It’s a Good Thing I Don’t Believe in "Intellectual Property"
What do you think, kids? At MR on October 27, Tyler pointed to the higher TIPS yield than nominal, as evidence that the market was predicting deflation. In the comments (time-stamped at 1:23 PM), I referred to a FRED graph that showed the history of the two series, in order to argue that Tyler’s explanation was bogus.
Then, on the evening of October 27, I posted that same (incredible) chart here on Free Advice, with an elaborated explanation.
Now today, Matt Machaj linked me to this post (note it was made on October 28) and asked what I thought. You can imagine my first thought, and it had nothing to do with the bond market.
Now it’s not a smoking gun, I grant you. After all, we are both linking to a FRED-generated graph. But still…
Today, Non Sequitur; Tomorrow, Ziggy
This blog is growing by leaps and bounds. It obviously inspired this cartoon:
(HT2 Steve Horwitz)
Two New Websites
Ilana Mercer and Matthew Mueller have both recently launched new websites, which may prove interesting to Austro-libertarians.
I Told You Greenspan’s "Admission" Was Fatal
Reader Bob Roddis alerted me to this annoying cartoon. All I can say is, I told you so.
Cap & Trade: If I Can Change Just One Mind…
…I’m not sure it’s worth it, but hey it’s encouraging. AEI’s Ken Green and I butted heads (politely) at last year’s Heartland “denier” conference in NYC. Green acknowledged the caveats but, at that time, still thought the government should try to implement a revenue-neutral cap & trade program. He has now apparently retracted his earlier support (HT2 Rob Bradley):
I previously felt that a revenue-neutral carbon tax was a good idea, because it would be both effective and could even be economically beneficial. But three developments have caused me to retract my support. First, rising energy costs have already imposed a huge carbon tax with little GHG reduction. This suggests that the elasticity of energy use could be lower than prior estimates, meaning it would be a useless gesture. Second, as implementations of carbon taxes in Europe and Canada have demonstrated, governments simply cannot implement such tax systems without sucking up some of the revenue, and using the rest to benefit crony-capitalists and steer money to favored constituencies. And finally, because using biofuels such as ethanol would let people save on carbon taxes, demand for such fuels will grow, only compounding the environmental and nutritional mischief they cause.
What is interesting about Ken is that he is quite clearly still concerned about manmade climate change (just skim his article above). So he is living proof that someone can endorse the IPCC’s science, but not its policy recommendations.
And by the way, Ken is not recommending a “do-nothing” approach:
Policymakers who really want to implement rational climate policy should be focused, here and elsewhere, on building resilience to climate variability by removing the kind of risk subsidies that lead people to put themselves in climatically sensitive areas, to build on flood plains, in storm tracks and so on. They should be focused on ending the kind of subsidized infrastructure programs that lead people to build giant cities in deserts dependent on far-away sources of seasonal snow. And they should put economic repairs first: only the surplus wealth of productive economies allows us to protect our environment, set aside natural resources, and tread more lightly on the Earth.
Two Random Notes
Andrew Sullivan linked to my Crash Landing post challenging Obama supporters to list things that he could do (assuming he wins) that would make them regret their current support for him. Traffic jumped 732% from the previous day. Too bad there are no Google ads over there!
On a completely unrelated note, my friend Sam is a graphic artist and mentioned that he redid the cover of a Mark Twain publication with which you may be unfamiliar. It’s odd that this book is so obscure, because I guarantee school boys would read this volume more than Heart of Darkness or other “classics.”
Is the Market Forecasting Deflation?
As I have explained in a previous post, a typical measure of the market’s inflation forecast has been falling, and just recently actually went negative. Specifically, if you take the yield on 5-year Treasurys and subtract the yield on 5-year TIPS, that should give you an approximate reading on what investors think annual increases in the CPI will be over the next five years. (I explain this a bit more in the post linked above.)
Tyler Cowen happily cites this fact, since it buttresses his argument that the credit markets are collapsing. (I.e. if there is no credit, prices fall.)
But if we look at the actual constituents of this “market forecast”–i.e. if we break it down into the nominal and TIPS yields–then we see something very strange. Since 2003 (when the Treasury began offering 5-year TIPS), the spread between nominal and TIPS Treasurys has been 2-points-and-change, presumably reflecting the market’s expectations of moderate price inflation.
But then since about June of this year, the gap between the nominal and TIPS has completely disappeared. To repeat, this is why those calling for a deflationary depression feel vindicated. But if their explanation is correct, we would expect that the TIPS yield fell during the last 5 months (as investors’ forecasts about future growth got more and more pessimistic), while the nominal yields fell even more (as investors grew pessimistic about the economy and started to factor in lower and lower price increases).
But the opposite happened, as the chart below beautifully illustrates. Nominal yields have fallen a little, but the main reason the gap between nominal and TIPS disappeared is that the TIPS yield shot way up. In fact, the 5-year TIPS yield is currently the highest it has ever been, going back to 2003.
This chart is totally incompatible with Tyler Cowen’s explanation. It can’t possibly be the case that investors are currently forecasting the strongest 5-year growth since 2003. Something else must be going on here.
I submit that one explanation is that investors are growing less confident in the government honoring TIPS contracts. Remember, the way these work is that the government pays a contractually fixed rate, but the principal is adjusted based on changes in the CPI. Thus, it is a “Treasury Inflation Protected Security” (TIPS).
But what if the Treasury is running an $800 billion deficit next year? Isn’t it just possible that, before it actually defaults on nominal Treasurys, it first starts cutting corners with the principal adjustment on TIPS? It wouldn’t even have to be an official adjustment in the rules; it could simply lean on the BLS to underreport the increase in CPI.
I am not saying this aspect is the whole story, but I think it is definitely a part of it. The market price for insuring even regular Treasurys against default has risen sharply since January. So I think it is very reasonable to suppose that investors are insisting on higher TIPS yields, because they fear hanky panky in the principal adjustment over the next five years.
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