22 Jun 2013

Common Sense vs. Scott Sumner

Inflation, Krugman, Scott Sumner 22 Comments

I am at Porcfest–lots of video forthcoming–so perhaps I’m missing nuances here, but my understanding is:

(1) The Fed announced it would scale back its purchases of Treasuries and other assets (depending on the situation) in such a way, as to make the markets think that the Fed was going to tighten sooner than previously thought.

(2) The stock market fell sharply.

(3) Price inflation expectations fell.

(4) Nominal Treasury yields rose.

(5) Real Treasury yields went through the roof (e.g. from June 3 to June 21, the 30-year TIPS yield went from 0.95% to 1.45%).

So the common layman would presumably interpret the above by saying, “Bernanke’s massive money pumping and Treasury buying had been propping up stock and Treasury prices, and raising price inflation expectations. When the Fed announced it was backing off, people expecting less price inflation, and with less of a buyer the price of Treasuries fell (i.e. yields rose). Duh.”

Yet if I’ve understood Scott Sumner and Nick Rowe (not going to look up links right now), this is a very ignorant perspective. It’s wrong to think the Fed pushes up the price of bonds when it buys them; the opposite is the norm. Consequently, people who think there is a cozy relationship between the Fed and the government just don’t know macro.

So this week’s situation should at least throw sand in their gears. When something like this happened in Japan recently, I think they had the decency to admit it puzzled them. And to be fair, Scott has the decency right now to write: “I have no idea why real T-bond yields are soaring—no idea at all. However given the rise in real bond yields, the stock market setback is quite small, indicating that the market doesn’t expect significantly slower growth. That also confuses me.”

In summary, my point isn’t here to say, “Aha! Sumner is a fool.” Rather, my point is to remind the free-market fans of Sumner that his worldview doesn’t “explain everything perfectly since 2008” the way his more energetic supporters like to claim. The allegedly naive commonsense approach–which says the Fed is holding down interest rates right now–also has a lot going for it, in addition to being common sense.

P.S. Recently Krugman did a post where he walked through the permutations of stock, dollar, and bond prices to tell whether the Keynesians or their critics were right, in assessing Fed policy. I don’t have time to go look that up right now, but does Krugman’s analysis–which at the time made him look like a genius of course–show, in light of this week’s events, that the Fed is the bad guy?

22 Responses to “Common Sense vs. Scott Sumner”

  1. Anonymous says:

    I imagine this is the Krugman post (05-29-13):

    •”…And while day by day there are variations, basically what you see over the last month or so is line 3: falling bond prices accompanied by rising stocks and a rising dollar. So this looks like a story about macroeconomic optimism.”

  2. Max says:

    It’s a conundrum, as Greenspan would say.

    Or maybe it’s nothing.

  3. joe says:

    The common layman would presumably interpret the fall in price of gold by saying, “Bernanke’s massive money pumping and Treasury buying had been propping up gold prices.” However, the same crowd is telling investors to buy gold.

    • Tel says:

      They have been telling people to buy gold, because of a belief that QE, QE2, QE3 would result in an infinite series of QE which could be guaranteed to prop up the price of gold.

      If there was reason to believe that the Fed was about to tighten up hard on monetary policy, you most certainly would want to sell your gold before that happens.

      Do we have reason to believe that such a tightening is coming? Hmmm, maybe a little, but going to be very difficult for the Fed to say NO to government spending… there’s the real rub. When the President comes around and bangs on the door and says, “Why aren’t you buying my bonds any more? I can’t afford the interest payments.” that’s the day when things get bumpy.

      • MMT: it's a Nominal Thing says:

        There are reasons to own gold besides QE. Puplava talks about this in a recent newshour piece: Prosperity.

        My opinion continues to develop though. P. metals don’t track inflation closely, they have bull and bear markets like anything else. QE and doomsday fears gave P. metals a boost, and these fears have begun to wane. P. Metals ran up dramatically during the “prosperous” Bush years.

        Gold might find a new floor of say $800/oz due to all of the new money. Although I suspect the price will go much much higher if banks begin lending even a fraction of the excess reserves, along with most other prices.

        Things get sold during scary times. They put their money in “safe” things. It has so far been the USD. It could continue being this way if the US is the best behaved of the bunch. As such, it may make sense to hold USD, and not stocks, commodities etc during the next downturn. I don’t really expect this to be the case, but it is absolutely a possibility.

        So far the Elliot wave deflationistas have the absolute worst track record. I am not bashing them. They are honest and well reasoned, but things so far have turned out differently.

        In summary, I don’t know what the hell is going to happen. One thing I am sure of though. Bonds. Bonds are guaranteed to crumble. US treasury bonds may have one last dying breath. I pray for this. Although I always second guess myself…… why is Marc Faber optimistic on US treasury bonds?!?!?

        • Tel says:

          My point remains that if you knew the Fed was going to tighten up monetary policy hard in (say) two weeks exactly, and you had a lot of gold right now, then you should be selling, right?

          I’m not pretending that I do know what The Bernank is doing, but if you want to play the game of double-guess-the-Fed then the right rule for playing is buy physical assets when you expect QE and sell physical assets when you expect QE to stop.

          If you want to hold your gold for a long time and just accumulate, then you are opting out of that particular game. Good luck to you as an honest save of wealth, but you know that some of the game-players will beat you.

          Bonds are guaranteed to crumble. US treasury bonds may have one last dying breath. I pray for this.

          Hmmm, I don’t know of any limit to how many Bonds the Fed can buy, but if all they ever do is just keep buying then eventually (price) inflation must surely be the result. In terms of third parties (i.e. you and me) making a profit on bonds then yeah, as the interest rate gets closer to zero there’s no upside to be found, and potentially lots of downside should inflation ever get out of hand.

          Will the Fed be dumb enough to push this right to the wire? I’m cautiously optimistic that they will reign it in, gently but firmly at the same time.

  4. Keshav Srinivasan says:

    Bob, here is Krugman’s post with his table of different possibilities:

  5. JSR08 says:

    Occam’s Razor.

    • Ken B says:

      Ask and ye shall receive!

  6. Innocent says:

    First the stock market fell because people got spooked in the short term of Bernanke’s inflationary spending from $85 Billion to $65 Billion, which means the market is jumping at shadows. We should see a jump during this next week in preparations to earnings ( which will be down if indicators have anything to say about it ) China is on fire, yet they are saying it is not. Japan is in the process of inflating its currency and attempting to drive investors off their shores for the short term, goodness knows what will happen to their debt. Europe is still on a path to ruin. India is in trouble.

    So hey lets do another Government Stimulus cause nothing can go wrong with that.

    Anyway… right now economically we are sitting on a keg of dry powder with a large amount of oxygen in the room and a tap dancer with flint on their shoes is about to start an encore performance.

    Now I could be wrong about all of this… But I doubt it. The Fed knows it has created an inflationary bubble in stocks and it has no idea how to mitigate it at this point without undoing all the ‘good’ they have done to date.

    I am more worried about all the other economic choices that have been made propping up everything rather than allowing the parts that should have fallen in on themselves to have fallen in. Portions of the economy are still on VERY shaky ground and there is no relief in sight.

  7. Tel says:

    I stumbled across something that I consider to be good news (possibly off topic, but I’ve been met with tolerance in the past):


    Note the horizontal flat endy bit in the last couple of years. The US dollar has been softly locked to commodities, almost as if by an invisible hand. Any bets on how long it stays locked?

    • Major_Freedom says:

      I’m looking at the early 1970s to now, and thinking “not for long”.

      • Tel says:

        It is entirely a matter of choice though. The Fed have plenty of opportunity to tighten up monetary policy should they choose to.

        In principle, they could stop buying treasury bonds and force government to pay more in interest rates and thus throttle off the easy money supply. Whether they have the guts to do this is another matter, but they could do, there’s nothing actually stopping them.

        To my eye, the PPIACO sitting right on 200 seems very artificial, I think it shows all the signs that the Fed might be targeting stable commodity prices — if that’s what they are doing then it is good news. Common sense indeed.

    • Max says:

      Good news if you live in Saudi Arabia.

  8. skylien says:

    Common Sense tells me that Mr Bernanke (by only whispering some words) is the only one who really moves the markets now, which means the dependency on him is so huge, which means the very feedback of the financial industry that is completely non-existent in any macro model and nobody can account for (yet it is those models on which our economists and FED officials look to decide how much money we need to print, how many and what assets should be put on the FEDs balance sheet, how high the government deficit/spending (no matter on what) should be to close the “output gap”, at what height interest rate should be fixed etc..), this very unaccounted currently huge feedback tells me that those guys really don’t know what they are doing, and hence I will BTFD in PMs no matter if they are going to really tighten or start QETWISTOMTWHATEVER.

  9. Ken P says:

    Is this a preview of what may happen when QE really ends? Is their any market concern on how smoothly that wind-down will go?

  10. Lio says:

    I’m tired of hearing all these inflationists! Sumner, Krugman, Stiglitz, Blanchard… all the same!

  11. Edward says:

    “I’m tired of hearing all these inflationists! Sumner, Krugman, Stiglitz, Blanchard… all the same!”

    Better get used to them, because we’re not shutting up.

    And by the way, we’re right

  12. Ken Pruitt says:

    I see you’re still quarreling with others on monetary theory. For myself, I’ve been quarreling with Protectionists.

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