Working Papers

Cranking Up the Wayback Machine on Stephen Roach

Stephen Roach accuses central banks of promoting ‘bubbles’ through excessively accommodative monetary policies.  So I thought I would dig up what Roach had to say at the time of the last Fed easing in 2003 (emphasis added):

the key objective for the authorities is to get the US economy back to a sustainable 4% growth pace - and hold it there for several years.  That’s the only way the deflationary gap between aggregate supply and demand can be closed once and for all.  A temporary growth spurt won’t do the trick, and yet that’s a classic symptom of a post-bubble economy.  I continue to fear that a post-bubble US economy plagued by a lack of policy traction will be unable to complete the critical transition from subpar to rapid growth.  And that underscores the ultimate risk: A persistence of subpar growth in the current climate could take the US economy further down the slippery slope toward outright deflation.

Once again, financial markets are telling me that I’m dead wrong.  The sharp run up in equities speaks of expectations of a sustained upturn in earnings that only a vigorous economy could deliver.  The recent sharp sell-off in Treasuries speaks of a bond market that now believes that the Fed has done enough to fight deflation and spark a snapback in the real economy.

Yet, if I’m even close to being right on the economy, the markets could well be blindsided by the next in a long string of relapses.

That’s the problem with Roach: you are either in a ‘bubble’ or a ‘post-bubble.’  The ‘bubble’ paradigm is an all-purpose analytical framework that explains everything and nothing.


posted on 18 June 2006 by skirchner in Economics, Financial Markets

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Permabears Seek Validation in the Cycle

Markets are sending very strong signals of late.  The yield curve inversion in the US and elsewhere, falling stock and commodity prices are all pointing to a weaker global growth outlook.  The curve flattening in particular reflects a ‘stagflation trade’ which anticipates central banks overdoing monetary policy tightening to contain inflation pressures. 

The permabears have been busy recasting their long-running structural bear call into a cyclical one, hoping the cycle will finally validate them.  It is increasingly likely that the cycle will finally oblige them on at least some counts.  If nothing else, they have the law of averages on their side.  Yet markets have not yet delivered much joy to the purveyors of macroeconomic anti-Americanism.  Just ask anyone who followed their advice and bought non-USD denominated asset markets, particularly Asian equities, as a hedge against USD weakness.  So far, the USD has been a beneficiary of recent market developments and Asian equities have been crunched.  Some hedge!

posted on 14 June 2006 by skirchner in Economics, Financial Markets

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The Wisdom of Crowds and Insider Trading

Henry Manne argues that the success of prediction markets supports the legalisation of insider trading:

The implications of what we already know of this “wisdom of crowds” approach to price formation, as against the traditional marginal pricing/arbitrage approach, are apt to be startling. We should rethink any current policies based on a view of pricing in which we exclude the best-informed traders and discard the wisdom of the many. For instance, we now have a new and more powerful argument than we had in the past for legalizing most insider or informed trading.

Since such trading clearly makes the market process work more efficiently, it aids capital allocation decisions and informs business executives through market-price feedback of the best predictions about the value of new plans. Furthermore, the Supreme Court’s “fraud on the market” theory of civil liability under the federal securities laws and Congress’s ideas of correct civil damage claims for insider trading no longer have any intellectual merit. The same is true of any other part of our securities laws implicitly based on the notion of the marginal trader as a rational arbitrageur of price.

The new approach would suggest that it is undesirable to have laws discouraging stock trading by anyone who has any knowledge relevant to the valuation of a security.

posted on 13 June 2006 by skirchner in Economics, Financial Markets

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