course the actual outcome won’t tell us, unless we make many repeated predictions, and look at many different outcomes.)

There is one other odd thing worth mentioning.  Let’s suppose that China is in a recession, or clearly entering one.  In that case why would the Chinese market be 34% higher than a year ago, when most experts did not forecast a recession?  But there’s a good counterargument to this. The Chinese market has always seemed disengaged from the Chinese economy, often doing very poorly when RGDP boomed.  So this would be nothing new.  Bottom line, the Chinese market tells little about their macroeconomy, and if it is telling us something, it’s not clear if we should look at 3 month or 12 returns. Or maybe the Hong Kong market is the best indicator of China, as the mainland market is distorted by government intervention. Given this uncertainty, I’d recommend focusing more on the Chinese macro data, with the caveat that that data also looked horrible in early 2009, and the economy still did pretty well.  We should probably have an answer by mid-January, when the Q4 data comes in.

Over at Econlog I have another post on the Chinese stock market, comparing it to 1987.



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.