There was an old lady who swallowed a fly. I don't know why she swallowed a fly; perhaps she'll die.
I don't know if you know this nursery rhyme, but the fly was the least of the old lady's problems. She subsequently swallowed a spider (which wriggled and tickled and tickled inside here) to catch the fly. Then a bird (wasn't that weird), to catch the spider. A cat, dog, cow and finally a horse followed. She's dead, of course.
I can't help thinking that US monetary policy since the defeat of inflation in the 1980s bears some similarities to the behaviour to the old lady in the nursery rhyme. The Federal Reserve is charged with running policy in such a way as to keep inflation under control and the economy at full employment. But inflation is being kept at bay more by a global labour market and technological innovation than by anything the Fed is doing. The Fed doesn't have to 'do' anything very much to control consumer prices and this affects policy. Fed policy is geared towards reacting to periods of falling unemployment by ever-so-cautiously tightening (or un-loosening) monetary policy, because that 'seems the right thing to do'.
By contrast, at the first sign of economic trouble, the lack of inflation means that the Fed can go all in, cutting rates, allowing the dollar to fall and encouraging those who can to borrow more, in order to boost demand and help create the jobs that will get the economy back on an even keel. Indeed, we have been forced to re-think 'all-in' as we saw the Fed cut rates to 3% in 1993, then to 1% after the dot-com bubble burst and now almost to zero, with a huge QE programme on top.
Meanwhile, the United States' overall debt level has gone on going up. That's "OK" because 'net debt' is offset by asset price gains, and 'debt-servicing' is kept down by low rates. The periods of low rates have caused asset bubbles - sometimes in the US, more often elsewhere. But one man's bubble is another man's boom and asset price inflation is apparently less dangerous than consumer price inflation. Never mind that it represents a huge transfer of wealth from one generation to another, that it dramatically increases economic inequality or that asset prices have a nasty habit of coming back into line with the underlying trend of the economy eventually. What we are concerned with, is the unemployment rate and the only thing that could deflect the Fed's attention would be consumer - not asset - price inflation.
So having swallowed a recession in 1990, the US sent down a 3% policy spider to catch it. Then a bird in 1998. Then a cat in 2001 and a dog in 2008. On that basis, the cow comes next and then the horse, and it all goes wrong. I thought that 2008 was going to represent the last leg of what the Bank Credit Analyst terms the Great Debt Super-cycle. I was wrong. But was it the second-last, or the third-last?
The Phillips curve - a dinosaur
At the heart of this, is the fact that monetary policy-making is still dominated by the Phillips Curve. AWH Phillips established that there was a correlation between inflation and the unemployment rate in the UK, between the mid-19th and mid-20th centuries. The conclusion was that high unemployment pushes wages down, and low unemployment pushes them up, and this is what drives inflation. Sounds simple and plausible. Milton Friedman responded by introducing the concept of the NAIRU (non-accelerating inflation rate of unemployment) arguing that since the labour force is rational, you can't just pick a point on the Phillips curve where you choose a combination of unemployment and inflation. Unemployment would tend to gravitate back to NAIRU, and you could only hold it below that by accepting rising inflation and indeed, could only get inflation back down by keeping unemployment high.
I was reminded of how out-dated the Phillips curveseems when I read a post by the BBC's Economics Editor, Stephanie Flanders in which she argues that the cause of the relatively low unemployment rate the UK enjoys now, is falling wages. That fits in with the Phillips curve view of the world, except in the small detail that the causality is the wrong way round. Low wages keep unemployment down, as opposed to high unemployment driving wages down. So what is driving the wage growth down in the UK?
The world of AWH Phillips was one of a closed economy where people could move between industries, but not between countries. It works less well when labour can move pretty freely around the world and when productive capacity and employment can also move at the drop of a hat, to places where labour is cheaper, or perhaps where tax rates are lower. And the Phillips curve doesn't work at all if we can't even measure unemployment.
A global labour market makes casual measurement of one country's unemployment rate somewhat redundant. When goods-producers can shift production at a moment's notice to a more competitive location, the going wage rate is determined internationally, not as a result of a domestic Phillips curve. When people can come and go from one country to another, they drive down costs in many new industries. Coffee shops stand out. And as a piece I read last week by Paul Krugman argues, an economy where the biggest and most successful companies don't actually employ many people, you have to look at the labour market differently. Not least when the driving force deciding where they hire people is the corporate tax rate more than the wag rate. Finally, when we have seen a collapse in labour market participation rates in this cycle, we simply have no idea what even one country's real unemployment rate is. The 'underemployed' are people who aren't recorded as looking for work, but would love to work (or at least earn) more. And they will act as an anchor wage growth even as the 'official' unemployment rate falls.
The warning from all of this is that economic recovery may not drive inflation up, because I can't see what drives wage growth up in developed economies in this cycle. But while that's good, what it does, is lead to continued unbalanced monetary policy. The FOMC must know that current policy settings are dangerous, just as you would have thought the old lady would know swallowing a cat was a bit risky. But there's no CPI inflation and that means that if the US economy were to lose a bit of momentum, perhaps as a result of a falling stock market and rising mortgage rates, the Fed would be sorely tempted to re-inject some monetary accommodation - a metaphorical dog to get after the unemployment rate...
Saturday, 22 June 2013
Sunday, 9 June 2013
Are we really stupid enough to prefer 2006-2010 to 1995-1999?
I have spent the last week seeing investors in the US. there is a huge debate going on in markets at the moment about whether the US Federal reserve should, or will, slow down the pace at which they have been buying Treasuries, and what it might mean for markets. This note is a short update on the previous post I put on this blog - which was intended as a basic aide-memoire for anyone who wanted to understand a little about how the 1994 'bond crash' played out in financial markets. That period being a reference point for what happens when the Fed starts the process of exiting periods of extraordinarily accommodative monetary policy
The chart below shows US jobs and GDP growth through the 1990s. You can clearly see how in 1994/1995 (when the US Federal Reserve increased its target for Fed Funds from 3% to 6% in 12 months), employment growth slowed from around 350k/month to a trough of around 100k/m, and GDP growth slowed from 5% to 1%. Briefly. Now that is a pretty sharp slowdown and is the basis for arguing that the 'bond crash' represented at the very least a poor piece of policy communication on the Fed's part. Let's forget anything else going on in the world, and accept that if the Fed had either done a better job of preparing financial markets for the necessary monetary policy normalisation, or if they had tightened more slowly, the economy's path would have been smoother.
That's all fine. But what I find surprising is that even now, there is a general sense that the Fed should do everything in its power to avoid a repeat. "We remain unconvinced that the eventual tapering of the central bank's asset purchases will trigger a 1994-style bloodbath in the bond market", John Higgins of Capital Economics is quoted as saying in the Sunday Times today.
The sense that is conveyed is twofold. Firstly, that there is a risk that 'tapering' could be as bad in 2013 or 2014, as raising rates from 3% to 6% was in 1994. And secondly, that the crash was so disastrous everything that can possible be done to avoid a repeat, should be - despite what we have learnt since.
Here is GDP and employment (and Fed Funds) in the period of the last policy tightening that started in mid-2004. This time, rates increased from 1% to 5.25% in 2 years. The start of the process still saw employment growth slow to 100k/m, but GDP growth held up much better - until the end of the move. Then, of course, after the Fed had finished raising rates, everything went very, very badly wrong.
So I will concede that 1994 could have gone better. In particular, If the Fed had worked harder on communication, the markets would have been less surprised when the first rate hike was announced. But, the economy didn't slide back into recession and 1995 to 1999 was simply a very good period for the US economy. This, overall, was no disaster.
The 2004-2006 rate hike cycle by contrast, allowed asset prices to go on rising far too fast, for far too long. Allowed leverage to increase throughout the US and global economies. Again, this is not the place to argue against the general view that the great Crash was mostly caused by greed, and poor regulation. But just as Fed policy caused a slowdown in 1995, Fed policy helped cause a massive recession. So the exit from the last two significant periods of very easy monetary policy both have faults - but are we really supposed to err on the side of a 2004-2006 outcome because we must, at all costs, avoid a repeat of 1994-1995? . But are we that stupid? Employment growth running at 170k/m, and GDP at 2% justify accommodative policy, but not zero rates and massive bond purchases for ever.
The chart below shows US jobs and GDP growth through the 1990s. You can clearly see how in 1994/1995 (when the US Federal Reserve increased its target for Fed Funds from 3% to 6% in 12 months), employment growth slowed from around 350k/month to a trough of around 100k/m, and GDP growth slowed from 5% to 1%. Briefly. Now that is a pretty sharp slowdown and is the basis for arguing that the 'bond crash' represented at the very least a poor piece of policy communication on the Fed's part. Let's forget anything else going on in the world, and accept that if the Fed had either done a better job of preparing financial markets for the necessary monetary policy normalisation, or if they had tightened more slowly, the economy's path would have been smoother.
That's all fine. But what I find surprising is that even now, there is a general sense that the Fed should do everything in its power to avoid a repeat. "We remain unconvinced that the eventual tapering of the central bank's asset purchases will trigger a 1994-style bloodbath in the bond market", John Higgins of Capital Economics is quoted as saying in the Sunday Times today.
The sense that is conveyed is twofold. Firstly, that there is a risk that 'tapering' could be as bad in 2013 or 2014, as raising rates from 3% to 6% was in 1994. And secondly, that the crash was so disastrous everything that can possible be done to avoid a repeat, should be - despite what we have learnt since.
Here is GDP and employment (and Fed Funds) in the period of the last policy tightening that started in mid-2004. This time, rates increased from 1% to 5.25% in 2 years. The start of the process still saw employment growth slow to 100k/m, but GDP growth held up much better - until the end of the move. Then, of course, after the Fed had finished raising rates, everything went very, very badly wrong.
So I will concede that 1994 could have gone better. In particular, If the Fed had worked harder on communication, the markets would have been less surprised when the first rate hike was announced. But, the economy didn't slide back into recession and 1995 to 1999 was simply a very good period for the US economy. This, overall, was no disaster.
The 2004-2006 rate hike cycle by contrast, allowed asset prices to go on rising far too fast, for far too long. Allowed leverage to increase throughout the US and global economies. Again, this is not the place to argue against the general view that the great Crash was mostly caused by greed, and poor regulation. But just as Fed policy caused a slowdown in 1995, Fed policy helped cause a massive recession. So the exit from the last two significant periods of very easy monetary policy both have faults - but are we really supposed to err on the side of a 2004-2006 outcome because we must, at all costs, avoid a repeat of 1994-1995? . But are we that stupid? Employment growth running at 170k/m, and GDP at 2% justify accommodative policy, but not zero rates and massive bond purchases for ever.
Saturday, 25 May 2013
Thoughts on trading
Legendary trader Paul Tudor Jones has got himself into troubled waters for comments he made in a discussion in front of students and alumni of the University of Virginia about the impact of having children on female traders' focus. Blogger Finansakrobat was the first I have seen who dared to speak up in Mr Jones' support.
Mr Jones is trying to back-peddle on the interpretation of what he said. I have nothing insightful to say on the subject of childbirth and trading but his point (I think) is that macro trading requires total focus. There are lots of examples of women who do extraordinary things after they have children. But what makes a great trader is something Mr Jones knows a lot about. So it set me thinking.
Since the industrial revolution, it has become the norm for 'work' and 'play' to be separated for most people. The cry of 'TGIF' says that for many, 'work' is still place you have to go to to earn the money to pay for 'play', which happens elsewhere. But that model is breaking down. Lots of people take work home now, some work from home. And lots of people enjoy work as much as they enjoy the time they spend 'not working'. "Macro Traders" as described by Mr Jones, usually fit into this category. But getting work and non-work life into balance is important. I've worked in a firm where the CEO was having an affair as the firm fell apart around it and worse still, so were a worrying numbers of the rest of the senior management team. I would have thought that one secret of a good leader in a high-stress environment, is that he or she is either brilliant at separating work and home life, or has a very stable home life that doesn't distract him/her from the day job. Sir Alex Ferguson, for example, seems to fit into this mould of work-obsessive whose home life is a rock of stability.
Trading, as a career, is pretty simple. You use other people's money (and sometimes your own) to make bets and get paid if you get it right. But underneath that simplicity is a need for clear rules and understanding, and almost above all else, balance within a team. A group of traders who risk each others' money as well as other people's on a day-to-day basis, need to have clear rules about much risk they can take, and how much they earn as individuals in return for making money for their employer and their investors.
A simple example is a group of four people in an investment team They are all of a similar age and experience. Three of them have no debts, reasonably healthy bank balances, but not enough money to, say, buy a Caribbean island. Their 'dream' in working together in a fund is that they will make some money every year, grow the assets under management and maybe make a lot of money one day They definitely don't want to retire and die a slow death running down their savings, but they don't feel the need to 'bet the house' on a turn of the card - they can wait for success. The fourth member of the team through, has been through a divorce, has a young family and while he lives in a sumptuous house, drives an expensive car and wears a pretentious watch, he has a big mortgage as well.
This is a team (probably) doomed to failure because one member has completely different emotional (and financial) drivers determining how he trades. He's not trying to wait for a great trading opportunity while building a business slowly and carefully. He needs success quickly and in the world of finance, he has the tools at his disposal to try. A more aggressive trading style may work, but probably won't.
An aggressive trader can bring down a hedge fund or indeed, a bank. Defenders of female traders sometimes argue that they are less inclined to behave that way. I don't know if it's gender-specific at all. What I do know, is that in a small business, it is important for all the people in the business to have consistent goals and ambitions. Not identical, just consistent. In a trading firm, where one person's focus and style can undermine everyone's efforts and where decisions need to be made at work, or at home or on holiday (markets won't stand still and allow you to ignore them) this consistency of goal, ambition and style is all the more crucial. Mr Jones, I sense, understands this very well.
I have always found the intellectual part of trying to work out where markets are headed more interesting than the nitty-gritty of executing trades. The best traders I have worked with, by contrast, have enjoyed the psychology of markets as much as I have enjoyed the economics of them, and are far better at the psychology than I could dream of being. For better or for worse, they have tended to be able to make sure their non-work life doesn't interfere with their ability to focus on trading, too.
Mr Jones is trying to back-peddle on the interpretation of what he said. I have nothing insightful to say on the subject of childbirth and trading but his point (I think) is that macro trading requires total focus. There are lots of examples of women who do extraordinary things after they have children. But what makes a great trader is something Mr Jones knows a lot about. So it set me thinking.
Since the industrial revolution, it has become the norm for 'work' and 'play' to be separated for most people. The cry of 'TGIF' says that for many, 'work' is still place you have to go to to earn the money to pay for 'play', which happens elsewhere. But that model is breaking down. Lots of people take work home now, some work from home. And lots of people enjoy work as much as they enjoy the time they spend 'not working'. "Macro Traders" as described by Mr Jones, usually fit into this category. But getting work and non-work life into balance is important. I've worked in a firm where the CEO was having an affair as the firm fell apart around it and worse still, so were a worrying numbers of the rest of the senior management team. I would have thought that one secret of a good leader in a high-stress environment, is that he or she is either brilliant at separating work and home life, or has a very stable home life that doesn't distract him/her from the day job. Sir Alex Ferguson, for example, seems to fit into this mould of work-obsessive whose home life is a rock of stability.
Trading, as a career, is pretty simple. You use other people's money (and sometimes your own) to make bets and get paid if you get it right. But underneath that simplicity is a need for clear rules and understanding, and almost above all else, balance within a team. A group of traders who risk each others' money as well as other people's on a day-to-day basis, need to have clear rules about much risk they can take, and how much they earn as individuals in return for making money for their employer and their investors.
A simple example is a group of four people in an investment team They are all of a similar age and experience. Three of them have no debts, reasonably healthy bank balances, but not enough money to, say, buy a Caribbean island. Their 'dream' in working together in a fund is that they will make some money every year, grow the assets under management and maybe make a lot of money one day They definitely don't want to retire and die a slow death running down their savings, but they don't feel the need to 'bet the house' on a turn of the card - they can wait for success. The fourth member of the team through, has been through a divorce, has a young family and while he lives in a sumptuous house, drives an expensive car and wears a pretentious watch, he has a big mortgage as well.
This is a team (probably) doomed to failure because one member has completely different emotional (and financial) drivers determining how he trades. He's not trying to wait for a great trading opportunity while building a business slowly and carefully. He needs success quickly and in the world of finance, he has the tools at his disposal to try. A more aggressive trading style may work, but probably won't.
An aggressive trader can bring down a hedge fund or indeed, a bank. Defenders of female traders sometimes argue that they are less inclined to behave that way. I don't know if it's gender-specific at all. What I do know, is that in a small business, it is important for all the people in the business to have consistent goals and ambitions. Not identical, just consistent. In a trading firm, where one person's focus and style can undermine everyone's efforts and where decisions need to be made at work, or at home or on holiday (markets won't stand still and allow you to ignore them) this consistency of goal, ambition and style is all the more crucial. Mr Jones, I sense, understands this very well.
I have always found the intellectual part of trying to work out where markets are headed more interesting than the nitty-gritty of executing trades. The best traders I have worked with, by contrast, have enjoyed the psychology of markets as much as I have enjoyed the economics of them, and are far better at the psychology than I could dream of being. For better or for worse, they have tended to be able to make sure their non-work life doesn't interfere with their ability to focus on trading, too.
Saturday, 11 May 2013
1993 all over again, not
A brief history of the Fed's exit from mad money in 1994...
My aim when blogging is not to write the kind of "research" that I'm paid to produce for my employer and definitely not to send out anything that could possibly be construed as an investment recommendation. This piece is a response to questions I get asked fairly frequently about how the US Federal Reserve exited from its first period of monetary madness in 1994, when after leaving interest rates at 3% for a long time they shocked the world by moving them up to 6% over the course of 12 months. That send bond yields sharply higher and sowed the seeds of the Asian financial and economic crisis as countries which had "imported" excessively easy US monetary policies thanks to pegged exchange rates found themselves with excessive (private sector) debts in both local and foreign currencies.There are four charts in the box below, three showing how 1994/1995 unfolded and the fourth showing the current period for some kind of reference.
The top left chart shows the Fed Funds target rate (in green), the 3-month US dollar rate and the 4th Eurodollar futures contract, expressed as a rate. The 4th Euro$ contract reflects the rate market participants will trade for 3-month rates in roughly 12 months' time (the contracts have expiry dates in March/June/Sep and Dec, so on Jan 1 the 4th contract is the December one, and in April it is the one for the following March, and so on). I use it because 20 years ago, this was already a very well-established and liquid instrument for trading interest rates.
1994 started with Fed Funds at 3% and the futures market pricing an increase of roughly 1% over the following year. That premium had been gradually eroded through 1993 as an extended period of low rates forced anyone betting on an earlier hike to capitulate (sound familiar?). Two things leap out - the entire rate-hiking cycle was priced into the futures market by mid-year (when 3-month futures rates got above the eventual peak in actual rates) and the market went on to dramatically over-price the eventual policy rate peak. Remember, the previous peak in rates had been just shy of 10%, so market participants were wary of how far the Fed might have to go.
The top-right chart adds the 10yr Treasury yield and the S&P 500 index to the picture. The S&P drifted lower in the fist half of 1994 as rates and 10yr yields rose pretty sharply. The second half of the year saw a further sell-off in the bond market while the equity market meandered sideways. Stock markets didn't know whether to fear higher rates or welcome economic recovery. By the end of 1994 however, well before the eventual peak in (Fed) rates, 10-year Note yields had peaked, as had the rate implied by the Euro-dollar futures contracts. That was the signal for a long bull market to start in the equity market. It was clear both that the economic recovery would not be undermined by tighter policy and that the peak in rates would be very low by (recent) historical standards.
The bottom left chart shows how the Dollar Index traded through this period. I've really only included this as a warning to anyone who thinks currency markets follow stable rules. The dollar went down as US rates rose through 1994 (partly because the bond market sell-off saw capital flow out of the country in particular being repatriated to Japan, partly because the US current account deficit was growing). The dollar only started to move higher in the spring of 1995, once the unrest from the bond market's gyrations was over, the yen had become unsustainably strong, and the out-performance of the US economy sent both currency and US equity market on a long march higher that lasted for pretty much the rest of the decade. Those who are bullish of the outlook for dollar in the years to come reference this period because once the Fed has to some degree 'normalised' policy in the wake of improving economic conditions (over the next couple of years) there will be some pretty powerful similarities with the 1995-2000 period.
The bottom right chart show the current situation Fed Funds are at 25bp. Euro-dollar futures price no chance in rates over the next twelve months and I don't know anyone who expects any move. The 10-year Note yield is going up, but the 2 1/2% gap between Fed Funds and 10-yr yields at the start of 1993 is 1 1/2% now. We are either complacent or we are more confident about how the unwinding of US monetary accommodation plays out: believing the eventual peak will be far lower than in the past partly because this is a new-normal sluggish recovery and partly because total (private and public sector) debt levels in the US economy are too high for an old-fashioned rate cycle.
I think the US economy is showing signs of life as a weak dollar attracts jobs back from abroad, as healthier banks and low rates ignite a housing recovery, as bumper profits finally start to turn into some capital spending by companies. I don't think that means the Federal reserve will hike in the next 12 months however. But I do think that one similarity with the mid-1990s is valid - that the US will be to a significant degree indifferent to the external impact of policy decisions. Moving towards energy independence must make US policy makers more focused on the US and less on the rest of the world in a range of ways. The European crisis has certainly played a part in US policy-making of late but calmer markets (even if disaster still lurks below the surface) will also allow a more US-centric focus. The US was indifferent (or oblivious) to the Asian bubble as it grew in the early 1990s and largely indifferent to it when it burst at the end of the decade. I can't see concern about how unwinding easy money in 2014/2015 affects everyone else being very high on the Fed's list of priorities.
Sunday, 28 April 2013
The Grapes of Wrath
I was asked this week whether it was possible under any circumstances for member states of a monetary union to operate different monetary policies. The standard response is simply "no" but it's worth going into it a bit deeper and I thought I'd at least out write down a few thoughts on the subject of monetary union in one place. And advertise a couple of very good books in the process.
The Postwar International Money Crisis was published in 1981 and written by the late Victor Argy, an Australian economist who worked for the IMF and the OECD but finished his career teaching at Macquarie University. At that point, the EEC's attempts at any form of monetary union (the post-Bretton Woods "snake" were deemed a failure). Argy describes monetary union as "weak" if it is a system of pegged exchange rates, or "strong" if it involves a single currency. A strong monetary union is assumed to have a common currency and a common central bank. Capital markets are unified and independent monetary policy becomes impossible. Some independent fiscal policy continues to be feasible. And he goes on to list the conditions which make the costs of joining a union smaller, or the benefits larger. They are 1) that differences in growth rates and labour productivity are not large; 2) that intra-union trade is large; 3) that there is no long-run trade-off between inflation and unemployment; 4) the differences in propensities to inflate are relatively small; 5) differences in degree of domestic instability are relatively small; and 6) there is a significant degree of labour mobility.
Some of that sounds as if it was written at the end of the 1970s, as it was. But what strikes me, over 30 years later, is that 3 of those conditions represent the root causes of some of current woes; labour productivity (and competitiveness; propensities to inflate (Buba); and domestic instability (Spain's construction bubble).
Parts of Europe suffered from a massive credit bubble, particularly in housing and construction, and when it burst it left devastation behind. The textbook solution in a monetary union is for there to be either fiscal transfer or labour movement. Both have happened in a very modest fashion. Large competitiveness and productivity gaps always existed but have become more apparent in the recession. And because the biggest country in Europe is much less inclined to inflate than most of the others, the only 'cure' to the productivity crisis is lower wages in the lower productivity economies, with huge knock-on implications for debt, fiscal policy and economic activity.
The situation has been exacerbated by the fact that while Europe shares a single monetary policy and a unified capital market, the way the capital market behaves is that there is no so single 'risk free' interest rate that all countries can borrow at. Rather, there is a tendency for regional borrowing costs to diverge dramatically.
A monetary union where the weaker members pay more to borrow, where the dominant member is the least inclined to inflate and therefore where productivity differentials can pretty much only be cured through falling wages in the lower-productivity member states, looks like a recipe for labour migration and social unrest. Is the fact that so far, migration has been relatively limited, a good thing or just a sign that we haven't yet reached that stage of the crisis?
Which brings me to my second book! I'm sure that when John Steinbeck wrote The Grapes of Wrath, or when Henry Ford made the film, they weren't thinking of it as a case study in the problems of economic shocks on a monetary union. But that's what it means to me. It's the story of a farming family from Oklahoma that migrate to California in search of work during the Depression in the 1930s. The fruit growers and pickers in the west of the United States are no more enthusiastic about the arrival of vast numbers of work-seeking 'Oakies' than you would expect and trouble follows. Oklahoma would have devalued its currency to cope with its economic woes, in a different era. Indeed, the east of the US might have devalued relative to the west. The United States share a common currency and use a mobile labour force and fiscal transfers to cope with regional and industry-specific shocks.
The economics of fixed and floating exchange rates, of monetary unions, are all about pros, cons and compromises. Steinbeck's tale is a cautionary one for Europe because if the US coped poorly with large scale economic migration in the 1930's, surely it would be even worse in the more disparate Euro Zone. That hasn't been a problem - at least until now. There are huge regional economic variations, and the fiscal transfers to soften the blow aren't big enough. But mass movement of labour hasn't really been an issue. However, the image still lurks in my mind because one possibility is that people only really up ticks and move in large numbers when things get really bad. Worse than they are now, but perhaps not worse than they could be if the remorseless rise in (particularly youth) unemployment goes on.
Now to that question of whether you can have different interest rates in member states of a currency union. The simplest answer is that you need capital controls to do it. The Asian economic crisis of the mid/late 1990s was caused in large part by a foreign currency credit bubble. Central banks fixed their exchange rates to the US dollar, but operated separate monetary policies so that banks were tempted to borrow cheap dollars (where rates were very low in 1992/1993) and lend in domestic currency at higher rates. hotel and golf course developers, and home-buyers, were tempted into foreign currency loans as well, and when the US raised rates and the global economy slowed, disaster followed. This seemed, at the time, a damning indictment of a fixed exchange rate system and a clear argument that either floating rates or a full monetary union were preferable.
The Asian example is relevant because to the borrowers, it 'felt' like a monetary union. Exchange rates were fixed so it made sense to borrow at the cheapest rate possible. I am sure that is how it felt when Hungarian borrowers took out Euro or Swiss franc mortgages, too. So the borrower thought he was 'arbitraging' the system. At this point the regulator is supposed to either educate the market or regulate the market to make sure that foreign currency borrowings are not excessive. It is possible to have fixed rates and different polices ,as long as the flow of money is regulated. And surely, by extension, the same is true in a monetary union with a single currency, at least theoretically. But here's the problem - it may be possible to raise the cost of borrowing in some parts of a monetary union through regulation (tighter rules for German banks, and no access to foreign banks for German borrowers, say), but what Europe needs, is (even) lower rates in other countries and that's much harder to regulate. Because the perception that weaker countries and borrowers are inferior credits, raises their cost of borrowing and turning that upside down is pretty hard.
So, theoretically possible but not feasible? In the meantime, avoiding mass unemployment causing massive labour migration would be a good start....
Friday, 5 April 2013
The virtues of the virtual pub and FF to you all
Once upon a time, I spent a lot of effort promoting the concept of a "virtual pub" as the heart of a good financial market research team (or any other research team, for that matter).
A pub (in my experience at least) is a place where colleagues, friends and acquaintances can go and argue vociferously without falling out. The rules of engagement are that you arm yourselves with alcohol, stand very close to each other and disagree about almost anything, sometimes because you hold different views, and sometimes just because it's more fun to argue than agree. Views are expressed with considerable conviction (helped by tongues alcoholically-lubricated) and fingers are often poked in the direction of other debaters' faces. But it is considered extremely bad form for the argument to become violent, and it is of absolute imperative importance that at the end of the evening/argument, all participants leave, still friends and still respecting each other. If anyone drinks too much, or crosses any social lines of decent behaviour, a huge amount of embarrassed apology is required the following day.
I have had pub arguments about many things though perhaps mostly about cricket, football, politics, and economics. Lots of them. Not all of these debates answered important questions, but they were almost all the very opposite of the group-think which is the arch-enemy of constructive thought and analysis. It's easy for a sterile office discussion to end up with a bland consensual view of the world; much harder to get to that point in a pub argument where if someone says something stupid, there will be heart-felt howls of derision, rather than polite nodding of heads.
An American once told me that a pub argument is a very British concept and that other folks are a little too straight-laced to be able to cope without being offended. Maybe that is true. In certainly find that if I embark on a tirade against the accepted view of the world or of a particular asset market, I get a lot of silence and nervousness from continental European colleagues. Which is a shame because I am not trying to upset them, only to shake them out of their railway-track thought process. It's easy enough to see with hindsight that most asset bubbles, (EM, credit, dotcom, to name the last three) are the product of, or the very least aided and abetted by, groupthink.
What has this got to do with social media? I think that Twitter, in particular is replacing the virtual pub as the best mechanism for checking consensus and challenging it. If I think that someone on Twitter is talking codswallop, I don't have to start a fight, nor do I have to agree and seek a middle ground with a consensual view. I can gently challenge, or I can move to a different part of the pub. I can argue with the more robust souls who like that kind of thing, and I can listen in on the arguments and conversations of others without causing offence. I might try and be polite, but the worst someone can do is 'unfollow' me.
Facebook and Linkedin serve very different purposes. Linkedin would (I am told) allow me to keep tabs on the vast legions of people I have worked with, studied with, played with. Which might be useful if I were any good at networking. But I'm not. If Ex-colleagues, and clients, tend to ask if they can be on my research distribution list and the answer is usually yes. if they send me an email asking if i want a beer or coffee, the answer's usually yes, too. Why would I want Linkedin?
Facebook is a way for me to keep in touch with my friends - something I am incredibly bad at doing. But it appears time-consuming. I have agreed to befriend my wife, because it seemed wise and my brothers and sisters out of politeness. I know my children don't want me as a Facebook friend. To anyone else, I recommend sending me an email.
So one of the main social media helps people network, but I don't do that, and another is a way to chat with friends, but I've got better ways of dong that than Facebook. Twitter allows me to discuss with kindred souls about a subject dear to my heart but without leaving the comfort of my study. I can save my real pub time for arguments about politics and football. As for fellow tweeters, those I follow or those that follow me - I'm grateful for the debate, for agreeing with me or for telling me I'm talking horse-manure. This is how I find my way to answer questions about where the world's markets are headed. FF to you all, as they say on Twitter.
A pub (in my experience at least) is a place where colleagues, friends and acquaintances can go and argue vociferously without falling out. The rules of engagement are that you arm yourselves with alcohol, stand very close to each other and disagree about almost anything, sometimes because you hold different views, and sometimes just because it's more fun to argue than agree. Views are expressed with considerable conviction (helped by tongues alcoholically-lubricated) and fingers are often poked in the direction of other debaters' faces. But it is considered extremely bad form for the argument to become violent, and it is of absolute imperative importance that at the end of the evening/argument, all participants leave, still friends and still respecting each other. If anyone drinks too much, or crosses any social lines of decent behaviour, a huge amount of embarrassed apology is required the following day.
I have had pub arguments about many things though perhaps mostly about cricket, football, politics, and economics. Lots of them. Not all of these debates answered important questions, but they were almost all the very opposite of the group-think which is the arch-enemy of constructive thought and analysis. It's easy for a sterile office discussion to end up with a bland consensual view of the world; much harder to get to that point in a pub argument where if someone says something stupid, there will be heart-felt howls of derision, rather than polite nodding of heads.
An American once told me that a pub argument is a very British concept and that other folks are a little too straight-laced to be able to cope without being offended. Maybe that is true. In certainly find that if I embark on a tirade against the accepted view of the world or of a particular asset market, I get a lot of silence and nervousness from continental European colleagues. Which is a shame because I am not trying to upset them, only to shake them out of their railway-track thought process. It's easy enough to see with hindsight that most asset bubbles, (EM, credit, dotcom, to name the last three) are the product of, or the very least aided and abetted by, groupthink.
What has this got to do with social media? I think that Twitter, in particular is replacing the virtual pub as the best mechanism for checking consensus and challenging it. If I think that someone on Twitter is talking codswallop, I don't have to start a fight, nor do I have to agree and seek a middle ground with a consensual view. I can gently challenge, or I can move to a different part of the pub. I can argue with the more robust souls who like that kind of thing, and I can listen in on the arguments and conversations of others without causing offence. I might try and be polite, but the worst someone can do is 'unfollow' me.
Facebook and Linkedin serve very different purposes. Linkedin would (I am told) allow me to keep tabs on the vast legions of people I have worked with, studied with, played with. Which might be useful if I were any good at networking. But I'm not. If Ex-colleagues, and clients, tend to ask if they can be on my research distribution list and the answer is usually yes. if they send me an email asking if i want a beer or coffee, the answer's usually yes, too. Why would I want Linkedin?
Facebook is a way for me to keep in touch with my friends - something I am incredibly bad at doing. But it appears time-consuming. I have agreed to befriend my wife, because it seemed wise and my brothers and sisters out of politeness. I know my children don't want me as a Facebook friend. To anyone else, I recommend sending me an email.
So one of the main social media helps people network, but I don't do that, and another is a way to chat with friends, but I've got better ways of dong that than Facebook. Twitter allows me to discuss with kindred souls about a subject dear to my heart but without leaving the comfort of my study. I can save my real pub time for arguments about politics and football. As for fellow tweeters, those I follow or those that follow me - I'm grateful for the debate, for agreeing with me or for telling me I'm talking horse-manure. This is how I find my way to answer questions about where the world's markets are headed. FF to you all, as they say on Twitter.
Monday, 1 April 2013
Super Cycles.. not the end, perhaps the beginning of the end
David Stockman has written a piece in the NYT ahead of the launch of his latest book, The Great Deformation: Capitalism Corrupted which is out tomorrow. There has been plenty of fuss and he's succeeded in annoying Paul Krugman amongst others.
Mr Stockman blames crony capitalism, badly designed fiscal stimulus, financial bailouts and easy money for the woes of the US. And of course, he predicts than when the next bubble bursts, the US will be left defenceless and the effects will be awful. Cue a decent Easter debate (that's the polite term) in the press, and on social media.
Away from the rhetoric and the politics, there's at least a core of truth in some of what he writes. Anyone interested in the subject really ought to start by studying the work of the Bank Credit Analyst and you could do worse than google the term 'debt super-cycle'. Since the end of the Volcker era at the Federal Reserve, the US has seen a long-term downtrend in both nominal and real interest rates. That's the reward for the defeat of (consumer price) inflation, in turn helped by Mr Volcker but also thanks to the benign effects of globalisation.
What the Fed has done, is use the freedom created by subdued CPI, to adopt incredibly easy monetary policy at the first sign of danger, and keep rates very low regardless of the effect on other parts of the US economy. They started in the early 1990s, when the Fed cut rates to 3% in response to the S&L crisis. The denouement in 1994 and onwards, was fine for the US but catastrophic for many countries which had tied their currencies to the dollar. Some of you may say 'so what?' but it was hardly great global leadership. In 1998, the Fed cut rates far too quickly after the LTCM 'crisis' and was too slow to raise them, starting the housing bubble which lasted a decade and lighting the fuse for the dotcom bubble. And after a very mild recession at the turn of the Millennium, a period of crazy monetary policy was as much the cause of the credit bubble which ended with the 'Great Recession' as lax bank supervision and greedy bankers.
In 2008, I thought the debt super-cycle had ended. It seemed obvious that households and companies would reduce their leverage and that the financial sector would be forced by regulators and natural caution to lend less, and build up more defensive balance sheets. What I hadn't reckoned on, was that the public sector could take over so much of the debt and that the Fed would respond by adopting even easier monetary policy. The asset bubble whose explosion triggered the recession, was caused by negative real interest rates. Economic recovery is being built on even more negative real interest rates, which have indeed triggered a recovery in asset prices from equities to housing.
I've learnt to be wary of saying that the Fed is out of bullets. QE and ZIRP are working. There is collateral damage in the form of increased economic inequality and in terms of overvalued exchange rates in some emerging economies, but the US is going to out-grow most other developed economies in the next few years. And since ZIRP, QE and the dollar's reserve currency status all combine to allow the US to borrow money at deeply negative real yields, I don't even see why the government wouldn't go on postponing sensible fiscal policies. If I could borrow 10-year money at less than 2% per annum to invest in an economy growing at 4 1/2% in nominal terms, I would. And after all, political gridlock in Washington doesn't look that bad when you compare it to the synchronised fiscal masochism in Europe.
I wouldn't rule out a longer period than many expect when US bond yields can stay below nominal GDP growth, continuing to support asset prices; when globalisation keeps on keeping wage growth down and CPI inflation under control; and the US can give a very decent impression of being in the early stages of an OK economic recovery. The rest of us, wearing our hair shirts and struggling to get out debt levels under control in the face of recession, will be thankful for any growth we can import from the US.
That's where I disagree with Mr Stockman. 2008 didn't signal the last 'mini-cycle' of the debt super-cycle; maybe it didn't even signal the last-but-one. The philosophical rights and wrongs of mad money and ever-rising public sector debt levels, can fuel debate but when Ben goes and Janet takes over, the policy recipe could just stay the same. So Mr Stockman may find that he is an awful lot older before he is ever proved right in his warnings of doom...
Mr Stockman blames crony capitalism, badly designed fiscal stimulus, financial bailouts and easy money for the woes of the US. And of course, he predicts than when the next bubble bursts, the US will be left defenceless and the effects will be awful. Cue a decent Easter debate (that's the polite term) in the press, and on social media.
Away from the rhetoric and the politics, there's at least a core of truth in some of what he writes. Anyone interested in the subject really ought to start by studying the work of the Bank Credit Analyst and you could do worse than google the term 'debt super-cycle'. Since the end of the Volcker era at the Federal Reserve, the US has seen a long-term downtrend in both nominal and real interest rates. That's the reward for the defeat of (consumer price) inflation, in turn helped by Mr Volcker but also thanks to the benign effects of globalisation.
What the Fed has done, is use the freedom created by subdued CPI, to adopt incredibly easy monetary policy at the first sign of danger, and keep rates very low regardless of the effect on other parts of the US economy. They started in the early 1990s, when the Fed cut rates to 3% in response to the S&L crisis. The denouement in 1994 and onwards, was fine for the US but catastrophic for many countries which had tied their currencies to the dollar. Some of you may say 'so what?' but it was hardly great global leadership. In 1998, the Fed cut rates far too quickly after the LTCM 'crisis' and was too slow to raise them, starting the housing bubble which lasted a decade and lighting the fuse for the dotcom bubble. And after a very mild recession at the turn of the Millennium, a period of crazy monetary policy was as much the cause of the credit bubble which ended with the 'Great Recession' as lax bank supervision and greedy bankers.
In 2008, I thought the debt super-cycle had ended. It seemed obvious that households and companies would reduce their leverage and that the financial sector would be forced by regulators and natural caution to lend less, and build up more defensive balance sheets. What I hadn't reckoned on, was that the public sector could take over so much of the debt and that the Fed would respond by adopting even easier monetary policy. The asset bubble whose explosion triggered the recession, was caused by negative real interest rates. Economic recovery is being built on even more negative real interest rates, which have indeed triggered a recovery in asset prices from equities to housing.
I've learnt to be wary of saying that the Fed is out of bullets. QE and ZIRP are working. There is collateral damage in the form of increased economic inequality and in terms of overvalued exchange rates in some emerging economies, but the US is going to out-grow most other developed economies in the next few years. And since ZIRP, QE and the dollar's reserve currency status all combine to allow the US to borrow money at deeply negative real yields, I don't even see why the government wouldn't go on postponing sensible fiscal policies. If I could borrow 10-year money at less than 2% per annum to invest in an economy growing at 4 1/2% in nominal terms, I would. And after all, political gridlock in Washington doesn't look that bad when you compare it to the synchronised fiscal masochism in Europe.
I wouldn't rule out a longer period than many expect when US bond yields can stay below nominal GDP growth, continuing to support asset prices; when globalisation keeps on keeping wage growth down and CPI inflation under control; and the US can give a very decent impression of being in the early stages of an OK economic recovery. The rest of us, wearing our hair shirts and struggling to get out debt levels under control in the face of recession, will be thankful for any growth we can import from the US.
That's where I disagree with Mr Stockman. 2008 didn't signal the last 'mini-cycle' of the debt super-cycle; maybe it didn't even signal the last-but-one. The philosophical rights and wrongs of mad money and ever-rising public sector debt levels, can fuel debate but when Ben goes and Janet takes over, the policy recipe could just stay the same. So Mr Stockman may find that he is an awful lot older before he is ever proved right in his warnings of doom...
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