Working Papers

Fever Swamp Austrians versus the Fed

The Austrians of Auburn Alabama have always had a rather mono-causal view of the business cycle.  Through much of the current cycle, they have been ranting about easy monetary policy fuelling commodity and asset price inflation, while paying little attention to non-monetary fundamentals.  For devotees of free markets, they have little respect for actual market outcomes in relation to growth in credit aggregates and asset prices.

Former Federal Reserve Board member Wayne Angell makes the case for recalibrating our assumptions about what constitutes easy monetary policy:

many have not accepted the reality of lower interest rates that accompany an economy of abundance—and we seem to be not much better at this than Japan in the 1980s. Lower interest rates mean an upward adjustment to asset prices. The present value of houses, land, and capital goods is increased as the flow of rents and dividends are discounted at lower interest rates. The erroneous reaction was to think that higher asset prices spelled out easy money.

Price increases and decreases are the most important motivator and regulator in a market economy. In an economy without inflation, higher price motivates consumers to consume less while motivating business to produce more. High prices are somewhat short-lived as supply-side and demand-side price rationing soon returns the price to a normal level.

The introduction of market-economic growth to China and India added so much to the demand for commodities that their prices had to adjust upward to a new level. At a 9% annual growth rate, China doubles its use of resources every eight years. There is no global inflation consequence as China and India are adding workers to global production, and commodity prices only go up to set off a realignment of global resources producing more of the commodities with higher prices. Yet most observers interpreted rising commodity prices as easy money which they suspected would lead to inflation. That is wrong. If inflationary forces were evident, the supply and demand responses would be blunted by an understanding that prices have not gone up, but that, instead, the value of money has gone down.

posted on 23 April 2005 by skirchner in Economics

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In Defence of Speculative Capital Markets

Vernon Smith’s Inaugural Pope Lecture on globalisation contains a great defence of the role of speculative bubbles in capital markets:

Market efficiency does not require large numbers, complete information, economic understanding or sophistication…

stock markets…are inherently far more uncertain than markets for commodities and services because stock markets must anticipate innovations—the new commodities and services of the future. At the time of new innovations the extent of their subsequent economic success is inherently unpredictable.

If you limit people’s decisions to make risky investments in an attempt to keep them from harming themselves, how much will that reduce our capacity to achieve major technological advancements? The hope of great gain by individuals fuels thousands of experiments in an environment of great uncertainty as to which experiment, which combinations of management and technology will be successful. The failure of the many may be a crucial part of the cost of sorting out the few that will succeed. After a wave of innovation, and a bubble bursts managers know a lot about what did not work, and even a little about what did work.

posted on 22 April 2005 by skirchner in Economics

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‘They’re Commies?!’ An Australia-China Free Trade Agreement

In an episode of The Simpsons in which Homer goes to China, he expresses his disbelief that the Chinese are communists: ‘then how come I’m seeing rudimentary free markets?’  In reality, there is nothing rudimentary about them.  China’s industrial prices are overwhelmingly market-determined.  The Australian government is being criticised for conceding market economy status (MES) to China at the outset of the negotiations for an Australia-China Free Trade Agreement.  We are in fact doing ourselves a favour by making this ‘concession,’ since it potentially reduces the scope for Australian producers to take anti-dumping actions against Chinese imports.  As Peter Gallagher notes, Australia does not have much more to offer in terms of Chinese access to Australian markets.  MES is a small ‘price’ to pay for bringing China to the table.

posted on 20 April 2005 by skirchner in Economics

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Oil Doesn’t Make You Rich

Some controversial ads on Australian television have been berating us for supposedly giving East Timor a rough deal on the proceeds from the oil fields of the Timor Gap.  I suspect part of the motivation for this campaign stems from the popular view that national wealth is a function of resource endowments.  It is easy to refute this proposition by pointing to resource-rich countries that are poor, like Russia, and resource-poor countries that are rich, like Singapore, Hong Kong and Japan.

Oil endowments are no exception, as Tom Palmer has been explaining to the Iraqis.  There are obvious reasons why oil has not made Iraq rich (yet).  However, it is also less obviously true of some developed countries that do not have Iraq’s problems as an excuse.  This American ex pat in Norway observes that local living standards do not quite match its reputation as the world’s richest country:

After I moved here six years ago, I quickly noticed that Norwegians live more frugally than Americans do. They hang on to old appliances and furniture that we would throw out. And they drive around in wrecks. In 2003, when my partner and I took his teenage brother to New York - his first trip outside of Europe - he stared boggle-eyed at the cars in the Newark Airport parking lot, as mesmerized as Robin Williams in a New York grocery store in “Moscow on the Hudson.”

There is also evidence to suggest that overdependence on a single resource encourages rent-seeking behaviour and corruption.  East Timor’s share of the Timor Gap oil revenue by itself will do little to ameliorate its problems and could even make them worse.

posted on 18 April 2005 by skirchner in Economics

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So I’m a Tory After All

Not that I put much store in tests like this, but here is my score:

Conservative +51
Labour -6
Lib-Dem -66
UKIP +24
Green +3

What I thought interesting about these results is they suggest I should be close to neutral on Labour and the Greens.  My anti-EU responses are no doubt responsible for the high Conservative and UKIP scores, since these parties would not have benefited from my responses to most of the other questions.  One election I am glad I don’t get to vote in!

posted on 16 April 2005 by skirchner in Politics

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Wireless Broadband in Sydney

A temporary lapse into tech blogging.  I recently decided to try wireless broadband with Unwired, mainly because I want to encourage the process of disintermediating traditional telcos from broadband distribution.  I can’t say I have been overly impressed.  The problem is not necessarily that the signal is weak, but highly variable, even though I am well within the notional coverage area and in a reasonably elevated position.  Using Unwired’s own diagnostics, the signal strength bounces around anywhere from 1-6 out of 10 from the best location in the house.  Drop outs are frequent enough to be annoying, and even though only very brief, they can be enough to require a manual refresh of the connection and generally slow things down to a crawl.

Unwired are not lying when they say that the best place for the modem is parallel to a window.  I find the modem will only work reliably right up against the window.  A few centimetres inside and signal strength deteriorates rapidly.  The best place for the modem is actually outside.  This is obviously a widespread problem, because I have found one Sydney company that already produces dedicated kits to house the Unwired modem externally.

Unwired offer only a very narrow 14 day window in which to trial the service.  Unless you are getting a very reliable signal in the first few days, my suggestion would be to cancel the service immediately.

The university’s wireless broadband service is also flaky, from my very limited experience of it, but then again so is mobile reception (I had to get a CDMA mobile to get a signal at my UNSW office).  Perhaps it is due to Sydney’s undulating topography.  In any event, it’s back to ADSL for me.

posted on 15 April 2005 by skirchner in Misc

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The UK General Election as Lose-Lose

David Frum on why the UK general election outcome is a no-win deal for conservatives.

The Intrade contract for Labour winning the most seats in the Commons has managed to rally from levels that were already pricing this outcome as a near certainty.  Even in the absence of an outright Commons majority, this outcome would see Labour well placed to form government.  The market is not giving much credence to the scenario in which enough Labour voters stay home or vote Lib-Dem to hand the Tories the largest number of seats, yet I would have thought this was a non-negligible risk.  Never underestimate the left’s capacity for spite!

posted on 14 April 2005 by skirchner in Economics

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The Bond Yield ‘Conundrum’ and Excess Saving

Bernanke’s global saving glut explains Greenspan’s bond yield ‘conundrum,’ according to Richard Clarida:

in a world of excess saving relative to investment, not only will real interest rates be driven down, but some country or group of countries must run current-account deficits to absorb the excess saving. Because of the role of the dollar in international finance and the success of U.S. monetary policy at producing low and stable inflation, the U.S. capital markets are absorbing a great deal of this excess global saving via the current-account deficit. Were this deficit to fall in half overnight, the world saving-investment imbalance would worsen, and larger current-account deficits would be shifted elsewhere and/or a contraction in global growth would result. Mr. Greenspan’s conundrum and the current-account deficit are really two sides of the same coin.

posted on 12 April 2005 by skirchner in Economics

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The Bull Market in Bubbles

Barry Ritholtz on the bubble in bubbles:

we currently find ourselves now in a Bull market for Bubbles. There is the housing Bubble, the oil Bubble, the interest rate Bubble. I have read about the import Bubble, the China bubble, the current account deficit Bubble, and the credit debt Bubble.

The Fed does econometric research to see if we can detect Asset Price Bubbles in advance. Several writers believe China is one great big Bubble - if not the nation, than China Net stocks. Some books advise us how to survive Bubbles, while others warn us of the impending Bubble in US foreign policy. From Australia, we learn there is even a Bubble in economic blogs.

In short, we have a Bubble in Bubbles.

Yet if we give careful consideration to the nature of bubbles, we see that most of these are not bubbles at all. They may be assets whose prices are extended - but being overpriced is not the same as being a Bubble. Rapid price appreciation increases the chance of a significant price retracement in the future. But all Bubbles? Hardly.

Unfortunately, this meta bubble is unlikely to burst any time soon.  As with many so-called bubbles, it actually has a fundamental basis: the inability of so many commentators to understand or think seriously about the market processes underlying asset price determination.

posted on 12 April 2005 by skirchner in Economics

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Outsourcing Financial Market Journalism

Reuters has notoriously been shifting financial market journalism jobs to Bangalore at the expense of other centres, which says a lot about the commodification of financial market reporting.  For example, its Australian economic consensus forecasts are now compiled by its Bangalore Polling Unit. 

While I am all in favour of outsouring, basic knowledge of local conditions can sometimes be important, as Bloomberg found last week:

Just one of the many things that could have gone wrong and did was the Bloomberg newswire flash at 8.30am last Wednesday stating that the RBA had held interest rates steady at 5.5 per cent.

The bank was not due to announce its decision for another hour. Had Bloomberg got hold of a leak?

As traders reached for their phones, it emerged that the Bloomberg update was managed from South Korea, where an operator had failed to take account of the end of daylight saving, and gone to the RBA website where the old rate was still posted.

posted on 11 April 2005 by skirchner in Economics

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The Reserve Bank and the Electoral Commission

Yesterday’s SMH story turns out to have been something of a beat-up, with the RBA having now released some of its correspondence in relation to the matter.  Today Peter Hartcher tries to give it legs with a comment piece that seems to consist almost entirely of inference on his part (no sources are quoted).

The Secretary of the RBA wrote to a minor Liberal Party figure in response to a complaint from the public and asked the official to desist distributing a brochure that cited the RBA as a source for some of its claims.  My own recollection is that much of the Liberal Party’s campaign material cited the RBA as a source, something the press gallery did not make much of at the time.  This is technically defensible, since presumably they were offering the RBA as the source for the historical data on interest rates cited in their brochures.  Obviously, the Liberal Party would not have been too upset if people inferred more than this, but would the campaign have been less effective if the brochures cited Bloomberg or Reuters or even offered no source at all?  It was the electorate’s historical memory of rates that made the campaign effective.

The RBA is still not completely off the hook in this matter.  The fact that members of the public complained to the RBA shows that the electorate are quite capable of forming their own views about the material.  The RBA certainly had no business telling a political party to stop distributing an election brochure, whatever the content, even if only to mollify an irate member of the public.

UPDATE:  It all comes down to a missing asterisk.  Australia’s first punctuation-induced political crisis!  As silly beat-ups go, this one is hard to beat.

posted on 09 April 2005 by skirchner in Economics

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The Reserve Bank as Political Trade Practices Commission

This story makes the extraordinary claim that the RBA referred some of the Coalition’s advertising material to the Australian Electoral Commission during the last federal election campaign:

the central bank believed that some of the material in the Coalition’s campaign leaflets was exaggerated and that some was factually wrong, the officials said.

However, the bank concluded that it was the role of the electoral commission to police election campaigns.

Reserve Bank officials referred the Coalition’s leaflets to the commission during the six-week campaign and asked whether they breached any regulations.

The commission responded that it was unable to take action to halt a political party making policy claims or predictions even where they might be false and misleading, the officials said.

The bank decided that it would have to allow the Coalition’s claims to be contested by other political parties, and that it could not intervene without provoking headlines saying “Reserve says PM wrong,” a senior official said.

The bank was anxious to avoid this because it would make the bank itself the centrepiece of the campaign, the official said.

The Bank’s second decision (‘that it would have to allow the Coalition’s claims to be contested by other political parties’) was the correct one.  The fact that the AEC took no action shows that the RBA was grossly mistaken in thinking either it or the AEC had a role in arbitrating political truth.  Politicians make all sorts of ridiculous economic claims during election campaigns and the RBA could make a full-time job out of correcting them.  That the RBA would even contemplate setting itself up as some sort of political Trades Practices Commission is symptomatic of its paternalistic mistrust of markets, in this case, the political marketplace.

posted on 08 April 2005 by skirchner in Economics

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Breaking the RBA’s Cone of Silence

RBA Board members Jillian Broadbent and Warick McKibbin seemingly break with convention to comment on yesterday’s interest rate decision, with Broadbent quick to reassure us that the decision was unanimous.  Far from heralding a new age of RBA transparency, my suspicion is that the Bank was keen to pre-empt any speculation about dissent on the RBA Board or that the Bank’s senior officers had been rolled.  Broadbent and McKibbin were given the job of putting the word out.

One can understand the RBA’s desire to quash such speculation, because the media always turn any hint of conflict on the Board into something more than a legitimate difference of opinion.  Yet the reason for this lack of maturity on the part of the media is precisely that they have never been given the opportunity to treat dissent on the Board as a normal and routine part of the policymaking process.  This will only occur when the RBA formalises procedures for disclosing its deliberations in a systematic way.  Ad hoc revelation of the Board’s deliberations only when it suits the convenience of the Bank’s senior officers is a poor substitute for the transparency and accountability mechanisms that are now the norm among the industrialised world’s central banks.

posted on 07 April 2005 by skirchner in Economics

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More on Australia’s Terms of Trade

We have often highlighted the impressive growth in Australia’s terms of trade and the fact that volume-based measures of GDP do not adequately capture its contribution to national welfare.

The RBA’s Christian Gillitzer and Jonathan Kearns have examined Australia’s terms of trade over the last 135 years and reach some interesting conclusions:

Since Australia predominantly exports commodities and imports manufactures, the Prebisch-Singer hypothesis suggests that there should be a negative trend in the terms of trade. But the trend is no more than -0.1 per cent per annum, less than the trend decline in world commodity prices relative to manufactured goods prices. The weaker trend appears to be the result of Australia exporting, and importantly diversifying toward, commodities with faster price growth. Extending the sample using projections for the terms of trade for the two years to 2005/06 based on commodity price movements to date, the apparent downward trend disappears. Indeed, based on these projections, the terms of trade will have increased by around 50 per cent over the period 1987–2006, unwinding the decline over the preceding 30 years.

The RBA has previously pointed to the long-run relationship between the terms of trade and the Australian dollar.  Together, these results suggest that the secular decline in the AUD is over.  Recent developments in the terms of trade also serve to discredit the many advocates of ‘strategic’ industry and trade policy, especially in relation to the ICT sector.

posted on 06 April 2005 by skirchner in Economics

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Rational Choice Theory and the Papal Conclave

Can rational choice theory be used to divine the Will of God?  You bet.

Intrade is running both successor and country of origin markets for the next Pope.  The latter market suggests that the Italians have it.

posted on 05 April 2005 by skirchner in Economics

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