Gold as an Option on the End of the US

Spengler (aka David Goldman) makes the case for gold as a hedge against the Obama Administration:

The scurrilous fringe of financial journalism likes to speculate as to when China will dump the dollar, without asking the obvious question: what would China do in the absence of the dollar? The billion people who inhabit China’s interior are no substitute for the 300 million in the American market. They have a fraction of the purchasing power, they have little access to financial services, they have no credit bureaus to calculate their capacity to carry debt, and they have no means to make liquid their limited assets through mortgage markets. Perhaps over a dozen years of Herculean efforts, the situation might be changed - but that is then, and this is now.

The world not only is stuck with the United States for the time being, but wants to be stuck with the United States. But the Barack Obama administration’s attempt to substitute government spending for collapsing consumer spending makes US assets less attractive, while its attempt to diminish America power on dubious ideological grounds forces other countries to act as rivals, unsuited and unwilling as they might be to do so.

That is why options on the end of the US are trading well in the form of the gold price. Gold will have no official role unless America’s international role really does collapse, and the world is reduced from a system of trust (or imperial dictates, which amounts to the same thing) to a kind of barter at the international level. That would be a situation much to be abhorred, but it is not to be excluded. The world may need an alternative to the dollar if Obama persists in his present course.

posted on 17 September 2009 by skirchner in Economics, Financial Markets, Gold

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Prophet der Pleite

Oliver Hartwich and I have an article in Juedische Allgemeine profiling Nouriel Roubini. Linked text is in German, but an English language version can be found here.

posted on 17 September 2009 by skirchner in Economics, Financial Markets

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Minsky Remembered

Eric Falkenstein recalls Hyman Minsky:

I was Minsky’s TA while a senior at Washington University in St.Louis in 1987, and took a couple of his advanced classes, which regardless of the official name, were all just classes in Minskyism. He was a maverick, but perhaps a bit too much, being a little too dismissive of others, as he hated the traditional Samuelson/Solow Keynesians as much as the Friedmanite Monetarists. He always thought a market collapse was just around the corner…

Most articles celebrating Minsky have a strong subtext, kind of like Krugman’s wistful remembrance of his undergraduate macro based on the General Theory, that if we only go back to the days when Nixon famously said ‘we are all Keynesians now’, we would have more faith in government top-down solutions. That was when Federal spending was 30% of GDP. Now it’s 40%. Economists did not abandon Keynesianism because they are capitalist dupes, rather, it was inconsistent, generated poor models of economic growth, and it neglected the micro economic factors that make all the difference between a North Korea and South Korea: free markets, property rights, decentralized incentives. A Keynesian thought he could steer the economy via two controls, the budget deficit and the Fed Funds rate, and indeed in the short run these are very powerful tools, but in the longer run, rather unimportant.

It is reassuring that the critics of mainstream macro have nothing better than Minsky to turn to, but still no less excusable.

posted on 16 September 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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A Policy-Induced Financial Crisis

John Cochrane and Luigi Zingales, on how policymakers induced a financial crisis a year ago today:

the main risk indicators only took off after Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke’s TARP speeches to Congress on Sept. 23 and 24—not after the Lehman failure.

The risk of Citibank failure (the Citi-CDS spread) and the cost of interbank lending (the Libor-OIS spread) rose dramatically after Ben Bernanke and Hank Paulson spoke to Congress. On Sept. 22, bank credit-default swap (CDS) spreads were at the same level as on Sept. 12. On Sept. 19, the S&P 500 closed above its Sept. 12 level. The Libor-OIS spread—which captures the perceived riskiness of short-term interbank lending—rose only 18 points the day of Lehman’s collapse, while it shot up more than 60 points from Sept. 23 to Sept. 25, after the TARP testimony.

Why? In effect, these speeches amounted to “The financial system is about to collapse. We can’t tell you why. We need $700 billion. We can’t tell you what we’re going to do with it.” That’s a pretty good way to start a financial crisis.

Vindicating Fightback

I join the history wars with an op-ed in today’s Australian taking issue with Paul Kelly’s claim that ‘the defeat of Dr Hewson’s policy [of Reserve Bank reform] laid the basis for the successful monetary policy of the Keating-Howard era.’ I make the case that:

Far from being a repudiation of Fightback, as Kelly suggests, subsequent developments have largely vindicated its vision for monetary policy reform.

posted on 15 September 2009 by skirchner in Economics, Financial Markets, Monetary Policy, Politics

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The Merchants of Doom

Juedische Allgemeine, Germany’s leading Jewish newspaper, recently asked Oliver Hartwich and I to write a profile of Nouriel Roubini as a counter to the numerous puff pieces in the Anglo-American press. The German language version has yet to appear online, but there is an English language version in today’s Age:

For years, he argued that the US current account deficit would lead to a US dollar crisis and higher interest rates, pushing the US economy into recession. But that was not how the financial crisis unfolded.

One of Professor Roubini’s few specific predictions was that the US would experience zero GDP growth in the fourth quarter of 2006. This was far off the mark: the actual result was 3 per cent. After this embarrassment, he backed away from his recession prediction, writing in January 2007 that ‘it is not clear whether the bust of the housing bubble in the US will lead to a soft landing as the consensus view goes or a hard landing that could take the form of a growth recession or, less likely now, an outright recession’. The professor was hedging his bets in early 2007, clearly uncertain about the direction for the US economy.

The Age also runs a self-refuting profile of Steve Keen headed ‘This Keen professor overlooked by MSM [mainstream media].’ If only!

While on the subject of Keen, Christopher Joye has prepared a handy route map for Keen’s house price forecast death march from Canberra to Mt. Kosciusko.

posted on 10 September 2009 by skirchner in Economics, Financial Markets, House Prices

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Lehman Brothers’ Failure Was Not Pivotal

Even Steven Pearlstein recognises that the failure to rescue Lehman Brothers was not the pivotal event of last year’s financial crisis:

subsequent events have only confirmed that, if Lehman had somehow been rescued, things would not have turned out a whole lot better for Citigroup, or Washington Mutual or Wachovia or Bank of America, or any of the institutions that eventually needed cash injections from the Treasury. And it certainly would have done nothing to save AIG or Merrill, whose rescues were set in motion during the same Lehman weekend. For the reality is that, underlying the liquidity crisis of last fall was a massive credit crisis—too many risky loans made on loose terms and based on overly optimistic assumptions. Lehman’s failure may have sped up the process by which all this lousy lending was revealed and the losses acknowledged, but the financial reckoning was inevitable.

The final point is a political one. A year ago, in the wake of the Bear Stearns rescue, the public—left, right and center—was hopping mad about government bailouts of Wall Street. Paulson isn’t just kidding when he says that if he had used taxpayer money to save Lehman, impeachment proceedings would have begun against him the following day.

posted on 06 September 2009 by skirchner in Economics, Financial Markets

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Resolving Equity and Bond Market Divergence

Richard Cookson suggests two scenarios for the resolution of the current episode of equity and bond market divergence:

The benign argument for bond yields (and equities) revolves around supply. Many pundits and investors have been in a lather about the vast quantities of debt that governments have to issue. But if an unexpected mountain of supply raises the risk premium that investors demand for holding longer dated paper, the opposite is also true: supply that becomes less Everest-like than feared would reduce it.

So the benign explanation for why bond yields have been falling even as equity markets have been rallying is that worries about the surge in government bond issuance are lessening as signs of recovery mount.

That in turn should lead to a fall in government issuance and thus long-term yields, especially since inflationary pressures (apart perhaps from the UK) are so muted and yield curves so steep by historical standards.

And if that’s right, lower government bond yields would increase the appeal of riskier assets, equities included.

Effectively, the ex ante equity-risk premium would be driven higher because the long-term risk-free rate, but not the growth rate, would be lower.

Sadly, there’s also an altogether more malign explanation. Much as was the case in Japan in the 1990s, it could be that low government bond yields are telling you that this recovery is unsustainable once the monetary and fiscal medicine wears off.

It could be saying that, thanks to the required private sector deleveraging, especially in the US and UK, the long-term potential growth rate of the developed world is much lower than it was. That would lead to a sharply lower ex ante equity risk premium and thus potentially dreadful returns from equities.

Unfortunately, another lesson from Japan in the 1990s is that the world’s lowest bond yields can co-exist with the world’s worst fiscal policy outcomes. This makes the first of Cookson’s scenarios less plausible. We are more likely to end up with whatever is behind door number two.

posted on 01 September 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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The Political Economy of House Price Doom-Mongering

The Rismark Monthly for August suggests the following explanation for house price doom-mongering:

It’s very easy to rip into housing since it is a non-institutionalised asset class. All of Australia’s 8.4 million homes are owned by highly dispersed and faceless families. Australian and international equities, LPTs, unlisted commercial property, hedge funds, and private equity are, by way of comparison, mostly owned and controlled by powerful institutional stakeholders—fund managers, super funds, investment banks, corporates and/or super high net worths. In turn, most of the analysts, strategists, economists, investors and journalists’ business models are built on these asset-classes succeeding. It therefore makes little commercial sense to bludgeon them with the relentless hysterics we hear about housing. In contrast, bricks and mortar is easy game. There are few if any institutional constituents to annoy. Just anonymous individual families with little authority and influence.

Making unsubstantiated claims about a forthcoming housing Armageddon is a win-win situation. With one hand you distract attention away from the poor performance of your own Australian equities portfolio, while with the other you boost the likelihood of unsuspecting retail money flowing your way.

While this explains the sell-side bias against housing, it is harder to understand the buy-side interest in doom-mongering. Presumably, the media know their own market and stories of housing boom and bust undoubtedly sell.

posted on 31 August 2009 by skirchner in Economics, Financial Markets, House Prices

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A Supply-Side View of Global Housing Markets

Matthew Hassan looks at the supply-side of global housing markets, finding that Australia has one of the world’s most under-supplied markets, which in turn explains the resilience of Australian house prices. Hassan’s simple indicator does a good job explaining cross-national variation in house price growth.

posted on 28 August 2009 by skirchner in Economics, Financial Markets, House Prices

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Mid-Week Linkfest

The strangest bid in the worst of the worst of the US equity market.

How not to fall down the data mine.

Uncertainty and the negative equity risk premium.

How ‘peak oil’ nonsense leads to bad public policy.

Rule of law in the US ‘at the level of China’.

Tony Makin on Keynesian economics.

posted on 26 August 2009 by skirchner in Economics, Financial Markets, Oil

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Anchoring Fiscal Expectations

Eric Leeper argues that expectations for fiscal policy are as important as those for monetary policy. Leeper points to ‘an egregious example of non-transparent fiscal policy’:

the recent $787 billion American fiscal stimulus plan. Leading up to the introduction and passage of the American Recovery and Reinvestment Act, the entire economic rationale for thestimulus package consisted of the job creation prediction in a document by Romer and Bernstein (2009). The document claims it “suggests a methodology for ensuring the package contains enough stimulus. . . [to] create sufficient jobs to meet the Presidentelect’s goals [p. 2].” An appendix reports multipliers for a permanent increase in government spending and decrease in taxes of 1 percent of GDP. Four years after the initial stimulus, government purchases raise GDP by 1.55 percent, while tax cuts raise GDP by 0.98 percent. Sources for these numbers are reported as the Federal Reserve’s FRB/US model and “a leading private forecast firm.”

To assess how this rationale for stimulus measures up in terms of transparency, I raise some questions that are not addressed in the Romer-Bernstein document, but are important for anchoring fiscal expectations:

• What are the economic models underlying the multiplier numbers and are those numbers reproducible?
• Why consider permanent changes in fiscal variables when the Act makes transitory changes?
• What are the consequences of the stimulus for government debt?
• What are the repercussions of significantly higher government debt?
• Will the debt run-up be sustained or retired?
• How will policies adjust in the future to either sustain or retire the debt?
• What “methodology” does this document suggest for gauging the necessary size of fiscal stimulus?

Some might accuse me of finding a straw man to ridicule. But this is an important example because of its potential impact on the world economy.

The same questions could be asked in the Australian context.

Robert Carling and I make a similar case for rules-based fiscal policy here.

posted on 25 August 2009 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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Stimulus Skeptics

I’m quoted in a story in The Australian today on the effectiveness of fiscal stimulus. As I noted in this post, if we are to accept the proposition that fiscal stimulus has been effective in supporting demand, then this implies that monetary policy has had less work to do and that interest rates have been higher than they otherwise would have been. To be clear, that is not my view, but it is where the logic of the pro-stimulus camp must lead. In that case, all fiscal stimulus has done is trade-off monetary for fiscal easing.

Kevin Hassett has noted the same inconsistencies in the discussion of fiscal policy in the US:

Democrats opposed the Bush tax cuts from the beginning not because lower marginal tax rates are bad, but rather, because they believed they would lift deficits and interest rates.

The interest-rate effect is so large, goes this line of reasoning propounded by disciples of the “Rubin school,” that the net effect of tax cuts would be harmful.

But now we hear that we can adopt the Obama health-care plan, increase an already massive deficit, and it will be no problem. But if raising taxes can reduce deficits and spur the economy, then cutting spending should do that too. So why are we increasing spending yet again? Democrats have no answer…

The fact is, deficits are a problem precisely because politicians can get away with running them with near impunity. If interest rates did soar in the face of deficits, it would provide a constraint on the growth of big government.

Sadly, there will be no such constraint.

posted on 19 August 2009 by skirchner in Economics, Financial Markets, Fiscal Policy

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Demand is Not Supply

Asked about the effectiveness of discretionary fiscal stimulus measures, RBA Governor Stevens told the House Economics Committee on Friday that:

we believe that the fiscal measures have supported demand and, therefore, at least to some extent, output.

The distinction was probably lost on members of the Committee, but is nonetheless an important one. Demand can be met out of imports and inventories, without boosting domestic production. This is why indicators like retail sales are entirely inappropriate as a measure of the effectiveness of fiscal policy.

Some remarkably good questioning from Liberal MHR Scott Morrison also flushed out some more of the Governor’s position on using monetary policy to target asset prices:

One view, the Alan Greenspan view, is you cannot know it is a bubble until it has burst, so you should not do anything much, and then you should clean up the mess once it has burst… I personally would not want to commit to saying, ‘We’re definitely never going to pay attention to asset prices and totally ignore them.’ That has been shown to be a mistake, basically. But nor do I think it is our brief to aggressively chase down asset things that pop up here and there that we might personally find hard to accept or agree with, at the expense of other things that we have as our objectives. So I think that, into the future, it is going to be a matter of judicious, careful use of our instrument in trying to meet all these worthy goals—keeping in mind as well that there is a whole separate debate about other tools that might be applied to booms and busts and asset prices. That is a whole separate section of this debate—what tools could be used by the supervisory authority to rein in the lending.

In fact, no one has ever suggested that asset prices should be completely ignored. Greenspan explicitly rejected this proposition in his 1996 ‘irrational exuberance’ speech. The issue is whether asset prices should have a weighting in the central bank’s reaction function that is independent of the inflation forecast.

Stevens can at least be thankful he does not have to appear before the US Congress: