Archive for June 2019


Never assume the markets are wrong

Here’s the FT:

One can look at equities and bond yields and conclude that one of these markets is very wrong.

Of course markets are always wrong in the sense that each day new information comes in and prices move to new levels reflecting that new inflation. Ex ante, however, there is no reason to assume that the stock and bond markets cannot both be correct. Here’s what I see as the most likely explanation:

1. Long run changes in saving and investment are gradually producing a lower “new normal” of global real interest rates. For any given flow of corporate earnings, that’s bullish for stock prices.

2. Over the past year, expectations regarding economic growth in the US and elsewhere have fallen somewhat. These slower growth expectations have reduced the expected future flow of corporate earnings.

Both factors tend to depress bond yields, whereas factor #1 boosts equity prices while factor #2 depresses equity prices. Taking everything into account, you’d expect bond yields to be much lower than 9 months ago, and you’d expect relatively little change in equity prices. And that’s exactly what has happened.

Bubbles are such a useful concept!

Yes, I’m being sarcastic. I’m long past the point where I regard “bubbles” as an intellectual idea that should be taken seriously.

A few months back, I did a post mocking all of the (failed) previous predictions about Bitcoin being a bubble. Yet because the price at that time was well down from the peak, there continued to be lots of claims like the following:

We can safely say the ICO bubble is over now.

That was in March, when Bitcoin was at $4000. Today it’s up over $10,800.

If these are bubbles, then please give me more, and more, and more of them. I’ll laugh all the way to the bank.

HT: MSGKings

More on Libra and monetary policy

The FT has a new piece by a Facebook co-founder Chris Hughes, which argues that the proposed Libra cryptocurrency could undermine the power of central banks. I’m generally skeptical of that view, but in this case Hughes does make a respectable argument:

Let us imagine that Libra works as planned. Hundreds of millions of people around the world will be able to send money across borders as easily as they send a text message. The Libra Association’s goals specifically say that ability will encourage “decentralised forms of governance”. In other words, Libra will disrupt and weaken nation states by enabling people to move out of unstable local currencies and into a currency denominated in dollars and euros and managed by corporations.

According to Bitcoin Era, the Libra Association promises to choose stable currencies and assets unlikely to suffer inflationary crises. The sponsors are right that a liquid, stable currency would be attractive to many in emerging markets. So attractive, in fact, that if enough people trade out of their local currencies, they could threaten the ability of emerging market governments to control their monetary supply, the local means of exchange, and, in some cases, their ability to impose capital controls.

This is the most plausible argument for the claim that Libra could undermine monetary policy. If Libra were so successful that local currencies stopped being the medium of account, then Libra could completely take over the monetary system, effectively dollarizing the local economy. In that case, it would not be Facebook that controlled local monetary policy, it would be the Fed.

I’m still skeptical that Libra could be successful enough to make currencies like the India rupee or the Turkish lira disappear, but to the extent that Libra is a threat to monetary policy independence, it’s in the developing world, not the USA.

Will Libra impinge on monetary policy?

Here’s Tyler Cowen, discussing the proposed new Facebook cryptocurrency called “Libra”:

4. We are told “The association does not set monetary policy.  It mints and burns coins only in response to demand from authorized resellers.”  Maybe, of course there are hundreds of years of debate on that one, google “real bills doctrine,” noting that here we have a semi-dominant private issuer rather than a perfectly competitive banking system.  The association policy on interest rate spreads, floats, and credit, of course, can end up being a monetary policy de facto.  I don’t want to prejudge this one against Libra, since to me the validity of the real bills doctrine is a genuinely open question, but it is worth noting that most economists would not agree with the doctrine in most settings.

I’m no expert on cryptocurrencies, but here’s my best guess on this issue, FWIW.  It will be helpful to begin with a discussion of how the “real bills doctrine” applies to three situations:

1. Is the creation of private bank money inflationary under a gold standard?

2. Is the creation of government fiat money backed by valuable assets inflationary?

3. Is the creation of private currency substitutes inflationary under a fiat money regime?

In each case, you need to consider the impact on the supply and demand for the medium of account (gold in the old days, currency today.)

In my view, the creation of private bank money was slightly inflationary under the old gold standard.  This is because the creation of private bank money slightly reduced the global demand for gold.  But only slightly.  (It did not directly impact gold supply.) Thus you might view the old real bills doctrine as being false, but approximately true.

In my view, the creation of government fiat money is inflationary, even if backed by valuable assets.  There are other opinions, for instance check out the views of Mike Sproul.  My view is that the creation of fiat money tends to boost the supply of money more rapidly than the demand for money, because currency is not a close substitute for other financial assets.  This is obviously less true if you are talking about the creation of interest bearing reserves. For simplicity, it’s easier to evaluate this issue in terms of the pre-2008 monetary regime, where the monetary base was 98% currency.  In that case, I don’t believe the real bills doctrine is even approximately true.

In my view, the creation of private bank money substitutes is not inflationary under a fiat money regime.  While it’s true that these substitutes would slightly reduce the demand for government fiat money (currency), the effect would be small.  And even if the effect were large, I’d expect the central bank to offset it with a reduction in the monetary base.  To the extent that it impacted monetary policy, the issuance of private currency substitutes would merely reduce seignorage.

This last case seems the most applicable to Libra.  I’d expect this system to slightly reduce seignorage, but not too much.  Seignorage does not come from the creation of interest bearing reserves, it comes from the creation of currency.  Most US currency is held for the purpose of hiding wealth.  I expect the demand for $100 bills to remain high, even after Libra.

I suspect that if Libra turns out to be highly successful then it will be a much bigger threat to banks and credit card companies than to the Fed.  But I have no idea whether it will be successful.

Don’t be biased (It won’t be Trump’s fault)

How many pundits believe the following three things:

1. Trump is despicable, by far America’s worst President ever.

2. Trump’s trade war is stupid and hurts the economy.

3. If there is a recession in the next few years, it most likely will not be Trump’s fault.

I sometimes wonder if I am the only one who believes all three things, but perhaps there are a few others.

Most people engage in motivated reasoning, believing what they want to believe. I’d certainly like to believe that any recession is Trump’s fault, but I try my best to stick to the logic of my analysis, which says:

1. Most recessions are caused by tight money.
2. Presidents have little impact on the behavior of the Fed, even via appointments.

That’s not to say Presidents have zero impact.  The trade war obviously makes the Fed’s job slightly harder.  But if we make the mistake of blaming anyone other than the Fed for a demand-side recession, then we’ll never solve the problem.  Now if we had a recession despite stable NGDP growth (a real shock) that would be another story.  But I don’t expect that to occur.

Ironically, some of Trump’s defenders insist that appointments to the Fed are very important, and even that Ben Bernanke is personally responsible for the 2008 recession. Those Trumpistas will be forced by their logic to blame Trump for any Fed screw-ups. After all, he picked Powell.  

Will they follow their logic? 

In contrast, I believe the Fed has a lot of institutional inertia, that it follows the zeitgeist, and that no single appointment is all that consequential.

PS.  Here’s Yahoo:

The fallout from recent escalations in trade tensions could drag global economies into a recession within a year, according to at least one major Wall Street firm.

If the U.S. were to move forward with imposing a 25% rate of tariffs on about $300 billion worth of Chinese imports, and China were to retaliate, “the global cycle will be at risk,” Morgan Stanley chief economist Chetan Ahya wrote in a note Sunday.

“We could end up in a recession in three quarters,” he said.

A recession may or may not occur (I doubt it), but either way it won’t be Trump’s fault.

PPS. I’m not claiming to always avoid motivated reasoning, just that I try to avoid that sort of bias. You should too.

PPPS. I have a new post at Econlog discussing the optimal NGDP growth rate.