The dust is beginning to settle

Last August I did a post that expressed puzzlement about the fact that Indonesian stocks seemed to be negatively affected by rising US interest rates, even as American stocks rose to one record after another:

Tyler Cowen has a new post discussing the financial strains in developing Asia. At the end he suggests that some of their problems are due to expectations that the Fed will taper QE. I doubt that plays much of a role, but would acknowledge that the alternative explanations are not very appealing either. When the picture is this muddled, it almost always suggests that more than one factor is involved.

So what’s wrong with the tapering explanation of Indonesia’s problems? Tyler even suggests that it fits the market monetarist methodology””market indicators suggest tapering is the problem.

Maybe they do, but it’s also the case that market indicators fit another explanation just as well””Indonesia is being hurt by expectations of stronger growth in the US, in much the same way that America’s 1929 boom caused problems for the rest of the world (via higher interest rates.) The question is not why is the Indonesian stock market down 21 percent. The real mystery is why are US stocks higher than when the taper talk began? Perhaps they should also be down 21 percent. Long term real interest rates have risen sharply in recent months. That should cause a stock market crash, unless the higher rates are caused by something that would also raise equity prices. And what might that be? Obviously stronger real growth in America is one possibility (although there are others as well.)

However Evan Soltas showed that although US stocks have done well in recent months, they’ve tended to fall on days where taper talk raised long term yields. OK, but that implies that the mysterious X-factor driving up US stock prices is even stronger than we thought, as it’s also had to overcome the negative effect of taper talk. And I admit that I just don’t see the signs of stronger economic growth. But then what’s going on with US equity markets?

I’d encourage everyone to take a deep breath and let’s wait 12 to 18 months, by which time it may be easier to see what’s going on right now.

.  .  .

Just to be clear, I’m not saying that higher global real interest rates that are caused by changing conditions in US credit markets cannot hurt Indonesia. They can, just as higher global oil prices caused by Chinese factors hurt the US in mid-2008. But if someone said that the higher Chinese oil prices were caused by less Chinese oil supply, and not more Chinese demand for oil, a skeptic would ask why Chinese consumption of oil had increased. And if someone claims that higher global real interest rates are caused by tighter money in the US, and not stronger RGDP growth expectations in the US, a skeptic will ask why US equity prices are much higher than a few months back.

I am skeptical of my own analysis here, as I just don’t see the faster growth that stock investors seem to see. But I’m also skeptical of alternative explanations. We need to let the dust settle to figure out what’s going on here.

Well the dust is beginning to settle.  RGDP rose 4.1% in the 3rd quarter and is expected to rise 3% in Q4.  Here is C.W. at Free Exchange:

THE WORLD Bank’s Global Economic Prospects report, published today, gives a useful summary of how emerging markets have fared in the face of the Fed’s move toward tapering of quantitative easing.

Conventional wisdom has it that emerging markets have fared universally badly since May 2013, when Ben Bernanke hinted that the Fed would soon move to scale back QE, from the $85 billion per month pace of purchases at the time. Some did swoon. Between April and September 2013, India’s currency, the rupee, depreciated by an alarming 17%. But India was an exception: the majority of emerging-market currencies saw appreciations over the period. That could be because markets coalesced around a benign interpretation of tapering: that it signalled an improvement in American economic fortunes””which can only be good for global trade:

This sounds right to me, but of course it’s not an entirely satisfactory explanation, as it implies markets were misjudging the situation back in August.  Unfortunately it’s very difficult to ascertain the stance of monetary policy in real time, so it’s not surprising to me that markets view policy today in a more optimistic fashion than back in August.  At that time the rising rates were partly viewed as a sign of tighter money and slower NGDP growth ahead.  Since then we had the September delay, which only slightly reduced bond yields.  That suggested that much of previous rise had been strong growth, not taper fears.  And then the December taper was offset by more dovish forward guidance.  And both US and foreign markets seem to look better today than back in August.  In others words, 2.8% ten year bond yields today feature a slightly easier monetary policy combined with slightly higher growth expectations than a 2.8% yield back in August, but even in August some of the rise in US bond yields was due to rising US growth forecasts.

This is a good example of something I noticed frequently in Great Depression news coverage.  It was often the case that markets would move sharply, and that the reason for their movements would not become clear for several months.  In this case I was wrong back in August when I said I saw no signs of faster growth in the US.  Growth was already picking up, it’s just that the markets saw that fact before mere mortals like me.

PS.  My previous post was very sloppy.  I was trying to make two points:

1.  On target monetary policy is a necessary and sufficient condition for AD success, and hence fiscal policy is not an “alternative” to monetary policy.

2.  Summers and his supporters favor fiscal stimulus for big government reasons, even if monetary policy could keep NGDP on target.

The post blurred these points and treated every fiscal stimulus supporter as if they were Summers-supporters.  Thus it looked like I was accusing people of hiding their true motives.  I apologize.  Just to be clear, I believe people favor policies for the reasons they claim they favor policies.  That’s my working assumption.  If anything I’m on the naive side of the spectrum.  If Rand Paul says he thinks unemployment comp hurts workers, I assume he believes that.



7 Responses to “The dust is beginning to settle”

  1. Gravatar of Tommy Dorsett Tommy Dorsett
    15. January 2014 at 08:48

    Scott, if you were “wrong” about not seeing signs of growth picking up last summer, your previous “extreme” view that rising long rates=easier money/faster NGDP has been proved “right”.

    Also, you should be fair to yourself as I remember you saying that even though there weren’t “contemporaneous” signs that growth was picking up, the rising stock market suggested it was and that the next few months of data would be revealing.

    Well, now we have the data, and it has blown the Keynesian fiscal multiplier/liquidity trap model out of the water and totally vindicated the MM view.

  2. Gravatar of o. nate o. nate
    15. January 2014 at 09:24

    If I understand it correctly, back in August, there were two possibilities: (1) higher real rates + lower US growth = bad for emerging markets; (2) higher real rates + higher US growth = neutral for emerging markets. So the moves in US stock prices were consistent with (2) but the moves in EM prices were consistent with (1). We now see that (2) was the case, so EM prices have rallied to catch up.

  3. Gravatar of TravisV TravisV
    15. January 2014 at 10:15

    Daniel Kuehn:

    “I find Sumner so baffling sometimes. A lot of his criticisms of non-market monetarists are based on strange diagnoses of their claims. Until this morning reading this post I would have thought it obvious that most Keynesians see Japan in the 90s and the Bernanke Fed as running into exactly the same problems. And yet Sumner’s critique here is largely that Keynesians view them differently (and that’s a problem). Sumner claims that in the 1930s they would have laughed at Friedman and Schwartz, but monetary tightening was a major part of the diagnosis of the Depression for Keynes. Where I think the real disagreement lies is in the claim that the Fed could have saved us. Keynesians then and now think that is a harder case to make – not that monetary policy is useless or impossible (another thing Keynesians don’t claim but Sumner has a nasty habit of suggesting they do), but that it’s a difficult tool to use in deep depressions. Once a monetary collapse happens, long-term expectations can be hard to dislodge (market monetarists tend to think they’re easy to change, and therefore if they are not changed the monetary authority must be engaging in tight policy).”

  4. Gravatar of ssumner ssumner
    15. January 2014 at 10:29

    Tommy and O. Nate, Both good comments.

    Travis, a quick response to that quote.

    1. During the 1930s very, very few people thought money was tight. Perhaps they thought it tight in 1929, but not 1930-33. Friedman changed minds on that issue. By the way, my view that F&S changed the minds of many Keynesians on 1930-33 is the conventional view. If he disagrees then he’s expressing a contrarian view.

    2. Before the US got into trouble many NKs (including Bernanke) blamed the BOJ for being too cautious. After 2008 they started giving the Fed a pass for the exact same sort of errors.

  5. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    15. January 2014 at 10:40

    Too funny, M. Hollande is calling for tax cuts and lower govt. spending to create jobs in France, but all la presse wants to know is which mistress is the fairest one of all;

    “I understand you asking the question, and I am sure you will understand when I answer that everyone goes through trials in their private life. It hurts. But I have a principle: private business is dealt with privately.”

    Do the French have a word for unintended irony?

  6. Gravatar of dtoh dtoh
    15. January 2014 at 11:50

    You said, “On target monetary policy is a necessary and sufficient condition for AD success, and hence fiscal policy is not an “alternative” to monetary policy.”

    If increased government spending and/or tax cuts can raise AD, is it not also possible to say that fiscal policy is sufficient for AD success, and hence monetary policy is not an “alternative” to fiscal policy.

    Also, just as a nit, but it’s certainly possible to have a zero inflation monetary policy target, be on target and not have AD success.

  7. Gravatar of ssumner ssumner
    16. January 2014 at 06:08

    Patrick, Good catch.

    dtoh, Only under barter. If you have a monetary system, then monetary policy must be set at a position where expected growth in AD is on target. Otherwise fiscal policy fails. That’s a necessary condition.

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