Working Papers

2005 07

EMU Meltdown

We previously linked to this HSBC report on the long-term prospects for the euro in extract.  Here is the full text (pdf).

posted on 31 July 2005 by skirchner in Economics

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Consenting Adults versus Irrational Exuberance in Housing

Neil Barsky of Alson Capital Partners rubbishes the notion of a housing ‘bubble’ in the US in terms that will be very familiar to readers of this blog:

bubbles happen when prices become unhinged from intrinsic value. Homes are not stocks; their “intrinsic value” can only be in the eye of the beholder. A house has utility. Rational people might be willing to pay more for a water view, or for living close to work, or for a larger loo. Such voluntary economic decisions are neither irrational nor exuberant.

posted on 28 July 2005 by skirchner in Economics

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Reserve Bank Governance

Former Treasury Secretary Ted Evans will be giving a seminar for ABE on 18 August on the subject of RBA governance, including ‘some suggestions with respect to improving transparency at the Bank.’  This is a little surprising, since as Treasury Secretary and an ex-officio RBA Board member, Evans was rather dismissive of the issue.  Indeed, he once told a gathering of market economists that if ever the minutes of RBA Board meetings were released, we would be very bored with their contents, which doesn’t say much for the Board’s deliberations under its existing governance framework.  It will be interesting to see what Ted has to say on the subject now that he is a private citizen.

posted on 28 July 2005 by skirchner in Economics

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Killing Sesame Street

David Boaz on the Top Ten Reasons to Privatise Public Broadcasting.

posted on 27 July 2005 by skirchner in Economics

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Should the RMB Reval Keep Flordia Mortgage Holders Awake at Night?

There has been much ink spilled on the subject of the RMB revaluation, but few have put it in perspective quite as well as UBS economist Jon Anderson:

the current 2% revaluation (or, for that matter, even a move two or three times larger) is nothing to get excited about. By far the most common question in my inbox over the past three days has been the impact of the yuan adjustment on China’s trade and economic growth. The short answer is: no impact whatsoever. G-3 currencies fluctuate by 2% or more nearly every month without any noticeable influence on their economies, but somehow people who would never dream of asking about the effect of a yen move to 110 from 113 still can’t resist running for the phones when the yuan strengthens by the same amount. UBS hasn’t changed its forecasts for Chinese growth, inflation or employment, and I suspect most other economists haven’t either.

Nor do we foresee any sustained “yuan effect” on other Asian currencies, regional growth, the dollar or global bond markets. Despite the current press speculation, Florida mortgage holders can sleep soundly—at least as far China is concerned.

The notion that a few hundred billion in annual official reserve asset purchases by China could influence markets with the depth and liquidity of the US dollar and Treasuries has always been a stretch, but that has not stopped it from becoming an article of faith among many economists.

posted on 26 July 2005 by skirchner in Economics

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More Monetary Policy Central Planning from the AEI

The AEI is at it again, advocating that the Fed should fine-tune US house prices:

the Fed is raising interest rates, a central-bank policy move that has already quelled a housing boom in the United Kingdom, not to mention Australia and New Zealand. We need a “Goldilocks Tightening” that sets the temperature in the real estate sector just right: not too hot and not too cold.

Unlike many commentators, Makin acknowledges the prevalence of variable rate mortgages in the UK and Australia, but nonetheless argues that ‘the ability of rate increases [of the magnitude of past US tightening cycles] to slow the rate of increase of housing prices is not in question.’  Fine tuning house prices via monetary policy is still a risky proposition, even in Australia, where RBA Governor Macfarlane has argued against it along similar lines to the arguments made by Alan Greenspan.  It is an infinitely more risky proposition in the US, where the relationship between the Fed funds rate and mortgage rates is much looser. 

Makin’s article acknowledges the difficulties of fine-tuning monetary policy.  Indeed, as recently as late last year, Makin was arguing against further Fed tightening on the basis that it would plunge the US into recession in 2005.  The obvious conclusion to draw is that the Fed should not determine monetary policy on the basis of house or other asset prices, but because Makin is one of many analysts who take a ‘bubble’ in house prices as a given, he draws the opposite conclusion.  This is a good illustration of how bubble-talk can lead analysts astray.  Indeed, there is something profoundly absurd about the fact that central bankers like Greenspan and Macfarlane have become the de facto defenders of capitalist acts between consenting adults, while right-wing American think tanks have become advocates of the central planning of asset prices.

posted on 26 July 2005 by skirchner in Economics

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Acronyms You’ve Gotta Love

CKNAWWW (Clueless Know-Nothing Analysts of the World Wide Web).  From the anything but clueless James Hamilton.

posted on 25 July 2005 by skirchner in Economics

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The Future Fund as Revenue Laundering Operation

The government’s Future Fund, a massive proprietary trading operation being established at the expense of taxpayers, is a thinly disguised revenue hoarding scheme on the part of a government that has more money than it knows what to do with.  The Minister for Finance has now all but confirmed that the Future Fund’s earnings will be subject to taxation, siphoning the Fund’s earnings directly into consolidated revenue.  Of course, paying taxes on the Fund’s earnings is no less absurd that than the government using the Fund to purchase its own liabilities in the form of government securities.  It just serves to highlight the fact that the Fund has been explicitly designed to launder the proceeds of privatisation and protect them from being returned to taxpayers.

posted on 21 July 2005 by skirchner in Economics

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Spec Free Property Boom

Here is one property boom that is more or less guaranteed to be leverage and speculation free!

LONDON, July 20 (Reuters) - The rapid growth in investments compliant with Islamic Sharia law is gaining fresh impetus from high oil prices for energy-rich Muslim countries, and a large slab of this capital is going into real estate, researchers say.

Islamic banking and finance, fast becoming one of the biggest global niche financial services markets, is estimated to be worth up $500 billion worldwide, and is expected to grow at between 12 percent to 15 percent over the next 10 years, Ali Parsa of London’s South Bank University said on Wednesday…

The attributes of real estate investment lend themselves to Sharia law which forbids the payment of interest, and speculation in the form of short selling—as practised by hedge funds—or the use of derivatives, Parsa said.

(via Mahalanobis)

posted on 21 July 2005 by skirchner in Economics

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Greenspan as Failed Guru

Peter Hartcher continues the Greenspan bashing.  Implicit in Hartcher’s criticism of Greenspan, and praise of RBA Governor Macfarlane, is the idea that central banks can and should centrally plan asset prices through monetary policy.  Hartcher ignores the inconvenient fact that Governor Macfarlane has consistently argued against the wisdom of targeting asset prices in general, and house prices in particular.  But why let the facts get in the way of a lame story?

Then there is this anecdote:

[Prime Minister] Howard recalls vividly his first encounter with Dr Greenspan more than 20 years ago, when the economist, hearing that Mr Howard was from Australia, remarked: “Ah yes, Australia, the country with the biggest middle class in the world.”

The thought struck Mr Howard forcefully, and much of his political success since derives from his understanding of Australia as an aspirational middle-class society.  For John Howard, Alan Greenspan will always be a guru.

Somehow, I very much doubt John Howard’s famed political instincts owe much to Alan Greenspan.

posted on 20 July 2005 by skirchner in Economics

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Australia’s Bubble that Wasn’t

Australia’s experience with house price inflation is attracting a lot of attention in the US, featuring on the front page of the WSJ, which notes that Australia provides a ready example of a major house price inflation that has ended benignly:

As the U.S. confronts its own housing-price boom, Australia’s experience suggests that the end of a boom needn’t necessarily lead to widespread economic distress. So long as most people decide to hold on to their homes and ride out the storm, the economy can hold up. Australia has yet to experience a trigger, such as widespread job losses or a spread of panic about the real-estate market, that would drive owners to unload their homes en masse and create a crisis.

The above extract implicitly concedes the point that house prices are driven by broader economic conditions, not the other way around.  But the notion that people would ‘unload their homes en masse’ in response to some sort of exogenous shock is nothing short of bizarre.  There are many reasons why house prices might fall, but people abandoning their homes to rent or live in the streets is not one of them.  Most participants in the housing market are buying and holding, not speculating, and choose the most favourable time to rollover their asset.  Falling prices lead to a reduction, not an increase, in market turnover.  Much of the post-boom weakness in Australia has been seen on volumes rather than prices. 

The article also argues:

Mr. Greenspan has said that it’s hard to know when asset bubbles truly exist, raising the odds that a pre-emptive strike will unnecessarily damage an otherwise healthy economy. The other school of thought, exemplified by Australia, holds that it’s wiser to pop likely bubbles before they get out of hand. Even if Mr. Greenspan wanted to follow Australia’s lead, he might find it hard to. The U.S. Fed is already raising interest rates at a steady pace. If it moved any faster in an attempt to pop a bubble, it would risk putting the brakes on U.S. economic growth, with potential global consequences.

The RBA has in fact denied that it is targeting house prices and Governor Macfarlane has argued against the wisdom of doing so.  The article also overlooks the prevalence variable rate mortgages in Australia, which are closely tied to the RBA’s official cash rate.  This gives the RBA much more traction over household disposable income than is available to the Fed.  Targeting house prices with monetary policy is a much riskier proposition in the US than it is in Australia.  Greenspan is right not to follow Australia’s supposed example.

posted on 19 July 2005 by skirchner in Economics

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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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