Gold: The Once and Future Money with James Rickards
Gold: The Once and Future Money with James Rickards
James Rickards joins Cambridge House International, where he discusses how gold has dominated the financial scene throughout history and how it will once again rise from the ashes and take back its rightful throne. Gold is coming.
Jim Rickards explains the day after plan... Forget gold, Silver is going out of sight.
Jim Rickards explains the day after plan... Forget gold, Silver is going out of sight.
How should you be preparing for the big one? An economic collapse looms on the horizon, but many are simply unprepared. Don't be caught off guard, heed Jim Rickards latest advice and take action before you are completely and utterly wiped out.
It's Not Just Jim Rickards, I Prescribe To $10,000 Gold
It's Not Just Jim Rickards, I Prescribe To $10,000 Gold
The imminent collapse of modern currencies will push gold up to $10,000 an ounce, assuming central banks resort back to a gold-backed monetary system, said Byron King, editor of Jim Rickards’ Gold Speculator.
“If you take the global money supply, back it with 40% gold, you need $10,000 gold to make the math work, and that’s just using a 40% backing,” King told Kitco News on the sidelines of the PDAC 2018. “And it has to do with the eventual demise of modern currencies.”
Byron noted that gold stocks at current valuations are much more attractive now than they were two years ago, and said that today’s miners are backed by “better numbers” and “smarter geologists.” “We are in a new gold bull cycle, we’re in a blip of six or eight month downturn, but it will turn around.
These are fundamentally good companies with great value behind them,” he said.
Jim Rickards: Where is Gold Going in 2018? The Ultimate Gold Panel
Hosted by Kitco News at the 2018 VRIC. Rick Rule, Peter Hug, and Jim Rickards join a panel where they discuss the direction that gold is heading throughout 2018 and beyond.
In addition to this, they break down a number of key issues that are affecting the markets and some that have not yet come to pass...
What is the end game?
- Source, Cambridge House
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PhD Studentships UCD School of Economics
UCD School of Economics is pleased to announce a call for applications for the 2018-19 PhD Scholarship scheme. The aim of the scheme is to attract applicants of the highest academic standards to participate in the UCD School of Economics PhD programme (details here) and provide them with the training, experience and mentorship necessary to their professional development.
These PhD Scholarships will comprise an annual tax-free stipend of €15,000 plus a full waiver of fees. The scheme is open to both new applicants and existing PhD students, with the understanding that the stipend and fee waiver will continue to be provided to students up to and including their fourth year of PhD studies, subject to their continuing to make satisfactory progress in their studies and meeting the terms and requirements of their scholarship.
Students in receipt of a Scholarship are required to work as tutors in either undergraduate or graduate modules taught by the School of Economics. This will allow PhD students to develop the practical application of their academic skills by ongoing training and experience of tutorial teaching, assessment and pedagogical development. This taught component will amount to no more than 50 hours of teaching during each of our 12-week teaching semesters.
Selection Criteria
A selection board of School of Economics faculty members will review applications and make its recommendations on selection to the Head of School. Applications will be evaluated and ranked by the Selection Board according to the following criteria:
Academic excellence (transcripts, previous research experience, etc.)
The academic testament of referees;
Quality and clarity of the research proposal;
Fit with the research strengths of the School;
Teaching potential (past teaching experience, English proficiency, etc.);
Availability of other funding to applicant (such as Irish Research Council awards).
Application Process
Before applying for the scholarship, applicants must have a firm or conditional offer of a place on our PhD programme. Applicants who not yet received a Masters by September 2018 may be awarded a scholarship on a temporary basis if the student enrols in the school’s MLitt programme. However, the student must receive a Masters and transfer to the PhD programme by the start of semester 2 (January 2019) or the scholarship will terminate.
Details on the timing of scholarship application and awards for 2018/19 will be made available soon.
For students who are unsuccessful in applying for a PhD scholarship, the school also offers other forms of financial assistance, including fee waivers, hourly tutoring contracts, and marking exams.
These PhD Scholarships will comprise an annual tax-free stipend of €15,000 plus a full waiver of fees. The scheme is open to both new applicants and existing PhD students, with the understanding that the stipend and fee waiver will continue to be provided to students up to and including their fourth year of PhD studies, subject to their continuing to make satisfactory progress in their studies and meeting the terms and requirements of their scholarship.
Students in receipt of a Scholarship are required to work as tutors in either undergraduate or graduate modules taught by the School of Economics. This will allow PhD students to develop the practical application of their academic skills by ongoing training and experience of tutorial teaching, assessment and pedagogical development. This taught component will amount to no more than 50 hours of teaching during each of our 12-week teaching semesters.
Selection Criteria
A selection board of School of Economics faculty members will review applications and make its recommendations on selection to the Head of School. Applications will be evaluated and ranked by the Selection Board according to the following criteria:
Academic excellence (transcripts, previous research experience, etc.)
The academic testament of referees;
Quality and clarity of the research proposal;
Fit with the research strengths of the School;
Teaching potential (past teaching experience, English proficiency, etc.);
Availability of other funding to applicant (such as Irish Research Council awards).
Application Process
Before applying for the scholarship, applicants must have a firm or conditional offer of a place on our PhD programme. Applicants who not yet received a Masters by September 2018 may be awarded a scholarship on a temporary basis if the student enrols in the school’s MLitt programme. However, the student must receive a Masters and transfer to the PhD programme by the start of semester 2 (January 2019) or the scholarship will terminate.
Details on the timing of scholarship application and awards for 2018/19 will be made available soon.
For students who are unsuccessful in applying for a PhD scholarship, the school also offers other forms of financial assistance, including fee waivers, hourly tutoring contracts, and marking exams.
Unintended consequences
Unintended consequences of well-intentioned policies, unexpected behavioral changes in response to ignored incentives, unusual supply (or demand) responses to demand (or supply) interventions, and clever new pathways for changes to happen are the sorts of mechanisms that make economics fun, and I hope useful to cause-and-effect understanding of human affairs.
A case in point is an Atlantic article from 2012 that a friend pointed me to last week, by Richard Sander and Stuart Taylor Jr.
And a proponent of affirmative action could nonetheless make many arguments consistent with this work. Perhaps dropping out of UCLA is good for people. Perhaps more minorities on campus is useful for white students' social perceptions, even if it harms its intended beneficiaries. Perhaps things were going on at other universities that drove minority upperclasspeople UCLA's way. UCLA is part of the California state system, which encourages transfers at year two, which is not the case everywhere. I also don't know how the numbers are holding up post 2012. Finally, racial preferences seem to have advantaged whites by keeping asians out, which is an interesting scandal by the silence surrounding it.
Today's post is not about this larger argument.
I'm willing to bet Brad DeLong still blogs I'm racist for even mentioning the topic, but that will be an interesting test of today's political climate.
A case in point is an Atlantic article from 2012 that a friend pointed me to last week, by Richard Sander and Stuart Taylor Jr.
... UCLA, an elite school that used large racial preferences until the Proposition 209 ban [on overt racial preferences] took effect in 1998... Many predicted that over time blacks and Hispanics would virtually disappear from the UCLA campus.
And there was indeed a post-209 drop in minority enrollment as preferences were phased out. Although it was smaller and more short-lived than anticipated, it was still quite substantial: a 50 percent drop in black freshman enrollment and a 25 percent drop for Hispanics...[However,]
...The total number of black and Hispanic students receiving bachelor's degrees were the same for the five classes after Prop 209 as for the five classes before.
How was this possible?Indeed, I too would have guessed, if I didn't think hard about it, that eliminating racial preferences would have to have reduced the number of minorities who graduated, and that the affirmative action argument would have gone on to other pros and cons. But that's wrong.
First, the ban on preferences produced better-matched students at UCLA, students who were more likely to graduate. The black four-year graduation rate at UCLA doubled from the early 1990s to the years after Prop 209.Yes. Half the admits but double the graduation rate leaves constant the number of graduates.
Second, strong black and Hispanic students accepted UCLA offers of admission at much higher rates after the preferences ban went into effect; their choices seem to suggest that they were eager to attend a school where the stigma of a preference could not be attached to them. This mitigated the drop in enrollment.
Third, many minority students who would have been admitted to UCLA with weak qualifications before Prop 209 were admitted to less elite schools instead; those who proved their academic mettle were able to transfer up to UCLA and graduate there.
Thus, Prop 209 changed the minority experience at UCLA from one of frequent failure to much more consistent success. The school granted as many bachelor degrees to minority students as it did before Prop 209 while admitting many fewer and thus dramatically reducing failure and drop-out rates.To be absolutely clear, this post is about pathways. I do not wish to wade into a perilous pro or anti affirmative action debate, a basically radioactive topic for white male economists. (Though I am pleased to report a quick Google search that suggests both Sanders and Taylor still employed, something that might not happen if their book were published today.)
And a proponent of affirmative action could nonetheless make many arguments consistent with this work. Perhaps dropping out of UCLA is good for people. Perhaps more minorities on campus is useful for white students' social perceptions, even if it harms its intended beneficiaries. Perhaps things were going on at other universities that drove minority upperclasspeople UCLA's way. UCLA is part of the California state system, which encourages transfers at year two, which is not the case everywhere. I also don't know how the numbers are holding up post 2012. Finally, racial preferences seem to have advantaged whites by keeping asians out, which is an interesting scandal by the silence surrounding it.
Today's post is not about this larger argument.
I'm willing to bet Brad DeLong still blogs I'm racist for even mentioning the topic, but that will be an interesting test of today's political climate.
Lectureship in Environmental Policy and Behavioural Science
Full details, including a link to apply are available here.
Applications are invited for a permanent Lecturer/Assistant Professor post in Environmental Policy. Applicants must have a PhD in environmental economics and policy or a related area, a strong, demonstrable commitment to research and international publication in environmental policy design and behavioural science, an ability to teach at University level, a capacity for graduate student supervision, a strong quantitative research and teaching ability, a commitment to translating the fruits of research into policy innovation, excellent interpersonal skills, and a capacity and enthusiasm for working in an interdisciplinary context within the School, the UCD Earth Institute, UCD Geary Institute and the wider academic community. Methodological research interests and an ability to teach environmental economics, behavioural economics, policy analysis and environmental policy design are mandatory requirements. The successful candidate will join a strong team and contribute to teaching on BSc and MSc programmes in environmental policy as well as contributing to modules of relevance to the School, College of Engineering and Architecture and the wider university.
UCD is listed in the top 1% of universities worldwide. It is a dynamic research-intensive university at the forefront of research and teaching activities across a wide range of disciplines. The School is currently ranked within the top 100 in the QS World University Rankings. Lead by the UCD Earth Institute and the UCD Energy Institute, ‘Environment and Energy’ is a stated strategic area for the University. The Behavioural Science Group in the UCD Geary Institute for Public Policy brings together applications of research across universities, businesses, regulators, research groups, and government departments where a strong research theme in environmental policy design is being strengthened through the application of behavioural science principles. The School, of which the successful candidate will be a Member, are leaders in Europe in coordinating and participating in large-scale prestigious research consortia. In addition, the Environmental Policy Group are internationally recognised for expertise and experience in the direct application of environmental economics research into the policy development process, for example, the lead role played in providing research and policy support to the EU policy system for the design and implementation of the EU Emissions Trading Scheme, the world’s largest environmental policy instrument. The Group has provided direct policy advice to, inter alia, the Japanese Government, Irish Government, European Commission, European Environment Agency, OECD and World Bank and our graduates work worldwide. Key thematic areas of research include: Climate change and environmental policy instruments; Behavioural science, quality of life, subjective well-being and the environment; Risk analysis, Benefit-Cost Analysis and Environmental Valuation; Environmental policy analysis and environmental governance.
Applications are invited for a permanent Lecturer/Assistant Professor post in Environmental Policy. Applicants must have a PhD in environmental economics and policy or a related area, a strong, demonstrable commitment to research and international publication in environmental policy design and behavioural science, an ability to teach at University level, a capacity for graduate student supervision, a strong quantitative research and teaching ability, a commitment to translating the fruits of research into policy innovation, excellent interpersonal skills, and a capacity and enthusiasm for working in an interdisciplinary context within the School, the UCD Earth Institute, UCD Geary Institute and the wider academic community. Methodological research interests and an ability to teach environmental economics, behavioural economics, policy analysis and environmental policy design are mandatory requirements. The successful candidate will join a strong team and contribute to teaching on BSc and MSc programmes in environmental policy as well as contributing to modules of relevance to the School, College of Engineering and Architecture and the wider university.
UCD is listed in the top 1% of universities worldwide. It is a dynamic research-intensive university at the forefront of research and teaching activities across a wide range of disciplines. The School is currently ranked within the top 100 in the QS World University Rankings. Lead by the UCD Earth Institute and the UCD Energy Institute, ‘Environment and Energy’ is a stated strategic area for the University. The Behavioural Science Group in the UCD Geary Institute for Public Policy brings together applications of research across universities, businesses, regulators, research groups, and government departments where a strong research theme in environmental policy design is being strengthened through the application of behavioural science principles. The School, of which the successful candidate will be a Member, are leaders in Europe in coordinating and participating in large-scale prestigious research consortia. In addition, the Environmental Policy Group are internationally recognised for expertise and experience in the direct application of environmental economics research into the policy development process, for example, the lead role played in providing research and policy support to the EU policy system for the design and implementation of the EU Emissions Trading Scheme, the world’s largest environmental policy instrument. The Group has provided direct policy advice to, inter alia, the Japanese Government, Irish Government, European Commission, European Environment Agency, OECD and World Bank and our graduates work worldwide. Key thematic areas of research include: Climate change and environmental policy instruments; Behavioural science, quality of life, subjective well-being and the environment; Risk analysis, Benefit-Cost Analysis and Environmental Valuation; Environmental policy analysis and environmental governance.
Bear Stearns Anniversary
Justin Baer and Ryan Tracy have an excellent article in the Wall Street Journal commemorating the tenth anniversary of the Bear Stearns bailout.
So, if you want to stop a run, you need to convince creditors that their money is safe. Usually, you do that by issuing more equity, "recapitalization,'' But at this point, new equity holders understand that most of their money will go to pay off creditors who otherwise aren't getting anything, "debt overhang." So we need to find a source of new equity for whom the firm will be valuable enough that it's worth paying off the creditors to get it. That's the idea of one of these last minute sales to another firm, JP Morgan.
In this case, that failed too. There wasn't enough value in the firm left. It took $29 billion more to give the appearance of a buyout which would keep Bear going as part of JP Morgan, and more importantly to pay off the creditors. (That word "reacapitalization" more and more in the passive voice, tends to mean money from the government.)
Bailouts are not of the company or the management. It is all about making sure creditors get paid, so they don't run. Bailouts are always creditor bailouts.
Needless to say, this bailout did not in the end stop the financial crisis, and $29 billion would soon seem like couch change.
So, where are we now?
The first line of defense has always been one of these arranged last-minute marriages, in which a healthier firm takes over a failing one. This will not happen again.
So if a bailout is needed, private help won't be there.
Well, what about government help? We got $700 billion of that too last time.
I have long been suspicious of "orderly liquidation." The whole premise is that big banks are too complicated to go through bankruptcy court. So, the Treasury Secretary, Fed Chair and a few other officials are going to figure out who gets what over a weekend? What would you do if a big bank owed you a few billions, was on the brink, and you suspected these fine officials would be meeting this weekend to divvy up the carcass? How about run now?
Where will the next crisis come from? It always comes from a new and unexpected source, so don't plan on subprime mortgages funneled through investment banks. Look instead and ask, where is there a mountain of debt that can't be paid back, a bunch of really obscure accounting, off the books credit guarantees? China's great wall of debt suggests one answer.
The other worry " Congress might be asked to reinstate the bailout authority it took away after 2008." Yes, but even that was authority to use borrowed money. The last crisis cost us something like $5 to $10 trillion. If the US asks for that much money again, can we get it?
But all of this ignores the basic point. Financial crises are not about the failure of specific institutions. Financial crises are about runs. One way to stop runs is to convince short term creditors that no institution will ever lose money again, or that there is a big bailout ready. The other way is to fund risky investments with lots more equity. Not to beat a dead horse over and over again, but the real lesson of Bear Stearns and Lehman is what happens if you fund risky investments with a huge amount of short term debt. That can be fixed.
(Actually, subprime mortgages aren't even very risky. Google's self driving car is way more risky. All corporate cashflows are way more risky. Why are we spending all this money policing pools of mortgages, about the safest asset there is? Answer, because they are funded by huge amounts of run-prone short-term debt.)
The Federal Reserve tried to limit the damage with extraordinary actions, first extending the firm credit before forcing it into a hasty weekend shotgun marriage to JPMorgan Chase with $29 billion in assistance.More specifically,
Ten years ago, Bear’s crisis week began with rumors of liquidity problems following steep losses from mortgage bonds. Mr. Schwartz, the CEO, phoned JPMorgan Chief Executive James Dimon to ask for a simple overnight loan. By that Thursday, Bear’s lenders and clients had backed away, and the firm was running out of cash. Mr. Schwartz called Mr. Geithner for more help.
Fearing a Bear-induced panic could spread throughout the banking system, the Fed arranged a $12.9 billion emergency loan routed through JPMorgan. It ultimately agreed to purchase $29.97 billion in toxic Bear assets.First, Bear lost a lot of money in mortgage backed securities. Second, like Lehman to follow, Bear was mostly financing that investment with borrowed money, and short-term borrowed money at that, not with its own money, i.e. equity capital. Small losses then made it more likely Bear would not be able to pay back its debtors. Third, there was a run. Short term creditors ran out the doors just like Jimmy Stewart's depositors in a Wonderful Life. More interestingly, Bear's broker-dealer clients started running too. Just how investment banks like Bear were using their broker-dealer clients to fund investments is a great lesson of the event. Darrell Duffie lays this out beautifully in The failure mechanics of dealer banks and later How big banks fail.
So, if you want to stop a run, you need to convince creditors that their money is safe. Usually, you do that by issuing more equity, "recapitalization,'' But at this point, new equity holders understand that most of their money will go to pay off creditors who otherwise aren't getting anything, "debt overhang." So we need to find a source of new equity for whom the firm will be valuable enough that it's worth paying off the creditors to get it. That's the idea of one of these last minute sales to another firm, JP Morgan.
In this case, that failed too. There wasn't enough value in the firm left. It took $29 billion more to give the appearance of a buyout which would keep Bear going as part of JP Morgan, and more importantly to pay off the creditors. (That word "reacapitalization" more and more in the passive voice, tends to mean money from the government.)
Bailouts are not of the company or the management. It is all about making sure creditors get paid, so they don't run. Bailouts are always creditor bailouts.
Needless to say, this bailout did not in the end stop the financial crisis, and $29 billion would soon seem like couch change.
So, where are we now?
"Key players in the bailout, many of whom remain in finance, have spent the last decade arguing about what was done, defending decisions made then and wondering whether it could happen again. The consensus: It would be unlikely for another big firm to get into such trouble, or for the government to orchestrate such a bailout"I found this interesting, especially the last statement. For the other universally held truth (false in my view, but I'm a tiny minority) is that letting Lehman go under was a huge mistake and led to the financial crisis. If only the Fed had saved Lehman as it did Bear, the story goes, things would not have been so bad. So why would the government not orchestrate a bailout?
"Veteran Wall Street lawyer Rodgin Cohen, who helped shape the deal for Bear Stearns, says that if a crippled firm were on the brink today, none of its peers would arrive with a rescue. “Nobody will ever again buy a severely troubled institution,” he says. “Period.”"
Many officials in Washington feel another bailout is just as unlikely.Why not?
The first line of defense has always been one of these arranged last-minute marriages, in which a healthier firm takes over a failing one. This will not happen again.
Nearly everyone in charge on Wall Street today, including JPMorgan’s Mr. Dimon, says they would never buy a collapsing firm like Bear.
“No, we would not do something like Bear Stearns again—in fact, I don’t think our board would let me take the call,” Mr. Dimon wrote in his 2014 letter to shareholders. “These are expensive lessons I will not forget.”
In addition to the cost of bringing the two firms together, JPMorgan was saddled with billions of dollars in legal bills and regulatory penalties. Months after the Bear deal, JPMorgan made a similar last-minute agreement to buy Washington Mutual Inc. Of JPMorgan’s nearly $19 billion in legal costs from the mortgage crisis, some 70% stemmed from Bear and WaMu, Mr. Dimon wrote.
There were many other such deals in 2008. Wells Fargo & Co. bought Wachovia Corp., Bank of America Corp. acquired Merrill Lynch & Co. and Countrywide Financial Corp., and Toronto-Dominion Bank bought Commerce Bancorp. Today, many of these Wall Street executives say they feel betrayed by the government for hitting them with penalties tied to actions by firms they were pressured to acquire.
These days, a big financial firm rescuing another would also have to consider new restrictions on risk-taking. Banks today must pass regulatory tests before paying out profits to shareholders. In that environment, executives may be more reluctant to buy assets from a desperate seller.Loud and clear. Over and over, the government asks a big bank to help out by taking over a failing bank, which means agreeing to pay all that failing bank's debts. But this time, after the fact, the government made the new owners pay billions in fines for the old company's debts. Take my trash out, asks your neighbor, and you say "sure," then he calls the EPA to report on the toxic waste now in your trash barrel. Not again. And if that weren't enough, the government's own regulations will prohibit it.
So if a bailout is needed, private help won't be there.
Well, what about government help? We got $700 billion of that too last time.
Fed help like that would be illegal today. The 2010 Dodd-Frank financial-regulation law stipulates that emergency Fed lending must be “broad-based” and cannot be “established for the purpose of assisting a single and specific company.” Financial firms, like other corporations, are supposed to go bankrupt, not get bailed out.So what is supposed to happen? "Orderly liquidation."
If regulators and the Treasury secretary assert a bankruptcy would destabilize the financial system, Dodd-Frank provides a new backstop called the Orderly Liquidation Authority. The government would take over the failing firm, wiping out shareholders. After a weekend of work by federal officials, a new company, owned by creditors of the old firm, would open Monday morning. The government would be able lend money to the new company to keep the lights on while the government sells it off in pieces.
That is supposed to prevent a panic because people who had been doing business with the failing firm would know they could continue to do so, at least for a while.In sum, the lifejackets (shotgun marriages) and lifeboats (government bailouts), distasteful as they are, are likely gone. Speedy bankruptcy isn't here yet. We are relying on a new and untested idea, the watertight compartments.
I have long been suspicious of "orderly liquidation." The whole premise is that big banks are too complicated to go through bankruptcy court. So, the Treasury Secretary, Fed Chair and a few other officials are going to figure out who gets what over a weekend? What would you do if a big bank owed you a few billions, was on the brink, and you suspected these fine officials would be meeting this weekend to divvy up the carcass? How about run now?
What if orderly liquidation doesn’t prevent a panic? In a crisis, problems at one firm can lead investors to “run” to cut their exposures everywhere. Even healthy companies can’t get credit, damaging Main Street as badly as Wall Street. In that scenario, there may be little U.S. regulators can do on their own. Congress might be asked to reinstate the bailout authority it took away after 2008.
“Drafting big books, massive documents, having big teams—that’s all a good idea,” says Gary Parr, a longtime deal maker who advised Bear on its sale to JPMorgan. “But when you have a company get into a liquidity crunch, if things are going really fast, you don’t have time to study a book.”The best of all worlds is one in which nobody expects a bailout, it comes once to stop a run, and then we put the moral hazard genie back in the bottle. The worst of all worlds is one in which everyone expects a bailout, but then either by legal restriction or decision it does not come. Nobody has fire extinguishers any more, and the fire house has burned down.
Where will the next crisis come from? It always comes from a new and unexpected source, so don't plan on subprime mortgages funneled through investment banks. Look instead and ask, where is there a mountain of debt that can't be paid back, a bunch of really obscure accounting, off the books credit guarantees? China's great wall of debt suggests one answer.
The other worry " Congress might be asked to reinstate the bailout authority it took away after 2008." Yes, but even that was authority to use borrowed money. The last crisis cost us something like $5 to $10 trillion. If the US asks for that much money again, can we get it?
But all of this ignores the basic point. Financial crises are not about the failure of specific institutions. Financial crises are about runs. One way to stop runs is to convince short term creditors that no institution will ever lose money again, or that there is a big bailout ready. The other way is to fund risky investments with lots more equity. Not to beat a dead horse over and over again, but the real lesson of Bear Stearns and Lehman is what happens if you fund risky investments with a huge amount of short term debt. That can be fixed.
(Actually, subprime mortgages aren't even very risky. Google's self driving car is way more risky. All corporate cashflows are way more risky. Why are we spending all this money policing pools of mortgages, about the safest asset there is? Answer, because they are funded by huge amounts of run-prone short-term debt.)
Fama Portfolio
The essays explain the ideas in modern terms, tell you why the papers are important, explain how the papers influenced subsequent thinking, update you on where our understanding on each point is today, and speculate about where new ideas may go. The continuing vitality of this work, even parts decades old, is impressive.
The task was hard. Which Fama papers should one read? Well, all of them! but we nonetheless had to pick. We typically chose a famous one from early in one of Gene's many research programs, and then a less known later one that really sums it up clearly. Gene's ideas get clearer over time, just like the rest of ours do.
The press lets us post our essays. Here are mine (most joint with Toby):
- Preface;
- Efficient Markets and Empirical Finance;
- Luck vs. Skill;
- Risk and Return;
- Return Forecasts and Time Varying Risk Premiums;
- Our Colleague.
The contents:
Preface, by John H. Cochrane and Tobias J. Moskowitz
I. Introductions
My Life in Finance
Eugene F. Fama
Things I’ve Learned from Gene FamaKenneth R. French
Gene Fama’s Impact: A Quantitative AnalysisG. William Schwert and René M. Stulz
II. Efficient MarketsEfficient Markets and Empirical Finance
John H. Cochrane and Tobias J. Moskowitz
The Great DivideClifford Asness and John Liew
Efficient Capital Markets: A Review of Theory and Empirical WorkEugene F. Fama
Efficient Capital Markets: IIEugene F. Fama
Market Efficiency, Long-Term Returns, and Behavioral FinanceEugene F. Fama
III. Efficiency Applied: Event Studies and SkillFama, Fisher, Jensen, and Roll (1969): Retrospective Comments
Ray Ball
Eugene Fama and Industrial OrganizationDennis W. Carlton
The Adjustment of Stock Prices to New InformationEugene F. Fama, Lawrence Fisher, Michael C. Jensen, and Richard Roll
Luck versus SkillJohn H. Cochrane and Tobias J. Moskowitz
Luck vs. Skill and Factor SelectionCampbell R. Harvey and Yan Liu
Luck versus Skill in the Cross-Section of Mutual Fund ReturnsEugene F. Fama and Kenneth R. French
IV. Risk and ReturnRisk and Return
John H. Cochrane and Tobias J. Moskowitz
Risk, Return, and Equilibrium: Empirical TestsEugene F. Fama and James D. MacBeth
The Cross-Section of Expected Stock ReturnsEugene F. Fama and Kenneth R. French
Common Risk Factors in the Returns on Stocks and BondsEugene F. Fama and Kenneth R. French
Multifactor Explanations of Asset Pricing AnomaliesEugene F. Fama and Kenneth R. French
V. Return Forecasts and Time-Varying Risk PremiumsReturn Forecasts and Time Varying Risk Premiums
John H. Cochrane
Short-Term Interest Rates as Predictors of InflationEugene F. Fama
Forward Rates as Predictors of Future Spot RatesEugene F. Fama
Forward and Spot Exchange RatesEugene F. Fama
Dividend Yields and Expected Stock ReturnsEugene F. Fama and Kenneth R. French
The Information in Long-Maturity Forward RatesEugene F. Fama and Robert R. Bliss
VI. Corporate Finance and BankingCorporate Finance
Amit Seru and Amir Sufi
Agency Problems and the Theory of the FirmEugene F. Fama
Separation of Ownership and ControlEugene F. Fama and Michael C. Jensen
Dividend Policy: An Empirical AnalysisEugene F. Fama and Harvey Babiak
Disappearing Dividends: Changing Firm Characteristics or Lower Propensity to Pay?Eugene F. Fama and Kenneth R. French
Financing Decisions: Who Issues Stock?Eugene F. Fama and Kenneth R. French
Banking in the Theory of FinanceEugene F. Fama
Conclusion: Our Colleague, by John H. Cochrane and Tobias J. MoskowitzContributors
Buybacks
A short oped for the Wall Street Journal here on stock buybacks. As usual, they ask me not to post the whole thing for 30 days though you can find it ungated if you search. An excerpt:
Update:
Based on follow up commentary, it's pretty clear than 99% of people do not understand the point: It's not about what companies do with today's profits. The case for buybacks is not that cash must chase investment. The point of the tax cut is the profitability of new investment. Without that, somebody will still just sit on the cash. With that, money will find its way to new investment. Otherwise, we're just putting money from the right pocket to the left pocket. Investment in the end comes when it is profitable, looking forward. Nothing about who gets what part of today's profits has anything to do with it. I will stress this next time! A good learning experience.
Tyler Cowen has a good Bloomberg View focusing on this point, my emphasis:
... Buybacks do not automatically make shareholders wealthier. Suppose Company A has $100 cash and a factory worth $100. It has issued two shares, each worth $100. The company’s shareholders have $200 in wealth. Imagine the company uses its $100 in cash to buy back one share. Now its shareholders have one share worth $100, and $100 in cash. Their wealth remains the same.
Wouldn’t it be better if the company invested the extra cash? Wasn’t that the point of the tax cut? Perhaps. But maybe this company doesn’t have any ideas worth investing in. Not every company needs to expand at any given moment.
Now suppose Company B has an idea for a profitable new venture that will cost $100 to get going. The most natural move for investors is to invest their $100 in Company B by buying its stock or bonds. With the infusion of cash, Company B can now fund its venture.
[Left out: The alternative would be for company A to lend the money to company B or to buy its stock. But why are the managers of company A, out of its own ideas, better than its investors at spotting other companies with new projects to invest the stockholders’ money?]
The frequent rise in stock price when companies announce buybacks proves the point. In my example, Company A’s share price stays fixed at $100 when it buys back a share. But suppose before the buyback investors were nervous the company would waste $40 of the $100 cash. Imagine an overpriced merger or excessive executive bonuses. Not every investment is wise!
The $100, stuck inside Company A, would be valued by the market at $60 and the company’s total value would be $160, or $80 a share. If it spent the $100 to buy back one share, the other share would rise from $80 to $100, the value of its good factory.
When a company without great ideas repurchases shares, the price of the remaining shares rise. This stock price rise is no gift to shareholders. It is just the market’s recognition that $100 has been saved from inefficient investment.Full oped in 30 days.
Update:
Based on follow up commentary, it's pretty clear than 99% of people do not understand the point: It's not about what companies do with today's profits. The case for buybacks is not that cash must chase investment. The point of the tax cut is the profitability of new investment. Without that, somebody will still just sit on the cash. With that, money will find its way to new investment. Otherwise, we're just putting money from the right pocket to the left pocket. Investment in the end comes when it is profitable, looking forward. Nothing about who gets what part of today's profits has anything to do with it. I will stress this next time! A good learning experience.
Tyler Cowen has a good Bloomberg View focusing on this point, my emphasis:
A basic principle of economic reasoning is to think in terms of real resources, not just the first-round flows of money. If a major corporation engages in buybacks, that simply transfers money from one set of hands to another -- from the corporate entity to the shareholders. It doesn’t destroy real resources or determine their final disposition. The money could still go to a venture capital fund, or into private equity or a real estate investment trust, in addition to numerous other undertakings, all of which might boost investment and real wages.
On tariffs
An oped on tariffs, for Fox news here. That tariffs are bad is rather obvious to readers of this blog, but perhaps marshaling and digesting things we've known for 250 years is worthwhile.
In a remarkable achievement, President Trump has united the nation’s economists by proposing tariffs on imported steel and aluminum, tariffs designed to reduce imports of those goods. Tariffs are bad for the economy. Tariffs on raw materials, produced by machine-intensive dirty declining industries are worse. Trade is good.
Trade is good. Why? Follow the money. If China sells us, say, a solar panel, what does it do with the dollars? There is only one thing to do with dollars — buy American goods, invest in America, or buy our government debt. Oh, and we also get a nice cheap solar panel.
China might use the dollars to buy, say, wheat from Australia, so it looks like China sells us more than we sell them. But then Australia must use the dollars here in America. Dollars always come home to roost. So how much more one country sells us than we sell them — the “bilateral trade deficit” — really is pretty meaningless.
The rest of the world sells us more than we sell them. But the rest of the world uses every cent of the extra dollars it gets from that trade to invest in the U.S. and to buy our government bonds. If we sell the whole world exactly as much as they sell us every year — in other words, if there were no overall U.S. trade deficit — we’re the ones who would have to start saving huge much larger amounts of our incomes in order to invest in U.S. companies, give mortgages to people to buy houses, and to fund the governments’ $1 trillion deficits.
Think of it this way: You run a huge “trade deficit” with the grocery store. Why not grow your own food? Well, you’re not very good at growing food. And if you do, the grocer will not have money to buy what you make, or to give to the bank to fund your mortgage.
So, trade is good. And tariffs? Tariffs are not good. Tariffs on steel hurt businesses that use steel, especially those that compete with imported products made of steel. Tariffs hurt consumers, who pay more for steel-using products. But perhaps the greatest damage is to the steel industry itself. Tariffs, like all protection, shield the industry from competition. And industries shielded from competition do not innovate, do not cut costs, do not make better products. Only when the Big Three faced import competition did they start to make better cars, and cut costs.
If it is good for each country to protect its businesses with tariffs, then it is good for each state to do the same, i.e. California should keep out those cheap Arizona surfboards. A key to U.S. prosperity is precisely our Constitution’s firm ban on state politicians’ desire to please local industries with protection. Until the EU came along, the U.S. was the world’s largest free trade area. Hint: Bigger is better.
Why is this so hard to understand? Tariffs, like all protection from competition, are great for the protected business and its workers, at least for a while. If you're a practical businessperson you think the way to get the economy going is to just to replicate for the economy what is good for your business, and hand out protection to everyone. But protection only helps one business at the expense of all the others, and at the expense of consumers, and the damage is worse than the gain. What is good for an individual business is not good, scaled up, for the economy as a whole. Business people and bankers turned policy makers miss that.
Tariffs, like other protections, also help visible, large, and politically powerful constituencies. The larger pain is spread throughout the economy, in ways most of us may not even notice in day-to-day living. But it adds up.
Some of the blame belongs to Congress. The trade laws invite protection. The standard for protection is only that the industry is hurt. Imagine if United Airlines could demand that Southwest pay tariffs – an extra tax at an airport – and in order to do so United needs only to show that Southwest might hurt United’s profits.
The “national security” clause under which the Trump administration is acting is weaker still. Even the defense department doesn’t want this tariff!
We pass populist laws, and then count on administrations not to enforce them. Well, President Trump may help here too, by acting on silly laws and forcing Congress to pass sane laws.
Perhaps some of the blame belongs to economists as well. The words “deficit” and “imbalance” make it sound like something is wrong with trade.
Tariffs do have one thing going for them however – they’re better than quotas! With a tariff, at least we can measure and limit the damage — steel will be 25 percent too expensive. But you can still buy it when you need it. Under a quota, in which countries are only allowed to sell a certain amount, the damage can be much larger and you never even know.
John H. Cochrane is a Senior Fellow of the Hoover Institution and an Adjunct Scholar of the Cato Institute.
Updates:
There is so much good stuff on trade, it's hard to know when to stop. A friend writes
"we blockade wartime enemies to stop the flow of goods, and levy tariffs on ourselves to do the same thing!"
A colleague catches me being mercantilist. What if the dollars stay overseas, he asks? The answer is, Great! We can print dollars cheaper than the Chinese can make solar panels. Working to make exports to buy imports is a cost not a benefit. And if China wants to tax its citizens to send us cheap solar panels, or steel, the proper response is a nice thank you card with flowers and chocolates.
I cannot resist the urge to notice that at the same time we are imposing sanctions on Iran, Russia and North Korea to ... stop them from importing things. So, we are doing to ourselves exactly what we are dong at great expense to these, to hurt them.
A friend urged me to read the comments on Fox. If economists want to understand what we're up against this is a good sobering read. The amazing thing is that most of the commenters seem not to be steel workers or steel executives. They genuinely believe that laws which will force them to pay a lot more for the benefit of a very few, and will actually lower their wages or eliminate their jobs, are a good thing. They might get that banning machines is bad, but if the exact same thing -- produce more at lower cost -- is labeled "China," they don't. The art of rhetoric is understanding your audience's frame of mind, and these comments are a good education for us. Alas, I think explaining trade to the public, which is a bit like explaining why yes the earth goes around the sun from a scientific point of view, is so boring that most economists don't bother. Me included, usually, I must admit.
In a remarkable achievement, President Trump has united the nation’s economists by proposing tariffs on imported steel and aluminum, tariffs designed to reduce imports of those goods. Tariffs are bad for the economy. Tariffs on raw materials, produced by machine-intensive dirty declining industries are worse. Trade is good.
Trade is good. Why? Follow the money. If China sells us, say, a solar panel, what does it do with the dollars? There is only one thing to do with dollars — buy American goods, invest in America, or buy our government debt. Oh, and we also get a nice cheap solar panel.
China might use the dollars to buy, say, wheat from Australia, so it looks like China sells us more than we sell them. But then Australia must use the dollars here in America. Dollars always come home to roost. So how much more one country sells us than we sell them — the “bilateral trade deficit” — really is pretty meaningless.
The rest of the world sells us more than we sell them. But the rest of the world uses every cent of the extra dollars it gets from that trade to invest in the U.S. and to buy our government bonds. If we sell the whole world exactly as much as they sell us every year — in other words, if there were no overall U.S. trade deficit — we’re the ones who would have to start saving huge much larger amounts of our incomes in order to invest in U.S. companies, give mortgages to people to buy houses, and to fund the governments’ $1 trillion deficits.
Think of it this way: You run a huge “trade deficit” with the grocery store. Why not grow your own food? Well, you’re not very good at growing food. And if you do, the grocer will not have money to buy what you make, or to give to the bank to fund your mortgage.
So, trade is good. And tariffs? Tariffs are not good. Tariffs on steel hurt businesses that use steel, especially those that compete with imported products made of steel. Tariffs hurt consumers, who pay more for steel-using products. But perhaps the greatest damage is to the steel industry itself. Tariffs, like all protection, shield the industry from competition. And industries shielded from competition do not innovate, do not cut costs, do not make better products. Only when the Big Three faced import competition did they start to make better cars, and cut costs.
If it is good for each country to protect its businesses with tariffs, then it is good for each state to do the same, i.e. California should keep out those cheap Arizona surfboards. A key to U.S. prosperity is precisely our Constitution’s firm ban on state politicians’ desire to please local industries with protection. Until the EU came along, the U.S. was the world’s largest free trade area. Hint: Bigger is better.
Why is this so hard to understand? Tariffs, like all protection from competition, are great for the protected business and its workers, at least for a while. If you're a practical businessperson you think the way to get the economy going is to just to replicate for the economy what is good for your business, and hand out protection to everyone. But protection only helps one business at the expense of all the others, and at the expense of consumers, and the damage is worse than the gain. What is good for an individual business is not good, scaled up, for the economy as a whole. Business people and bankers turned policy makers miss that.
Tariffs, like other protections, also help visible, large, and politically powerful constituencies. The larger pain is spread throughout the economy, in ways most of us may not even notice in day-to-day living. But it adds up.
Some of the blame belongs to Congress. The trade laws invite protection. The standard for protection is only that the industry is hurt. Imagine if United Airlines could demand that Southwest pay tariffs – an extra tax at an airport – and in order to do so United needs only to show that Southwest might hurt United’s profits.
The “national security” clause under which the Trump administration is acting is weaker still. Even the defense department doesn’t want this tariff!
We pass populist laws, and then count on administrations not to enforce them. Well, President Trump may help here too, by acting on silly laws and forcing Congress to pass sane laws.
Perhaps some of the blame belongs to economists as well. The words “deficit” and “imbalance” make it sound like something is wrong with trade.
Tariffs do have one thing going for them however – they’re better than quotas! With a tariff, at least we can measure and limit the damage — steel will be 25 percent too expensive. But you can still buy it when you need it. Under a quota, in which countries are only allowed to sell a certain amount, the damage can be much larger and you never even know.
John H. Cochrane is a Senior Fellow of the Hoover Institution and an Adjunct Scholar of the Cato Institute.
Updates:
There is so much good stuff on trade, it's hard to know when to stop. A friend writes
"we blockade wartime enemies to stop the flow of goods, and levy tariffs on ourselves to do the same thing!"
A colleague catches me being mercantilist. What if the dollars stay overseas, he asks? The answer is, Great! We can print dollars cheaper than the Chinese can make solar panels. Working to make exports to buy imports is a cost not a benefit. And if China wants to tax its citizens to send us cheap solar panels, or steel, the proper response is a nice thank you card with flowers and chocolates.
I cannot resist the urge to notice that at the same time we are imposing sanctions on Iran, Russia and North Korea to ... stop them from importing things. So, we are doing to ourselves exactly what we are dong at great expense to these, to hurt them.
A friend urged me to read the comments on Fox. If economists want to understand what we're up against this is a good sobering read. The amazing thing is that most of the commenters seem not to be steel workers or steel executives. They genuinely believe that laws which will force them to pay a lot more for the benefit of a very few, and will actually lower their wages or eliminate their jobs, are a good thing. They might get that banning machines is bad, but if the exact same thing -- produce more at lower cost -- is labeled "China," they don't. The art of rhetoric is understanding your audience's frame of mind, and these comments are a good education for us. Alas, I think explaining trade to the public, which is a bit like explaining why yes the earth goes around the sun from a scientific point of view, is so boring that most economists don't bother. Me included, usually, I must admit.
Economists letter on tariffs
Once per decade or so it is worth revisiting the famous 1930 economists' letter on Tariffs. (The link, at econjournalwatch.org, has a concise history and links to more.) 1028 economists -- a huge proportion of the number then around -- signed the following, urging President Hoover to veto the Smoot Hawley tariff.
We know how it turned out. No, we did not win that trade war. Well, not until about 1945.
What will this one lead to? I see some hope in that President Trump is at last uniting the country. As Greg Mankiw points out
The darker possibility. Many administrations start with some policy victories -- judicial nominees, deregulation, tax reform -- and then over reach. This may be the start of over reach.
Rereading the letter, it is impressive for stressing simple truths that apparently remain mysterious to many even today. If we buy a good from overseas, the dollar must come back, either as a purchase of American goods or investment in American capital. Conversely that purchase or investment cannot happen if we do not allow foreigners to sell us things. Open trade is important to peace and stability, not just prosperity. It stresses the final effects on people who end up paying more and working less, not just downstream producers.
Plus ça change, plus c'est la même chose.
We know how it turned out. No, we did not win that trade war. Well, not until about 1945.
What will this one lead to? I see some hope in that President Trump is at last uniting the country. As Greg Mankiw points out
How often do Jeffrey Sachs and the Wall Street Journal editoral writers agree?Perhaps, as with DACA, the President using the existing law, which allows and even encourages widespread protectionism, this action will spur Congress to pass trade laws that require a bit more than vague "injury" to industry or "national security" fantasies. But I am straining to find a silver lining.
The darker possibility. Many administrations start with some policy victories -- judicial nominees, deregulation, tax reform -- and then over reach. This may be the start of over reach.
Rereading the letter, it is impressive for stressing simple truths that apparently remain mysterious to many even today. If we buy a good from overseas, the dollar must come back, either as a purchase of American goods or investment in American capital. Conversely that purchase or investment cannot happen if we do not allow foreigners to sell us things. Open trade is important to peace and stability, not just prosperity. It stresses the final effects on people who end up paying more and working less, not just downstream producers.
Plus ça change, plus c'est la même chose.
The undersigned American economists and teachers of economics strongly urge that any measure which provides for a general upward revision of tariff rates be denied passage by Congress, or if passed, be vetoed by the President.
We are convinced that increased protective duties would be a mistake. They would operate, in general, to increase the prices which domestic consumers would have to pay. By raising prices they would encourage concerns with higher costs to undertake production, thus compelling the consumer to subsidize waste and inefficiency in industry. At the same time they would force him to pay higher rates of profit to established firms which enjoyed lower production costs. A higher level of protection, such as is contemplated by both the House and Senate bills, would therefore raise the cost of living and injure the great majority of our citizens.
Few people could hope to gain from such a change. Miners, construction, transportation and public utility workers, professional people and those employed in banks, hotels, newspaper offices, in the wholesale and retail trades, and scores of other occupations would clearly lose, since they produce no products which could be protected by tariff barriers.
The vast majority of farmers, also, would lose. Their cotton, corn, lard, and wheat are export crops and are sold in the world market. They have no important competition in the home market. They can not benefit, therefore, from any tariff which is imposed upon the basic commodities which they produce. They would lose through the increased duties on manufactured goods, however, and in a double fashion. First, as consumers they would have to pay still higher prices for the products, made of textiles, chemicals, iron, and steel, which they buy. Second, as producers, their ability to sell their products would be further restricted by the barriers placed in the way of foreigners who wished to sell manufactured goods to us.
Our export trade, in general, would suffer. Countries can not permanently buy from us unless they are permitted to sell to us, and the more we restrict the importation of goods from them by means of ever higher tariffs the more we reduce the possibility of our exporting to them. This applies to such exporting industries as copper, automobiles, agricultural machinery, typewriters, and the like fully as much as it does to farming. The difficulties of these industries are likely to be increased still further if we pass a higher tariff. There are already many evidences that such action would inevitably provoke other countries to pay us back in kind by levying retaliatory duties against our goods. There are few more ironical spectacles than that of the American Government as it seeks, on the one hand, to promote exports through the activity of the Bureau of Foreign and Domestic Commerce, while, on the other hand, by increasing tariffs it makes exportation ever more difficult. President Hoover has well said, in his message to Congress on April 16, 1929, “It is obviously unwise protection which sacrifices a greater amount of employment in exports to gain a less amount of employment from imports.”
We do not believe that American manufacturers, in general, need higher tariffs. The report of the President’s committee on recent economics changes has shown that industrial efficiency has increased, that costs have fallen, that profits have grown with amazing rapidity since the end of the war. Already our factories supply our people with over 96 percent of the manufactured goods which they consume, and our producers look to foreign markets to absorb the increasing output of their machines. Further barriers to trade will serve them not well, but ill. Many of our citizens have invested their money in foreign enterprises. The Department of Commerce has estimated that such investments, entirely aside from the war debts, amounted to between $12,555,000,000 and $14,555,000,000 on January 1, 1929. These investors, too, would suffer if protective duties were to be increased, since such action would make it still more difficult for their foreign creditors to pay them the interest due them.
America is now facing the problem of unemployment. Her labor can find work only if her factories can sell their products. Higher tariffs would not promote such sales. We can not increase employment by restricting trade. American industry, in the present crisis, might well be spared the burden of adjusting itself to new schedules of protective duties.
Finally, we would urge our Government to consider the bitterness which a policy of higher tariffs would inevitably inject into our international relations. The United States was ably represented at the World Economic Conference which was held under the auspices of the League of Nations in 1927. This conference adopted a resolution announcing that “the time has come to put an end to the increase in tariffs and move in the opposite direction.” The higher duties proposed in our pending legislation violate the spirit of this agreement and plainly invite other nations to compete with us in raising further barriers to trade. A tariff war does not furnish good soil for the growth of world peace.
Tremors
A debt crisis does not come slowly and predictably. This year's short term bond holders, a very risk averse lot, are mostly interested in whether next year, new bondholders will show up, to lend the government money to pay this year's bondholders back. Bondholders can run on small jitters over that expectation.
When bondholders get nervous, they demand higher interest rates. More than higher interest rates, they diversify their portfolios, or just refuse. Debt gets "hard to sell" at any price. A different class of bondholders, willing to take risks for better rates, must come in to replace the safety-oriented clientele that currently holds short-term government debt.
As interest rates rise, interest costs on the debt rise. At $20 trillion of debt, when interest rates rise to 5%, interest costs rise to $1 trillion dollars, essentially doubling the deficit. That makes markets more nervous, they demand even higher interest rates, and when that spiral continues, you have a full blown debt crisis on your hands.
Short term debt compounds the problem. Since the US has borrowed very short term, interest increases make their way to the budget more quickly. If the US had borrowed everything in 30 year bonds, the spiral mechanism from higher rates to higher deficits would be cut off.
The crisis typically comes in bad times -- when in a war, recession, or financial crisis, the government suddenly needs to borrow a lot more and markets doubt its ability to repay.
But there is a case for a crisis to happen in good times as well. We have known for decades that the fundamental US problem is promised entitlement spending far beyond what our current tax system can fund. Markets have, sensibly I think, presumed that the US would fix this problem sooner or later. It's not that hard as a matter of economics. Well, say markets in 2005, OK for now, you have a war on terror and a war in Iraq on your hands, we'll trust you to fix entitlements later. Well, say markets in 2012, OK for now, you're recovering from a massive financial panic and great recession. We'll trust you to fix entitlements later, and we'll even lend you another $10 trillion dollars. But what's our excuse now? At 4% unemployment, after 8 years of uninterrupted growth, if we can't sit down now and solve the problem, when will we? Markets have a right to think perhaps America is so fractured we won't be able to fix this in time. Or, more accurately, markets have a right to worry that next year's markets will have that worry, and get out now.
All this is well known, and most commenters including me think that day is in the future. But the future comes often quicker than we think.
With that prelude, two pieces of news strike me as distant early warning signs. Here, from Torsten Sløk's excellent email distribution are two graphs of the bid-to-cover ratio in Treasury auctions.
Torsten's interpretation:
Again, we're not there yet, and I think we have a long way to go. But this is a little rumble.
The second tremor is Why International Investors Aren’t Buying U.S. Debt in the Wall Street Journal. The overall message is also that international investors are getting nervous.
US 10 year yields are 2.9% already. German yields are 0.68%. Why aren't people buying our debt? Well, number one, they are worrying a further slide in the dollar. Which comes when next year's international bond holders really don't want to hold US debt.
Most of the article is.. well, difficult for this former finance professor to follow. The article claims that one used to be able to lock in the difference, "Last year, buying Treasurys and swapping the proceeds back into euros provided European investors with a higher return than buying German sovereign bonds."[my emphasis] This sounds like arbitrage, "covered interest parity violations." That arbitrage is not perfect, but my impression is that it's not whole percentage points either. And you really can't lock in 10 years of funding. Besides which, someone else is on the risk-taking side of the swap. So the interviewed traders must be only partially hedging the difference. Perhaps it's really "uncovered interest parity," where you borrow Europe 0.68% invest in the US 2.9% and pray or only partially hedge the exchange rate risk. (On that, "The New Fama Puzzle by Matthieu Bussiere, Menzie D. Chinn, Laurent Ferrara, Jonas Heipertz, blog post at econbrowser documents that uncovered interest parity, where you invest in the high yield currency and take the risk, is losing its profitability. Interest spreads seem to correspond to future exchange rate changes after all.)
All to follow up on for another day. Mostly, it rang a bell as a little tremor that people who answer WSJ reporter's phone calls are expressing nervousness about US debt.
Again, these are little rumbles. I still think that a full blown crisis will come only amid a large international crisis, featuring some big country defaults (Italy?), big financial trouble in China, perhaps a war, state and local pension failures, and the US comes to markets with unresolved entitlements and asks for another $10 trillion. But I could be wrong. We live on an earthquake fault of debt, and the one thing I know from my own past forecasting ability (I have lived through 1987, the dot com boom and bust, 2008, the recent boom, and more, and saw none of them coming in real time) that I will not see it coming either.
Update: Reply to Benjamin Cole, below. The US has never spent less on defense, as a fraction of GDP or of the federal budget, than it is doing today, since the 1930s. Here is defense / GDP. Defense / federal budget is even less, as the budget has expanded as a share of GDP.
When bondholders get nervous, they demand higher interest rates. More than higher interest rates, they diversify their portfolios, or just refuse. Debt gets "hard to sell" at any price. A different class of bondholders, willing to take risks for better rates, must come in to replace the safety-oriented clientele that currently holds short-term government debt.
As interest rates rise, interest costs on the debt rise. At $20 trillion of debt, when interest rates rise to 5%, interest costs rise to $1 trillion dollars, essentially doubling the deficit. That makes markets more nervous, they demand even higher interest rates, and when that spiral continues, you have a full blown debt crisis on your hands.
Short term debt compounds the problem. Since the US has borrowed very short term, interest increases make their way to the budget more quickly. If the US had borrowed everything in 30 year bonds, the spiral mechanism from higher rates to higher deficits would be cut off.
The crisis typically comes in bad times -- when in a war, recession, or financial crisis, the government suddenly needs to borrow a lot more and markets doubt its ability to repay.
But there is a case for a crisis to happen in good times as well. We have known for decades that the fundamental US problem is promised entitlement spending far beyond what our current tax system can fund. Markets have, sensibly I think, presumed that the US would fix this problem sooner or later. It's not that hard as a matter of economics. Well, say markets in 2005, OK for now, you have a war on terror and a war in Iraq on your hands, we'll trust you to fix entitlements later. Well, say markets in 2012, OK for now, you're recovering from a massive financial panic and great recession. We'll trust you to fix entitlements later, and we'll even lend you another $10 trillion dollars. But what's our excuse now? At 4% unemployment, after 8 years of uninterrupted growth, if we can't sit down now and solve the problem, when will we? Markets have a right to think perhaps America is so fractured we won't be able to fix this in time. Or, more accurately, markets have a right to worry that next year's markets will have that worry, and get out now.
All this is well known, and most commenters including me think that day is in the future. But the future comes often quicker than we think.
With that prelude, two pieces of news strike me as distant early warning signs. Here, from Torsten Sløk's excellent email distribution are two graphs of the bid-to-cover ratio in Treasury auctions.
The first chart below shows that the bid-to-cover ratio at 4-week T-bill auctions is currently at the lowest level in almost ten years.... demand is also structurally weaker when you look at 10-year auctions, see the second chart. The main risk with issuing a lot of short-dated paper such as 4-week T-bills is that in 4 weeks it all needs to be rolled over and added to new issuance in the pipeline. In other words, the more short-dated paper is issued, the bigger the snowball in front of the US Treasury gets.
Things are so far looking ok, but the risks are rising that the US could have a full-blown EM-style fiscal crisis with insufficient demand for US government debt, and such a loss of confidence in US Treasury markets would obviously be very negative for the US dollar and US stocks and US credit. The fact that this is happening with a backdrop of rising inflation is not helpful. Investors in all asset classes need to watch very carefully how US Treasury auctions go for any signs of weaker demand.The last part is the mechanism I described above. As an ivory tower economist, I tend to overlook such technical issues. If the bid to cover ratio is low, well, then that just means we need higher rates. But higher rates aren't a panacea as above, since higher rates make paying it back harder still. As I look at debt crises, also, it isn't just a matter of higher rates. There comes a point that the usual people aren't buying at all.
Again, we're not there yet, and I think we have a long way to go. But this is a little rumble.
The second tremor is Why International Investors Aren’t Buying U.S. Debt in the Wall Street Journal. The overall message is also that international investors are getting nervous.
US 10 year yields are 2.9% already. German yields are 0.68%. Why aren't people buying our debt? Well, number one, they are worrying a further slide in the dollar. Which comes when next year's international bond holders really don't want to hold US debt.
Most of the article is.. well, difficult for this former finance professor to follow. The article claims that one used to be able to lock in the difference, "Last year, buying Treasurys and swapping the proceeds back into euros provided European investors with a higher return than buying German sovereign bonds."[my emphasis] This sounds like arbitrage, "covered interest parity violations." That arbitrage is not perfect, but my impression is that it's not whole percentage points either. And you really can't lock in 10 years of funding. Besides which, someone else is on the risk-taking side of the swap. So the interviewed traders must be only partially hedging the difference. Perhaps it's really "uncovered interest parity," where you borrow Europe 0.68% invest in the US 2.9% and pray or only partially hedge the exchange rate risk. (On that, "The New Fama Puzzle by Matthieu Bussiere, Menzie D. Chinn, Laurent Ferrara, Jonas Heipertz, blog post at econbrowser documents that uncovered interest parity, where you invest in the high yield currency and take the risk, is losing its profitability. Interest spreads seem to correspond to future exchange rate changes after all.)
All to follow up on for another day. Mostly, it rang a bell as a little tremor that people who answer WSJ reporter's phone calls are expressing nervousness about US debt.
Again, these are little rumbles. I still think that a full blown crisis will come only amid a large international crisis, featuring some big country defaults (Italy?), big financial trouble in China, perhaps a war, state and local pension failures, and the US comes to markets with unresolved entitlements and asks for another $10 trillion. But I could be wrong. We live on an earthquake fault of debt, and the one thing I know from my own past forecasting ability (I have lived through 1987, the dot com boom and bust, 2008, the recent boom, and more, and saw none of them coming in real time) that I will not see it coming either.
Update: Reply to Benjamin Cole, below. The US has never spent less on defense, as a fraction of GDP or of the federal budget, than it is doing today, since the 1930s. Here is defense / GDP. Defense / federal budget is even less, as the budget has expanded as a share of GDP.
Summer Course: Intensive Longitudinal Methods - Introduction and Data Analysis Camp
See below for details of what looks like a very useful summer course being run in Aberdeen.
Summer Course: Intensive Longitudinal Methods - Introduction and Data Analysis Camp
Instructors: Dr Gertraud Stadler, Dr Dan Powell, and Prof Niall Bolger
Date: 23rd - 27th July, 2018
Location: University of Aberdeen, Scotland, UK
A 5-day course covering the design and analysis of intensive longitudinal studies.
Early bird date for registration is Monday, 16th April 2018.
This five-day course provides an introduction to designing and analysing intensive longitudinal studies. Intensive longitudinal methods allow researchers to examine processes in daily life in a way that is not possible using traditional methods. Researchers can obtain repeated observations over the course of hours, days, and weeks, and often even longer. Intensive longitudinal data, however, present multiple design and data analytic challenges stemming from the various possible sources of interdependence in these data. This course will help participants in choosing their design in line with their theoretical questions, and practice analysing intensive longitudinal data with example data sets and their own data.
For further information, including details on how to book a place, please visit our website https://www.abdn.ac.uk/iahs/research/health-psychology/ilm-aberdeen-summer-course-1367.php or contact lyn.ajanaku@abdn.ac.uk, our workshop administrator.
Summer Course: Intensive Longitudinal Methods - Introduction and Data Analysis Camp
Instructors: Dr Gertraud Stadler, Dr Dan Powell, and Prof Niall Bolger
Date: 23rd - 27th July, 2018
Location: University of Aberdeen, Scotland, UK
A 5-day course covering the design and analysis of intensive longitudinal studies.
Early bird date for registration is Monday, 16th April 2018.
This five-day course provides an introduction to designing and analysing intensive longitudinal studies. Intensive longitudinal methods allow researchers to examine processes in daily life in a way that is not possible using traditional methods. Researchers can obtain repeated observations over the course of hours, days, and weeks, and often even longer. Intensive longitudinal data, however, present multiple design and data analytic challenges stemming from the various possible sources of interdependence in these data. This course will help participants in choosing their design in line with their theoretical questions, and practice analysing intensive longitudinal data with example data sets and their own data.
For further information, including details on how to book a place, please visit our website https://www.abdn.ac.uk/iahs/research/health-psychology/ilm-aberdeen-summer-course-1367.php or contact lyn.ajanaku@abdn.ac.uk, our workshop administrator.
A great EFG
On Friday, I went to the NBER EFG (Economic Fluctuations and Growth) meeting at the SF Fed. Program and papers here. The papers were great, the discussions were great, the comments were great, even the food was good. (You know you're in California when the conference snack is avocado toast.)
The papers:
1) Fatih Guvenen, Gueorgui Kambourov, Burhanettin Kuruscu, Sergio Ocampo-Diaz, Daphne Chen, "Use It Or Lose It: Efficiency Gains from Wealth Taxation" Discussant: Roger H. Gordon.
If everyone earns 4% return on their investments, a 50% rate of return tax (combining corporate income and personal taxes) is the same thing as a 2% wealth tax. Everyone gets a 2% after tax return on their investments.
But what if some people -- Mike, in the example, -- are skillful entrepreneurs and can earn 20% rate of return, while and others -- Fredo -- earn 0% returns. Now a 50% rate of return tax lowers Mike's return to 10% but has no effect on Fredo. If the government raises the same amount of money -- 10 cents -- from a 0.10/2.20 = 4.5% wealth tax, Mike earns a (1-0.045) x 1.20 -1 = 14.6% rate of return, and Fredo earns a - 4.5% rate of return. The incentive to be Mike rises, and to be Fredo declines.
The paper has a model with all sorts of useful bells and whistles -- you want these to do tax policy -- building on this intuition. The model fits all sorts of facts including the wealth distribution. The wealth tax ends up helping workers too, because wages rise.
2) Matteo Maggiori, Brent Neiman, Jesse Schreger, "International Currencies and Capital Allocation"
Discussant: Harald Uhlig (funniest discussion award)
Mutual funds have a strong home currency bias, which completely drives out home bias. These investors like to hold bonds in their own currency, but not necessarily issued by companies in their home country. If you want to sell bonds to Canadians -- even Canadian mutual funds -- sell them in Canadian dollars. There is one exception: the dollar. When funds branch out to other currencies, they start with dollars. Likewise, small companies primarily raise money in their own currency. When they branch out, they start with dollars.
3) Katarína Borovičková, Robert Shimer, "High Wage Workers Work for High Wage Firms" Discussant: Isaac Sorkin
A clever measure of correlation, showing that, as the title says, high wage workers work for companies that pay high average wages, and also low wage workers work for companies that pay low wages. This seems obvious, but it has not been in the data. The previous approach to this question by Abowd, Kramarz and Margolis (1999) found no correlation. A big discussion about correlation vs the AKM regression estimate. It turns out the definition of correlation is very subtle, and depends on the kind of search model you have in mind.
Ellen McGratten asked a sharp question: Wait, if a firm outsources its janitors, does this not spike? Really we are learning about the boundaries of the firm. Answer yes, and really we want to know whether high wage people work with other high wage people. More discussion about what the fact means about joint production and the sorting and matching process.
4) Marcus Hagedorn, Iourii Manovskii, Kurt Mitman, "The Fiscal Multiplier" Discussant: Adrien Auclert
The papers:
1) Fatih Guvenen, Gueorgui Kambourov, Burhanettin Kuruscu, Sergio Ocampo-Diaz, Daphne Chen, "Use It Or Lose It: Efficiency Gains from Wealth Taxation" Discussant: Roger H. Gordon.
If everyone earns 4% return on their investments, a 50% rate of return tax (combining corporate income and personal taxes) is the same thing as a 2% wealth tax. Everyone gets a 2% after tax return on their investments.
But what if some people -- Mike, in the example, -- are skillful entrepreneurs and can earn 20% rate of return, while and others -- Fredo -- earn 0% returns. Now a 50% rate of return tax lowers Mike's return to 10% but has no effect on Fredo. If the government raises the same amount of money -- 10 cents -- from a 0.10/2.20 = 4.5% wealth tax, Mike earns a (1-0.045) x 1.20 -1 = 14.6% rate of return, and Fredo earns a - 4.5% rate of return. The incentive to be Mike rises, and to be Fredo declines.
The paper has a model with all sorts of useful bells and whistles -- you want these to do tax policy -- building on this intuition. The model fits all sorts of facts including the wealth distribution. The wealth tax ends up helping workers too, because wages rise.
In the simulated model calibrated to the U.S. data, a revenue-neutral tax reform that replaces capital income tax with a wealth tax raises welfare by about 8% in consumption-equivalent terms. ... optimal wealth taxes result in more even consumption and leisure distributions (despite the wealth distribution becoming more dispersed)...wealth taxes can yield both efficiency and distributional gainsMuch discussion, centering on whether skill really is tied to returns.
2) Matteo Maggiori, Brent Neiman, Jesse Schreger, "International Currencies and Capital Allocation"
Discussant: Harald Uhlig (funniest discussion award)
Mutual funds have a strong home currency bias, which completely drives out home bias. These investors like to hold bonds in their own currency, but not necessarily issued by companies in their home country. If you want to sell bonds to Canadians -- even Canadian mutual funds -- sell them in Canadian dollars. There is one exception: the dollar. When funds branch out to other currencies, they start with dollars. Likewise, small companies primarily raise money in their own currency. When they branch out, they start with dollars.
3) Katarína Borovičková, Robert Shimer, "High Wage Workers Work for High Wage Firms" Discussant: Isaac Sorkin
A clever measure of correlation, showing that, as the title says, high wage workers work for companies that pay high average wages, and also low wage workers work for companies that pay low wages. This seems obvious, but it has not been in the data. The previous approach to this question by Abowd, Kramarz and Margolis (1999) found no correlation. A big discussion about correlation vs the AKM regression estimate. It turns out the definition of correlation is very subtle, and depends on the kind of search model you have in mind.
Ellen McGratten asked a sharp question: Wait, if a firm outsources its janitors, does this not spike? Really we are learning about the boundaries of the firm. Answer yes, and really we want to know whether high wage people work with other high wage people. More discussion about what the fact means about joint production and the sorting and matching process.
4) Marcus Hagedorn, Iourii Manovskii, Kurt Mitman, "The Fiscal Multiplier" Discussant: Adrien Auclert
This paper is about repairing the ridiculously huge estimates of fiscal multipliers in New-Keyensian models at the zero bound. There is a lot going on including heterogenous agents with financing constraints, which I can't review.
Here's one thing I learned from it -- naturally related to the issues I have thought about in this context in "the new-Keynesian liquidity trap" here. Building on an earlier paper by Hagedorn, they posit a money-like demand for government debt. Thus they have nominal debt/price level = function of something real. Like the fiscal theory, in which nominal debt/price level = expected present value of real surpluses, and like MV=PY, this can determine the price level, and thus pick equilibria. They pick equilibria with limited inflation jumps, which like the fiscal theory serves to limit the size of the usual huge multipliers. The money-like nature of government bonds, whether from a backing theory like the fiscal theory, or from this mechanism similar to money demand, is a common thread to many resolutions of new-Keynesian paradoxes. And it offers a much more conservative way forward than fundamental surgery, such as abandoning rational expectations.
5) Carlos Garriga, Aaron Hedlund, "Housing Finance, Boom-Bust Episodes, and Macroeconomic Fragility" Discussant: Guido Lorenzoni
I'm really impressed with the detail of modern housing models like this. Rent vs. own decisions, supply of rental housing, search and transactions costs to change housing, incomplete markets, realistic mortgages, mortgage default, adjustment costs, nonseparable housing and nonhousing consumption, refinancing, cash-out refinancings, and I probably missed half of it. Solve, match a bunch of facts, analyze a crisis and policy alternatives.
6) John Kennan, "Spatial Variation in Higher Education Financing and the Supply of College Graduates" Discussant:Danny Yagan
Different states subsidize college education to different degrees. Does having a great state university pay off, in that you get a better workforce? Or do your graduates just all leave to New York and work for investment banks, or to Palo Alto to work for Google? Apparently not.
Slok on QE, and a great paper
DB's Torsten Sløk writes in his regular email analysis:
I'm interested by the latter tension: Industry and media commenters are deeply convinced that the zero interest rate and QE period had massive effects on financial markets, in particular lowering risk premiums and inflating price bubbles.
I'm deep in the academic view. The industry view forgets that the Fed does not just suck up bonds, it issues interest-bearing reserves in exchange. For every $1 of bond the market does not hold, the market has to hold $1 of additional reserves. Industry analysis is very insightful about individual traders and investors and the mechanics of markets but forgets about adding up constraints and equilibrium which are the bread and butter of academia. You personally may sell a bond and put the money in to stocks. But someone else has to sell you that stock and hold the reserves.
The risk premium is the same if you borrow at 2% and lend at 4% than if you borrow at 4% and lend at 6%. So there is no relationship at all in basic economics between the level of interest rates and the risk premium, or between the maturity structure of outstanding government debt (reserves are just overnight government debt) and the risk premium. That one cannot see any movement at all in 10 year rates or inflation with QE is also noteworthy.
But us academics need to listen as well as to lecture. Often industry people know something we don't. So I find this striking difference interesting. Though I haven't changed my mind yet.
Torsten wrote back:
TS: But that argument only holds in a closed economy, no? In other words, what if the US based seller of Treasuries to the Fed took the proceeds of their sale of US Treasuries and invested it in Indonesian government bonds?
JC: Then the seller of Indonesian government bonds now is sitting on US reserves.
TS: And what it the European insurance company used the cash they get for selling bunds to the ECB to buy US IG credit?
JC: Then the seller of US IG credit is now sitting on reserves. Someone is sitting on reserves. And reserves are now just very short term Treasury debt.
TS: Anyways, you may say the market view is partial equilibrium but almost everyone in the industry saw the portfolio substitution with their own eyes and believe that it is real.
JC: That helps. Yes, but they saw one side of the portfolio susbstitution. They did not see the other side of that substitution! I think in the end it's mostly foreign banks now sitting on the reserves, so those banks took deposits from someone who sold securities to your industry contacts.
A fascinating conversation..
The monetary policy forum is here. The paper is "A Skeptical View of the Impact of the Fed’s Balance Sheet'' by David Greenlaw (Morgan Stanley, so not everyone in industry has the industry view!) Jim Hamilton, Ethan S. Harris (Bank of America Merrill Lynch), and Ken West. It's excellent. It takes 96 pages (plus graphs) to put to rest verities that have been passed around unquestioningly for 8 years. Excerpts from the abstract:
A much-recycled graph showing 10 year rates have been trundling down for 20 years unaffected by QE or much of anything else, and that actual QE purchases - - increases in reserves -- are associated with higher 10 year rates:
Yesterday I participated in the annual US Monetary Policy Forum here in Manhattan, and the 96-page paper presented concluded that we don’t really know if QE has worked. This was also the conclusion of the discussion, where several of the FOMC members present actively participated. Nobody in academia or at the Fed is able to show if QE, forward guidance, and negative interest rates are helpful or harmful policies.
Despite this, everyone agreed yesterday that next time we have a recession, we will just do the same again. Eh, what? If we can’t show that a policy has worked and whether it is helpful or harmful how can we conclude that we will just do more next time? And if it did work, then removing it will have no consequences? There is a big intellectual inconsistency here.These lovely paragraphs encapsulate well the academic and industry/policy view, and the tension in the former.
Investors, on the other hand, have a different view. Almost all clients I discuss this topic with believe that QE lowered long rates, inflated stock prices, and narrowed credit spreads. Why? Because when the Fed and ECB buy government bonds, then the sellers of those government bonds take the cash they get and spend it on buying higher-yielding assets such as IG credit and dividend-paying equities. In other words, central bank policies lowered risk premia in financial markets, including in credit and equities. As QE, forward guidance, and negative interest rates come to an end, risk premia, including the term premium, should normalize and move back up again. And this process starts with the risk-free rate, i.e. Treasury yields moving higher, which is what we are observing at the moment.
I'm interested by the latter tension: Industry and media commenters are deeply convinced that the zero interest rate and QE period had massive effects on financial markets, in particular lowering risk premiums and inflating price bubbles.
I'm deep in the academic view. The industry view forgets that the Fed does not just suck up bonds, it issues interest-bearing reserves in exchange. For every $1 of bond the market does not hold, the market has to hold $1 of additional reserves. Industry analysis is very insightful about individual traders and investors and the mechanics of markets but forgets about adding up constraints and equilibrium which are the bread and butter of academia. You personally may sell a bond and put the money in to stocks. But someone else has to sell you that stock and hold the reserves.
The risk premium is the same if you borrow at 2% and lend at 4% than if you borrow at 4% and lend at 6%. So there is no relationship at all in basic economics between the level of interest rates and the risk premium, or between the maturity structure of outstanding government debt (reserves are just overnight government debt) and the risk premium. That one cannot see any movement at all in 10 year rates or inflation with QE is also noteworthy.
But us academics need to listen as well as to lecture. Often industry people know something we don't. So I find this striking difference interesting. Though I haven't changed my mind yet.
TS: But that argument only holds in a closed economy, no? In other words, what if the US based seller of Treasuries to the Fed took the proceeds of their sale of US Treasuries and invested it in Indonesian government bonds?
JC: Then the seller of Indonesian government bonds now is sitting on US reserves.
TS: And what it the European insurance company used the cash they get for selling bunds to the ECB to buy US IG credit?
JC: Then the seller of US IG credit is now sitting on reserves. Someone is sitting on reserves. And reserves are now just very short term Treasury debt.
TS: Anyways, you may say the market view is partial equilibrium but almost everyone in the industry saw the portfolio substitution with their own eyes and believe that it is real.
JC: That helps. Yes, but they saw one side of the portfolio susbstitution. They did not see the other side of that substitution! I think in the end it's mostly foreign banks now sitting on the reserves, so those banks took deposits from someone who sold securities to your industry contacts.
The monetary policy forum is here. The paper is "A Skeptical View of the Impact of the Fed’s Balance Sheet'' by David Greenlaw (Morgan Stanley, so not everyone in industry has the industry view!) Jim Hamilton, Ethan S. Harris (Bank of America Merrill Lynch), and Ken West. It's excellent. It takes 96 pages (plus graphs) to put to rest verities that have been passed around unquestioningly for 8 years. Excerpts from the abstract:
Most previous studies have found that quantitative easing (QE) lowered long term yields, with a rough consensus that LSAP purchases reduced yields on 10-year Treasuries by about 100 basis points. We argue that the consensus overstates the effect of LSAPs on 10-year yields...We find that Fed actions and announcements were not a dominant determinant of 10-year yields and that whatever the initial impact of some Fed actions or announcements, the effects tended not to persist.This is important. Most of the pro-QE evidence was how yields moved on specific QE announcements. We all know there is price pressure, but it usually lasts only a few hours or days. Much commentary has presumed the price pressure was permanent, as if there is a static demand curve or individual bonds. And the first work will naturally pick the events with the biggest announcement effects, then incorrectly generalize.
...the announcements and implementation of the balance-sheet reduction do not seem to have affected rates much.And implementation... When the Fed actually bought bonds, interest rates went up 2/3 times. See below.
Going forward, we expect the Federal Reserve’s balance sheet to stay large. This calls for careful consideration of the maturity distribution of assets on the Fed’s balance sheet.Mild objection. If QE has no effect, then the maturity distribution is irrelevant, as Modigliani and Miller would have predicted, no?
A much-recycled graph showing 10 year rates have been trundling down for 20 years unaffected by QE or much of anything else, and that actual QE purchases - - increases in reserves -- are associated with higher 10 year rates:
Deficits
The graph is federal surplus (up) or deficit (down), not counting interest costs, divided by potential GDP. I made it for another purpose, but it is interesting in these fiscally ... interesting .. times.
Taking interest costs out is a way of assessing overall fiscal stability. If you pay the interest on your credit card, the balance won't grow over time. Granted, interest costs are increasing -- 5% times a 100% debt/GDP ratio is a lot more than 5% times a 30% debt/GDP ratio, and interest costs threaten to crowd out much of the rest of the budget if interest rates go up. But still, as an overall measure of fiscal solvency, whether one way or another you are paying interest and then slowly working down debt, or if you are not even making the interest payments and the balance is growing over time, is the relevant measure.
I divided by potential rather than actual GDP so that we would focus on the deficits, and not see variation induced by GDP. If GDP falls, then it makes deficit/GDP larger. The point is to detrend and scale deficits by some measure of our long-run ability to pay them. Yes, deficits after 2008 are even larger as a fraction of actual rather than potential GDP. So this is the conservative choice.
Now, comments on the graph. Once you net out interest costs, it is interesting how sober US fiscal policy actually has been over the years. In economic good times, we run primary surpluses. The impression that the US is always running deficits is primarily because of interest costs. Even the notorious "Reagan deficits" were primarily payments, occasioned by the huge spike in interest rates, on outstanding debt. On a tax minus expenditure basis, not much unusual was going on especially considering it was the bottom of the (then) worst recession since WWII. Only in the extreme of 1976, 1982, and 2002, in with steep recessions and in the later case war did we touch any primary deficits, and then pretty swiftly returned to surpluses.
Until 2008. The last 10 years really have been an anomaly in US fiscal policy. One may say that the huge recession demanded huge fiscal stimulus, or one may think $10 trillion in debt was wasted. In either case, what we just went through was huge.
And in the last data point, 2017, we are sliding again into territory only seen in severe recessions. That too is unusual.
Disclaimer: All of these measures are pretty bad. Surplus/deficit has lots of questionable reporting in it, and the interest cost only has explicit coupon payments. I thought it better here to show you how the easily available common numbers work than to get into a big measurement exercise. I'll be doing that later for the project that produced this graph, and may update.
Update: Sometimes a blog post makes a small point that can easily be misinterpreted in the broader context. So it is here.
The US fiscal situation is dire. The debt is now $20 trillion, larger as a fraction of GDP than any time since the end of WWII. Moreover, the promises our government has made to social security, medicare, medicaid, pensions and other entitlement programs far exceeds any projection of revenue. Jeff Miron wrote to chide me gently for apparently implying the opposite, which is certainly not my intent. One graph from his excellent "US Fiscal Imbalance Over Time":
Here, Jeff adds up the promises made each year for spending over the next 75 years. Others, including Larry Kotlikoff, make the same point by discounting the future payments, to estimate that the actual debt -- the present value of what the US owes less what it will take in -- is between $75 trillion and $200 trillion -- much more than the $20 trillion of actual GDP.
I've been one of those guys wandering around with a sign "the debt crisis is coming" so long that I forget to reiterate the point on occasion, and Jeff rightly points out my graph taken alone could be so misinterpreted.
In a nutshell, the problem is this: The US has accumulated a huge debt. Interest costs on that debt are already in the hundreds of billions per year. If interest rates rise, those costs will rise more. $20 trillion of debt times 5% interest rate is $1 trillion extra deficit, or even faster-rising debt. Unlike the case after WWII, when the spending was in the past, the US has also promised huge amount of spending in the future.
And, as Jeff points out, this did not start in 2008. Entitlements have grown and crowded out regular spending. Now they are growing to crowd out interest payments. Soon they will grow more.
Update 2
Deficits / Potential GDP; Interest costs / Potential GDP; (Deficit + interest costs)/Potential GDP
Debt / GDP. (Thanks Vic Volpe for suggesting this better graph.)
