Archive for January 2022


What does it mean to say that something is inflationary?

Tyler Cowen has a new post looking at the question of whether cryptocurrencies are inflationary. I’d like to take a stab at this question from another perspective.

Let’s start with the question of whether cryptocurrencies like Bitcoin are “money”. If you view Bitcoin as money, then it has been hyperdeflationary. Prices of goods and services in terms of Bitcoin have plummeted at a phenomenal rate over the past decade.

But that’s clearly not what people mean when they ask whether Bitcoin is inflationary. They are thinking of inflation in US dollar terms. In that case, asking whether Bitcoin is inflationary is sort of like asking whether gold, copper, or shares of Tesla stock are inflationary. So are they?

In the most simple possible model, crypto doesn’t seem to be inflationary because it doesn’t directly affect the dollar money supply. But what if it somehow boosts velocity? Is that possible?  

Crypto could theoretically cause market interest rates to rise, which would boost velocity. But if the Fed is targeting interest rates then this will not occur.

Cryptocurrency is new and uncharted but new rules are rising up to define acceptable practices. The murky is becoming clearer! Be wise, seek help from an expert like a cryptocurrency investment coach, and avoid legal troubles while making a little extra cash. It always pays to be a pioneer in a new land, so don’t hesitate to take the right steps—just take it with care.

Crypto might raise the natural interest rate to a level above the policy rate, and hence boost inflation. This is actually the best theoretical argument for crypto being inflationary, but it is still rather implausible.

First, why wouldn’t the Fed offset this effect by raising the policy rate?  More importantly, why would crypto have any significant impact on the natural rate of interest? The total market value of cryptocurrencies is roughly $3 trillion, similar to Apple’s market value. People don’t typically ask if Apple stock is inflationary. They might ask if the stock market as a whole is inflationary, but not a single stock.

I suspect the confusion here comes from the fact that crypto is viewed as a form of “money” (it is often called “coins” or “currency”), and people wrongly think that monetary models of inflation are about money. They are not. Monetary models in macroeconomics are about the medium of account, the asset in terms of which goods and services are priced. Most cryptocurrencies are not media of account, and hence are not relevant to monetary models of the inflation, NGDP, etc. (And they aren’t even much of a medium of exchange.) As for stablecoins, I presume the Fed offsets their impact.

People often argue that monetary offset doesn’t work perfectly.  That’s obviously true, but the implication of this fact is frequently misinterpreted.  At times, the Fed is too expansionary (1970s, 2021) and at other times they are too contractionary (1930s, 2008-16).  But ex ante we don’t know what sort of mistake they will make, and hence a lack of monetary offset is not an argument for either an inflationary or a deflationary effect. 

Tyler spends a portion of his post discussing how crypto might affect aggregate demand, but I’m not persuaded by his reasoning.  He doesn’t tell us why this effect would lead the Fed to make a mistake in one direction or another.  The Fed knows about crypto.  Perhaps they overestimate its inflationary impact or perhaps they underestimate its inflationary impact.  I don’t know which is true, and I suspect that you don’t know either.

Perhaps Tyler is not thinking about monetary offset, rather he is viewing his analysis as a sort of input into Fed decision-making. Advice on how they might need to adjust policy from the baseline in response to crypto, in order to achieve effective monetary offset. But what is the baseline? There is no such thing as the Fed doing nothing. There is no baseline, except perhaps 2% inflation. But that merely assumes the answer! So what does it mean to talk about anything being inflationary? Holding what constant?

Lost in translation

More than 10 years ago, Forbes reported:

China Daily reported Friday that unnatural deaths have taken the lives of 72 mainland billionaires over the past eight years. (Do the math.)

Which means that if you’re one of China’s 115 current billionaires, as listed on the 2011 Forbes Billionaires List, you should be more than a little nervous.

I seem to recall that I criticized this article, but I cannot find the post. In any case, it’s hard to keep down fake news. Just a couple months ago the Financial Times repeated this nonsense:

Citing statistics from the Chinese press, the article pointed out that 72 of the country’s billionaires had died premature deaths in the previous eight years. The original piece in China Daily, which is published by the Communist party, provided the details: “Among the 72 billionaires, 15 were murdered, 17 committed suicide, seven died from accidents, 14 were executed according to the law and 19 died from diseases.”

Doesn’t the FT have a fact checker?

This is from the original China Daily story from 2011:

Since 2003, 72 billionaires in the Chinese mainland have died an unnatural death, the Changchun-based New Culture News reported Friday. . . .

Among the 72 billionaires, 15 were murdered, 17 committed suicide, seven died from accidents, 14 were executed according to the law and 19 died from diseases.

There were approximately 60,000 people with 100 million yuan in the Chinese mainland at the end of 2010, according to the GroupM Knowledge – Hurun Wealth Report 2011.

So all of this comes from the obscure New Culture News. Let’s take a closer look.

The first problem is that Forbes refers to the fact that in 2011 China had 115 US dollar billionaires, whereas the New Culture News is referring to yuan billionaires. A billion yuan is more like 150 million US dollars.

The second problem is that the article cites the fact that back in 2011 there were 60,000 people with 100 million in wealth. But 100 million yuan is not a billion. The most likely explanation for this discrepancy is that round numbers are defined differently in China. In the West, a thousand, a million, and a billion are considered focal points. In China the basic units are a hundred (bai), ten thousand (wan), and a hundred million (yi). A Chinese newspaper aimed at a local audience would be unlikely to use the term “billionaire” unless perhaps referring to a Western concept, like US dollar billionaires. Certainly not for a wealthy Chinese person.

So they are almost certainly referring to people with a net worth of at least $15,000,000. And 72 premature deaths among 60,000 people is much less shocking that 72 deaths among 187 people (leaving 115 survivors.)

Think about this logically. Does it really seem likely that 72 of 187 Chinese dollar billionaires would have suffered premature deaths in a brief period of time and only the “New Culture News” would have noticed the problem? These people are celebrities, and their lifestyles are widely reported on both in and out of China.

In fact, the Chinese new story is almost useless. It’s not clear that a single Chinese US dollar billionaire has suffered a premature death. I suspect a few have, as China occasionally executes a businessman for corruption. But the article cited by both Forbes and the FT doesn’t tell us anything useful.

PS. I’d like to thank my wife for help with the Chinese numbering system.

HT: Jordan Schneider

The Fed is behind the curve (as usual)

There’s a widespread impression that the Fed has recently tightened monetary policy. And it’s true that they have taken specific steps to signal an intention to raise rates and end QE earlier than had been expected six months ago. Nonetheless, monetary policy has effectively eased in the past six months, becoming more expansionary. The stance of monetary policy is not about Fed actions, it’s about market expectations of inflation/NGDP growth.

During the summer of 2021, 5-year TIPS spreads hovered around 2.5%. As of today, they are over 2.9%. The problem is that the equilibrium interest rate is rising faster than the Fed’s signals about future rate increases. This is actually the typical pattern over the business cycle. The Fed tends to raise rates too slowly during booms and cut them too slowly during recessions.

Actually, the situation is even worse than suggested by the rising TIPS spreads. The Fed isn’t targeting inflation; it’s targeting average inflation. That means a period of above target inflation should be followed by expectations of lower inflation going forward. Ideally, after the high inflation of the past 6 months, TIPS spreads should have declined, as markets anticipated a make-up period of below 2% inflation.

I still believe the Fed did a good job in promoting a rapid recovery in NGDP. Monetary policy is not binary situation of “success” and “failure”. All monetary policy ends in failure of some sort, it’s just a question of how bad. There’s still time for the Fed to remedy the situation and produce a soft landing. To do that, they need to aim for no more than 4% NGDP growth going forward, and no less than 3%. (In my view, trend RGDP growth is now below 2%) To do that the Fed needs to get ahead of the curve. Tighten policy enough to significantly reduce market inflation forecasts.

Socrates would have opted for index funds

Almost a year ago I posted on GameStop. I’m reluctant to revisit that post, as I’m almost certain to be misunderstood. But . . . when has that ever stopped me before?

Here’s what I said on January 29, 2021:

In the early 2010s, I had no idea what was going on with Bitcoin, and still don’t really understand the investment. But I think I at least understand that I don’t understand it. You say nothing “fundamental” has changed with GameStop in the past week? OK, maybe, but are you sure? Does becoming 10 times more famous and developing a strong emotional connection to many millennials have zero value to a retailer? I don’t even play computer games, so I have absolutely no opinion on this stock. But how confident are you in your opinion?

This is why it’s so hard to test the EMH. The collapse of what looks like speculative bubbles seems like evidence against the EMH, but in fact the theory predicts that the vast majority of speculative “bubbles” will collapse, in order that the expected rate of return on portfolios that include Bitcoin, Amazon and Tesla is consistent with the risk-adjusted rate of return on other portfolios. The statement “speculative stock X is very likely to be lower in a couple years” is not at all equivalent to “speculative stock X is a bad investment.”

A commenter responded:

I’m surprised to see GameStop used as an example here. It closed today more than 14 times the pre-social movement high, which started a bit over two weeks ago.

Could the company cash in on this extra capital? Yes, though it hasn’t done so yet. Could millennial affection help permanently boost prospects for earnings? Yes, but 14 fold, for a retailer that still mostly depends on buying and selling increasingly obsolete products in many increasingly obsolete retail spaces, like malls?

In less than a year, GameStop has moved from obsolete malls to NFTs:

The day started hot for video game retailer GameStop (NYSE:GME) after the company announced an NFT marketplace. Shares jumped 22.3% at the start of trading but started losing that bounce quickly and were trading 8% higher at 10:40 a.m. ET. 

The Wall Street Journal reported after the market closed on Thursday that GameStop is building a non-fungible token (NFT) marketplace and partnerships in the cryptocurrency business. About two dozen people have already been hired for the project, and management thinks it can translate the brand to a valuable position in the market.

Translate the brand to a valuable position? Interesting idea . . .

My fear is that readers will view this as a buy recommendation for GameStop. Nothing could be further from the truth. (It still seems like one of those long shots–like Bitcoin.) I invest in index funds because I believe in the EMH. I believe that I don’t know anything about individual stocks.

Where does Socrates come into the picture?

I know that I know nothing.

Socrates would have invested in index funds.

The job market is very weak and very tight

Last year, I began talking about labor shortages. Lots of commenters suggested that it was just employers gripping because they didn’t want to raise wages. They pointed to the fact that total employment remained far below pre-pandemic levels.

Employment is still far below pre-pandemic levels, but it’s now pretty clear that I was right. There really is a labor shortage. The labor market is “weak” in the sense that total employment is low, and “tight in the sense that it’s hard to find workers and wages are rising fast. Unemployment is only 3.9%.

The latest employment report is a disappointment, but the job market is actually somewhat stronger than this number would suggest. Consider the following:

While the payroll survey shows gains of only about 450,000 over the past two months, the (less accurate) household survey shows gains of over 1.7 million. That’s a phenomenal number, as household employment has gone from a deficit of 4.6 million to a deficit of 2.9 million in just two months.

But why pay any attention to the less accurate household survey? Because even though it is less accurate, it provides some information, at the margin. Thus it picks up gains in self-employment, which might matter during a period where people like working at home to avoid Covid.

It’s also worth noting that the payroll figures will likely be adjusted upward. How do I know this? Because the payroll numbers were revised upward in each of the past 8 months. The odds of that happening randomly are 1 in 256. Let’s revisit my prediction in two months to see if I’m right:

Wage growth again came in higher than expected, and the unemployment rate fell by more than expected. Inflation is way above target, and NGDP is growing at a rate than is not consistent with the Fed’s inflation target. Even worse, NGDP growth in 2022 is likely to be excessive. TIPS spreads are excessive at both 5 and 10 year time frames. We need tighter money. Under FAIT, the Fed should be shooting for below 2% inflation.

There’s a lot of confusion about full employment. We are at “full employment” (as defined by economists) given the headwinds of Covid. And yet it’s equally possible that by July the full employment level will be three million higher than today. But that would not mean that we are not at full employment today. Full employment is not a fixed number, it moves around due to “real” factors, such as Covid.