The Running of the Bears
The top seven attention-hungry doomsayers:
The Running of the Bears only happens every ten years or so, so you’ve got to give the likes of Roubini, Whitney, Schiff, and Taleb a break for seeking to monopolize our attention while they’ve got it. After all, nobody likes a pessimist, and we’ll tune them out as soon as we’re brave enough to do so. That said, the depth of the current crisis suggests this bear market may last a little longer than the last few, so get used to hearing their names. Taleb’s got at least one more book in him about how smart he is.
Of course, even a stopped clock tells the correct time twice a day. If the likes of Whitney or Roubini want to truly cement their place in the history of financial prognostication, they will show the foresight to call a turn in the other direction, back to bullish conditions. Elaine Garzarelli made herself famous calling the 1987 crash. She never made another big one again.
posted on 12 February 2009 by skirchner in Economics, Financial Markets
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The Next Freddie and Fannie
State pension funds with politicised investment mandates.
posted on 10 February 2009 by skirchner in Economics, Financial Markets
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Rudd Bank versus AussieMac
A curious feature of the debate surrounding the so-called Rudd Bank (see previous post) and AussieMac is that the same people have taken different positions on the two interventions. Opposition leader Malcolm Turnbull supported the government’s intervention in the RMBS market, but opposes Rudd Bank. In The Australian today, Christopher Joye criticises Ian Harper for supporting Rudd Bank while opposing the RMBS intervention. Joye supports the RMBS intervention and (at least on a relative basis) opposes Rudd Bank.
In my op-ed for the AFR on Rudd Bank yesterday, I deliberately linked the two interventions, because I see them as suffering from similar problems. Both interventions implicate the government in favouring specific industries and firms, on the assumption that this will prevent wider adverse economic outcomes. This overlooks the fact that those sectors deemed most worthy of assistance may also be those most in need of adjustment and may see low relative returns on government resources compared to alternative policies. Both interventions rely on a rather stretched transmission mechanism from the government’s balance sheet, via the balance sheets of business, to the wider public.
One of the advantages of generalised tax cuts as a stimulus measure is that they are relatively neutral from the standpoint of resource allocation. Tax cuts may also have other supply-side benefits through easing distortions and disincentives flowing from the operation of the tax system. From a demand management perspective, unfunded tax cuts are subject to the same Ricardian equivalence critique as unfunded spending measures, but from a supply-side perspective, they have a distinct advantage.
From a political perspective, however, the advantage of Rudd Bank and the RMBS intervention is that they can be written up as loans and investments rather than outright spending. The fiscal transfers involved are therefore much less transparent. One could say the same of the provision of term funding to banks via the Future Fund, although at least this is at arms length from the government of the day and may not differ significantly from the market-based outcomes that would prevail if the Future Fund did not exist.
posted on 29 January 2009 by skirchner in Economics, Financial Markets, Fiscal Policy
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Rudd Bank Puts Taxpayers Last
I have an op-ed in today’s AFR on the so-called ‘Rudd Bank.’ Text below the fold (may differ slightly from edited AFR version).
Henry Ergas made related arguments in The Australian yesterday.
continue reading
posted on 28 January 2009 by skirchner in Economics, Financial Markets, Fiscal Policy
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Right Forecast, Wrong Trade II
Mike Shedlock is far from impressed with Peter Schiff.
posted on 27 January 2009 by skirchner in Economics, Financial Markets
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US Government Debt Default – It’s Happened Before
Alex Pollock reviews the US government’s 1933 decision to repudiate its gold clause obligations:
The United States quite clearly and overtly defaulted on its debt as an expediency in 1933, the first year of Franklin Roosevelt’s presidency. This was an intentional repudiation of its obligations, supported by a resolution of Congress and later upheld by the Supreme Court.
Granted, the circumstances were somewhat different in those days, since government finance still had a real tie to gold. In particular, U.S. bonds, including those issued to finance the American participation in the First World War, provided the holders of the bonds with an unambiguous promise that the U.S. government would give them the option to be repaid in gold coin.
Nobody doubted the clarity of this “gold clause” provision or the intent of both the debtor, the U.S. Treasury, and the creditors, the bond buyers, that the bondholders be protected against the depreciation of paper currency by the government.
Unfortunately for the bondholders, when President Roosevelt and the Congress decided that it was a good idea to depreciate the currency in the economic crisis of the time, they also decided not to honor their unambiguous obligation to pay in gold.
The fact that the US defaulted on these obligations demonstrates that a gold standard is only a very weak constraint on government once the decision is made to go off it. The gold standard fails an important test that all monetary institutions should satisfy, namely that they be politically robust. It is noteworthy that private and public debt defaults are often associated with the failure of fixed exchange rate regimes, because those who borrow in foreign currencies at the former parity can face a sudden increase in their debt burden.
A floating exchange rate regime, by contrast, is much less likely to give rise to the need for default on debt obligations. In the case of the US, the ability to borrow in its own currency shifts exchange rate risk to its creditors. Although this currency risk might be reflected in interest rates, in practice, this seems to be a relatively minor influence on interest rates. For countries like Australia that are also heavily dependent on foreign borrowing, the exchange rate risk is typically swapped out. The exchange rate can then carry most of the adjustment to an external shock, without causing significant problems for domestic borrowers.
posted on 27 January 2009 by skirchner in Economics, Financial Markets, Gold
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An Offer Über Dollar Bears Cannot Refuse
David Henderson offers to ease the worries of US dollar bears:
please contact the publisher for my address and send me all of your bills with pictures of dead presidents on them, especially the ones with pictures of Ulysses S. Grant. (I will even accept the ones with pictures of Benjamin Franklin, although he was not a president.) In return, I will send you an equal weight of blank paper. I promise.
posted on 25 January 2009 by skirchner in Economics, Financial Markets
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The Terms of Trade: Not Dead Yet
The December quarter trade prices release saw the largest quarterly and annual increases in export prices since the current series began in the September quarter 1974, at 15.9% q/q and 54.9% y/y. Import prices were up 10.8% q/q and 21.1% y/y, the largest annual increase since the December quarter 1985. The merchandise terms of trade are up nearly 30% on a year ago.
How did Australia pull-off a further gain in the terms of trade against the backdrop of collapsing world commodity prices? The depreciation in the Australian dollar over the quarter, which supported Australian dollar commodity prices. This is a very good illustration of the role of a floating exchange rate in insulating the economy against external shocks.
Given the magnitude of the external shock now confronting the Australian economy, the appropriate exchange rate response is massive depreciation. In this context, US dollar strength is perfectly explicable, because weakness in the US economy is an external shock for the rest of the world.
Unfortunately, this may see pressures for competitive devaluations and foreign exchange market intervention, not least on the part of the new US Administration. This would be in sharp contrast to the highly principled stance the Bush Administration took against intervention in foreign exchange markets. The new US Treasury Secretary, Tim Geithner, was a protégé of former Treasury Secretary Robert Rubin, who presided over massive intervention in foreign exchange markets.
posted on 24 January 2009 by skirchner in Economics, Financial Markets
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Credit Default Swap Myths
Peter Wallison tackles the many myths surrounding the role of credit default swaps in the financial crisis:
One conventional explanation for the Bear rescue has been that CDSs made the financial markets highly “interconnected.” It is in the nature of credit markets to be interconnected, however: that is the way money moves from where it is less useful to where it is most useful, and that is why financial institutions are called “intermediaries.” Moreover, there is very little evidence that Bear was bailed out because of its involvement with CDSs—and some good evidence to refute that idea. First, if the government rescued Bear because of CDSs, why did it not also rescue Lehman? If the Treasury Department and the Federal Reserve really believed that Bear had to be rescued because the market was interconnected through CDSs, they would never have allowed Lehman—a much bigger player in CDSs than Bear—to fail. In addition, although Lehman was a major dealer in CDSs—and a borrower on which many CDSs had been written—when it failed there was no discernible effect on its counterparties. Within a month after the Lehman bankruptcy, the swaps in which Lehman was an intermediary dealer were settled bilaterally, and the swaps written on Lehman itself ($72 billion notionally) were settled by the Depository Trust and Clearing Corporation (DTCC). The settlement was completed without incident, with a total cash exchange among all counterparties of $5.2 billion. There is no indication that the Lehman failure caused any systemic risk arising out of its CDS obligations—either as one of the major CDS dealers or as a failed company on which $72 billion in notional CDSs had been written.
posted on 08 January 2009 by skirchner in Economics, Financial Markets
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Macro Non-Predictions for 2009
Macro Man’s non-predictions for 2009.
Macro Man’s strike rate for 2008: 7/10.
posted on 08 January 2009 by skirchner in Economics, Financial Markets
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Right Forecast, Wrong Trade
The WSJ profiles ‘doomsayers who got it right’ – well, almost:
[Peter Shiff] has been wrong on significant parts of his argument. Many detractors point out that two of his core beliefs—a longstanding prediction that the dollar would collapse and that foreign stocks would outperform U.S. shares—have been well off the mark in this crisis. A rush into the safety of the greenback sent the dollar soaring against other currencies and, as a side effect, helped undermine shares of stocks around the world.
Mr. Schiff acknowledges that he wasn’t expecting that to happen. But he says his worries aren’t misplaced: A dollar dive and foreign-stock outperformance are still in the cards.
posted on 02 January 2009 by skirchner in Economics, Financial Markets
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Market-Based Predictions for 2009
Predictions for 2009 derived from people who put their money where their mouth is:
1 GM to announce a merger with another major auto manufacturer: 35%
2 More than US$25 billion to be injected into the big 3 auto-makers: 60%
3 Caroline Kennedy to replace Hillary Clinton in the US Senate: 53%
4 Guantanamo Bay Detention Camp to be closed in 2009: 84%
5 The US in Recession in 2009: 85%
6 An air strike against Iran before end of 2009: 21%
7 US unemployment rate at or above 8% in December 2009: 50%
8 Robert Mugabe to depart as President of Zimbabwe in 2009: 50%
9 Slumdog Millionaire to win Academy Award for Best Picture: 52%
As at 7am EST 12/29/2008.
posted on 31 December 2008 by skirchner in Economics, Financial Markets
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‘Really big, bad things tend to be surprises’
An article on how the economics profession is reflecting on the GFC:
Robert Lucas, an economist and Nobel laureate at the University of Chicago and a champion of the rationality of markets, doesn’t see much fundamental change coming out of the crisis, either. What it has reminded us of, he argues, is simply the impossibility of seeing these events in advance.
“I don’t know anybody involved who thought he could predict these turning points. Do macroeconomists know as much as we thought we did?” he asks. “Of course not.”
By this logic, the problem isn’t how economists see the world so much as it is what we expect of economics.
Laurence Ball, an economist at Johns Hopkins, makes a similar point. “Nobody ever sees anything coming,” he says. “Nobody saw stagflation coming, nobody saw the Great Depression coming, nobody saw Pearl Harbor or 9/11 coming. Really big, bad things tend to be surprises.”
Even Monty Python understood this basic rational expectations insight: ‘Nobody expects the Spanish Inquisition!’
posted on 23 December 2008 by skirchner in Economics, Financial Markets
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Monetary and Fiscal Policy Effectiveness in a Globalised World
Alan Greenspan, interviewed in Die Zeit, on the effectiveness of monetary and fiscal policy:
Global forces can now override most anything that monetary and fiscal policy can do. Long-term real interest rates have significantly more impact on the core of economic activity than the individual actions of nations. Central banks have increasingly lost their capacity to influence the longer end of the market. Two to three decades, ago central banks were dominant throughout the maturity schedule. Thus, the more important question is the direction of long-term real interest rates…
The resources of central banks relative to the size of global forces have markedly diminished. We have 100 trillion dollars of arbitragable long-term securities in the world today so that even large movements initiated by central banks have little impact. Until the seventies, central banks and finance ministries were able to hold exchange rates fairly stable. Since then, the ability to intervene in the exchange markets and stabilize the rates has gone down very dramatically. And that is also true for other financial markets. Global forces fostering global equilibrium have become by far the most dominant influence for financial and economic activity. Governments have ever less influence on how the world works.
The way it should be.
posted on 22 December 2008 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy
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Debunking the Lehman Brothers Bailout Myth
John Taylor debunks the myth that failing to bailout Lehman Brothers was responsible for the subsequent intensification of the global financial crisis:
Many commentators have argued that the reason for the worsening of the crisis was the decision by the U.S. government (more specifically the Treasury and the Federal Reserve) not to intervene to prevent the bankruptcy of Lehman Brothers over the weekend of September 13 and 14.
The [LIBOR-OIS] spread moved a bit on September 15th, which is the Monday after the weekend decisions not to intervene in Lehman Brothers. It then bounced back down a little bit on September 16 around the time of the AIG intervention. While the spread did rise during the week following the Lehman Brothers decision, it was not far out of line with the events of the previous year.
On Friday of that week the Treasury announced that it was going to propose a large rescue package, though the size and details weren’t there yet. Over the weekend the package was put together and on Tuesday September 23, Federal Reserve Board Chairman Ben Bernanke and Treasury Secretary Henry Paulson testified at the Senate Banking Committee about the TARP, saying that it would be $700 billion in size. They provided a 2-1/2 page draft of legislation with no mention of oversight and few restrictions on the use. They were questioned intensely in this testimony and the reaction was quite negative, judging by the large volume of critical mail received by many members of the United States Congress. It was following this testimony that one really begins to see the crises deepening, as measured by the relentless upward movement in Libor-OIS spread for the next three weeks. Things steadily deteriorated and the spread went through the roof to 3.5 per cent.
…identifying the decisions over the weekend of Sept 13 and 14 as the cause of the increased severity of the crisis is questionable. It was not until more than a week later that conditions deteriorated. Moreover, it is plausible that events around September 23 actually drove the market, including the realization by the public that the intervention plan had not been fully thought through and that conditions were much worse than many had been led to believe. At a minimum a great deal of uncertainty about what the government would do to aid financial institutions, and under what circumstances, was revealed and thereby added to business and investment decisions at that time. Such uncertainty would have driven up risk spreads in the interbank market and elsewhere.
Taylor doesn’t say it, but his event study is also consistent with the view that it was irresponsible scare-mongering by the US authorities in support of the TARP legislation that was responsible for the subsequent blow-out in the LIBOR-OIS spread.
posted on 15 December 2008 by skirchner in Economics, Financial Markets
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