Market Prices Mean Something, When an Economist Agrees With Them
This is pretty funny. In the great debate over Bernanke, guys like Scott Sumner and Paul Krugman keep pointing at the bond market to show that guys like me are nuts for worrying about (price) inflation.
My strongest comeback is to point at commodities, and in particular the price of gold. After all, surely S&K aren’t going to argue that gold is up simply because of the increased demand for dental fillings in emerging markets.
So how do I deal with the undeniably low yields on US debt? Well, maybe the fact that the Fed has absorbed so much of it is one big factor. (Speaking of which: Does Krugman really think that bond yields would hardly move, even if the Fed not only stopped accumulating, but actually dumped its entire portfolio over the next month? I’m not asking that sarcastically.)
My other response is to say, “Gosh I don’t study these things as much as the professional bond traders, but I nonetheless think sovereign debt is in a bubble. A few years from now, I think we’ll look back at the collapse in bond prices and realize ‘the market’ was as deluded as during the housing bubble.”
Not entirely satisfactory responses, I’ll grant you, and I am actively refining my views on these things since the massive grocery store price inflation has not yet materialized as I was confident it would by now.
But in terms of grasping at straws, Krugman’s explanation for gold prices strikes me as downright silly. Whereas I can try to explain bond prices due to Ben Bernanke and his trillion-dollar-plus printing press, Krugman blames…Glenn Beck, with his radio and TV shows:
Kash, at the Street Light, has a very good post on the price of gold and its relationship or lack thereof to inflation fears. He points out that the market for gold is surprisingly small, so that it would take only a relatively small number of extra buyers to push the price way up, even when other, more direct measures of expected inflation remain low….
Surprisingly, though, Kash doesn’t say explicitly that this parallel is not at all hypothetical. Glenn Beck was financially intertwined with Goldline, and therefore had a financial stake in pushing fears of hyperinflation. And he had many, many viewers. So there was a direct channel through which conservative Americans were being pushed into buying gold.
Market prices almost always tell you something useful. But sometimes what they tell you is that there’s a marketing scam in progress.
So, the US treasury bond is a giant marketing scam?
That would be one way to reconcile Krugman and my position, yes, von Pepe.
Also, Krugman is pretty inconsistent about pointing to the lack of bond vigilantes. Somehow, their non-existence is proof of the unfoundedness of inflation fears, but you have to ignore 10-yr treasury yields altogether when calculating the risk of not raising the debt ceiling.
Does anyone doubt that, if 10-yr yields had been shooting up, he would cite that as evidence of the danger of not raising the debt ceiling (or otherwise deviating from his preferred policies)?
Silas, right, though I guess Krugman would say, “Bond traders expect a deal.”
i don’t know what you guys are still arguing over this for. in 5 billion years, the sun is going to turn into a red giant and eat up the earth, and all of this will be forgotten anyways
You don’t think humans will have left the Earth in 5 billion years?
Not if the debt ceiling is not raised before.
I’ll offer a trader’s perspective. There’s incredible inertia in the sovereign bond markets, especially in the “AAAs”. There’s a three decade down trend in the 30 year yield and a very well defined down trend channel going back to the early nineties. Changes in secular trends take years to play out, and that is what is occurring now. Here’s a chart I prepared back in February when the yield was just poking above the channel.
http://chart.ly/uploads/33miyjo.png
The projected path has pretty much played out (somewhat luck here), though yield did not dip as much as expected. It might go higher, lower or sideways from here. The point is that when price definitively breaks out of the channel, it will catch the attention of every trader, including the bond vigilantes, and that is when we might see the rapid appreciation (in yield).
As to gold, bulls are helped, and not constrained, by its secular trend, which turned bullish a decade ago.
Gold is a small market? I believe there are ~5 bil troy ounces above ground(~140k metric tonnes.) That’s about $8 Trillion worth at todays price.
According to the LBMA in April there was an average turnover of 22.5 million ounces per day($35 bil worth per day) in the london physical market.
Then you have multiple futures contracts (GC YG MGC QO XGN ZG) and options and all the OTC swaps. (I don’t feel like finding the O/I, volume and notional value of all those contracts but you can look at the CME, NYSE-LIFFE, and BIS websites if you’re interested).
Sure, the GC contract at the CME trades relatively thin but all these markets are arbed so…
“Krugman, at the NYT, has a very good post on the price of bonds and its relationship or lack thereof to inflation fears. He points out that the free market for bonds is surprisingly small, so that it would take only a relatively small number of extra Fed buys to push the prices way up, even when other, more direct measures of expected inflation remain high….
“Surprisingly, though, Krugman doesn’t say explicitly that this parallel is not at all hypothetical. Primary dealers are financially intertwined with the Federal Reserve, and therefore had a financial stake in pushing fears of hyperdeflation. And they had many, many buyers. So there was a direct channel through which progressive Americans were being pushed into buying bonds.
“Market prices almost always tell you something useful. But sometimes what they tell you is that there’s a marketing scam in progress.”
I’m not going to defend Krugman, but Sumner’s view is that the increase in gold is driven by increased demand from emerging markets.
Two points:
First, the price of gold is inversely related to the level of real interest rates. Real interest rates are low.
Second, inflationary expectations are not, I would suggest, fully captured these days by a point estimate or a single expected value. In calmer times, not only would inflationary expectations across individuals exhibit more similarity but each individual’s estimated probability distribution of future inflation outcomes would likely be much more concentrated around the mean. Nowadays, an investor might think that, on balance, inflation will remain lowish, but also believe that there is a non-negligible probability that inflation will be substantially higher due to, for example, debt monetization or more rapid erosion of the US dollar’s position as world reserve currency.
In such circumstances, gold may trade in part like an option. The greater the range of potential likely outcomes, the greater the potential future volatility and the greater the value. The network effect that helps to sustain the choice of a reserve currency in stable times could in unstable times help to speed a decline in value. This increases the potential future volatility in an environment in which confidence in the currency or policymakers has been undermined.
Thus, the bond market and gold may not be sending inconsistent signals, they may just be conveying information about different elements of inflationary expectations (point estimate vs. dispersion). Put another way, you may not expect your house to burn down (the point estimate) but you will probably still buy fire insurance (the option).
Need I point out that to refer to Krugman’s explanation as silly, when it’s consistent with the data, while yours is completely inconsistent with it is laughable? lol
You have no idea what you’re talking about, period. The patterns of gyrations in gold prices versus interest rates, inflation metrics, etc. are completely inconsistent with your stated views. You don’t even understand what inflation is, much less what drives the gold market, of which far less is widely known. You’re not an economist, you admit you’re wrong versus the data, but you still venture opinions. Is there a better description of the behavior of a fool?
The Fed has “printed” an enormous amount of money, but it has been very creative in feeding it into the market. Velocity remains way down. As Velocity returns to normal the Fed most remove all that money – carefully, without tanking the economy.
Gold and bond prices do not represent the entire market, They are different markets and I suspect have different investors, representing different future expectations. Essentially to a small extent Krugman is right, Gold prices are up because people expecting inflations – a group with a probably larger than normal overlap against Glenn Beck viewers, are flocking to that market. To the same extent Bond yields are artificially low, because alot of that printing press money is propping up debt. Further a “soveriegn debt crisis” in the US is not the same as one in Greece. A total default by Greece would kill off a few european banks, and probably drive europe back into recession. When the US economy sneezes the entire world gets a cold. I remember an adage from awhile back that when you owe a bank a couple of hundred thousand, they have you by the balls. When you owe them a couple of Billion you have them by the balls. How much leverage is there in more than $10T ? It is in the interests of the entire market to believe the US will get its financial house in order – because the alternative is inconceivable. You can bet against greece and win, how do you profit from global financial collapse ?
I am a bit hyperbolic, but the point is still there. The global need for US financial stability distorts signals.