A trillion here and a trillion there . . .
. . . and pretty soon you are talking real money. The Summers pullout boosted global equities by more than half a trillion dollars, which means a trillion or so compared to the level if he had been picked with 100% certainty. Yesterday Bernanke gave global equity investors another 3/4 of a trillion.
Recently I’ve been very happy:
1. Policy is slowly moving my way (Japan, no US tapering, etc.)
2. The Fed justifies its policy with monetary offset language.
3. My 401k is rising.
But I’m a silver lining guy anyway. In contrast, Tyler Cowen takes a “cloud” perspective. He cites data showing emerging markets were “on fire” yesterday, and then adds the following cautionary note:
I’ve read many pro-delay-the-taper posts, and agreed with the (domestic) analysis in most of them, but I haven’t seen anyone address the um…shall we call it a trade-off?…here.
The optimistic reading is that those are sustainable gains based on higher U.S. growth, and thus higher demand for developing country exports, but it’s very hard to get the numbers to add up, or anything close, for that kind of explanation. More likely the pricking of those bubbles has been delayed. Is that good or bad? (What happened to caring most about the poor?) To even raise such a question means we probably should be agnostic about what is going on, and that is hardly the most popular attitude in the economics blogosphere when it comes to monetary policy.
My view is that there is no such thing as bubbles. That means if emerging market equity prices rose (and they did) it makes a future financial crisis less likely not more likely. I see belief in bubbles as a sort of cognitive illusion, as it certainly looks to the average person (and to me) as if there are bubbles. But applying rigorous logic to the problem suggest that bubbles do not exist, and that people are “fooled by volatility.” It you generate a line on graph paper with a random walk process, it will look like it contains bubbles, even though (by construction) it does not.
So yesterday really was good new for emerging markets.
PS. There is a certain irony in me accusing Tyler of falling for a cognitive illusion, as he better than almost anyone else at avoiding that sort of mistake. I recently emailed him a new set of “George Bush paintings” that I thought he would find interesting. He very gently and very politely asked me if I had considered that it might have been a hoax. Too gently, as it took me another round of emails before I realized what a fool I was. Of course it had to be a hoax, why didn’t I see that right away? Because I’m not Tyler Cowen.
PPS. A few days ago Andy Harless left a comment pointing out that when interest rates are falling, higher stock prices don’t necessarily imply higher NGDP expectations. BC left a comment with data suggesting that NGDP growth expectations have probably risen as a result of recent events:
I do have some inflation swaps data. Inflation swaps are usually a little higher than TIPS breakevens due to some differences in financing rates between TIPS and nominal treasuries in the repo market.
The most pronounced change in inflation swap rates was in 1-2 yr forward inflation (expected inflation between Sep 2014 and Sep 2015). It rose from 1.80% to 1.95% between Friday 9/13 and Monday 9/16, coincident with the Summers withdrawal. As of Wednesday, it had risen to 2.18% in response to the Fed surprise non-tapering. So, overall in increase of 0.38% between Friday and Wednesday. Over that period, 0-1 yr inflation has not changed much (increased from 1.59% to 1.63%), nor has 2-5 yr inflation (decreased from 2.54% to 2.49%). 5-10 yr inflation has increased from 2.70% to 2.93%.
And RGDP expectations? That’s why we need a . . . that’s right, an NGDP FUTURES MARKET!!!
Tags:
19. September 2013 at 09:36
Didn’t the Fed signal yesterday that they were trapped in endless QE? They had more cover than they could have ever asked for to start the tapering process, yet they didn’t. If the economic data does improve over the next few months, inflation rises to 2.5% and unemployment comes down substantially, will the Fed taper if the ten year yield is over 3%? My guess is that they won’t, because they cannot afford to let yields rise much higher than that. They are in an endless loop where the foreseeable consequences of tapering are never good for the stock or bond markets. If the market eventually gets the impression that the Fed can’t or won’t taper ever, then high inflation could occur very quickly, and perhaps uncontrollably.
19. September 2013 at 09:59
Neil, You said;
“Didn’t the Fed signal yesterday that they were trapped in endless QE? They had more cover than they could have ever asked for to start the tapering process, yet they didn’t.”
No, they signaled just the opposite. Both inflation and growth are below target, so there is no reason at all to taper. If inflation rises over 2.5%, they will certainly taper.
19. September 2013 at 10:15
I think that will be the real test: to see if they actually can taper once they hit their economic targets without crashing the bond and stock markets. I honestly have my doubts. I think that the recovery party ends if and when they start to taper.
19. September 2013 at 10:33
I suppose we must take this as a positive evolution in the views of Felix Salmon (HT Tyler Cowen): http://blogs.reuters.com/felix-salmon/2013/09/19/the-surprising-value-of-not-tapering/
19. September 2013 at 11:14
Pressed for time but I could not resist having fun with the Drudgetaposition:
http://classicalvalues.com/2013/09/the-markets-are-speaking/
19. September 2013 at 11:36
Do you think there’s a chance that the post-Summers stock rally was more a response to what would have been a tortuously uncertain confirmation process of Summers vs. an expectedly smooth one for Yellen?
19. September 2013 at 12:50
On bubbles, I have come to the conclusion the entire debate is a giant distraction. What people are really angsting about is asset price instability: putting it in terms of “bubbles” does not merely not add anything to the analysis, it actively gets in the way.
On housing, it is even more so, since the land rationing creates the asset price instability, the blocks to social mobility, the inequality effects, the poverty effects which are the real issues. Again, putting it in terms of “bubbles” add heat while getting in the way of clear analysis.
19. September 2013 at 13:03
Maybe the folks over at Intrade.com could be persuaded to start an NGDP futures betting pool? Not quite an “official” market but it would be fun.
19. September 2013 at 13:25
Neil is correct IMHO, it is a flow issue. Regardless of the data at this point, the mere thought of tapering will push rates higher. Fed has boxed themselves.
https://en.wikipedia.org/wiki/Stock_and_flow
19. September 2013 at 15:04
Prof. Sumner,
I voted for Obama and even I can’t believe you fell for those “Bush paintings.”
Lorenzo,
Great point about land rationing.
19. September 2013 at 15:35
Coming soon by Calomiris and Haber; Fragile by Design: The Political Origins of Banking Crises and Scarce Credit
http://www.amazon.com/Fragile-Design-Political-Origins-Banking/dp/0691155240/ref=sr_1_6?s=books&ie=UTF8&qid=1379619199&sr=1-6&keywords=Calomiris
With powerhouse blurbs; Rajan, Sargent, Goodhart…
19. September 2013 at 15:58
There is a peevish, sullen and insipid school of economic thought that any period of economic prosperity is followed by bust, and the longer the prosperity the worse the bust…ergo better to avoid the busts by never having the prosperity.
I prefer prosperity, bring on the boomtimes, I say.
Fat City? I wish it was my home.
19. September 2013 at 16:13
Scott,
I’ve said this before but an NGDP futures market is not going to get off the ground. One of the problems is monetary offset, i.e, with a policy of NGDP targeting, there would be no volatility and therefore no reason to buy or sell the future.
What you need is an indexed note (GAIN – Growth Adjusted Index Note) issued by the Fed in exchange of Treasuries.
19. September 2013 at 16:31
dtoh, how does this GAIN compare to what JP Koning proposes in his latest post entitled:
“Woodford’s forward guidance””why not use forward contracts instead?”
(sorry, but I can’t link there).
19. September 2013 at 16:37
Scott, O/T: How would you describe Michael Pettis? MMist? Something else?
19. September 2013 at 16:48
Damn there’s another BC? I better choose another name
19. September 2013 at 17:33
Everyone here in Australia seems to think that ‘no taper’ is bad for us, because it has caused the AUD to rise. Even though stocks rose markedly on the news. Almost all commentators here are saying that the decision means an RBA rate cut is more likely.
19. September 2013 at 18:03
“And RGDP expectations? That’s why we need a . . . that’s right, an NGDP FUTURES MARKET!!!”
The fed should target broad money rates which are much more relevant the overall economy than base. Broad money is not at the ZLB.
19. September 2013 at 21:11
ETF structure? Instead of Treasurys or futures on the balance sheet, swap the Fed’s notional assets 1:1 dollars for shares — that is float the entire asset side of the Fed’s balance sheet into a special purpose vehicle, on the exchange, that pays holders weekly in (new monetary base) new currency or reserves per share. (retire/annul the Treasury debt and make base money provision market-driven.) Think money market ETF, Fed operates the SPV to keep NAV steady — issuing or redeeming new shares, and is essentially pay-in-kind — with NEW shares accompanied by 1:1 NEW base money to holders. On average, long run new monetary base creation “yield” would be about 6%. (You buy the SPV shares to get base money issuance.) Float the Fed’s capital on the liability side while we’re at it, to monitor and price their counterparty risk and arb (its only other liabilities being base money currency and reserves). Require banks to hold some proportion of of assets % NGDP in the SPV. If they lend more — or otherwise desperately need reserves — they buy the SPV to gain more base money, the NAV goes up, and the Fed supplies the shares/reserves. On the flip side, if NGDP is sluggish — likely below 6% — then other buyers would boost the NAV premium of the SPV and lower its yield (just like you or I buy bonds). The Fed then enters and provides the new shares to bring 1:1 NAV back — the economy grows, so most of the action will be on the positive NAV side. But if NGDP overheats, then investors pass over the SPV return and buy elsewhere, and NAV premium falls (just like you or I sell bonds — yield rises). This (more rare) negative NAV scenario — here’s the ETF part — banks and people redeem reserves/currency back to the Fed SPV to bring NAV back into line — AND GET A NOTE ENABLING FUTURE SHARE BUYING AT THE DISCOUNTED PRICE.
Think money market pay-in-kind ETF. Off the cuff, complicated, and crude.
19. September 2013 at 22:41
“… Mr Bernanke mused that an inflation floor might be a useful thing to add to forward guidance.”
http://www.economist.com/blogs/freeexchange/2013/09/monetary-policy-0?fsrc=scn/fb/wl/bl/septapetsurprise
20. September 2013 at 01:29
“The Summers pullout boosted global equities by more than half a trillion dollars, which means a trillion or so compared to the level if he had been picked with 100% certainty. Yesterday Bernanke gave global equity investors another 3/4 of a trillion.”
Again with the conflating riches with wealth. Seems like this is a habit.
If the stock market index goes up because investors expect a depreciated dollar in the future, this increase in capital does not represent an increase in wealth, the way it would if the capital markets increased because of an increase in real savings.
20. September 2013 at 01:31
“And RGDP expectations? That’s why we need a . . . that’s right, an NGDP FUTURES MARKET!!!”
Again, there is no value to the investor in these securities other than what the central bank pays, as modelled, in interest to the accounts.
As such, the prices will not represent NGDP expectations, but rather a fixed income security.
20. September 2013 at 02:58
A monerist denial of the existence of economic bubbles is due to cognitive dissonance.
Bubbles after all are caused by the very central banking system upon which monaterism is based.
It is very much like a drug czar denying the existence of drug cartels, or a creatinist denying the existence of wars over religion, or a Keynesian denying the existence of state induced capital consumption.
If the monetarist were to accept and recognize bubbles, ultimately they will find that they are to blame. Thus the denial.
20. September 2013 at 03:56
Isn’t part of what causes “bubbles” a change in liquidity of a particular asset class?
Given two assets of equal underlying value, the more liquid asset – i.e. the asset that can be more readily exchanged for cash – will be worth more than the less liquid asset. That’s a real component of the value of an asset. (Think about it – would you offer more or less to buy a home that, for whatever reason, you were forbidden to sell?)
Homes were seen as very liquid investments in the early 2000s, less liquid from 2005-2008, and extremely illiquid since 2009. Part of the movement of home prices, then, was a rational reflection of the liquidity value of homes.
20. September 2013 at 04:22
Neil, You said;
“I think that will be the real test: to see if they actually can taper once they hit their economic targets without crashing the bond and stock markets. I honestly have my doubts.”
Actually we already know for certain that they can. Recall that a few days ago they were widely expected to taper, and yet stocks were near record highs. tapering will not cause stocks to crash, they’ll be down a couple percent at most.
Ashok, Almost all the commentary I read suggested they feared Summers would be more hawkish. I think that’s the most likely explanation.
Lorenzo, Good point.
Randomize, I doubt there’d be enough trading to make it useful.
Anonymous, No, he is definitely wrong. Indeed it’s not even debatable. See my reply to Neil.
Travis, Believe it.
Patrick, Sounds intriguing.
dtoh, You said;
“I’ve said this before but an NGDP futures market is not going to get off the ground. One of the problems is monetary offset, i.e, with a policy of NGDP targeting, there would be no volatility and therefore no reason to buy or sell the future.”
I’m afraid you don’t know what I am proposing. The NGDP futures targeting market I propose would have zero volatility by design. Lack of interest due to monetary offset would not be a problem at all. I’d encourage you to take a look at my Mercatus paper on NGDP targeting.
In any case, the proposal in this post had nothing to do with NGDP targeting. The Fed needs to create a NGDP futures market even if they do not do NGDP targeting.
Tom, No, Pettis is certainly not a MM. I don’t know his views on monetary policy.
Rajat, Perhaps stocks rose BECAUSE an RBA rate cut is now more likely.
Saturos, What does Bernanke propose to do if inflation falls though the floor?
Michael, Yes, liquidity may play a role, but to the extent it does, then it’s not a bubble.
20. September 2013 at 05:43
The Fed’s main problem at this juncture is that bond yields appear to have bottomed at extremely low levels back in the summer of 2012. Sentiment has reversed and is no longer in the Fed’s favor. It is now trending toward higher yields instead of lower. So the Fed is now swimming against the current with its treasury purchases, rather than with it. With yields now trending higher, tapering will have a much greater impact on the market, leaving a 400 to 500 million dollar hole in the bond market every day which won’t be filled, at least not completely. And that’s just with a ten billion per month initial taper. When yields rise, home sales decline, and home prices come down, which puts pressure on banks. I think the Fed really would like to keep the 10 year yield below 3% if at all possible. If they reach 3.5% or higher they may actually increase QE in my view. The flow of money into the primary dealers via QE is very important as well. To reduce that flow is like giving those banks a pay cut. I know people see the situation differently, but we have to stop fooling ourselves about the state of the economy. It isn’t good. The most we’ve done is paper over a very big problem with more liquidity. More liquidity does not translate to more real wealth.
20. September 2013 at 05:56
Neil, 2012 was an unsustainable historical aberration for rates. Last December 12, 30-year TIPs were yielding 0.24%, and 10-year TIPs were yielding -0.87%.
Today, the environment is more (new) normal. 30-Year TIPs yield 1.44%, and 10-year yields 0.49%.
Those yields look kinda meh- they’re more than 1% lower than they were back in 2004, but I’d be surprised to see them get back to that level anytime soon.
Why? Baby boomers. You may remember them from such classics as “Let’s lower tax rates to all-time lows during our peak earning years while massively expanding the scope of government. What could go wrong?”
Over the next 10-20 years, they’re all gonna be frantically trying to convert wealth to income at the same time. Voila- ceiling on yields.
20. September 2013 at 07:33
Let’s feed the troll a bit, he seems starved for attention.
Geoff,
Please provide a definition of a “bubble” – one that doesn’t rely on hindsight and doesn’t translate into “the price is higher than I would prefer”.
20. September 2013 at 07:56
Scott,
I’ve seen all the projections. Random walk processes do not generate the kind of massive drops seen on the stock market!! That kind of thinking is why people discount the possibility of a 20% decline (and invest as though this is impossible) as a one in 20 billion years event yet they’ve happened more than once in only one hundred years. The random walk model does not describe stock price movements. It is only a first order approximation not a fact.
For some reason I don’t fully understand–I don’t think anyone does–a random walk model catches the bull markets pretty well but doesn’t catch the type of down markets we see following a “bubble.” I think you might be burying your head in the sand on this issue.
20. September 2013 at 07:58
Speaking of painting by famous politicians, Hitler wasn’t a bad painter whatever his other faults were. If only he had been accepted at the Vienna Art Institute history might have been very, very different.
20. September 2013 at 08:25
Remarks by James Bullard: http://blogs.wsj.com/economics/2013/09/20/feds-bullard-small-taper-possible-in-october/
20. September 2013 at 08:51
Daniel –
“Let’s feed the troll a bit, he seems starved for attention.
Geoff,
Please provide a definition of a “bubble” – one that doesn’t rely on hindsight and doesn’t translate into “the price is higher than I would prefer”.”
>> Are you suggesting Geoff is a troll merely for, gasp, suggesting that bubbles exist? One doesn’t need to rely on hindsight or simply define bubbles as prices higher than one individual’s preference. What would you call asset prices that deviate significantly from underlying economic fundamentals for an extended period of time driven by speculative buying? Some may refer to that as a “bubble.” Others may not. But would you at least concede that such phenomena described as such, can and does occur?
20. September 2013 at 08:56
Probably don’t need to post this here as well, but just really want to make sure Scott does respond to this: http://johnhcochrane.blogspot.com.au/2013/09/the-new-keynesian-liquidity-trap.html
20. September 2013 at 09:40
Re: John September 2013 at 07:56
No opinions on this Arnold Kling piece, but here are his thoughts on why crashes are sudden:
http://econlog.econlib.org/archives/2010/04/a_simple_reply.html
20. September 2013 at 10:59
Cochrane’s hitting them on some of the same stuff Scott has.
Even more puzzling, new-Keynesian models predict that all of this gets worse as prices become more flexible. Thus, although price stickiness is the central friction keeping the economy from achieving its optimal output, policies that reduce price stickiness would make matters worse.
20. September 2013 at 11:05
My spidey senses smell Roger Farmer.
20. September 2013 at 12:22
I just had a long conversation with Cullen Roche:
http://pragcap.com/the-monetary-realism-matrix
Mostly I learned he is enormously unwilling to acknowledge mistakes in basic quantitative facts, and likes to pretend he he understands central bank flow of funds better than anyone. (Give me a break, I’ve been reading the flow of funds since I was in diapers.)
However, something substantive did come up. Although Monetary Realism evidently prides itself on its differences from MMT and their similarities to Post Keynesian Economics, Cullen at least has some truly odd beliefs when it comes to fiscal stimulus, which puts him at odds with Post Keynesian Economics.
He genuinely believes that any fiscal deficit, even Greece’s, provides positive fiscal stimulus. According to him this evidently comes about from the fact such deficits provide a flow of financial assets with which the private sector repairs its balance sheets. He claimed this is responsible for the US economic recovery (such as it is).
However I did some basic analysis that shows this claim is ridiculous. (Cullen is too busy engaging in a ritual display of his accounting credentials to dispute it.)
The following is the private sector’s Net Worth:
http://research.stlouisfed.org/fred2/graph/?graph_id=138183&category_id=0
It reached a low of $75.4 trillion in 2009Q2. It is up to $96.7 trillion as of 2013Q1 or an increase of $21.3 trillion.
Here’s private sector Total Assets and Liabilities:
http://research.stlouisfed.org/fred2/graph/?graph_id=138181&category_id=0
Total assets have increased from $169.5 trillion in 2009Q2 to $203.1 trillion in 2013Q1, or an increase of $33.6 trillion. Total liabilities have increased from $94.1 trillion in 2009Q2 to $106.5 trillion in 2013Q1, or an increase in $12.4 trillion. Since credit market instruments declined from $41.6 trillion in 2009Q2 to $39.6 trillion in 2013Q1, or by $2.0 trillion this means the entire increase in liabilities has been due to non-credit market instrument forms of liabilities.
How much of the $33.6 trillion increase in assets has been due to increased holdings or Treasuries? According to the Flow of Funds private sector holdings of Treasuries were $2.3 trillion in 2009Q2 (Table L.209):
http://www.federalreserve.gov/releases/z1/20110310/z1r-4.pdf
As of 2013Q1 they were $3.8 trillion, or an increase of $1.5 trillion:
http://www.federalreserve.gov/releases/z1/Current/z1r-4.pdf
Intragovernmental federal government securities are not counted as a private sector asset by the flow of funds. However, since Cullen Roche insisted that they be included, I obliged. Intragovernmental federal government securities rose from $4.4 trillion in 2009Q2:
http://www.treasurydirect.gov/govt/reports/pd/mspd/2009/opdm062009.pdf
To $4.9 trillion in 2013Q1:
http://www.treasurydirect.gov/govt/reports/pd/mspd/2013/opdm032013.pdf
Counting intragovernmental federal government securities as private sector assets results in a figure of $6.7 trillion for Treasuries held by the private sector in 2009Q2 and a figure of $8.7 trillion for Treasuries held by the private sector in 2013Q1, or an increase of $2.0 trillion.
Thus only $2.0 trillion of the $33.6 trillion increase in private sector assets from 2009Q2 to 2013Q1, or 6.0%, is due to increased Treasury holdings.
I can’t imagine how anyone can think that this is what is the main factor responsible for the recovery of private sector balance sheet health.
20. September 2013 at 13:20
More remarks from Bullard: http://www.reuters.com/article/2013/09/20/us-usa-fed-idUSBRE98J0W420130920
20. September 2013 at 13:24
Mike T,
deviate significantly from underlying economic fundamentals
I wasn’t aware there was such a thing called “the one true price”.
driven by speculative buying
Ummm … last time I checked, all buying was speculative.
So a bubble is when prices deviate significantly from an unknown and unobservable “true price” caused by normal economic activity. Yes, such phenomena do occur all the time.
Truly, the Austrian school deserves its places in the gallery of clowns.
20. September 2013 at 13:44
Ya know IF Janet Yellen had a PLAN that explained when the taper is coming…
That’d be awesome.
If she had a plan that explained, the fastest least painful way to do the taper…
That’d be world class genius.
If ONLY we knew someone who could craft that argument for her…
http://www.zerohedge.com/news/2013-09-20/david-stockman-warns-calamity-janet-yellen-has-no-clue
20. September 2013 at 14:55
Daniel:
“Please provide a definition of a “bubble” – one that doesn’t rely on hindsight and doesn’t translate into “the price is higher than I would prefer”.”
Do you really think I would pander to your request, after you called me a troll?
Actually I would answer, because I’m more mature than you and I ignore churlish yammering.
A “bubble”, as I’ve defined on this blog more than once before, is a REAL phenomena. It isn’t a phenomena that you can measure by looking at nominal statistics like prices or spending or interest rates over time, and then concluding that the shape of the trend line is what makes it a “bubble” or “no bubble”.
So what do I mean by “real” phenomena? A bubble occurs when too many scarce resources have been allocated to physically unsustainable projects in a division of labor. No individual knows the true quantity of real capital that “should” be invested here or there. But thankfully, in an unhampered price system, i.e. free market economy WITH a free market in money, the profit motive regulates capital allocation and prevents the kind of undue partial relative overinvestment (and thus partial relative underinvestment) that inflationary economies promote, encourage, and fail to stop.
If for example too many scarce resources are devoted to longer term projects, and thus not enough to shorter term projects, that is an economic “bubble”.
The reason why “bubbles” are associated with “rapidly rising prices” in the observational sense, is because rapidly rising prices is typically a consequence of the CAUSE of the “real” misallocation of capital, namely, central bank inflation of the money supply.
Dr. Sumner recognizes that the money supply grew rapidly throughout the 1920s, but he denied this was a problem because economists and the Fed did not measure M2/M3 back then, so it doesn’t count (not kidding).
He also recognizes that the money supply grew rapidly throughout the 1990s and 2000s.
Now, please be advised that I am not saying rapidly rising money supplies is the proximate cause of “bubbles” either. This too is yet another consequence or related effect.
The proximate cause of bubbles is non-market interest rates, which prevents the market from regulating capital allocation in a sustainable way that prevents the kind of partial relative overproduction that takes place WITH non-market interest rates.
Interest rates are in our economy “controlled” by a central planner. They are not determined by unhampered market forces. This is the core of the problem. Interest rates MEAN SOMETHING. To you they are but a tool of coercive monopolies. To economists they are a crucial regulating function that ensures a minimization of incorrect capital allocation.
All you positivists who are looking at historical data and trying to find patterns and trends in order to derive economic concepts like “bubbles” are beyond clueless. Economic concepts are derived from actors self-reflecting on their own selves, i.e. rationalism.
Positivists such as yourselves are really data munching historians and bookkeepers with a central planning chip on your shoulders. You’re not economists. It’s why you constantly have to walk the razor thin edge and couch your phrases and gobbledygook in massively conditioned, claused, and hedged statements like “generally” and “most of the time” and “sometimes this, sometimes that.”
It’s because history is constantly befuddling you. You’re looking for patterns THAT DO NOT EXIST.
Dr. Sumner is now doing a 180 and trying to pull the wool over your eyes by claiming that he’s “always said” that expansionary monetary policy sometimes makes interest rates go up, and sometimes makes them go down. He says that because he hasn’t the foggiest idea what causes interest rates to begin with.
It would be like me saying sunspots sometimes makes the stock market go up, and sometimes makes it go down. No matter what happens, if sun spots increase, and the stock market decreases, then I’ll say “This is one of those “sometimes” times.” But if the opposite occurs, then I’ll say “This is one of those “sometimes other times” times.”
You will never find economic concepts or laws or principles by looking into the past.
20. September 2013 at 15:21
So, in other words, since we don’t have “free market money”, everything is a bubble.
And then you wonder why nobody takes you people seriously 🙂
20. September 2013 at 15:37
A preview of the Calomiris/Haber book would be this paper, earlier this year, presented at the Atlanta Fed;
http://www.frbatlanta.org/documents/news/conferences/13fmc_calomiris.pdf
If the book is anything like the paper, it should be fantastic. I’ve simply never read anything as well organized, well written, and packed with historic information on the history of banking in Scotland, England, Canada, and the USA, as this.
Why Canada has had such a stable banking environment, while the USA’s has been susceptible to frequent banking panics is explained chapter and verse. Different political coalitions led to different systems.
Oh yeah, Housing Cause Denialists will hate it thanks to the number he does on the political coalition of ‘urban populists’, mega-banks, and politicians that caused our real estate bubble-bust.
I’ve already written a couple of posts about it on my blog, and have a couple more in mind.
20. September 2013 at 17:53
Neil, The point of the policy is to raise NGDP, not reduce interest rates.
John. You are describing the fat tails problem. I agree that stock movements are not normally distributed, but I still think they are random.
Patrick, I talked to Lars Christensen today. He told me that Denmark got along fine without deposit insurance until 1987. He said that if you proposed our convoluted system (Fannie, Freddie, the CRA, etc) in Denmark people would think you are crazy.
20. September 2013 at 18:10
Saturos, I don’t have a dog in that fight between the NKs and Cochrane. I think they are both wrong. It is a nominal shock problem (demand problem) but it’s not about interest rates and liquidity traps, and the laws of economics don’t get thrown out the window. It’s about what Friedman would call tight money, combined with sticky wages.
It sounds like he’s saying the same thing as Nick Rowe, there is no deterministic equilibrium, it’s indeterminate.
20. September 2013 at 18:13
Saturos, It’s good to know that at least one person at the Fed takes their targets seriously.
20. September 2013 at 23:53
Mark,
1) I never said Greece’s deficit was stimulative. I never even brought Greece up. You did. In fact, I was responding to your Greek comments trying to show you that Greek govt spending had declined, which you acknowledged, while US govt spending had increased since 2008 which rendered your use of the Greek comparison totally flawed. Greece is implementing real austerity via real spending cuts. The US budget deficit is not falling because of govt spending cuts but because the US pvt sector is improving and tax receipts are increasing. I tried to explain this to you, but you didn’t want to understand it.
2) Your “basic analysis” was wrong. Originally, you posted a chart using financial business liabilities only including credit market instruments. I pointed out that that was the wrong way to read the Flow of Funds section L.107. That is why your accounting was off by the tune of $50 trillion. I see you’ve since corrected the errors you made although it looks like you’re STILL using the wrong data in some places (I won’t bother to correct you since you obviously don’t care about getting the accounting right). But at least you’re a lot closer to getting it right this time.
3) In your own calculations here you concluded that pvt sector net worth has increased roughly $20T since 2009. According to your own data. That means 10% of the increase was due to govt issued securities. Remember, t-bonds are a pvt sector net financial asset. Is that the “main factor” of the recovery? No, and I never said it was. But I would call it statistically significant. And as you noted in your comments at Pragcap, the US govt has increased spending by 13% since 2008 which would also note is nothing like Greece and certainly not the “austerity” you attempted to depict before I corrected you. You also admitted I was right there though you then altered the data to your liking so it was adjusted by GDP which gave your comments the appearance of being at least somewhat statistically meaningful….
4) The point that I can’t seem to get across to you and the other MM guys is that T-bonds are very similar to a form of the monetary base. Cash, coins, reserves and t-bonds are all essentially forms of “outside money” in MR. They’re net financial assets for the private sector because they have no corresponding pvt sector liability. The reason I brought up Beckworth’s “safe asset shortage” concept was because this is perfectly in paradigm with the MM view of the world. That is, the easiest way to issue safe assets to the private sector is to have the govt print them up via forms of outside money. You guys focus on the base, but it could just as easily be done via T-bond issuance. Different agency, could be done with tax cuts, but really not that different than having the Fed fire dollar bills out the front door.
Lastly, I think monetary policy has contributed to the recovery. I also think fiscal policy has contributed to the recovery. You said “it’s safe to say whatever recovery we have is due entirely to monetary policy.” I respectfully disagree with that.
Anyhow, it looks like we’ve made a mountain out of a molehill here so let me apologize to Scott and to you for making a bigger deal of this than it was. I still think there’s overlap between our views and the MM views and that I am either not communicating them very well or I am too stupid to realize that I am wrong. Probably the latter. Oh well.
Good chatting and thanks for the aggressive data filled debate.
21. September 2013 at 02:21
Scott, you said;
“It’s about what Friedman would call tight money, combined with sticky wages.”
I would say it’s about the fact that wages (and prices of real goods/services) are sticky while the prices of financial assets are not sticky.
21. September 2013 at 05:14
When the asking price of an asset that is traditionally or always valued by cash flow rises to a level where the cash flow becomes negative, the rational move is to not bid at that price. The irrational move is to change one’s thinking about how to value such assets and justify the price based on expected appreciation, then argue that this is somehow a new paradigm and the old ways of valuation will not return. When that change in thinking occurs, that defines a bubble to me and it is obvious that the change can be detected as it is happening and not merely in hindsight.
I agree with Scott that many things that look like bubbles are in fact not bubbles. But it is undeniable that a “negative cash flow” mentality took hold in various real estate markets in the 2000s. You can’t wave that away as simple volatility.
21. September 2013 at 06:32
The Dutch Tulip Bubble didn’t happen, it just was a random walk in the tulip garden.
21. September 2013 at 06:49
I was going to say the same thing David N did. It is not always obvious when a a bubble exists. But it is obvious when a bubble has popped. The bubble bursts when there is a rapid readjustment of future value that causes a severe dislocation in present value. The history of inflated human expectation, whether it concerns real property or Tickle me Elmo is so replete I am surprised that one could claim Bubbles do not exist.
I do think there are guides to help detect the presence of bubbles. In the case of asset purchased with borrowed money one might consider whether there is sufficient income to pay the interest on the debt. The reason the housing bubble was clearly a bubble was the growing abundance of homeowners who were using home equity to pay their bills. In other words, a main driver allowing house prices to increase was the ability of people to borrow increasing amounts of money against the increasing value of the house. This is an unsustainable cycle that was certain to be broken, it was only a question of when.
21. September 2013 at 09:22
Cullen Roche,
1) My original statement on this matter was:
Mark A. Sadowski:
“Fiscal deficits are not identical to fiscal stimulus.
In my opinion the most objective way of measuring fiscal policy stance is the change in the general government cyclically adjusted balance, particularly the cyclically adjusted primary balance (CAPB). The cyclically adjusted balance takes into account any changes in the general government budget balance due to the business cycle. Thus changes in the cyclically adjusted balance are mostly due to discretionary fiscal policy, and consequently may be taken as a proxy for the degree of fiscal stimulus. The CAPB goes a step further, factoring out changes in net interest on government debt and thus ensuring that practically all of the changes in fiscal balance are discretionary in nature.
You can find estimates of the CAPB in the IMF Fiscal Monitor which comes out twice a year. The CAPB for the Advanced Economies are on the bottom half of Table 2:
[Link to IMF Fiscal Monitor]
The US CAPB was (-6.7%), (-5.7%) and (-4.4%) of potential GDP in calendar years 2010, 2011 and 2012 respectively. It is forecast to rise to (-2.7%) of potential GDP in 2013.
Thus the change in CAPB was 1.0% and 1.3% of potential GDP in 2011 and 2012 respectively and is forecast to be 1.7% of potential GDP in 2013. I don’t think there is any doubt that fiscal policy has been a major drag on the economy for nearly three years now.”
To which you responded by saying:
Cullen Roche:
“Yikes. Are you guys another group who just changes the definition of well known concepts to suit your views? Fiscal policy has a pretty standard definition in economics. It’s the use of receipts and expenditures to influence the economy. Whether you believe components of this are automated or the result of other factors is really irrelevant. The fact is, a deficit is fiscal policy because it’s the result of expenditures that outpace receipts. Redefining broadly agreed upon terms is not helpful and makes it look like you’re just trying to move the goal posts.”
[Note that my way of measuring fiscal policy stance is excruciatingly conventional and mainstream. Even Post Keynesian do not think that all fiscal deficits are equivalent to fiscal stimulus.]
2) My original analysis read:
Mark A. Sadowski:
“In the US private sector assets (not counting financial sector land) less credit market instruments reached a bottom of $127.5 trillion in 2009Q1. As of 2013Q1 they are $163.5 trillion, an increase of $36.0 trillion. Private sector assets have risen from $169.8 trillion to $203.1 trillion. Private sector credit market instruments fell from from $42.3 trillion to $39.6 trillion, thus almost all of the increase in assets less credit market instruments is due to increased assets, not reduced credit market instruments.
Most importantly, private sector holdings of Treasury securities have only increased from $2.5 trillion at the end of 2008Q4 to $4.3 trillion at the end of 2013Q1. *Thus holdings of Treasuries represent only about 5% of the increase in private sector assets net of credit market instruments*.
In Greece, private sector financial assets less credit market instruments have fallen from a peak of 745.6 billion euro in 2010Q2 to 606.7 billion euro as of 2013Q1, or a decrease of 138.9 billion euro. Private sector financial assets have fallen from 1,063.8 billion euro to 885.3 billion euro. Private sector credit market instruments have fallen from 318.2 billion euro to 278.7 billion euro. Thus the decline in the value of private sector financial assets more than accounts for the decline in private sector financial assets less credit market instruments.
*And all of this has occured despite the fact Greece’s general government has borrowed 57.5 billion euro from 2010Q3 through 2013Q1 alone, which is equal to roughly 30% of Greece’s current nominal GDP*.”
[Note that there is absolutely no mention of the word “liabilities” anywhere at all.]
To which you responded:
Cullen Roche:
“Where are you getting that data from?
You’re obviously excluding govt holdings (like SS & retirement funds) in your Treasury data which means you’re off by over FOUR TRILLION. That’s a little misleading don’t you think?
[Link to Treasury Bulletin]
Govt spending in Greece is down 25% from its peak in 2007. US govt current expenditures were 3.82T in Q2 which is barely shy of an all-time high. It’s UP 26% since 2008.
[Link to FRED *federal* government expenditures]
[Note that in the case of the US this is
1) moving the base year back from calendar year 2010 to 2008Q1
2) moving from general government to federal government
3) changing the criteria of fiscal policy stance from changes in cyclically adjusted budget balances to nominal sepnding
In the case of Greece this is simply wrong. Greek general government spending peaked at 124.7 billion euro in calendar year 2009. It fell to 106.1 billion euro in 2012. That’s a decrease of 14.9% in nominal terms.]
Why are you dividing by GDP and doing all sorts of other screwy things to make the data appear the way you want it to look?”
And skipping ahead you continued:
Cullen Roche:
“Ah, I see what you did there that’s confusing. You should just use the Flow of Funds report. For instance, your nonfinance noncorporate liabilities are listed at 4027 in your data, but on the flow of funds the liabilities total 14073 + 5808 so the liabilities you listed are off by FIFTEEN TRILLION. Come on man.”
And again:
Cullen Roche:
“Oh, and you got the financial sector liabilities wrong by roughly 54 trillion.
You know, if your thing is to try to steamroll over people with data and research papers (that no one will read) then you really need to get the data right and learn how to read a balance sheet. When you mess up the data by almost 100 trillion you just make yourself look bad….I mean, this is so far off I can’t even believe you posted it. I know you guys hate accounting, but this is just a mess….
[Again, note I never once used the word “liabilities”.]
21. September 2013 at 09:45
Cullen Roche,
3)In your original discussion of the effects of US fiscal policy you stated:
“You’re just cherry picking data left and right. Jared Bernstein was wrong like a lot of other liberals were at the beginning of 2012 & 2013 because they misinterpreted the impact of govt policy on the private sector. I know you like to think that the central bank steers aggregate demand, but the reality is that there’s a great big private sector out there doing most of the heavy lifting most of the time. Fiscal policy and monetary policy are mostly just stabilizing factors around a much larger machine.
The govt has been issuing $1 trillion in safe assets every year for 5 years. Now, you might not want to call that fiscal policy, but you’re just moving the goal posts. Whether you cyclically adjust that or not is irrelevant. Your cyclically adjusted view can’t prove or disprove whether it’s been stimulative. But we know for a fact that private balance sheets have improved during this expansion of govt issued financial assets. That story doesn’t align with your fiscal multiplier view because most economists don’t actually understand how deficit spending adds not only cyclical spending, but also net financial assets that totally change the composition of private balance sheets. To deny that is to fail accounting 101 (which you did when you brought up Greece where the pvt balance sheet has been contracting during the entirety of the crisis). If you’re looking for a big reason why households and businesses have picked up the slack during the last few years it’s because their balance sheets have been supported by the contribution of a trillion dollars in NFA via deficits AND continued govt spending.”
The main problem with this statement is that it suggests that US fiscal policy has added $5 trillion in financial assets to the private sector balance sheet. The correct figure is $1.5 trillion. *If* one adds intragovernmental federal securities, which I think is highly debatable, it rises to $2.0 trillion. Furthermore you may not have called it the main reason but you called it “a big reason”. Even counting intragovernmental federal securities it is only equal to 9.2% of the change in private sector net assets since 2009Q2 and only 6.0% of the change in private sector total assets. That doesn’t sound very “big” to me.
I think by far the most correct way to measure fiscal policy stance is by cyclically adjusted primary balances.
However this statement that fiscal expenditures have not been a drag on US economic growth is simply wrong. As I pointed out…
The size of government relative to the economy can be measured a variety of ways. The two principle approaches are budgetary and as a component of GDP.
Let’s look at budgetary measures first. The following are general government, federal, and state and local Total Expenditures as a percent of GDP. I would prefer to look at potential GDP but the CBO has not yet re-estimated potential GDP in light of the BEA’s recent revision of the national accounts:
http://research.stlouisfed.org/fred2/graph/?graph_id=138177&category_id=0
Government Total Expenditures have fallen from 39.2% of GDP in 2009Q2 to 34.8% of GDP in 2013Q2 or a decline of 11.3%. Federal government Total Expenditures have fallen from 26.5% of GDP in 2009Q2 to 23.4% of GDP in 2013Q2 or a decline of 11.7%.State and local government Total Expenditures have fallen from 16.6% of GDP in 2009Q3 to 14.4% of GDP in 2013Q2 or a decline of 13.0%.
Now let’s look at government as a component of GDP. There are three standard approaches to estimating GDP: 1) expenditure, 2) gross value added and 3) income:
http://research.stlouisfed.org/fred2/graph/?graph_id=138179&category_id=0
Government Consumption and Gross Investment has declined from 21.6% of GDP in 2009Q3 to 18.7% of GDP in 2013Q2 or by 13.5%. The Gross Value Added of Government has declined from 13.3% of GDP in 2010Q1 to 12.2% of GDP in 2013Q2 or by 8.3%. Government Income has declined from 13.6% of National Income in 2009Q2 to 11.6% in 2013Q2 or by 14.4%.
There’s still another way we can look at the size of government relative o the economy and that’s employment. The total civilian employment of the US government has fallen from 22,679 thousand in April 2009 to 21,831 thousand as of August 2013, or down by 848,000 jobs or by 3.7%:
http://research.stlouisfed.org/fred2/graph/?graph_id=127333&category_id=0
(Note I’m ignoring the burst in employment in 2010 due to the Census.)
So in terms of budgetary measures, as a share of GDP and in terms of employment, government has been shrinking the last few years. This is important because this is a source of fiscal policy drag to the economy.
I don’t see how anyone can can look at this additional evidence and still honestly claim that there is no fiscal austerity taking place in the United States.
21. September 2013 at 10:03
Cullen Roche,
4) Historically the supply of U.S. private safe assets has been significantly larger than the stock of U.S. government safe assets.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1986945
Consequently it is unlikely that the U.S. Treasury could create enough securities to fill the gap created by the shortage of private safe assets without undermining the safe asset status of Treasuries.
Historically a sudden and permanent rise in the expected growth of NGDP leads to a rise in the supply of private safe assets and a decline of public safe assets.
http://fmwww.bc.edu/ec-p/wp802.pdf
http://people.wku.edu/david.beckworth/irfsblog.pdf
And in turn the global shortage of safe assets is related to the shortfall in NGDP in much of the advanced world since 2008.
The resolution to the safe asset shortage problem, then, is monetary policy catalyzing the private sector into recovery.
I think the big lesson from looking at the US private sector balance sheets is that only 4.5% of the increase in total assets from 2009Q2 to 2013Q1 has come from increased holdings of US Treasuries (not counting intragovernmental securities of course). In fact the vast majority of the improvement has come from increases in the value of private assets.
21. September 2013 at 10:09
If running deficits = fiscal stimulus, does that mean that the UK actually DOES have a fiscal stimulus (rather than austerity) going on right now?
I find it hard to follow Keynesians on this issue.
21. September 2013 at 10:18
Cullen Roche,
“Lastly, I think monetary policy has contributed to the recovery. I also think fiscal policy has contributed to the recovery. You said “it’s safe to say whatever recovery we have is due entirely to monetary policy.” I respectfully disagree with that.”
One way of assessing monetary policy’s contribution to this recovery is by considering a conventional mainstream estimate of fiscal policy’s contribution to that recovery.
Evan Soltas has written an excellent blog post where he presents estimates of how much ARRA contributed to the US recovery:
http://esoltas.blogspot.com/2013/08/did-stimulus-help-you-decide.html
In particular I want to draw attention to the following images:
http://i.imgur.com/J4Vbuqg.png
I think the most you can say is that ARRA prevented the recession from being deeper than it was. The effects of ARRA are largely over by now, so the current level of economic activity owes almost nothing to it.
When one takes into account the cuts to government spending and the increases in taxes that have occured over the past few years, I don’t see how anyone can say anything other than “it’s safe to say whatever recovery we have is due entirely to monetary policy.”
21. September 2013 at 10:19
Now I feel bad for Cullen…
21. September 2013 at 10:28
Mark,
1) The reason I corrected your data on pvt sector balance sheets was because you originally used a chart and data showing the financial business sector’s assets relative to credit market instruments. You might think that’s a fair presentation of the financial business sector’s balance sheet, but it misses over $50T in liabilities. You basically presented a banking system’s balance sheet without deposit liabilities. That’s like presenting Heidi Klum with her head, torso arms and legs chopped off. What’s the point? You might have no problem with the accounting there, but I doubt you’ll find too many people who agree that that’s a fair way to present the financial business sector’s balance sheet.
2) The reason this is important is because the govt bonds are net financial assets for the pvt sector. There is no corresponding pvt sector liability. In other words, it’s pure net worth for the private sector when a t-bond is issued. This is one of the purest forms of safe financial asset that can be issued.
T-bonds are extremely similar to the monetary base. They’re outside money assets for the non-govt sector. I don’t see any reason why you guys wouldn’t support the issuance of t-bonds via something like tax cuts.
Additionally, if you think a few trillion dollars of QE has done anything meaningful, then it would be purely hypocrtical to claim that a few trillion in t-bond issuance hasn’t done anything. But you’re blinded by policy bias here and therefore can’t see how extremely similar the two things are.
3) Regarding the govt’s spending…well, state, local and federal spending just reached an all-time high. As a % of GDP it’s down a bit, but still higher than at any point pre-crisis. The govt might have fired some people (most state & local employees), but it just spread the spending around to other areas like welfare. It didn’t actually cut anything. In total, state, local and Federal spending is up 21% since 2008. So, unless up is down, then I don’t see how it’s fair to present this as “austerity”.
http://pragcap.com/wp-content/uploads/2013/09/s_l_expend.png
Anyhow, I know you won’t budge on this stuff so I’ll just let it die. Sorry we couldn’t agree. Have a nice weekend.
21. September 2013 at 11:53
Cullen Roche,
1) It might be useful to take a closer look at private sector liabilities. But first let’s review the facts.
Here’s private sector Total Assets and Liabilities:
http://research.stlouisfed.org/fred2/graph/?graph_id=138181&category_id=0
Total liabilities have increased from $94.1 trillion in 2009Q2 to $106.5 trillion in 2013Q1, or an increase in $12.4 trillion.
In particular, since you brought up deposit liabilities, let’s take a look at that. Currency and checkable deposits and time and savings deposits are a liability of the financial sector. In addition I want to look at corporate equities and pension fund reserves. Corporate equities are a liability of the nonfinancial corporate sector and the financial sector, and pension fund reserves are a liability of the financial sector.(Keep in mind the majority of pension fund reserves are invested in corporate equities.)
The following is a graph of corporate equities and pension fund reserves in blue, and currency, checkable deposits, small time deposits and large time deposits (actually large time deposits at commercial banks) in red:
http://research.stlouisfed.org/fred2/graph/?graph_id=138276&category_id=0
Corporate equities and pension fund reserves have increased from $23.8 trillion in 2009Q2 to $38.3 trillion in 2013Q1, or an increase of $14.5 trillion. Currency and deposits have increased from $9.4 trillion in 2009Q2 to $11.4 trillion in 2013Q1, or by $2.0 trillion.
In other words the $12.5 trillion increase in private sector liabilities from 2009Q2 to 2013Q1 is more than explained by the increase in corporate equities and pension fund reserves which in turn are related to the rise in the stock market. In contrast deposits are a relatively trivial matter.
2) “T-bonds are extremely similar to the monetary base.”
If you had said that *T-bills* are “money-like” then I might have agreed. In fact T-bills were counted as part of the old M4 and L monetary aggregates from 1975-80 and are still part of the Divisa M-4 estimated by the Center for Financial Stability (CFS).
But T-bonds have very significant and important differences from the monetary base, namely:
1) They have interest rate risk.
2) They are a liability to the taxpayer.
3) T-bonds are not the *medium of account*.
That’s all I can think of right now. (I’m still lifting my jaw off of the floor.)
3) “Regarding the govt’s spending…well, state, local and federal spending just reached an all-time high.”
This is simply not true. Even in nominal terms total government expenditures were $5,799.6 billion in 2013Q2 which is down $31.8 billion from $5,831.4 billion in 2012Q4:
http://research.stlouisfed.org/fred2/series/W068RCQ027SBEA
There is simply no measure of government that is at an “all-time high”.
“The govt might have fired some people (most state & local employees), but it just spread the spending around to other areas like welfare.”
Actually spending on government social benefits such as Medicaid and Unemployment Insurance has fallen from 3.69% of GDP in 2010Q1 to 2.95% of GDP in 2013Q2, or by 20.1%:
http://research.stlouisfed.org/fred2/graph/?graph_id=138293&category_id=0
More importantly, government spending and employment should be measured relative to potential output, and failing that it should be measured relative to current output. Measuring it in nominal terms fails to take into account inflation and increased real output.
21. September 2013 at 12:48
David, I think the traditional cash flow from real estate is often negative, so I don’t follow that argument. In any case, you cannot predict asset prices by looking at cash flow.
Dan, You said;
“The Dutch Tulip Bubble didn’t happen, it just was a random walk in the tulip garden.”
Yes, there is a book that argues the tulip bubble never happened. Is that the book you are referring to?
Dan, You said;
“The history of inflated human expectation, whether it concerns real property or Tickle me Elmo is so replete I am surprised that one could claim Bubbles do not exist.”
The reason I can claim that bubbles don’t exist is that I rely on logic, while most people rely on gut instincts. I concede that lots of things look like bubbles, but when you start to think about the problem more systematically the whole idea of bubbles seems increasingly preposterous. If bubbles existed I’d be rich. I’d sell short during the bubble phase, and buy back after it popped. Easy pickings!
21. September 2013 at 13:17
Mark,
F—ing clinic!
Scott,
Is it possible that bubbles exist but are unpredictable?
21. September 2013 at 13:49
Cullen Roche’s response:
“Looks like Sumner banned me. Here’s my last comment there that he won’t publish:
“So let’s conclude:
1) You admit govt spending is UP since 2008, but you call this “austerity”. In other words, up is down in the USA. But in Greece, where you admit govt spending is actually down since 2008, down is really down. Okay.
2) You originally excluded corp equities in financial businesses liabilities (you incorrectly used credit market instruments originally), but now you’ve decided to add them back in because you think they “more than explain” a relevant balance sheet change. Is this from the Enron accounting 101 text?
3) You’ve since used my data and proper reading of the L.107 on the FOF to correct your previous $50T accounting error and are now presenting private sector net worth correctly.
4) You are never wrong about anything.
Yes, I too am lifting my jaw off the ground. You made an egregious accounting mistake in your original comments and have spent the better part of two days trying to to backpedal out of your mistake. For those not paying close attention you’ve managed to write so many words and comments on the matter that the accounting error has been nicely disguised within a sea of other data-mining.
I can see this is totally pointless. You can’t even admit when you’ve made an obvious mistake. And I was actually saying you made a relevant point otherwise, but that’s been lost in your uncompromising commentary. Have a good one!”
These people are so defensive and insecure about their ideas! And I wasn’t even saying they were totally wrong!!!! Jeez.”
21. September 2013 at 13:51
Sumner,
“If bubbles existed I’d be rich. I’d sell short during the bubble phase, and buy back after it popped. Easy pickings!”
There are investors that did that because they recognized a subprime housing problem.They noticed it, others did not. If that is not a bubble what should we call it and how should we describe it?
21. September 2013 at 14:16
You can estimate a value by looking at cash flow and then consider if the current price is attractive or not. If the current price is wildly unattractive you may rationally expect it to be lower at some point in the future. That’s not the same as predicting a future price.
In many cases the price of an asset is much higher than a conservative DCF valuation, because there is a compelling growth story. That’s fine, and people can disagree on whether the story is compelling or not without introducing the word “bubble.”
What I am asking you to consider is the case where the growth story is absurd, or implies a permanent shift in human nature. I’m talking about when people give a high valuation to having the “best” domain name and nothing else, “getting big first,” EBITDA, etc. When you see phrases like “the new normal,” “paradigm shift,” etc. your bubble meter should be active.
I’m claiming if you used this one criteria you would have identified the dot com bubble and the housing bubble, and avoided a lot of false positives.
I made money on the housing bubble by buying LEAP puts on a few home builders in 2005. But I also have to admit that I would have made much more money if I had shorted them instead; my LEAPS expired a little too early.
Identifying a bubble is a judgment call, but it’s not “gut instinct.” The start and end of a bubble can’t be accurately timed, but that is also not a standard we hold other investment ideas to.
A lot of the “no money down” crowd might seek out negative cash flow properties, but I don’t think anyone trying to grow a serious real estate portfolio would take that approach, so I would dispute your use of the word, “often.”
21. September 2013 at 14:43
“As long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
21. September 2013 at 14:49
Cullen Roche,
Sometimes comments get held up in moderation if you have a lot of links (it happens to me frequently). I’ve seen comments removed and warnings issued for various matters but given his pragmatic libertarian leanings Scott Sumner is just about the most tolerant blog host I’ve ever had the pleasure of dealing with. I seriously doubt have been blocked, much less banned.
1) Talking about the change in spending since *2008* is quite simply changing the subject. My original claim was that fiscal policy stance as measured by changes in the US general government cyclically adjusted primary balance (CAPB) was contractionary in calendar years 2011 and 2012, and is projected to be contractionary in 2013.
(And to be clear the peak in Greek nominal general government spending was in 2009, not in 2008.)
2) My original comment on the subject never once mentioned the word *liabilities*. You first brought up the subject so I thought it might be interesting to see why private sector total liabilities are up since 2009Q2. Don’t you want to add something substantive to what I have just said?
3) Since I never once used the term *net worth* in my original comment on this subject, what exactly am I correcting, and in what sense am I now using “your data”?
4) I am frequently wrong, and all to happy correct myself when someone points out an error. In this particular case you keep repeating over and over and over again a la Goebbels that I have made some sort of an accounting mistake but you still haven’t shown me where. Please do. Quote me at will (verbatum if you please).
I am all ears.
21. September 2013 at 16:28
Daniel:
“So, in other words, since we don’t have “free market money”, everything is a bubble.”
So, in other words, you didn’t understand the argument.
And you wonder why I don’t take you seriously.
21. September 2013 at 19:16
Scott,
Speculation is a necessary attribute of a free-market. So its presence in economic activity does not mean a bubble exists. However, when the speculative activity exceeds all limits of common-sense then economists are correct to label it a bubble. What made the dot-com bubble a bubble was that the collective valuation of dot-com companies was unsustainable by every possible economic metric. This has been born out now that the Dow & S&P are at all-times highs but the Nasdaq is still 30% below its all-time high of 13+ years ago! If you believe there is logic to explain the collective valuation of the Nasdaq in April 2000 please share.
The truth is that the crowd can get its understanding of the future very wrong. This crowd includes economists, scientists and other so-called experts. I suppose this explains your reluctance to recognize bubbles exist. For if they do then that would mean economic models are mainly suggestive and not predictive – for you cannot model that which you cannot predict.
21. September 2013 at 21:53
Someone raised a good point at Pragmatic Capitalism so I’m posting my response here:
LGV,
“You’re unbearably arrogant. You’re using two different accounting standards in some of your calculations. Sometimes you use the Flow of Funds and some times you use the Integrated Macro Accounts from the BEA.”
This is actually a substantive point but the differences are very minor and purely using flow of funds account standards actually slightly strengthens my argument.
1) The credit market instrument data I used is all according to flow of funds account standards (FFA).
2) The asset and liability data for the household, nonfinancial corporate, and nonfinancial noncorporate sectors is nearly all (there is one exception) according to system of national account standards (SNA) but there are no differences at all from FFA for these data series for those sectors.
3) The asset and liabilities data for the financial sector is according to SNA standards, and there are differences from FFA. So this is the only substantive difference.
In particular financial sector assets are higher by $1.6 trillion in both 2009Q2 and 2013Q1 when using SNA compared to FFA. Financial sector liabilities are higher by $2.9 trillion in 2009Q2 and by $5.5 trillion in 2013Q1 when using SNA compared to FFA.
Using FFA for the financial sector in place of SNA results in the following changes
Non-government sector total assets have increased from $167.9 trillion in 2009Q2 to $201.5 trillion in 2013Q1, or an increase of $33.6 trillion. Non-government sector total liabilities have increased from $91.3 trillion in 2009Q2 to $101.0 trillion in 2013Q1, or an increase in $9.7 trillion.
Consequently non-government sector net worth rose from $76.6 trillion in 2009Q2 to $100.5 trillion in 2013Q1 or an increase of $24.7 trillion.
So using FFA instead of SNA for the financial sector results in the same increase in non-government sector total assets, a smaller increase in non-government sector total liabilities and a larger increase in non-government sector net worth.
On the other hand nobody has raised the fact I’ve included the Federal Reserve’s assets and liabilities in these calculations so perhaps now is the time to take care of that. Federal Reserve assets and liabilities were $2.0 trillion in 2009Q2 and $3.2 trillion in 2013Q1.
Counting the Federal Reserve in the government sector instead of the financial sector yields the following.
Non-government sector assets have increased from $165.9 trillion in 2009Q2 to $198.3 trillion in 2013Q1, or an increase of $32.4 trillion. Non-government sector total liabilities have increased from $89.3 trillion in 2009Q2 to $97.8 trillion in 2013Q1, or an increase in $8.5 trillion.
Needless to say the net worth figures are unchanged.
Now, non-government sector holdings of Treasuries increased by $1.5 trillion from 2009Q2 to 2013Q1. Counting intragovernmental Treasuries as non-government sector Treasury holdings raises the change in non-government sector holdings to $2.0 trillion.
Thus only $2.0 trillion of the $32.4 trillion increase in non-government sector assets, and of the $24.7 trillion increase in non-government sector net worth, or 6.2% and 8.1% respectively, is due to increased Treasury holdings.
P.S. Why use SNA standard instead of FFA standards for the financial sector? That’s all that FRED seems to have for financial sector total assets and liabilities. Besides it makes almost no difference, and the US is in the process of joining the rest of the planet in using the SNA standards anyway.
21. September 2013 at 22:41
I just spotted an error. The change in net worth should read $23.9 trillion so increased Treasury holdings are actually 8.4% of the change in net worth.
22. September 2013 at 00:47
If bubbles existed I’d be rich. I’d sell short during the bubble phase, and buy back after it popped. Easy pickings!
That naïve argument is often made by those denying the existence of bubbles. You need very deep pockets to bet against the market for any length of time.
22. September 2013 at 05:50
The above comment led another brief good natured exchange with Cullen before he quickly returned to his usual form. I have no need to repeat all that he said. I’m mostly interested if anyone can make any sense of the following:
“QE changes the pvt sector’s assets and maintains the way the non-bank pvt sector has a net financial asset via the asset swap. So technically, the T-bond issuance and asset swap has disguised something MUCH more impactful than your figures imply. To the tune of a few trillion dollars. So tack on roughly $2.1T to your t-bond figure there. You see, QE just changes the composition of non-bank financial assets, but doesn’t add a liability as a bank loan normally would. This isn’t a minor detail. It lifts your figure to 17%, which again, I’d say is statistically meaningful. That pretty much blows up your point on t-bonds so I am sorry you went through all that trouble with the math before I dropped the hammer on this one.”
I told him it was gibberish and that he needed to try explaining it as though you actually cared about convincing me that this claim is true. I don’t even want to repeat what he said next.
22. September 2013 at 05:54
Brian, “Is it possible that bubbles exist but are unpredictable?”
That’s an oxymoron.
Mark, Why would I ban Roche? I’ve never banned anyone!
22. September 2013 at 06:06
TESC, You said;
“There are investors that did that because they recognized a subprime housing problem.They noticed it, others did not. If that is not a bubble what should we call it and how should we describe it?”
These people just got lucky. And we know that because ever since 2009 they have done HORRIBLY in their predictions (Roubini, Paulson, Shiller, etc.)
David, There was nothing “absurd” about US housing prices circa 2005. Prices in Australia, Britain, Canada, New Zealand all rose by comparable amounts, and never crashed. They are still up at those levels, or higher. The US is the exception, and hence was unpredictable.
Dan, You said;
“However, when the speculative activity exceeds all limits of common-sense then economists are correct to label it a bubble.”
That never happens. By definition stock prices always reflect common sense. They are the market consensus. Most bubble proponents argue that common sense is stupid. The average person is stupid.
You said;
“The truth is that the crowd can get its understanding of the future very wrong. This crowd includes economists, scientists and other so-called experts. I suppose this explains your reluctance to recognize bubbles exist. For if they do then that would mean economic models are mainly suggestive and not predictive – for you cannot model that which you cannot predict.”
This is 180 degrees from the truth. I deny bubbles predict precisely because I don’t think economic models can predict asset prices. If bubbles did exist then economic models COULD predict asset prices. So you have things exactly backwards.
sdfc, You said;
“You need very deep pockets to bet against the market for any length of time.”
That’s no problem for me. I have very deep pockets and a very long time horizon (50 years).
22. September 2013 at 07:06
Scott,
Most of the United States did not experience a real estate valuation bubble. It was mostly confined to areas near coastal cities and Las Vegas. There were international areas too. Spain comes to mind. Using US aggregate statistics was a good way to obfuscate then and I guess it is now, too.
If the price of tulips skyrockets (I know you think it never happened, but bear with me), it’s not fair to plot the average price of all flowers. If Beanie Babies are selling for $3,000, you don’t average over all toys.
The vast majority of people did not participate in the Beanie Babies phenomenon, or the Nasdaq bubble, or the housing bubble. A small minority of people created the “consensus,” so it’s not correct to label all market movements as equivalent to “common sense.”
I’m sure we’ll never convince each other at this point, so I’ll leave it here. But if I’m ever ready to declare another bubble, perhaps you and I will make a friendly wager.
22. September 2013 at 07:23
Since Cullen Roche will not explain what he meant I will share what I think about this particular additional effect of the “T-bond issuance and asset swap” and see if anyone has a thought on this matter.
Between 2009Q2 and 2013Q1 the Fed has increased its assets by about $1.2 trillion of which $1.1 trillion has been due to increased holdings of Treasuries. Reserve balances have risen by about $1.1 trillion which in turn is reflected by increased assets by the non-bank private sector.
But the fact that almost all of the change in the Fed’s holdings of assets is reflected in Treauries is immaterial. There’s no way of knowing precisely what Treasury holdings would have been in its absence, but I would guess a substantial proportion, if not a majority, would have been held by foreign and international investors. Furthermore the Fed could just as well have increased its holdings of any of the few other forms of some $30 trillion in assets that are eligible for purchase.
22. September 2013 at 07:59
“”Is it possible that bubbles exist but are unpredictable?”
“That’s an oxymoron.”
If you believe that statement is an oxymoron, then you don’t understand bubbles.
Bubbles are not predictable. There is no rhyme or reason why unsustainable growth has to reveal itself as an objective time and date after which the errors are realized by human activity.
If a man is building a house thinking he has 50,000 bricks, but he only has 40,000 bricks, then calling this activity “unsustainable”, i.e. a BUBBLE, does not necessitate the existence of a measurable set of data from which we can know exactly WHEN he will realize his error, nor the extent of resource wastage.
I can know that the existence of non-market interest rates sends information signals that are not purely a reflection of market time preferences, and as a result, bring about malinvestment. But this doesn’t mean I also have to provide you with an objective time and date on which these malinvestments will be learned as such by human actors.
Bubbles are real phenomena. They are not spending or price phenomena.
The reason why bubbles are associated with spending and price trends that resemble a rise and then a collapse, is because bubbles as real phenomena are typically brought about by non-market central banking intervention, which has as a consequence periods of rising spending and prices and then falling spending and prices. The spending and price trends are a consequence, not the substance, of bubbles. The interest rate changes brought about by non-market money supply changes is the cause for both the bubbles, and the spending and price trends that you incorrectly believe to be the substance of bubbles.
22. September 2013 at 08:00
“”Is it possible that bubbles exist but are unpredictable?”
“That’s an oxymoron.”
If you believe that statement is an oxymoron, then you don’t understand bubbles.
Bubbles are not predictable. There is no rhyme or reason why unsustainable growth has to reveal itself as an objective time and date after which the errors are realized by human activity.
If a man is building a house thinking he has 50,000 bricks, but he only has 40,000 bricks, then calling this activity “unsustainable”, i.e. a BUBBLE, does not necessitate the existence of a measurable set of data from which we can know exactly WHEN he will realize his error, nor the extent of resource wastage.
I can know that the existence of non-market interest rates sends information signals that are not purely a reflection of market time preferences, and as a result, bring about malinvestment. But this doesn’t mean I also have to provide you with an objective time and date on which these malinvestments will be learned as such by human actors.
Bubbles are real phenomena. They are not spending or price phenomena.
The reason why bubbles are associated with spending and price trends that resemble a rise and then a collapse, is because bubbles as real phenomena are typically brought about by non-market central banking intervention, which has as a consequence periods of rising spending and prices and then falling spending and prices. The spending and price trends are a consequence, not the substance, of bubbles. The interest rate changes brought about by non-market money supply changes is the cause for both the bubbles, and the spending and price trends that you incorrectly believe to be the substance of bubbles.
22. September 2013 at 08:05
“If a man is building a house thinking he has 50,000 bricks, but he only has 40,000 bricks, then calling this activity “unsustainable”, i.e. a BUBBLE, does not necessitate the existence of a measurable set of data from which we can know exactly WHEN he will realize his error, nor the extent of resource wastage.”
To expound on this very important point, EVEN IF you observed the builder laying approximately 500 bricks per day for the last week say, and you also know he has already laid 10,000 bricks, then this does NOT entitle you to claim that this is a measurable set of data from which we can predict when he will realize his investment error. For he could always change his mind and change the rate of brick laying. There is also the fact that we can’t predict how many bricks he has to lay before he LEARNS of his error. Maybe he’ll learn when he’s down to 20,000 bricks. But we can’t know that, because we can’t predict the future path of human learning. If we could, then we would all become omniscient demi-gods in the present. In other words, it is a contradiction to claim that we can learn now what we will learn in the future. For if we learn it all the present, there would be no future learning in the first place.
Bubbles exist and are unpredictable. They exist because human errors exist. They are unpredictable because human learning is logically unpredictable.
22. September 2013 at 17:20
David, You said;
“But if I’m ever ready to declare another bubble, perhaps you and I will make a friendly wager.”
There’s no need to bet me, you can bet the market and get much better odds. That’s the beauty of the bubble hypothesis.
22. September 2013 at 17:43
Scott,
Do you recognize the existence of financial panics? If so how do you differentiate between a panic and a bubble? I would say a panic is the consequence of irrational economic fear while a bubble is the consequence of irrational greed – greed that creates an absence of fear.
Are panics predictable? Are panics consistent with Gaussian models? History says the answer to both is no. As Geoff rightly explains no matter how much we learn today we have little knowledge of the future. Mankind will always be faced with the challenge of warding of ignorance. This is so because the future is never quite like the past. Consequently, no amount of information in the present can accurately predict the future. This means that not only is risk an omnipresent variable but that the value we assign to that variable is always an estimate.
In such an environment it would seem the government priority should be on making the economy more robust. Devaluation of one’s currency to create the veneer of economic growth is a poor substitute to an actual appreciation of the factors that create economic value. The farce that is our Central Bank is that the board blames Fiscal policy, and uses this blame to justify perpetual intervention, but the governors lack consensus on what good Fiscal policy actually is.
23. September 2013 at 03:26
Yes, I recognize “panics” and no they are not irrational. If a bank is about to fail it’s perfectly rational to try to get your money out first.
And if you want me to persuade me then don’t cite Geoff, he’s wrong about EVERYTHING.
I don’t favor a monetary policy that papers over problems, I favor one that avoids causing problems. Do you disagree?
24. September 2013 at 17:56
Sumner:
“And if you want me to persuade me then don’t cite Geoff, he’s wrong about EVERYTHING.”
How can I be wrong “about everything” when I have repeatedly shown you to be wrong, with actual substantive posts? Please, prove your claim for everyone to see. It shouldn’t be hard to refute a moron, right?
But I just have to be wrong “about everything”, don’t I? For if you concede to me any point, no matter how trivial or obvious, then that will open the floodgates in your mind, and the truth will eventually out. Then your lifelong intellectual investment would collapse. Like a bubble. Maybe if the central bank prints enough money for you, you won’t have to experience your intellectual malinvestment.
“If a bank is about to fail it’s perfectly rational to try to get your money out first.”
You didn’t mention that you believe it would be rational for these people to experience a decreased purchasing power of their money, for whenever people take their money out of the banks to hoard, “NGDP” will fall, and you want a devaluation of the currency.
“I don’t favor a monetary policy that papers over problems, I favor one that avoids causing problems. Do you disagree?”
Your conception of “problems” is irrational. To you, the means (employment) are more important than the ends (consumption). Full employment but impoverishment and socialism is where your worldview leads.
You favor papering over problems, you just refuse or are unable to see it. The way your advocacy “papers over problems” is by way of NGDPLT. You want to paper over problems that are caused by inflation itself. These problems will, if inflation is temporary, manifest in eventual correction, which means unemployment and spending deflation / rising money holding times. You don’t want unemployment caused by deflation in spending. But the capital structure problems of inflation can only be fixed by falling spending and rising money holding times!
So by advocating for zillion dollar printing press sprees to counter ANY aggregate fall in spending, you are in fact calling for a “papering over of problems” that are caused by the inflation itself.
You just deny this for intellectual investment reasons. To recognize this and admit it, would make your worldview collapse.
BTW, you’re also a hypocrite. When I first started posting here, you used to chide me all the time for advocating “politically infeasible” ideas, like a free market in money. You called me all sorts of names. You tried to make me feel like I was wrong for staying true to my principles, that you yourself claim to agree with (laissez-faire). But then, much later, when some country signalled it would inflate more to your liking, you wrote something to the effect of “Never let anyone tell you that your ideas are politically impossible.”
It’s like you’re the only one in the world who is allowed to advocate for change based on principles, and everyone else who does the same are “ideologues.”
———————–
Dan W:
What do you mean by “more robust”? I think that means stronger individual property rights, and less central planning like monetarism, so that decision making concerning scarce resources and capital is more decentralized and more reflective of individual preferences. What does it mean to you?
25. September 2013 at 05:05
Geoff,
My view of “Robust” means what you say but I am not so laissez-faire as it concerns corporations and their executives. Excessive debt leverage is at the root of most financial crisis. Government regulations are one means to managing leverage ratios. But perhaps the way to make those regulations mean something is to waive limited liability for financial firms. Traders would not be so willing to bet and lose billions if their own skin was in on the game, would they?
The rules of the game as they exist now make it perfectly rational for financial firms to make big gambles. If they win the executives and traders pocket the profits. If they lose so what. It wasn’t their money to start with!
25. September 2013 at 17:07
Dan W:
“My view of “Robust” means what you say but I am not so laissez-faire as it concerns corporations and their executives. Excessive debt leverage is at the root of most financial crisis. Government regulations are one means to managing leverage ratios. But perhaps the way to make those regulations mean something is to waive limited liability for financial firms. Traders would not be so willing to bet and lose billions if their own skin was in on the game, would they?”
What does government know about leverage ratios that those with skin the game don’t?
“The rules of the game as they exist now make it perfectly rational for financial firms to make big gambles. If they win the executives and traders pocket the profits. If they lose so what. It wasn’t their money to start with!”
So you’re against fractional reserve lending?
26. September 2013 at 05:08
Major:
When done with moderation, fractional reserve lending is beneficial. So how does the system encourage moderation? How does the system determine what is moderation and what is speculative?
Answer: The system doesn’t know and the models built on the overconfidence that experts do know have proven to be faulty, with very costly consequences.
Given the lack of clarity on the true level of financial risk it behooves lenders to err towards caution. Unfortunately and ironically, the current regulatory state absolves bankers from personal responsibility and thus encourages them to follow their peers in assuming more risk than they otherwise would do.
Here are some ideas:
1) Banks that accept government insurance (ie FDIC) ought to be managed in the most conservative manner. Maybe this means a 25% capital reserve or 50%? I don’t think a 3% capital reserve requirement fits the definition of conservative.
2) To help minimize government intrusion in the financial industry the FDIC program ought to be limited and focused on protecting small depositors. $250K per account is ample. As a taxpayer I would prefer it to be less, much less.
3) Private alternatives to FDIC ought to be allowed and in fact encouraged.
4) The most important change in the Financial Industry would be to actually hold fiduciaries accountable for the responsibility they claim and from which they greatly profit. The current system invites excessive risk because neither the trustee of a pension fund or the Wall Street trader bear little personal risk if those funds are mismanaged. The heads I win, tails you lose paradigm has to change. Perhaps profits and fees ought to be escrowed and only claimed well after trading gains are reported. Perhaps fiduciaries ought to post bond that they will lose if their managed funds do not perform according to the prospectus. Construction firms must do this. Why not Wall Street?
The financial system can survive Donald Trump going bankrupt. It cannot survive the entire banking industry running like lemmings off the cliff chasing more profit. Fewer bankers would act like lemmings if they knew they would lose their wealth and could go to jail. But as long as they believe they are trading other peoples money and that they are unaccountable to the law why wouldn’t they behave as they have done?