« A Lament for Public Policy | Main | All money is helicopter money. Against the Law of Reflux. »

Comments

Feed You can follow this conversation by subscribing to the comment feed for this post.

Clever post. I like the framing of "put location".

" a central bank put and call on stock prices would be a better thermostat than a central bank put and call on government bond prices"

Better for whom? It's possibly worth remembering at this point, given the US fiscal situation, that governments don't finance themselves with equity but with bonds.

Can tight money or a put on government bonds be a form of financial repression?

I don't think there's a put on government bond prices in the US. A put says, "When the price goes down to a certain level, we promise to buy and prevent it from going lower." The Fed's policy is more like, "When the price goes above a certain level, we buy and push it even higher." Maybe it's like some kind of complicated straddle or some such thing, but not an ordinary put.

Sorry but both QE1 & QE2 were failure, boosting stock price for a short period of time. Not sure that operation twist is going to be any better. Who gains from very low l/t interest rates? Houshold cannot afford to refinance, corporations are long cash -- they want higher rates. Insurance companies and pension funds ditto.

Strangely, stock investors care about returns, not prices. But stock returns, ex-post, have already been very low over the last decade and a half. They have been sufficiently horrible to justify indifference between stocks and bonds at very low bond yields.

Does that mean the CB has succeeded in creating a low yield environment?

Is this what you meant by a put?

Is your middle name "Chauncey"?

I'm going to have to re-read my options definitions (again).

The recent Fed move(s) first promised to keep overnight rates low until 2013. Then they did "Operation Twist". But here's the thing: they didn't really "twist" the yield curve, they lowered the long end but the short end is clamped at their 2013 commitment. That looks like QE3 to me.

I have doubts the market didn't figure this out. And look how they reacted.

On the thermostat analogy, yes there should always be consideration that the temperature sensor is not measuring things properly. Perhaps a more apt analogy is a coal fired furnace, where adding more coal won't cause its heat to increase; it needs more air velocity. (OK that's enough)

I'm having trouble following your logic. It seems to imply that Bernanke is some more reliably tightening whenever inflation expectations get too high, implying a market put on US Gov't bond prices that differs from whatever may normally exist. I don't think this is a great description of the current Fed policy.

Isn't is more like this? Bernanke has opened his Collar.

That is, in normal times there is a tight Fed collar on Treasuries, the market owns a put if prices get below a floor, but has sold a call (to the Fed) if prices get above a ceiling. Now, the Fed has probably not altered the strike of put (i.e. if we got an organic increase in velocity we don't really have reason to think the Fed would actively tighten prematurely as maybe the BOJ has done in the past). But it surely had raised the strike of the sold call instead by allowing bond prices without sufficiently loosening, widening the market's usual bond collar. And this collar creates a more volatility and more room for animal spirits, luck, reflexivity, etc. to determine the price of bonds amid this wider range. Bernanke needs to button his collar (re-establish a lower strike for the sold call) and slap on a tie for good measure (set out some communication anchor like level targeting in place of overnight rates).

Maybe under panic panic conditions, like 2008, setting an explicit stock market floor would be a good idea. When volatility is very high it would have some potency, even if the floor is at a low level. Effectively the government would be a "value investor of last resort".

Nick: "Right now, the US seems to have a Bernanke put on US government bond prices. That's more than Greece has"

I think it's worse than worthless.

The signal that bond prices are giving is less ambiguous than you think. Over the past 6 months the correlation with stocks is about 80% and the beta is *negative* as always. Buying bonds is a lot like selling stocks. The 30 yr bond is a *really* excellent hedge for a stock portfolio.

So when the Fed buys 30 yr bonds it has the same effect on the market as shorting stocks. The Fed, rather than removing systemic risk exposure, is removing our only macro hedge. That's really bad. That's why, when "Operation Twist" was announced, the market puked. Like someone hedging a short put position, the Fed essentially shorts the stock market more and more, whenever the market goes down. So rather than a Bernanke put, we have a Bernanke "short put". The good news is it wont actually last. Next time they try it and the market pukes again, they are going to get the message and stop.

What the market really wants is more, not less, treasuries. The Fed could oblige by unloading its balance sheet. But ultimately borrowing and spending by the treasury is what's going to bail us out.  And the market knows it.

dlr: I couldn't follow your comment. Can you parse this sentence?: "But it surely had raised the strike of the sold call instead by allowing bond prices without sufficiently loosening, widening the market's usual bond collar."

K said: "What the market really wants is more, not less, treasuries. The Fed could oblige by unloading its balance sheet. But ultimately borrowing and spending by the treasury is what's going to bail us out. And the market knows it."

I believe the solution to too much debt is not more debt. Specifically, the solution to too much lower and middle class debt is not more gov't debt.

I also believe the "rich treasury market" knows the USA can't grow enough (unless some new industry comes along) for the amount of debt there is and so the "rich treasury market" is really after the Social Security, Medicare, and Medicaid benefits of the lower and middle class. The "rich treasury market" believes those will be cut, if necessary, to appease them/it.

"But ultimately borrowing and spending by the treasury is what's going to bail us out. And the market knows it."

Do you mean borrowing and spending by the Fed, or by the government? It sounds like the market is rather concerned with using monetary adjustments in an attempt to affect real growth. Someone could probably write a paper on this.

Too Much Fed: "I believe the solution to too much debt is not more debt. Specifically, the solution to too much lower and middle class debt is not more gov't debt."

You mean that the gov't should create money without increasing its debt? (The gov't creates money to offset the loss of money when people pay off their debt, as well as to supply money to meet the demand for it.)

I say that. Too Much Fed asked me this in another thread. I say we need more irredeemable base money, not more debt. Less Treasury securities, more Federal Reserve Notes.

David: I meant better for stabilising the growth path of Aggregate Demand. I have heard people talk about "financial repression", but I'm not really sure what it means. Unless it means some form of regulation?

Andy: "The Fed's policy is more like, "When the price goes above a certain level, we buy and push it even higher." "

Yes, it's a very strange sort of put. And it's because the news coming from the bond market is perverse. High bond prices are bad news, so the Fed pushes them even higher. So the signals are very misleading.

finance: I'm not optimistic either. A clearly announced target for the price level, or nominal GDP, plus a commitment to do what was necessary to hit it, would I think be better.

rsj: "They have been sufficiently horrible to justify indifference between stocks and bonds at very low bond yields."

That should always be true at the margin. But yes, higher real growth would justify higher stock prices at the same yield.

"Does that mean the CB has succeeded in creating a low yield environment?
Is this what you meant by a put?"

The CB has "succeeded" in creating an environment where there's low growth, and so stock yields are low despite the relatively low stock prices. If it raised stocks prices by loosening monetary policy, that would give both higher yields and higher stock prices.

crf: you lost me. "No" is the short answer. Is that a reference to "Being There"? Chauncey Gardner?

jesse: I would say that bond prices are the poor thermometer. If they rise because the Fed pushed them up, that's supposed to be good. But if they rise of their own accord, that's supposed to be bad. So they are hard to interpret. If stock prices rise because the Fed pushed them up, that's good. If they rise of their own accord, that's good too.

dlr: you lost me a bit there. I would prefer to think like Andy. If the Fed sees bad news, and rising bond prices, it raises the strike price on its bond put.

Max. That's my thinking too. But I think we never really escaped 2008, and it looks like we risk a repeat.

K. That's a new (to me) perspective. And an interesting one. I'm going to try to get my head around it.

"If it raised stocks prices by loosening monetary policy,"

Monetary policy is already as loose as it could possible be.

All you really expect with a low IR regime is that the *return* from holding stocks is low, since the arbitrage between bonds and stocks is one of return.

That could be achieved with either low or high capital prices, low or high dividends, low or high capital rental rates.

But if the economic impact is the capital rental rate, how do you ensure that low returns correspond to low capital rental rates?

In the current environment, capital rental rates are high, but stock returns are low.

rsj: "Monetary policy is already as loose as it could possible be."

Suppose the IS curve slopes up. Assume the LM curve is steeper than the IS curve. Tighten monetary policy, by shifting the LM left. Interest rates will fall. All the way to 0% if you tighten monetary policy far enough.

Determinant: "I say we need more irredeemable base money, not more debt."

Politically, that seems wise, as it would reduce the fear mongering about the deficit and debt. (The fear mongers could try to scare people about inflation, but I doubt if that would resonate as well as scaring them about debt.) Also, I wonder if an increase in non-debt currency would act as an automatic stabilizer on the down side. Debt money has a way of disappearing.

Pace Nick Rowe, it seems to me that we have had mostly increasing gov't debt (= money) over the centuries. How much would it hurt to have a portion of that replaced by coin of the realm?

I would argue that central banks can't shift the LM curve, as they do not control the quantity of money, they control the quantity of reserves, which are irrelevant to money demand (or to money, as held by the non-bank sector).

You keep pretending that inside money does not exist and that the private sector doesn't create all the money it needs all by itself. Your central banks have magical powers to move aggregates, whereas our own earth-based central banks can only set conditions (e.g. the short rate) which indirectly influence the the quantity of money by means of changing the demand for it. Once the private sector demands more money, more is automatically created. If it demands less, less is created. The CB plays no role in this process at all, other than ensuring that the underlying payment system keeps functioning.

Nick: "If they rise because the Fed pushed them up, that's supposed to be good. But if they rise of their own accord, that's supposed to be bad."

I guess it depends on what side of the trade you're on, though. As a saver (or pension fund...), higher yields would be a good thing if my portfolio's duration is short. As for being a bad thermometer, I think today that's true; sovereign CDSs are increasing of late, an indication that current sov bond yields are mis-priced. If you're looking to make $ off this, good luck with the timing! ;)

Min: as a stabilisation tool, I agree that varying the amount of money is better than varying the amount of debt. Government fiscal policy has got other, microeconomic jobs to do. It can't do both micro and macro. Monetary policy doesn't have anything else to do.

rsj: "Once the private sector demands more money, more is automatically created. If it demands less, less is created."

Funny you say that. Most economists agree with you, including some very good ones. I've just been arguing just the opposite with David Glasner. Money is not like other goods. People are willing to accept more money in exchange for other goods, even if they have no desire to *hold* more money. But don't argue this here and now. Wait for my (eventual) post.

http://uneasymoney.com/2011/09/21/comments-on-christensen/

jesse: in this post, I'm assuming the economy needs more AD, and "good" is shorthand for "more AD". More AD is not good for everyone. Someone who holds a stock of very safe nominal bonds will be worse off. But savers would benefit from higher real interest rates, and more AD would mean the economy would escape the recession and increase real interest rates. It's people who have already done their saving, and who hold their stock of savings in safe nominal bonds, who would benefit from continued recession and deflation.

Jesse:"sovereign CDSs are increasing of late, an indication that current sov bond yields are mis-priced"

What do you mean? Which sovereigns are you thinking about?

Nick: "K. That's a new (to me) perspective."

It's new to me too. It came to me as I watched the market puke on the Fed announcement on Wednesday. I realized that if you removed the bonds from of my portfolio, I'd have to *sell* stocks to get back to my risk tolerance. And that *that* is what CAPM says I should do if bonds are a negative beta asset. If I'm right, it means the Fed is out of QE bullets unless they find a way to buy high beta assets (which is pretty tough under the federal reserve act). This weeks markets suggest I'm right, though QE2 suggests otherwise (I think there may have been other factors at work in that case though).

K. This sounds important.

If I understand you correctly: long bonds work as a good hedge on your holdings of stocks, because the prices of stocks and long bonds are strongly negatively correlated. And short bonds don't work as well, because....(their prices aren't as negatively correlated?). So when the Fed buys long bonds, and sells short bonds, there aren't as many long bonds in the market for guys like you to use as a hedge. And competition between guys like you bids up the prices of long bonds, lowers their yield, so your hedging strategy of holding a (say) 50-50 mix of stocks and long bonds now gives you lower returns. So you want to sell stocks. So stock prices fall, until the yield on your 50-50 portfolio returns to about where it was. But those lower stock prices are bad for AD and the economy. It lowers Tobin's Q, for starters.

1. Did I understand you right?

2. Anyone else who understands what real people are doing in stock markets want to weigh in?

I run a fund and don't agree with K. I think the perspective is too narrow. We could imagine the Fed doing operation twist by selling Tbills and buying low beta stocks. For many equity portfolio managers this might feel like a reverse portfolio balance effect because you are reducing safer stocks, at which point they might want to sell riskier stocks to balance. And that really starts to sound strange. The market for assets is huge and the median agent is far from the representative agent. Insurance companies for example are enormous asset managers who think endlessly about duration risk and face more direct choices between bonds and bills as opposed merely bonds versus stocks. More generally this very partial equilibrium stuff just seems like a bad way to think about it. I realize you could maybe find or argue for a some version of beta that would render Tbills riskier than Tbonds but I'm pretty suspicious of assigning that view to the market. Not how the market on balance sees the relatively riskiness between bills and bonds in my view.

Apparently I didn't explain my wider-collar versus put option analogy well, but unfortunately I'm out of time. Can I get away with just asserting I still think it's a better way to think about it?

rsj: "You keep pretending that inside money does not exist and that the private sector doesn't create all the money it needs all by itself."

Jiminy Christmas! Hasn't that proposition been falsified many times over? Not only by recessions and depressions, but by the history of the American British Colonies in the 17th century? Starved for cash, they used wampum, tobacco, and the Spanish dollar, among other expedients. But then in the 1690s Massachusetts got the bright idea of making its own money. Pennsylvania did, too, via a land bank. Other colonies followed, and an economic boom followed. When asked in London for an explanation of the prosperity of the colonies, Benjamin Franklin is supposed to have replied, "Colonial Scrip." That story may be apochryphal, but it accords with Franklin's beliefs. (He was instrumental in the Pennsylvania experiment.) To be sure, mistakes were made. Rhode Island went way overboard, for instance. But it was not the private sector that produced the money that it needed, it was the colonial gov'ts.

And what about the Long Depression in the U. S.? In 1873, when the U. S. went off of a bimetallic standard of gold and silver to one of gold alone, the price of silver dropped in half. Silver that would have been monetized was not. Was that not a factor in the following regime of deflation and low inflation? And was not the discovery of gold in South Africa in the 1890s not a factor in ending the Long Depression?

The private sector could handle its money supply well on its own, but isn't there ample evidence that it does not do so? Bubbles and panics are not natural phenomena. They are man made, and evidence of a poorly regulated system.

Nick Rowe: " as a stabilisation tool, I agree that varying the amount of money is better than varying the amount of debt. Government fiscal policy has got other, microeconomic jobs to do. It can't do both micro and macro. Monetary policy doesn't have anything else to do."

And how has that division of labor been working out? ;)

I guess that Canada and Australia are doing better than the U. S. and U. K. The Euro Zone is a fascinating experiment in the extreme division between fiscal and monetary policy. Without Federal fiscal intervention, wouldn't the U. S. look a lot like Europe?

Min's post said: "Too Much Fed: "I believe the solution to too much debt is not more debt. Specifically, the solution to too much lower and middle class debt is not more gov't debt."

You mean that the gov't should create money without increasing its debt? (The gov't creates money to offset the loss of money when people pay off their debt, as well as to supply money to meet the demand for it.)"

Does it have to be the gov't?

Determinant said: "I say that. Too Much Fed asked me this in another thread. I say we need more irredeemable base money, not more debt. Less Treasury securities, more Federal Reserve Notes."

How do you want to do that?

Also and more broadly, if an economy needs more medium of exchange, how should that happen?

Min: "And how has that division of labor been working out? ;)"

Not very well. If you can't figure out how to fix the alternator, or won't fix it, then buying a new battery at Canadian Tire is a lot better than nothing, as a temporary bodge to get you home. We can't keep on doing it though.

Min said; "Also, I wonder if an increase in non-debt currency would act as an automatic stabilizer on the down side."

Can you expand on that one?

"Debt money has a way of disappearing."

Certain debt defaults and certain debt repayments?

More broadly, how can the amount of medium of exchange go down?

rsj said: "You keep pretending that inside money does not exist and that the private sector doesn't create all the money it needs all by itself. Your central banks have magical powers to move aggregates, whereas our own earth-based central banks can only set conditions (e.g. the short rate) which indirectly influence the the quantity of money by means of changing the demand for it."

It seems to me that the short rate (I assume the central bank overnight rate) is an attempt to indirectly influence the amount of medium of exchange and its velocity.

Moi: "You mean that the gov't should create money without increasing its debt? (The gov't creates money to offset the loss of money when people pay off their debt, as well as to supply money to meet the demand for it.)"

Too Much Fed: "Does it have to be the gov't?"

Well, there are credit card points and airlines miles and savings stamps. ;)

Min: "Also, I wonder if an increase in non-debt currency would act as an automatic stabilizer on the down side."

Too Much Fed: "Can you expand on that one?"

Nick Rowe would be better at that than I. :) But my idea was that non-debt money acts as a floor, limiting how far the money supply can drop. Increase it, and the money supply has less far to fall. It is plausible, then, that increasing it would help to stop or slow the descent of a dropping money supply, even though we do not actually expect the money supply to reach the floor. All I have is an analogical idea, which is not really an argument or explanation. {shrug}

Yes, it would be much better to have a Bernanke put on stocks than bonds. And even better . . . a Bernanke put on a futures contract linked to the policy goal.

Min,

You are using examples of commodity money economies to disprove the concept that money is endogeonous in a credit economy?

This is pretty much the whole problem. The economists learned to play the commodity money game, and never got around to money in a modern world. So fine, in your gold coin economy, yes, no one can increase the stock of money. In an economy in which money is just one type of bank liability, then the stock of money can be easily increased by the private sector, as long as the government continues to guarantee that bank deposit liabilities are perfectly substitutable for cash.

dlr: I don't think my perspective is either "median" or high beta stock. Professionally, my perspective is foremost complete market/risk-neutral. Personally, my principal guide is the logic of CAPM. I look to own the whole market, adjusted only for what I believe to be my intrinsic income and consumption market exposure. But I don't claim to be a representative agent and my argument isn't based on my own risk allocation (not that we live in a rep agent economy - wealth and access to credit matter). I don't see the relevance of either the equity portfolio manager or insurance company perspective. The equity PM is trying to provide a particular exposure; the insurance company is trying to hedge its liabilities. Neither is attempting to construct a globally risk/return-optimized portfolio. 

My claim is more based on the following: as the market has become more and more distressed

1) a increasingly large fraction of the treasury market is either owned by the Fed or trading at a yield that is so low that it no longer has significant volatility. At the same time, high grade corporate bonds, which used to be close proxies for treasuries now have yields that are principally made up of credit spread rather than treasury yields. So at the same time that the total risk in treasuries has declined, assets that used to be good proxies for treasuries are now far more correlated with stocks. So as the market declines the variance associated with risk-free yields becomes a decreasing fraction of the variance of the whole market. There comes a point when treasuries are not only negatively correlated with stocks, but also with the market as a whole (including treasuries). 

2) treasuries are far more negatively correlated with stocks than they used to be. I've checked this over a few time frames and it seems to be true. If so, why would this be? I think it's because the worse things get, the more the market becomes worried about deflation rather than inflation. David Glasner has documented a large shift in the correlation between TIPS spreads and stocks before and after 2008. Whereas the correlation was previously low  (because the Fed was successfully targeting inflation and residuals were therefore largely noise), the correlation is now quite positive. Since the TIPS spread is a very large driver of the bond yield (and the other part, is already positively correlated with stocks) we now see that bond yields are far more positively (and prices negatively) correlated with stocks than before. 

As the market continues to fall both of these factors will become increasingly significant. The treasury risk factor will be a declining fraction of total market risk, and treasuries and stocks will become increasingly negatively correlated as inflation risk becomes increasingly irrelevant. Eventually treasuries become negative beta. I think we may be well into that regime. 

Negative beta, by the way, doesn't make bonds "safer than t-bills." They are certainly far more volatile, in both real and nominal terms. It just makes them a really critical portfolio component. 

Min said: "Too Much Fed: "Does it have to be the gov't?"

Well, there are credit card points and airlines miles and savings stamps. ;)"

And, "All I have is an analogical idea, which is not really an argument or explanation. {shrug}"

Actually, I was thinking about removing the currency printing entity from the fed/gov't and setting it up as a separate entity.

Plus, can you describe the difference between non-debt currency and debt currency?

rsj said: "In an economy in which money is just one type of bank liability, then the stock of money can be easily increased by the private sector, as long as the government continues to guarantee that bank deposit liabilities are perfectly substitutable for cash."

What if no one in the private sector wants to go into currency denominated debt?

rsj: "You keep pretending that inside money does not exist and that the private sector doesn't create all the money it needs all by itself."

Moi: Long post, including the situation in the American English colonies before the introduction of fiat money.

rsj: "You are using examples of commodity money economies to disprove the concept that money is endogeonous in a credit economy?"

It is the second claim that seems to me to have been falsified many times over, that the private sector creates "all the money it needs all by itself." OC, if you are talking only about things after 1971, maybe there is not a whole lot of evidence yet.

Too Much Fed: "can you describe the difference between non-debt currency and debt currency?"

Well, there are those who say that all money is debt. That makes sense, but it includes the degenerate case, IOUs that are redeemable only for other IOUs, which are redeemable for other IOUs, etc., etc. When it makes a difference to the discussion, I would prefer to call the degenerate case non-debt money.

Min,

If I remember correctly, there are various ways you can model endogenous money. The Kaldor approach (broad money is demand-determined from the customer side) can be dismissed empirically pretty quickly, while others can take longer. However, I agree that any theory of money worth taking seriously allows the demand & supply of money to be in disequilibrium.

@Too Much Fed:

IANAL, but, as I understand it, under current U. S. law the Treasury must issue Treasuries before spending if it does not have enough on deposit. Such deficit spending actually ends up creating money, which would be debt money. (I don't think that currency is the right term for that money, though.) During the recent debt ceiling farce an idea gained the support of a number of experts that there is a loophole of sorts. The Treasury, on its own initiative, can have platinum coins struck as needed. If Congress did not raise the debt ceiling, the Treasury could deposit trillions of dollars of such coins with the Fed and use that money to meet its obligations. Those coins would be what I meant by non-debt currency (as is the lowly dollar bill).

Peden,

"The Kaldor approach (broad money is demand-determined from the customer side) can be dismissed empirically pretty quickly"

You've repeated this before, but without any evidence. How on earth would you dismiss this empirically? I think if you defined "money" to be deposits, then it's a rock-solid theory, both empirically and theoretically, although of course demand for money will be affected by the state of the economy.

Of course, by "deposits", I mean deposits held by the non-financial private sector (households and non-financial firms).

Min said: "Well, there are those who say that all money is debt."

I've seen that. I believe it depends on the definition of debt.

As far as non-debt currency and debt currency, keep that thought in mind.

The comments to this entry are closed.

Search this site

  • Google

    WWW
    worthwhile.typepad.com
Blog powered by Typepad