Working Papers

Meta Bubbles and Contrarians

We have previously noted the bubble in bubbles phenomenon, not least in relation to economics blogs.  The LA Times notes the growing prevalence of blogs dealing with the alleged housing bubble.  While I am generally dismissive of the notion of bubbles in asset markets, I’m less dismissive of the idea of a bubble in bubble-talk.  Bubble-talk is effectively unpriced, because those who engage in it, unlike participants in asset markets, rarely put their money where their mouth is.  While some have a professional reputation to defend, accountability for bubble-talk can often be fudged.  As for the rationality of bubble-talk, consider the representative housing bubble blogger profiled in the LA Times story, who imagines Alan Greenspan secretly reads his blog:

A self-described “economic activist,” Jones, 41, sees his mission as chronicling a seminal financial event, something future scholars can turn to just as historians today would read an anthology of letters written by Dutch tulip traders in the 1630s.

“In 100 years, economists may be studying the comments of this blog because this was a real-time skeptics’ log in the middle of a financial mania,” said Jones, who rents a house with his wife in Sedona, Ariz., and doesn’t own any real estate.

Traditionally, those who drew attention to bubbles were considered contrarians, ie they were notable for going against the crowd.  The bubble in bubble-talk has resulted in something of a role reversal.  It is the bubble skeptics who are now the real contrarians.

posted on 17 July 2005 by skirchner in Economics

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Bubbles in Everything

There is not a single asset class that has not been pronounced as being in a ‘bubble’ in recent years.  My working definition of a bubble is anything that goes up in price faster than The Economist magazine can understand.  Now bubbles have apparently spread from assets to services, with a ‘bubble’ in, of all things, freight:

Clearly, investors in shipping companies—and the brokers who book freight—are looking beyond the horizon. It takes a long time to turn an oil tanker around, and the shipping market is slow to respond to sudden upturns in demand. Prices for freight rose so rapidly in 2003 and 2004 in part because it takes a long time to commission new oceangoing tankers and container ships.

When demand rises more rapidly than capacity, of course, the natural response by companies is to increase capacity. But now there’s concern that capacity growth could outstrip demand. If China’s growth slows dramatically, and global demand for oil doesn’t materialize as projected, in a few years there may be a lot of empty ships haunting the seas, like so many Flying Dutchmans. And investors in many of these newly public companies could be left high and dry.

What makes this article so annoying is that the author actually carefully analyses the various fundamental factors that are driving global freight, all of which argue against the notion that shipping is subject to a bubble, unless you see freight as being a sub-set of a China ‘bubble.’  It seems the author is using ‘bubble’ as shorthand for anything that is subject to a rise and possible fall in price driven by fluctuations in supply and demand.  That’s not a bubble: it’s a market.

The article is also interesting in showing the parochial nature of the debate about capacity constraints in Australia.  US west coast ports are severely stretched coping with imports from China.  This is just the flipside of the commodities export bottlenecks in Australia. 

While it is now taken as an article of faith that the Nasdaq saw a bubble in the late 1990s, this conventional wisdom is also being challenged:

Contrary to what many academics and finance practitioners believe, Nasdaq prices at the turn of the millennium did not necessarily constitute a price bubble. The authors’ stock valuation model suggests that the fundamental value of firms increases with uncertainty about future profits. This uncertainty was abnormally high during the late 1990s and led prices to be unusually high as well. In fact, Nasdaq prices were not far from firms’ real values, so the description of the phenomenon as a bubble is incorrect.

posted on 15 July 2005 by skirchner in Economics

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More Euro Scepticism

More euro scepticism, this time from investment bank HSBC, as reported in the Torygraph:

In a new paper entitled “European meltdown?”, the world’s second biggest bank said Italy, Germany, and Holland had all been damaged by the perverse effect of the one-size-fits-all interest rate policy, and might be tempted to leave.

It said the euro had pushed Germany to the brink of deflationary spiral, while causing a “dramatic boom and bust” in Holland. At the same time, Italy was now trapped in slump with a “truly appalling export performance” and exorbitant unit labour costs.

The report said the risks of break-up had now reached a point where it had become necessary to “think more carefully about the costs and benefits of exiting”.

HSBC said Germany might choose to leave in order to cut real interest rates, regain control of fiscal policy, and fight deflation by resorting to the sort of “unconventional” monetary methods in vogue in Tokyo and Washington - but denied by EU law to the European Central Bank.

posted on 14 July 2005 by skirchner in Economics

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The Demise of the Euro

Back in 1999, I gave the euro five years at most.  My prediction might have worked out if the goal posts, in particular, the Stability and Growth Pact, had not been shifted.  Milton Friedman gave himself more wriggle room by forecasting the euro’s demise within ten years.  The euro project is now being seriously questioned, and its possible demise actively canvassed, as Joachim Fels notes:

A full-blown political union in Europe is not only unlikely, it is also undesirable. Europe’s cultural, political and institutional diversity should be seen as a strength rather than a weakness because it encourages institutional competition for ideas and for mobile capital…

The euro’s founding fathers assumed that monetary union would over time quasi-automatically lead to political union and thus didn’t spend much time worrying about the long-run viability of the euro. But their assumption is clearly no longer valid…

As long as all euro members agree that higher inflation and fiscal deficits are desirable or at least unavoidable, this does not yet put the euro at risk. Each euro would merely buy less domestic and foreign goods and services. However, some member states’ tolerance for inflation and fiscal deficits is likely to be lower than that of others, especially if the euro would turn into a mini-lira. In this case, the more stability minded members might decide to introduce a harder currency. Needless to say, a break-up of EMU would be economically very costly for all parties involved. But that doesn’t mean it cannot happen.

These costs need to be balanced against the reduction in macroeconomic policy risk that would occur with the demise of the euro, in particular, the risk of serious monetary policy mistake by the ECB being propagated across the euro zone.

posted on 07 July 2005 by skirchner in Economics

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The Rise and Fall of Monetary Targeting in Australia

My review of Simon Guttmann’s (2005) The Rise and Fall of Monetary Targeting in Australia.

continue reading

posted on 06 July 2005 by skirchner in Economics

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The Economics of On-Line Dating

Hal Varian reports on some research into on-line dating in the US, including an interesting application of the Gale-Shapley algorithm:

There was a strong Lake Wobegon effect in the data, with only 1 percent of the population admitting to having “less than average” looks. Even so, only a third actually posted a photo. The reported weights of the women were substantially less than national averages and about 30 percent were blonde. The reported weights of the men were consistent with national averages and only about 12 percent were blond…

Having a lot of money is good for attracting e-mail messages, at least for men. Those men reporting incomes in excess of $250,000 received 156 percent more e-mail messages than those with incomes below $50,000…

I would guess that none of these findings are terribly surprising. Everyone knows you can’t be too rich or too thin.

Call me romantic, but I suspect these results grossly overstate the importance of money.  Income probably proxies for a broad range of other characteristics that are desirable in their own right, not least the ability to write a literate and appealing profile, something which might not otherwise be captured in the data.

posted on 05 July 2005 by skirchner in Economics

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RBA Governor Macfarlane on Global Imbalances

An excellent speech given by RBA Governor Macfarlane in China, which argues that the sustainability of current account surpluses under fixed exchange rate regimes is much more questionable than the sustainability of current account deficits under floating exchange rate regimes:

there is a belief that current account deficits are unsustainable, whereas surpluses could go on forever. This was a reasonable assumption for most of the post-war period, particularly under the Bretton Woods system, but may no longer be so. In a world of floating exchange rates and mobile international capital, the old rules may no longer apply. The discipline applied by the international market place on developed countries with current account deficits now may be very weak.

Even under earlier monetary regimes, there are examples of countries that have maintained current account deficits for long periods. The United States in the nineteenth century is a good example, as is Australia in the twentieth. In the 1970s, Singapore ran a current account deficit which averaged 15 per cent for a decade. For developed countries with deep financial markets and little or no foreign currency exposure in their borrowing, current account deficits are not the problem they once were…

the scenario whereby world financial markets react to the US current account deficit by withdrawing funding has disappointed those who thought it would come into play. It may happen yet, but people have been predicting it for a long time and yet it seems no closer. A large part of the reason for this is that investors who want to get out of US dollars have to run up their holdings of another currency – they cannot get out of US dollars into nothing. They have to take the risks involved in holding some other currency, possibly at an historically high exchange rate, and they may well be reluctant to do so.

Macfarlane reproduces a quote of his own from 1998, which shows him to have been remarkably prescient on the rise of East Asian mercantilism in relation to official reserve assets.

posted on 29 June 2005 by skirchner in Economics

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Krugman Makes New Lows

Alex Tabarrok points to Paul Krugman’s continuing intellectual implosion.

posted on 29 June 2005 by skirchner in Economics

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Border Security or Tariff Police?

It is an interesting sign of the times that one of the better rating shows on Australian television is Border Security, which goes behind the scenes to document the activities of the Australian Customs Service and Immigration.  For anyone with classical liberal sensibilities, it makes uncomfortable viewing, not least because of the enormous effort that goes into enforcing bad laws.

An example from a few weeks ago was the two Indian shoe salesmen, who were carrying with them 150 shoe samples.  The fact that the shoes were unpaired was not enough to convince Customs that these were samples.  As a Customs officer explained, the other shoes could be brought in separately and then re-paired for local sale!  So the hapless shoe salesmen were required to destroy each shoe by drilling a hole in them. 

The real problem was that the two merchants had not completed the right paperwork, but one Customs officer explained that part of their job was to protect Australian industry from damage that might be inflicted by foreign goods.  We can all sleep easier at night knowing that we have been kept safe from 300 Indian shoes that might have otherwise found their way on to the feet of unsuspecting Australian consumers.

posted on 28 June 2005 by skirchner in Economics

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Econometrics in the City

At least one person is hoping econometrics will help him pick up.

(via Freakonomics)

posted on 25 June 2005 by skirchner in Economics

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Housing ‘Bubbles,’ Financial Intermediation and Moral Hazard

More refreshing housing ‘bubble’ scepticism from James Hamilton, invoking a ‘consenting adults’ view of financial intermediation in relation to housing:

even if you readily believe that large numbers of home buyers are fully capable of just such miscalculation, there’s another issue you’d have to come to grips with before concluding that the current situation represents a bubble rather than a response to market fundamentals. And that is the question, why are banks making loans to people who aren’t going to be able to pay them back? Maybe your neighbor doesn’t have the good sense not to burn his own money, but is the same also true of his bank?

If you want to come up with an answer more sophisticated than “banks are stupid, too,” I think you’re ultimately led to look for the real roots of the housing bubble, if you think there is one, in some kind of moral hazard argument explaining why the equity capital of lending institutions is insufficient to cover the risk in the mortgage loans they issue or hold.

I earlier mentioned deposit insurance as one story that could be told along these lines, while Greg Hess and the Chicagoboyz some time back argued that Fannie Mae could be playing such a role. But it’s not obvious what changed recently along these lines to only now be producing a housing bubble.

Astute readers will notice this is the same argument we have been making in relation to current account deficits.

posted on 25 June 2005 by skirchner in Economics

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Putting Your Money Where Brad DeLong’s Mouth Is

One of my frequent complaints about those who indulge in ‘bubble’ talk is that they rarely put their money where their mouth is.  Most people are probably correct in thinking that they have made prudent decisions in relation to their own finances, but they are equally ready to assume that everyone else is being imprudent (inconsistencies of this sort are a common result in behavioural economics/finance).  What amuses me most about those who worry about the current account deficit is that many would have personal balance sheets that are little different in substance from the current account deficit and, indeed, make a direct contribution to it, but few would perceive themselves as part of the ‘problem.’ 

Mark Kleiman would appear to be a notable exception, selling his house for speculative reasons, or as he says, putting his money where Brad DeLong’s mouth is.  Unfortunately, his reasoning is little more than a tautology, combined with Bush Derangement Syndrome:

If the current fiscal and trade deficits are unsustainable, especially with national economic policy run by the cast of a clown show, then they won’t sustain themselves forever.

While I think this is incredibly silly, Kleiman gets full marks for consistency.  He is certain to suffer for his beliefs.

posted on 23 June 2005 by skirchner in Economics

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Demographic Underpinnings of US Potential Growth

A very good critical review of some of the demographic-panic literature in the US, including this observation:

the US is exceptional. Our birthrates have fallen, and thus the average age of our people has increased, but it has happened more gradually than elsewhere. What’s more, our population is projected to keep growing. This is not only because of immigration, as Wattenberg suggests, but because of higher fertility among native-born women; even college-educated, non-Hispanic white women have a total fertility rate of 1.7 children, higher than the overall rates of Canada, Britain, or Australia, not to mention the even lower rates of Japan, Germany, Italy, and Spain.

Within the context of falling birthrates worldwide caused by urbanization, education, and the rest, Americans, as both a more religious and more optimistic people, simply choose to have more children. In fact, the only Census Bureau scenario that foresees a declining U.S. population in this century is based on the highly unlikely assumptions that, first, the fertility of American women will fall to European levels, and second, immigration will be reduced to levels below even what most restrictionist organizations call for. Barring catastrophe, then, the population of the US will not decline during the lifetime of anyone reading this article.

posted on 22 June 2005 by skirchner in Economics

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Austrian School or Austrian Schooled?

An editorial in New Zealand’s National Business Review refers to me as ‘Australia’s Austrian school economist.’  NBR must be the only mainstream media publication in the world that doesn’t have to explain ‘Austrian school’ to its readers.  Only in New Zealand!

As careful readers of this blog will have noticed, I am very sympathetic to most Austrian School insights, and I’m a disequilibrium rather than a general equilibrium theorist.  As the article implies, that is partly why I’m a ‘bubble’ sceptic, but it is also what sets me apart from most people who call themselves ‘Austrian,’ especially the fever swamp Austrians of Auburn Alabama.  These people are all too ready to run with ‘bubble’ talk, because it ties in with their naïve, mono-causal explanation of the business and asset price cycle as being entirely attributable to fiat money supply errors. 

An authentic interpretation of the Austrian tradition would see asset price inflation and deflation as a necessary part of the market discovery process, which would emerge under a variety of plausible monetary regimes, including whatever model of free banking one might prefer.  My only reservation about the Austrian School label is the dubious company it has increasingly come to keep.  It’s high time authentic Austrians drained the fever swamp!

posted on 21 June 2005 by skirchner in Economics

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Ken Henry and the Classics

The Secretary of the Treasury calls for a return to classical economics as the basis for macroeconomic policy:

one has to wonder whether the policy debate in this country is not the sort of thing that one might have hoped to see in a ‘classical’ economy of the sort that economists thought existed before the Great Depression and the ensuing Keynesian revolution; a debate about the factors that influence our productive capacity rather than the factors that influence our demand for it.

This shift in policy attention – from pre-occupation with the management of effective demand to an interest in the things that affect aggregate supply – is timely since, especially for demographic reasons, the principal macroeconomic issue of the very near future will be inadequate participation, not unemployment – a problem of too few people wanting a job, not too many…

It might be worth asking the question whether, because of the reform efforts of the past, we should not now consider ourselves to be most often in a ‘classical’ world in which the economy naturally trends toward, and in fact spends most of its time quite close to, its productive capacity, or supply potential, without the need of continuous macro policy stimulus.

Answering this question in the affirmative would not imply a view that we have eliminated the business cycle. There will be future economic downturns. And when we see evidence of one we should not be afraid of responding with activist expansionary macroeconomic policy.  Rather, an affirmative answer implies some conditioning of the exercise of macro policy activism – an acceptance that large swings in macro instruments are to be implemented (only) in extremis.

posted on 21 June 2005 by skirchner in Economics

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