For the last decade or so, most of the English speaking countries have been running large and generally increasing trade deficits, and therefore running up increasing foreign debt. At the same time, until recently, both real and nominal world interest rates have been falling, which has made debt more affordable. This has produced a sense of security which is about to be reality-checked.
Short-term interest rates have been rising for the last couple of years, and now long-term rates are rising as well. The US 10-year bond rate is now 5.1 per cent, and has been rising fairly fast in recent weeks. The effect is to add a rising interest bill to a large and growing trade deficit. Brad Setser does the math for the US and it isn’t pretty.
If the average rate [on private and government debt] should rise to 6% — roughly the interest rate the US paid back in 2000 — the 2008 US interest bill would reach $420b. That is more than three times the 2005 interest bill.
Unless the trade deficit starts turning around fairly sharply, this would imply a current account deficit close to 10 per cent of GDP, which no country has ever sustained (please point out exceptions in comments).
The story for Australia is broadly similar, though the picture is complicated by the effects of commodity prices, which still seem to be generally rising. As long as that continues, our trade deficit should decline. But, high commodity prices have rarely been sustained for more than a few years at a stretch.
John Quiggin 
Chris C.
You have given me an answer to the question: Does the RBA have the know-how and ability to stop the major financial institutions from going bankrupt and hence prevent a total collapse of the monetary system.
My question was: What can the RBA do to control asset prices from increasing much faster than CPI changes (and wages)?
PS: I am not saying that ‘damage control’ is not important
I agree that M0 is not that controversial. You are not telling me anything I don’t already know which is why I did not see fit to respond previously.
M0 is currency in the hands or anybody other than the central bank. ie citizens, foreigner individuals, companies, private banks, foreign central banks. Plus it also includes currency held by the central bank which private banks (or others) have legally title over. In practice the latter might just mean the balance of the private banks settlement account or else statutory reserve account (for countries where these apply) held at the central bank.
When I say currency “in circulation” I mean M0. Clearly some of M0 is not in peoples wallets but may be in the vault of a foreign central bank. If I use the term “in circulation” in an unfamiliar manner then I apologise for any confusion.
I take it that your remark was meant to be patronising. Is this your way of saying that you have nothing to contribute?
No, it’s my way of saying I’ve repeatedly attempted to disabuse you of your delusion that a tax which 99% of Ethiopian farmers don’t pay has any immediate impact on their living standardfs.
But hey something bad is happening so obviously the iron fist of government oppression is at fault, you just need to find the right connecting mechanism.
By the way, I notice you’ve only posted around 20 posts on Wannisky, the gold standard and supply side economics today, I hope you’re feeling better soon and are back at full speed.
Of course most Ethipians don’t pay the higher tax. They are discouraged from ever earning that much (US$4000pa). Why improve your output if it involves commercial risk and 90% of any surplus that you do manage to produce gets taken away.
Which of course shows the utter futlitiy of such a tax. It raises no revenue because so few earn that much, yet it discourages the level of production that would allow the people to insulate themselves from the more severe hardships of future droughts.
You seem stuck on static tax analysis. Try a little dynamic tax analysis next time.
Terje, your comment is ridiculous on its face. The average income in Ethiopia is around $100. Yet you claim that a tax that cuts in at 40 times average income discourages all of them from earning, say, 30 times average income. Or even 2 times average income.
Yep. That’s a good argument.
Hey, I’ve got a good idea. Australia doesn’t have a tax like that, so let’s introduce one. It’ll cut in at an income of $2,000,000. 99% of us won’t pay it. But wait, here’s the good bit: we’ll repeal the tax and the people who didn’t pay it will suddenly be motivated to earn more than $2,000,000!!! Everyone in Australia will become multi-millionaires!!! Because they won’t be discouraged anymore!!!.
Chris C
I can assure you international credit creation is not determined by the BIS it is created entirely by central banks, payments imbalances and weird co-dependent relationships like the one China and the US have going.
Chris C
I can assure you international credit creation is not determined by the BIS it is created entirely by central banks, payments imbalances and weird co-dependent relationships like the one China and the US have going.
“Of course most Ethipians don’t pay the higher tax. They are discouraged from ever earning that much (US$4000pa).”
The average Ethiopian farmer probably earns under $1,000 per year. I doubt that the thought of being taxed at a high rate if he he quadruples his income is much of a deterrent when compared to the incentive of not starving.
“I can assure you international credit creation is not determined by the BIS it is created entirely by central banks, payments imbalances and weird co-dependent relationships like the one China and the US have going.”
I concur that the BIS does not “determine” the creation of international credit.
I dont’ agree that central banks in market oriented economies can force people to borrow or margin trade derivatives and import or export. But this would be required if central banks could “determine” international credit creation and payments imbalances.
There is also the small matter of international agreements on trade between the governments of countries.
Chris C,
By all means, rush in.
You seem pretty convinced you got this thing licked (as an aside, perhaps you can confirm whether or not ignorance is bliss). No doubt, the world central banks and primarily the Fed “deflated” the speculative equity bubble- indeed they did so by creating still larger and now proliferating speculative bubbles. No doubt the 1929-32 Fed did not step in as aggressively to reliquefy the system. Case closed? In a pig’s eye.
Here’s what I had said in my first comment on this thread: “Bottom line, whether central bankers will ‘pop’ the mother of all credit/asset bubbles is not in question- they certainly will not. The question is rather how much longer their acquiescence will remain relevant.”. I would only add to that that it is also highly probable (although less assured) that central bankers will aggressively attempt to resuscitate the credit markets and act as lender (i.e. printer) of last resort when this latest misadventure ends badly (I should say, ends so badly as to end all ending badlys). The remainder reads the same.
What does it all mean? Policy responses to the lead up and fallout of the great depression had their consequences. Similar policy responses to the speculative fervor of the 1990s combined with differing policy responses to its fallout, (the confidence scam), may not share the consequences of that period, but that doesn’t mean there won’t be consequences, and it doesn’t mean those consequences will be any less or even as dire. They certainly have the capacity to be worse.
Currency crises tend to have that effect, even for currencies that do not house the wealth of billions, (just fyi, here, larger is not better). It can be still worse when total debt to GDP is higher than in recorded history, as it currently is in the US. How to inflate your way out of a currency crisis I wonder? Perhaps you can provide more color on this novel idea. In any case, you should keep in mind that it is not necessary for “imbalances” to always lead to systemic collapse for central bankers to concern themselves with them. The fact that they heighten the possibility should be sufficient (that is, when you have central bankers with their heads, hands and feet outside of their colon).
One of the things you haven’t registered is that asset bubbles are not merely a financial phenomenon- they have massive implications for the real economy. Here’s Herbert Hoover on the subject:
“Whatever the remote causes may be, a large and immediate cause of most hard times is inflationary booms… These inflations in currency or credit, in land or securities, or overexpansion in some sort of commodity production beyond possible demand—even in good times—may take place at home or abroad; but they all bring retributionâ€?
I suggest you do more reading and less typing, and perhaps you’ll begin to grasp just what it is you seem to think you know a lot about. This and its follow-up are particularly good places to start.
Neato. Perhaps you can explain why the distinction is relevant. The bag holders are the (ultimate) providers of the savings currently being mostly sucked up by specious IOUs, (including some Oz originated), and by and large, these are Asian central banks and to a growing extent, petroleum exporters (with ancillary emerging markets contributing at the margin).
Chris C,
I’ve said my piece to disabuse you of this notion,
, however it does present an opportunity to elaborate on the nature of the current epidemic of trade and current account deficits. For starters, CADs themselves are indirectly related to asset bubbles. They are engines of credit creation, and credit creation is the fuel of asset speculation everywhere and for all time (an intuitive notion beguilingly difficult to properly grasp). The reverse causality is more direct- that asset bubbles fuel demand and hence trade and CA deficits. This positive feedback accounts for the pernicious self-reinforcing characteristic of CADs and asset bubbles.
In answer to a question that Katz raised, asset prices prime the demand pump, so the greater the degree to which credit creation is stoked, (either by stimulative fiscal or monetary policy), the greater the upward pressure on asset prices, the more the balance of trade is likely to turn unfavorable. There are other factors, including those relating to the jobs/economic activity most people think of a prosperous society creating, (hint: not selling real estate or managing bond portfolios), but from a policy makers perspective, these are the most controllable.
Andrew Reynolds,
The distinction is neither fundamental nor easy to grasp. They are indeed both resultant of indistinguishable monetary excess. Furthermore, there is no material difference in buying a good to be consumed now, over the course of a lifetime or in an investment, (or, as in the case of a residence, some combination of the three). They all have their respective markets that set their relative values based on the attributes that households and firms value, (in the case of investments, perceived yield per risk). Where the distinction comes into play is by the relative levels of consumer and asset inflation, as the difference accrues to demand stimulus via the wealth effect. See my prior comment.
Elementary Ernestine. Asset price bubbles are fueled by credit, and monetary/financial authorities have numerous levers at their control to ensure the soundness of specific credit creation (i.e. policy can be targeted at various areas of speculation). The Hunt brothers were made aware of this rather rudely when a change in margin requirements cost them the better part of their fortune (at least that part that could not be kept from the bankruptcy court). In the US at the moment, there are numerous regulatory steps the Fed, SEC, CFTC and Treasury/OCC could (and should) have been taking to clamp down on asset price problems including notably structured finance especially as it relates to residential real estate, speculative lending both in terms of regulating hedge fund capital margins and broker dealers, and getting a handle on the snake pit where they keep the derivatives dealers. I am less familiar with the scene in Oz, though I’m certain residential real estate remains a culprit and probably also a gold rush of sorts. Ultimately the monetary authority has a large inventory and can use it to restrict aggregate credit growth, the pain of which typically falls heaviest on the areas of unsound credit processes.
More generally the relationship between asset and consumer price inflation is highly complex. For example, one component of the dynamic certainly is the downward pressure on consumer price inflation that asset bubbles exert through their encouragement of overinvestment and, relatedly, overproduction. In any case, because of the degree of complexity involved, it is very difficult to say (and what’s more, highly controversial even excluding the highly compromised) whether and to what extent restricting asset bubbles results in disinflation or deflation and under what circumstances. A relevant topic perhaps too tricky for a casual blog.
Majorajam says: “Asset price bubbles are fueled by credit…” I agree, but not only by credit. The Howard Govt. has created the Future Fund, whereby large Budget surpluses are to be capitalised and used for investment in private sector assets. The Fund will have an initial capitalisation of $18b., forecasted to rise to (from memory) $140b. by 2020. This pile of taxpayers’ money will be administered by a Govt.-appointed Board in a way similar to any other investment fund. They have hired an ex-banker to Chair the Board. It isn’t hard to guess that the investments will help to prevent collapse of asset inflation, particularly the inflated values of financial assets.
I can’t help wondering whether the Bush Administration’s aborted attempt at “reform” of the Social Security system in the US wasn’t an attempt to do something similar, with a similar aim of preventing the collapse of asset markets by throwing good money after bad.
Majorjam,
You quoted my question to Chris C. and said “Elementary, Ernestine�. Unfortunately, Majorjam, you can’t convince me of this because you didn’t answer my question either.
My question to Chris C. was: What can the RBA [Reserve Bank of Australia] do to control asset prices from increasing much faster than CPI changes (and wages)?
One can form two sub-questions.:
a) What is the relationship between asset price changes and CPI and changes in wages..
b) Who can control asset price inflation?
Regarding a) you say: “More generally the relationship between asset and consumer price inflation is highly complex. …..……… A relevant topic perhaps too tricky for a casual blog.�
Regarding b) you say: “Asset price bubbles are fueled by credit, and monetary/financial authorities have numerous levers at their control to ensure the soundness of specific credit creation (i.e. policy can be targeted at various areas of speculation).�
I don’t agree with an approach where forebodings of economic calamities are put on a ‘casual blog’ but questions aimed at sorting out hype from observations of problems are side-stepped.
My question contained a hypothesis as to the conditions under which ‘asset price inflation’ becomes an ‘asset price bubble’, which will burst. I don’t know whether your notion of ‘asset price bubble’ corresponds to mine.
Credit not only influences asset prices, it also influences consumer goods prices (The USA led consumer credit ahead of Australia and continental Europe.). The relationship between credit and wages is more difficult, due to corporate borrowings and the growing income inequality, particularly between those who receive and pay wages within one enterprise and those who only receive wages.
So, who controls ‘credit’ creation? I can’t accept your statement.�…and monetary/financial authorities have numerous levers at their control to ensure the soundness of specific credit creation (i.e. policy can be targeted at various areas of speculation).� as universally applicable at all times. In my opinion, the answer depends on the institutional environment (regulatory).
To illustrate
1) You refer to the “snake pit of derivative dealers�. Why? People have to make a living and dealing in derivatives is one way to do that. In NSW (State in Australia) the Gaming Act had to be changed before derivative securities could be traded. This was done during the period of ‘financial deregulation’.
2) You refer to ‘real estate prices’. In some continental EC countries, real estate prices did not ‘inflate’. There may be several reasons, including demographics and the observation that governments provided both incentives for saving (slowing down trading) and controls on interest rates for investors versus owners. Another reason is that people aren’t very ‘mobile’.
3) Leveraged ‘investments’ in financial securities markets by individuals are often mortgaged to real estate. To try to influence real estate prices per se seems to be aiding the default spiral you were talking about. I am not aware that the RBA has the power to instruct banks not to lend for leveraged investment in financial securities.
The crucial question is: Do monetary authorities have the power to restrict the quantity of various types of financial securities (including zero constraint). Without this power, I can’t see how you can hold monetary authorities responsible for credit creation.
While I (and many others) agree with the proposition that credit expansion precedes a financial bubble, I hope you agree that the question, what precedes the conditions under which credit grows to an extent that is of concern to you is also interesting. I propose that the credit growth was preceded by changes in the regulatory environment (at least in some countries) and these were preceded by:
a) Return to the 19th century macro-economics via Milton Friedman.
b) The Accounting-Finance ‘school of thought’, as epitomised by Fama, Jensen and Meckling, as distinct from the Economics-Finance branch K. Arrow, R. Radner, O. Hart, D. Daffie. The former produced volumes of empirical studies on ‘the semi-strong form efficiency’ of share markets. This methodologically flawed work stopped on or immediately after the 1987 stock exchange crashes but lingers on in texts.
c) A ‘media management’ industry, which spreads mythologies under various names.
While the above enterprise (a to c) was going on, US (and others) academics, including those I would group into the Economics-Finance area (eg K. Arrow, R. Radner, O. Hart, D. Duffie) produced theoretical research which put (a) and (b) and the entire deregulation mania into doubt.
I am saying instead of spreading ill forebodings, it might be useful to first find out what the problem is.
Ernestine,
Appreciate the tale of antagonism, full of dramatic prattle and rhetorical pause, signifying that blogging is a particularly productive use of my time. If nothing else, you’ve scored one relevant point.
One doesn’t follow from another so your comment is nonsensical. I don’t write, “the global economy is in a precarious position because of the complex relationship between asset price inflation and consumer price inflation”. The tangent is the the why to which most of my posts have regarded the what. You’ve confused relation with equivalence.
My post continues below:
“Credit not only influences asset prices, it also influences consumer goods prices”
If that sounds familiar, it’s because in the post you responded to, I wrote, “They (asset and consumer price inflation) are indeed both resultant of indistinguishable monetary excess.” Read more carefully.
Continued below:
¿Que? The monetary/financial authorities are the regulators making this one of a number of asinine rebuttals.
Again, consistent if nothing else. Since you don’t know anything about the controversy surrounding derivatives, it may be worth your while read up before posting a bunch of jeopardy in answer to questions no one asked. In that, a reasonable place to start is with Warren Buffet’s running description of his multi-year epic of winding down General RE’s derivatives business (and there are numerous commentaries available at the click of a mouse).
Where? Have the courtesy if you’re going to expect a response to read what I have written and attempted to understand its meaning before inflicting more of your boilerplate on the blog.
Who’s talking about individuals? Again, figure out what it is I said or ask a question about it. Here again your ‘deductive reasoning’ is getting you into trouble.
First of all, your parenthetical is gibberish. Second of all, I posted a very concrete, very clear example of regulatory authorities popping a speculative bubble. As it turns out, the case is a special one and not generally representative. However, as a demonstration of how regulations (in this case, quasi-fractional banking regulations) can deflate credit/asset bubbles, it is instructive nonetheless. From that you should be able to infer at least some of the controls available to the authorities, of which, as stated, there are many.
___
The rest of your post is getting into another issue, whose ground was covered briefly before you sidestepped my response in another thread. That said, with the opening comment in mind, I can’t say that was a bad outcome.
Majorajam,
Thanks for the many words – a word bubble so to speak.
Contrary to your assertion, that the answer to my question is “elementary”, it remains unanswered.
My question was addressed to Chris C. and not to you. You chose to pick it.
My question was. What can the RBA do to control asset prices from increasing much faster than CPI changes (and wages)?
I now believe Chris C. put it rather aptly when he wrote: “Before you keel over at the sheer grandeur of the forthcoming collapse, lets all understand something ..”
You mention that I sidestepped your response in another thread. Please let me know which one and I’ll see if a response is required.
Have a good day.
Ernestine,
I would have thought that the way to have CPI move higher than asset price inflation would be to re-inflate the economy. This would prioritise current consumption over long term investment in most participants in the economy, with the increased uncertainty also having the same effect.
This would tend to cause asset prices to drop rapidly, but it may not be desirable.
Andrew,
My question is still: “What can the RBA do to control asset prices from increasing much faster than CPI changes (and wages)?” I believe this question is important for the topic of this thread.
As you may appreciate, the documentation of regulatory measures since the first unpleasant experience with ‘deregulation of the financial system’ in the 1980s has grown a lot. There is Basel I, Basel II, Basel III, and local interpretations. If you happen to have a concise summary document of the current regulatory power of the RBA, I’d be most grateful getting it. If not, don’t worry, I can search for it myself.
There is very little the RBA can do, Ernestine. It no longer has the regulatory power – that is now in the hands of APRA. The RBA only has, essentially, macro-economic power over the Banks, by the control of some of the reserve ratios – very blunt instruments.
The last real attempt by the government was the move to only allow 80% geared housing loans to attract the concessional 35% weighting under Basel I (the current accord). All that happened was the explosion of the mortgage insurance industry. The next one, Basel II, may change matters by enforcing the use of stress tests for capital weights. Given the loss ratios, particularly on housing loans, over the last 10 years, though, I would not hold my breath.
Essentially, if you want to try to reduce asset prices by qualitative, or even quantitative, controls the current regime only has limited ability to do it – correctly, IMHO. The chances that a bureaucrat or politician could get the ratios right, and make them watertight, is pretty low and the economic damage of them is worse than an asset bubble.
To me, I think the majority of the recent climb in asset values is rational – there may have been some overshoot, but people seem to be pricing in an expectation that inflation has dropped for the foreseeable future. They are buying houses in the expectation that real interest rates will not climb too high. That expectation may prove wrong (no one has a crystal ball) but it does not appear irrational.
Maybe I should do some work on the wikipedia entry for the RBA and APRA.
o.k. Andrew, I get the information myself.
Ernestine,
Monetary authorities can prevent asset prices from racing ahead of consumer prices by appropriately regulating intermediation, i.e. doing their job. It’s as simple as that. The late 20th and early 21st century boom in asset prices was an animal of a credit juggernaut unprecedented in history. But the dependency is mutual, and therein lies the insight. Credit directed toward assets inflates prices, makes people wealthy, encourages and makes room for still more credit growth. The credit apparatus calcifies, metastasizes and is nourished again.
In my original post to you, I listed a number of specific ways that monetary authorities have not done the job of regulating intermediaries and securities markets, replete with historical examples of the opposite. You didn’t realize that what you read was an answer? Well, have I got news for you: your ignorance is not my problem.
Majorajam,
The fact that you have cited Herbert Hoover on economics is amusing … and worrying.
Asset bubbles do NOT need to have sustained impacts on the real economy, and nothing you have said, despite all the wordiness has demonstrated any clear linkages that would nullify this assertion.
Sufficient liquidity CAN ALWAYS be created to obviate the potential aftereffects of an asset bubble. The main problem is knowing when to turn the tap off afterwards.
You have also conclusively failed, despite all the bluster, to explain how a currency crisis MUST NECESSARILY lead to either systemic monetary collapse or depression.
WRT:
WRT:
MAJORAM: “1) Creditors most notably holding the bag, in our case currency manipulating central banks, pull the plug. �
CHRIS C: Are you talking about Australia? If so, dya mean the Govt or private borrowers? Because last time I looked, our Govt has NO foreign-denominated (or $A denominated) debt.
MAJORAJAM: Neato. Perhaps you can explain why the distinction is relevant. The bag holders are the (ultimate) providers of the savings currently being mostly sucked up by specious IOUs, (including some Oz originated), and by and large, these are Asian central banks and to a growing extent, petroleum exporters (with ancillary emerging markets contributing at the margin).
It is actually your job to explain why the distinction is NOT important. If I as Private Citizen Chris C owe zero to overseas creditors, and my Govt owes zero to them, what the heck do I care that Private Citizens X, Y, Z, and J owe billions overseas?
If they default on their debts, I may incur some externalities via an increase in my interest rates (although they should still be lower than they would be in an autarkic state), and the currency in which my assets are denominated in will depreciate, but I still dont understand how other people’s CAD is conflated with my welfare???
Ernestine,
Do you really doubt the power of the RBA to affect asset prices in the wake of its actions during the late 1980s, early 1990s?
Or do you think ‘the world has changed’ since then?
Chris,
I think you misread Ernestine. He did not deny an ability for central bank monetary policy to effect asset prices. What he said was:-
“What can the RBA do to control asset prices from increasing much faster than CPI changes (and wages)?�
I think that a partial answer lies in the difference between controlling consumer price inflation and controlling wage inflation. For assets such as realestate I think wages growth is one of the factors in price rises. However there are also other factors such as capital gains tax etc which change the relative merits of paying a given amount for an asset.
I think also that there is something to be said about using interest rate targets rather than commodity targets to control consumer price inflation but I will bite my lip on that for the moment.
Regards,
Terje.
Terje, Ernestine,
My apologies.
WRT to controlling asset inflation vis-a-vis CPI, I do not think that that should be the role of the RBA (or anyone else for that matter).
Just like the RBA does not seek to keep milk price increases equal to petrol price increases, it should also not seek to align the price increases of any individual item.
Rather, it should be targetting some weighted basket of consumer goods (as it does now) but also somehow include assets in the basket.
If you are asking how that ‘somehow’ would be done, well that is more difficult.
But lets sya you wanted to control asset price growth – the RBA could specifically target the rate of growth of assets through the mechanisms described by Majorajam earlier.
The RBA actually has a lot of power over the regulation of credit and where it can flow to, but chooses (rightly) not to use it 90% of the time.
Not strictly on topic, but this thread on catallaxy is very helpful on economics generally and should be good reading for those advocating a drop in growth in particular.
Neither do I. And from what I can tell nor does Ernestine. The idea that the central bank should control both the rate of change in the CPI and asset prices is something that Majorajam is promoting.
For what it is worth my view is that a central bank that controls commodity prices (via a gold price target or similar) will by implication control consumer prices. And that by floating interest rates the credit markets will autostabilise more readily avoiding extreme asset price cycles.
I must say however that I have a lot of time for Majorajam when it comes to monetary policy because unlike most people here he seems to implicitly appreciate that an increase in output typically leads to a decline in prices (everything else being equal, ie static money supply). He does not seem to be weded to the errant notion that economic growth is the engine of inflation.
Terje,
You know the tulip boom occurred under a gold standard regime …
But I dont what to get you started talking about that barbarous relic.
Chris,
Slate ran an article a while back arguing that the dutch tulip price bubble was actually a rational market response to a rule change. Article below:-
http://www.slate.com/id/2103985/
Regards,
Terje.
If the legislature had not stepped and changed the rule it is possible that the tulip price craze remembered by history would never have happened.
As with the great depression it is important to look at the regulatory changes that might drive rational valuations of market goods. The regulators and plutocrats typically have a lot to answer for.
The working paper is worth a skim if you are really keen on tulip history:-
Click to access thompson-tulips.pdf
Terje,
I knew I would get you started – my mistake.
Let’s accept the Slate view on tulips for the time being. 1920s stockmarket boom also took place under a gold standard.
Which darn regulation change caused that?
Influential would have been a couple of factors:-
1. WWI had ended.
2. Harding-Coolidge tax cuts in the USA kicked off economic expansion.
3. A lot of the world was on the pound standard and the pound based prices were still inflating following the war time abandonment of the gold standard by the British.
Hence a price and output boom (to different degrees in different places).
4. In 1925 Churchill induced a very sharp deflation by re-entering the gold standard at a pre war price.
5. In 1929 the USA debated a highly protective set of tariffs. The stock market crashed when passage of the tariffs act seemed certain (ie the markets correctly predicting an imminent contraction in the real economy).
6. The great depression hit the world.
Note that the USA did not leave the gold standard prior to the great depression. There was a trade shock induced by the USA (the emerging global commercial power) and a slow moving monetary shock induced by the UK (the receding global commercial power).
Following WWII we had GATT to try and avoid a repeat of this horror.
Keep this up and people might think you are my sock puppet.
Plus of course Brenton Woods (championed in the final analysis by Keynes and others) to avoid the monetary mess.
Sorry Terje – that does not cut it as an explanation of the pre-Depression stock market boom.
Do you completely discount ‘herd mentality’ under all circumstances?
Why? Don’t you like tax cuts causing booms? Don’t you like an end to the destruction of productive assets (ie an end to war) leading to an increase in output? What is the objection with this logic?
No. But I don’t subscribe to it when there are more reasonable explainations.
Mean while you have skipped the stock market crash of 1987 (monetary), the asian financial crisis (monetary), the dotcom crash (monetary), the Irish boom of the 1990s (tax cuts), the Australian recession we had to have (monetary). However these were not of course during gold standard days so you might find them less fun to discuss.
Bubble theory presumes that people are irrational. Which means it is a theory that can predict nothing except that the world will be chaotic. We might as well call it the “sh!t happens” theory of markets.
Terje,
The US did not endure any destruction of productive assets during WW1 – the stockmarket boom was rampant, irrational speculation.
I agree that speculation happens under ALL types of exchange rate regimes, so I am quite happy to talk about all the ones you have mentioned. I just happen to think that the gold standard is not the panacea you claim it to be.
The Irish boom was actually much more to do with the ERM than tax cuts, however.
Terje,
Agreed, but if people ARE irrational, there is no point pretending they are not just so that we can predict their behaviour.
Besides, we can predict some things by assuming moderate irrationality – eg. that markets will tend to overshoot changes in fundamentals..
We dont have to assume everyone is psycho.
Paul Ormerod has written some interesting books on this stuff, and i did like Krugman’s “Depression Economics”
Yes but Europe did. Do you think there was no international trade in 1920?
Sorry Chris – that does not cut it as an explanation of the pre-Depression stock market boom.
You seem to be ignoring the very real increase in US living standards during the 1920s. It was not just some financial illusion.
Then why no comparable output boom in Italy?
As is your perogative.
Regards,
Terje.
Are we then to assume that monetary regulators are more rational and able to anticipate and prevent overshoots? And that there preventative action will not be interpreted irrationally by market participants.
Terje,
to your response to this “The US did not endure any destruction of productive assets during WW1” I would add, not directly, but turning the US economy to the production of machines of war, not productive assets or consumption certainly destroyed a lot of value.
Ernestine
You ought to join my men’s choir. You’d get on very well with the other chaps – Pauline (tenor), Francine (baritione), Nadine (baritone) and Christine (bass). What kind of voice do have, by the way?
Andrew,
Yes I agree. War diverts effort and resources away from private sector output that is consumption oriented towards the creation of munitions etc. And sending soldiers off to fight lowers the labour capacity of the economy.
The increase quality of life in the USA experienced after the first world war was very real. Unfortunately it lasted but a decade before it was decimated by errant trade policy. The great depression was not an irrational market overshoot. It was a very real collapse in economic output. A collapse in output precipitated by trade barriers and so tellingly predicted by the stock market.
Regards,
Terje.
In roughly reverse chronological order:
1. James Farrell. Analytical economics is gender neutral and there is no room for political correctness. As for your choir. do you happen to have the place of the lead soprano singer?
2. Andrew, I overlooked your post on the regulatory framework in Australia. Apologies.
3. Terje, remembered my question. This means I don’t have to respond to Majorajam yet again. Thanks.
4. Chris C. Thanks for the apology.
“WRT to controlling asset inflation vis-a-vis CPI, I do not think that that should be the role of the RBA (or anyone else for that matter).”
Right. Lets look at what we know about ‘competitive private ownership economies with securities (asset) markets).
There is a result by O.Hart from the mid-1970s in which he provided conditions under which models of such an economy have a solution (as distinct from markets where only physical objects are traded such as milk and oil). The conditions are:
i) each (all) individual is strictly risk averse. Not true since the Hunt Brothers are a real world observation.
ii) price expectations must not be ‘too different’ (ie are in a closed cone). I am saying the expectation that CPI and wages grow slower (over a prolonged period of time) than prices in asset markets is not consistent with the condition in Hart’s theorem. Something will have to give. Hart’s theorem pertains to a ‘closed economy’ (ie equivalent to a globalised market economy with “one market”). We don’t live in such a world (and it seems neither the USA nor the EC nor China nor the Islamic countries nor Russia are particularly keen on surrendering sovereignty). So, I am hypothesising that if ‘something has to give’ then in an open and relatively small economy, it shows up in the current account.
PS: I don’t subscribe to Terje’s ‘gold target’ proposal. Terje knows that.
Yes indeed.
Chris C,
Let’s see if I can’t pry your mind open with a crowbar. You think historical perception is the equivalent scientific truth? Without leaving my national borders, I can think of many examples that would call such a notion into disrepute. Gore Vidal has gone a long way to reconstruct Aaron Burr over the cries of many a purveyor of conventional wisdom (who mostly share your vague incredulity). John Adams had more integrity and wisdom than Thomas Jefferson, if perhaps not the same flare for dramatic prose, notwithstanding the disproportionate favoritism heaped on the latter. Ulysses S. Grant largely owed his onetime reputation as a murderous, incompetent general and corrupt politician to the success of the embittered South’s relentless historical spin, much of which has since been undone.
And then of course, there’s Hoover. I take it you didn’t use the links I laid out for you. Had you, you would’ve come across this:
As an aside, the sentences following that passage discuss a massive carry trade favored by 1920’s vintage bankers- borrowing in francs and investing in reichmarks. Sound familiar? Also in those essays, you’d have found this:
All of which is to say, you should be careful not to blithely believe everything you’ve been led to believe (an ounce of skepticism could also aid your understanding of asset/credit bubbles). And speaking of Jefferson, it remains self-evident that reading is superior to blogging.