The Doomsday Cult Comes to Reno

Warren Buffett is sounding more and more ridiculous:

“Right now, the rest of the world owns $3 trillion more of us than we own of them,” Buffett told business students and faculty Tuesday at the University of Nevada, Reno. “In my view, it will create political turmoil at some point. ... Pretty soon, I think there will be a big adjustment,” he said without elaborating.

One of the difficulties confronting the doomsday cult is that it requires a vivid imagination like Buffett’s to construct plausible scenarios that would give rise to serious concern about external imbalances, at least for countries with floating exchange rates.  Their worst case scenario - a ‘disorderly’ adjustment in foreign exchange markets - is something the doomsday cult should in fact welcome, since it is the shortest and most painless route to reducing imbalances.  It makes no sense to worry about the supposed disease as well as the cure.  One of the main advantages of having a floating exchange rate is that it insulates the domestic economy against external shocks.  It is far preferable to wear any adjustment to external imbalances on the exchange rate than on domestic growth.

posted on 25 January 2006 by skirchner in Economics

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Why I Don’t Lose Any Sleep Over the US Consumer

By his own admission, Stephen Roach is having trouble getting his colleagues and clients to take him seriously:

There was little sympathy for my long-standing complaint about the excesses of the asset-dependent American consumer.  Few seemed concerned that an income-short consumption dynamic might falter as the housing bubble now started to deflate.  Actually, few seem concerned about the US housing bubble, period…The group was nearly unanimous in believing that there was only modest downside to US consumption, at worst.

I don’t lose any sleep over the outlook for consumption either, yet reading the popular press, one could be forgiven for thinking that consumption was the single biggest risk to the growth outlook in the US and globally.  Since consumption is a large share of GDP measured on an expenditure basis, it necessarily figures prominently in terms of the contribution to growth.  This leads many to think of consumption as the main driver of growth.  Yet consumption is typically very stable as a share of GDP, suggesting a long-run equilibrium relationship between income and consumption. 

Concerns over the contribution of housing wealth in driving consumption are greatly exaggerated.  If anything, the increased availability of new financial products that allow individuals to better access their housing wealth will enable them to more effectively smooth their consumption over time, contributing to reduced volatility in GDP growth.

posted on 24 January 2006 by skirchner in Economics

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Why there is No Money in Monetary Policy

David Altig has a short history of the demise of monetary aggregates in the conduct of US monetary policy.  The recent outcry over the Fed’s decision to discontinue publication of the M3 aggregate suggests many people viewed M3 growth as being somehow a more reliable guide to the stance of US monetary policy than the Fed funds rate.  The implication among some of the populist investment newsletter writers has been that the Fed has something to hide.  A previous post has argued why this view is mistaken.  Altig nonetheless argues that it’s a pity that the role of money in monetary policy has been downgraded, without saying why in his post.  Let me suggest at least one reason.

Changes in the stock of real money balances have the capacity to push individuals off their demand curves for these balances, inducing portfolio balance effects that may in turn influence the economy-wide asset prices and yields that determine aggregate demand.  Changes in the stock of real money balances are likely to first work their way through goods and financial market disequilibria well before impacting prices.  This is both a real and nominal story (as argued in this post, even in the long-run, the neutrality of money could conceivably fail).  M3 and other monetary aggregates could thus have some predictive power for asset prices and real output.  This is ultimately an empirical question, but does suggest that growth rates in money are something that policymakers might want to consider as an information variable, even when targeting an interest rate as their main operating instrument.  As I argued in a review of Tim Congdon’s book, Money and Asset Prices in Boom and Bust, this is the only sense in which we should care about growth in broad money under an interest rate targeting regime. 

However, this is a far cry from saying that one can simply read-off from growth rates in money and credit that the stance of monetary policy is too loose or too tight, based on some a priori view of what constitutes reasonable growth rates in these aggregates.  The people most inclined to do this are the fever-swamp Austrians, who argue that every tick in the business cycle must be attributable to a fiat money supply error on the part of the Fed.  These are the same people who argue that money demand is too complex a phenomenon for the Fed to be able to calibrate an appropriate growth rate in the money supply.  That is perfectly true, which is why the Fed doesn’t even try.  Yet the fever-swamp Austrians are implicitly claiming enough knowledge about money demand to determine whether monetary policy is too loose or too tight, just by observing simple growth rates in money, credit and even asset prices.  This is what Hayek would term a ‘fatal conceit’ and is a travesty of Austrian economics.

UPDATE:  Larry White challenges me to name names.  The fever swamp reference is my attempt to distinguish between respectable and less respectable exponents of views that draw on the Austrian tradition.  Larry White, George Selgin, Kevin Dowd, and Leland Yeager all fall within the respectable category and I would be very surprised to find them holding to the self-contradictory position I’m attributing to others.

However, there are plenty of examples over at the Mises Institute blog of this phenomenon and it is a common enough theme in popular libertarian and conservative discourse about monetary policy that claims inspiration from Austrian ideas.  Anyone who asserts that given growth rates in broad money, credit or asset prices are in themselves proof of a fiat money supply error is implicitly making a statement that they know what the correct growth rates should be.  Since these growth rates are largely market-determined and only loosely connected with monetary policy, they are also implicitly criticising the market process.

It should also be noted that those claiming the Austrian mantle are hardly alone in this.  The Economist magazine does it all the time and it is routine for popular economic commentary to point to point to growth rates in money, credit and asset prices as being symptomatic of ‘excess liquidity.’  My point is that anyone claiming to represent the Austrian tradition should know better.  Larry White clearly does. I just wish there were more of him.

posted on 22 January 2006 by skirchner in Economics

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Is Bernanke a Conservative?

Forbes columnist Hunter Lewis poses the question ‘Is Ben Bernanke a Conservative?’  As Lewis himself indicates, this question is poorly defined, since not only is there no single conservative position on macroeconomics and monetary policy, there are in fact furious debates on these subjects within the conservative and libertarian tradition. 

Having read much of Bernanke’s academic work, I would argue that Bernanke, like any good economist, is first and foremost an empiricist.  He takes the positions he does because the evidence points him in that direction.  Consequently, he is difficult to typecast.  For example, Bernanke is perhaps best known for his work on exogenous credit crunches as a source of economic downturns.  This work is somewhat at odds with the monetarist view that credit crunches are an induced or endogenous response to monetary contraction.  At the same time, Bernanke and other researchers at the Federal Reserve Board have recently presented empirical research that supports quantitative approaches to monetary policy transmission in the context of the zero bound problem for nominal interest rates.  This was the origin of the criticisms of Bernanke as ‘printing press Ben,’ yet these views would find few objections from those in the classical monetarist tradition, such as Milton Friedman and Allan Meltzer.  This eclectic approach explains why many of his academic colleagues had no inkling of his Republican leanings prior to his appointment as a White House economic advisor.

Bernanke was appointed to run a fiat money regime, so criticising him for failing to uphold various hard money doctrines is beside the point.  Such criticism fails to distinguish between intra and inter-regime choice.  Much of this criticism naively assumes that the Fed is the source of every economic fluctuation and that the adoption of some pet hard money scheme would cause the business cycle to go away.  It is ironic that in recent years it has been central bankers like Greenspan and Bernanke who have upheld the view that markets and not monetary policy should determine growth rates in broad money, credit aggregates and asset prices.

posted on 20 January 2006 by skirchner in Economics

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An Inflation Target for Japan?

I have an article in Business Week arguing that 2006 may see the Bank of Japan drop its opposition to a formal inflation target:

With the termination of quantitative easing, the Bank of Japan will no longer have an inflation commitment guiding policy. This is an undesirable situation, since it leaves Japanese monetary policy without any formal policy guidance, and gives the market and the public nothing on which to condition expectations for the future path of interest rates, potentially impairing the effective transmission of monetary policy. Indeed, the lack of a nominal anchor for policy facilitated Japan’s slide into deflation from the mid-1990s.

posted on 19 January 2006 by skirchner in Economics

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PIMCO’s Bill Gross: The End is Nigh!

PIMCO’s Bill Gross, quoted in a Barron’s cover story, keeping the doomsday cult alive:

U.S. investors should accelerate their exposure to non-dollar stocks, because the dollar as a currency is doomed.

So very 2005.

posted on 17 January 2006 by skirchner in Economics

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Greenspan’s Legacy

The Economist has a tired and predictable piece on Greenspan’s legacy:

The Economist’s long-running quarrel with Mr Greenspan is that he chose not to restrain the stockmarket bubble in the late 1990s or to curb today’s housing bubble.

My long-running quarrel with The Economist is that this argument is nonsense.  Peter Hartcher attempted to string a book out of this argument, with disastrous consequences that I review here.  Elsewhere, The Economist says ‘One should not exaggerate Mr Greenspan’s influence—both good and bad—over the economy,’ before going on to do precisely that.  The Economist’s cover story, ‘Danger Time for America,’ contains the usual tired predictions of housing-related economic ruin.  According to The Economist:

The problem is not the rising asset prices themselves but rather their effect on the economy. By borrowing against capital gains on their homes, households have been able to consume more than they earn. Robust consumer spending has boosted GDP growth, but at the cost of a negative personal saving rate, a growing burden of household debt and a huge current-account deficit.

The Economist just assumes that all this is a bad thing.  It is in fact a sign of economic strength, not weakness.  The Economist remains as wedded as ever to Bretton Woods era economics.

I picked up a copy of the second edition of Peter Garber’s classic Famous First Bubbles the other day.  The conclusion has a great passage explaining why The Economist’s incantations in relation to ‘bubbles’ are the hallmark of intellectual confusion:

“bubble” characterizations should be a last resort because they are non-explanations of events, merely a name that we attach to a financial phenomenon that we have not invested sufficiently in understanding.  Invoking crowd psychology - which is always ill defined and unmeasured - turns our explanation to tautology in a self-deluding attempt to say something more than a confession of confusion.

posted on 13 January 2006 by skirchner in Economics

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Dow 12,500

Brian Wesbury is characteristically upbeat on prospects for the Dow:

Since the third quarter of 2001, after-tax corporate profits have surged 80%, interest rates have fallen, and yet the S&P 500 is up less than 8%. During this same time period the P-E ratio, based on trailing earnings, has fallen from roughly 37 to 18. A capitalized profits model, which discounts profits at current interest rates, shows the market more undervalued than at any time in modern history. The fundamentals suggest that today is a good time to own stocks.

...the past five years will prove to be just another pothole in a continued bull market. While 11,000 gives us something to cheer about, a 12,500 Dow this year is imminently (and eminently) doable, as is another decade of continued prosperity.

posted on 12 January 2006 by skirchner in Economics

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The Death of Newspapers

Joseph Epstein on the disintermediation of print media:

About our newspapers as they now stand, little more can be said in their favor than that they do not require batteries to operate, you can swat flies with them, and they can still be used to wrap fish.

I buy one newspaper a week, but since that is only for the TV guide, it doesn’t really count.  I couldn’t even be said to read the on-line versions.  So where do all those links come from, you might ask?  The answer is Google News Alerts.

posted on 11 January 2006 by skirchner in Economics

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Dollar Crashes, Comets and Yield Curve Inversions

Alan Reynolds reviews forecasts for 2006, before giving us something real to worry about:

Washington Post columnist Steven Pearlstein just wrote about the “remarkably rosy scenario” of the “economic pundocracy” (though he’s a member). On the same day, Robert Samuelson brushed off all the “sunny predictions” and offered a variation of Pearlstein’s shopping list of things that might go wrong. The dollar might crash, for example, which they almost certainly said last year. Or we might be hit by a comet…

The federal funds rate was deliberately pushed above the 10-year bond yield in 1969, 1973-74, 1979-81, 1989 and 2000. By no coincidence, the economy was in recession in 1970, 1974-75, 1980-82, 1990 and 2001.

posted on 09 January 2006 by skirchner in Economics

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A Tale of Two Stock Market Forecasts

Fortune profiles the views of Roger Ibbotson in its investment review for 2006:

In May 1974, in the depths of the worst bear market since the 1930s, two young men at a University of Chicago conference made a brash prediction: The Dow Jones industrial average, floundering in the 800s at the time, would hit 9,218 at the end of 1998 and get to 10,000 by November 1999.

You probably have a good idea how things turned out: At the end of 1998, the Dow was at 9,181, just 37 points off the forecast. It hit 10,000 in March 1999, seven months early. Those two young men in Chicago in 1974 had made one of the most spectacular market calls in history.

Curiously, the profile then presents the work of Robert Shiller as a challenge to Ibbotson’s approach.  Brad DeLong recently reviewed the original forecast that later became the foundation for Shiller’s (2000) Irrational Exuberance:

In 1996 Yale economist Robert Shiller looked around, considered the historical record on the performance of the stock market, and concluded that the American stock market was overvalued. Prices on the broad index of the S&P 500 stood at 29 times the average of the past three decades’ earnings. In the past, whenever price-earnings ratios had been high future long-run stock returns had turned out to be low. On the basis of econometric regression studies carried out by him and by Harvard’s John Campbell, Shiller predicted in 1996 that the S&P 500 would be a bad investment over the next decade. In the decade up to January 2006, he predicted, the real value of the S&P 500 would fall, and even including dividends his estimate of the likely real inflation-adjusted returns to be earned by investors holding the S&P 500 was zero.

The rest, as they say, is now history.

posted on 06 January 2006 by skirchner in Economics

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More True Confessions of Brad Setser

Brad Setser on his macroeconomic hypochondria:

What’s new.  I always worry.  I just now worry about a (somewhat) new and evolving set of things.

Like the song says, don’t worry, be happy!

Speaking of happy, Mark Mahorney is wishing everyone a Happy New Year.  Well, almost everyone:

everyone except the name caller, the perma-bears, commie-lovers…Everyone except all of those people.

posted on 05 January 2006 by skirchner in Economics

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Is Iran to Blame for the Bond Yield ‘Conundrum’?

Kevin Hassett, drawing on Robert Barro’s work on ‘Rare Events and the Equity Premium,’ asks whether the prospect of a show-down over Iran’s nuclear program might be responsible for low bond yields:

If Barro is right, long-term rates may depend on low- probability geopolitical variables. And the effects may be enormous, perhaps even dwarfing the effects of traditional variables such as the deficit.

Iran, not Iraq, may be the big story of 2006, both politically and economically.

I prefer a monetary policy credibility explanation for low bond yields, but would agree that Iran will loom large this year.

posted on 04 January 2006 by skirchner in Economics

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Candid Cultists

Brad Setser reviews the year that was in ‘Things I Got Wrong in 2005’:

Alas, this list is rather long.

To be fair, this sort of candour is quite admirable and not often seen among pundits.

Don Boudreaux has an extract from a recent interview with Milton Friedman that touched on the subject of global imbalances.  RBA Governor Ian Macfarlane made much the same point in a speech earlier this year, which should have received a lot more attention than it did:

the scenario whereby world financial markets react to the US current account deficit by withdrawing funding has disappointed those who thought it would come into play. It may happen yet, but people have been predicting it for a long time and yet it seems no closer. A large part of the reason for this is that investors who want to get out of US dollars have to run up their holdings of another currency – they cannot get out of US dollars into nothing. They have to take the risks involved in holding some other currency, possibly at an historically high exchange rate, and they may well be reluctant to do so.

posted on 31 December 2005 by skirchner in Economics

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20 Million Future Funds

The CIS gets behind the idea that the Future Fund should instead be used to endow individual private saving accounts:

A better alternative to the Future Fund would be to hand back the surpluses to the taxpayers who are funding them, and to remit future receipts from the sale of Telstra to the Australian public who notionally own these assets. In this way, the government could enable ordinary people to start saving for their own futures, rather than have the government doing it for them.

The Future Fund is expected to exceed $60 billion by mid-2007. An equal share-out among all permanent residents in Australia (children as well as adults) could at that time provide everyone with their own personal ‘future fund’ (PFF) worth around $3,000.  Further dividends from the Government as it disposes of surpluses in the future, together with contributions from individuals themselves, could swiftly raise this to around $5,000 per person.

posted on 21 December 2005 by skirchner in Economics

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