In the comments of this post, Gene Callahan doesn’t shirk his duty of constantly assuming I started reading financial economics last Tuesday:
But Bob, weren’t you predicting market disaster when the Dow was at 6000? (I was buying at that point, fwiw.) Weren’t you predicting it through the whole rise of the last seven years?
If I predicted the death of David Bowie every day for the last 7 years, do I get to crow this month when he actually dies?
If the Dow gets back down to 15,000 it is buy time again. Do you want to write a derivative contract on whatever position I take so you can short my position?
No, I don’t think I was predicting a stock market crash when the markets bottomed out in March 2009. I’m not betting my life on that, but I don’t remember doing that. I think instead what happened is that I was adamantly against the Fed’s policies from the fall of 2008 onward (actually from the fall of 2007 onward…), and then when various mockers pointed at the booming stock market as proof that guys like me were idiots, at that point I started saying the boom in equities was built on quicksand. However, if Gene can find me saying the stock market was overvalued in March 2009, I will note it here as a correction.
Now, the broader issue is that I don’t think I’m grasping at straws, or merely chanting “Disaster looms!” when I say that the stock market (I normally use S&P500 but below I use the DJIA for Gene) has been driven by the Fed:
I want to be clear that Austrian theory per se doesn’t posit a mechanical connection between the stock market and the Fed’s balance sheet. I have been using that graphical device to get people to see that there is an obvious connection if you are willing to use your eyes.
Now if the connection holds–which it might not, for example if everyone suddenly thought I was a genius then the market would tank instantly–then for the Dow to go back to 15,000, the monetary base would be “only” $3.2 trillion, still 4x the height it was eight years ago.
Does anyone think that is sustainable? Maybe that’s what is throwing people here. I am assuming throughout this discussion that the Fed eventually has to let its balance sheet (as a share of GDP if you prefer) go back to pre-crisis levels. That was what Bernanke said in the beginning when he unleashed this genie.
Beyond that, I am really puzzled by how many generally free market economists (not saying anarcho-capitalists but people who generally respect markets absent a compelling reason otherwise) think that trillion dollar deficits, massive government expansion in health care and health insurance, regulations on power plants and potential big carbon tax in the wings, and the list of horrible presidential candidates all lead to a record breaking stock market. When Krugman celebrates the Obama Boom that somewhat makes sense, because he thinks what this economy needs is more government. But it baffles me how many generally free-market economists think the booming stock market of the last few years makes perfect sense.
Here’s the long term picture. I don’t see why people warning that the market is poised for a big drop are being treated like kindergartners.
This might be useful to some of you:
It’s obvious in the above that the Fed action has raised very short term rates while bringing down longer rates. (To explain some of the movements earlier, remember that markets thought the Fed was first going to raise the fed funds target in September, and then it backed off when things went nuts in the financial markets in August after the China currency move.)
Fortunately Scott clarified in the comments of the last post that it was only a subset of Austrians who had simplistic views about short- and long-term interest rates. As you may recall, recently I invoked the common (but not perfect) pattern of a textbook Fed tightening leading to (a) rising short rates and (b) stable or even falling long rates to explain why an inverted yield curve “predicts” recessions, and how that flows naturally from textbook Austrian business cycle theory.
P.S. The Internet is awful at communicating body language, tone of voice, etc. Let me once again state that the reason I go after both Krugman and Sumner is that they are very intelligent and glib cheerleaders of policy proposals that I think are terrible. As David Beckworth has gained more traction I put him in the crosshairs too. If I try to blow you up on my blog, it’s because I respect your power.
We have a super duper awesome conference this weekend here at the Free Market Institute, so I have to be brief. Let me first motivate this post by issuing the following statement, to which I want you to react:
*** Ten-year bond yields have plummeted to 1.83%, from about 2.2% when the Fed “raised” interest rates in December. I hope all the Market Monetarists whining about the Fed’s “target rate being above the natural rate” are pleased to have gotten your way. ***
Let that sink in for a moment. I’m guessing any Market Monetarist fan reading this post will now be sure–in case there was any doubt before–that I am either (a) an idiot, (b) an intellectually dishonest scoundrel, or (c) both. If you think about the above statement, you’ll realize that there are at least three things wrong/unfair about it, and that I would have no business leveling that against Market Monetarists.
The reason I bring this up is that in reality, here is what Scott Sumner recently wrote on his blog:
“Or how about 10-year bond yields plummeting to 1.83%, from about 2.2% when they “raised” interest rates in December. I hope all you Austrians who whined about “artificially low rates” being set by the Fed are pleased to have gotten your way.”
Now on to something far more substantive. Look at how Scott–one of the world’s leading free market experts on monetary policy–thinks about this stuff: “In a better world the risk of recession and the risk of the economy overheating would always be evenly balanced. And I mean always, every single day of the year.”
And there you have it. When people in the comments refer to Scott as a Keynesian, this is what they mean. This is straight up crude demand management. We don’t need to know about relative prices or capital structure. There is a tradeoff between unemployment and (price) inflation and it’s the Fed’s job to turn the dial one way or the other to coast through the sweet spot.
Against that perspective, consider Hayek from his Nobel address:
The theory which has been guiding monetary and financial policy during the last thirty years, and which I contend is largely the product of such a mistaken conception of the proper scientific procedure, consists in the assertion that there exists a simple positive correlation between total employment and the size of the aggregate demand for goods and services; it leads to the belief that we can permanently assure full employment by maintaining total money expenditure at an appropriate level. Among the various theories advanced to account for extensive unemployment, this is probably the only one in support of which strong quantitative evidence can be adduced. I nevertheless regard it as fundamentally false, and to act upon it, as we now experience, as very harmful.
P.S. I realize Scott was just venting on this particular blog post, such that he devolved into jokes about the NBA. Take my remarks above in the same light-hearted spirit.
In this post, David Beckworth uses federal funds futures contracts to glean information about “the market”‘s expectations of future monetary policy shifts. Obviously there are caveats about reasoning from an expected price change, but I think this is a good avenue for the Market Monetarists to win skeptics over.
In particular, if people in (say) June 2008 thought that the Fed would raise the fed funds target over the following year, then that is an obvious sense in which the market expected a tightening of monetary policy.
However, I push back in the comments. Before I spend time digging up the numbers, I would like people (esp. fans of Market Monetarism) to weigh in on the validity of my nuance. Here is the full back and forth (so far) between David and me:
Very interesting post. I really like what you are trying to do with the one-year ahead federal funds rate, but I think your graph is consistent with the market continuously expecting easier policy as 2008 passed. (I’m not saying the chart proves my interpretation is right, I’m rather saying it could go either way; I don’t think there is enough information.)
Where did you get that data, so that if I try to show what I mean, I am using the same numbers as you?
Bob, I am not sure what you mean. If it is June 2008 and the current fed funds rate is 2% and the fed fund futures contract says it will be 3.5% in June 2009 there is really isn’t much room for interpretation here. The market expects it to go up from 2% to 3.5% next year.
The data is not easily accessible. You need access to a Bloomberg terminal to get it.
Yes I agree there are various possible meanings to the statement. But here’s what I mean: Suppose in June 2007 the 24-month fed futures contract predicts 3.5%. Then a year passes, and by June 2008 the 12-month futures contract is still at 3.5%.
Yes, you can say “In mid-2008 the market predicted a tightening of Fed policy over the coming year,” but that tightening would have been predicted a year beforehand. It doesn’t explain why everything was fine and then the markets screamed bloody murder in late summer / fall of 2008.
And it also would be inconsistent with Ted Cruz’s grilling of Yellen. He definitely was saying that the Fed changed people’s expectations about what it was going to do, with its announcements through the summer of 2008.
So do you agree that for the Ted Cruz / Market Monetarist story to make sense, the futures markets would have to show a tightening (measured as rising fed funds rate) relative to the previous path?
I think this is really important. It lies at the heart of the Market Monetarist “revisionism” of what happened in 2008.
Long-time readers know that I have been warning for years that the U.S. stock market was being driven by Fed policy. Last summer (in 2015) my co-author Carlos Lara and I began a three-part financial/economics seminar on “The Coming Storms” to Paige McKechnie of CCC Corporation in Nashville. We had already done the first one or two presentations and then the stock market dropped sharply in August.
So in the following session (when I think some of the participants were thinking “Wow I wish I had taken these guys more seriously when they sounded so alarmist a couple of months ago”) I wanted to show people that the previous two stock crashes were not one-shot events. Instead, they were slow-motion train wrecks.
(In the above, the camera guy was only on me, and so after the fact he interspersed shots of my PowerPoint with its animations. But you can’t see what I was hitting with the laser pointer, because he didn’t have a camera on the actual screen that the audience was seeing.)
Make sure you don’t misinterpret my argument: I’m not saying that any one disaster invalidates a whole system. What I’m saying is that you can’t point to government officials screwing up water supply as *further evidence* that we need government officials to provide water, as Krugman tries to do.