A Proposed Apology
[UPDATE: Some people got it in the comments, but just to be sure: This “apology” was a joke; I was just mimicking Krugman’s pseudo-apology in this piece. So if you knew right away that Krugman would never accept the below from Schiff or me, then do what you will with his own mea culpa…]
At this point, we could generate Paul Krugman’s blog posts with a gerbil, 3 index cards, and some twine. All you really need to write is, “The other side made bad predictions. They haven’t changed their policy recommendations. They are stupid, evil, or both. Winning.”
So I wonder if Krugman would move on with his life, if guys like Peter Schiff and me announced the following mea culpa:
[HYPOTHETICAL ADMISSION OF ERROR.] Yes, I made a mistake back in 2008, over Bernanke’s use of the financial crisis to push through a huge bailout of Wall Street, even though the arguments used to justify this “rescue” made no sense. The Fed started paying interest on excess reserves, at the same time they told the public its huge balance sheet expansion was all about maintaining lending to small business. This struck me at the time as banana-republic behavior, and still does.
However, I wrongly believed that markets would look at it the same way, and that they would lose faith in the Fed’s commitment to low inflation, driving up interest rates on our debt. Instead, bond investors discounted the cronyism, and acted as if they believed that the Fed would eventually pull itself together and start behaving responsibly. The jury’s still out on that, but clearly my short-run prediction proved wrong.
I have two questions for my readers:
(1) Does anyone think Paul Krugman would agree that the above was a candid acceptance of our mistake, and drop the subject?
(2) Does anyone know why I worded the above, the way I did?
I don’t think Krugman would accept that apology. My interpretation of the apology is, “I see it this way, markets see it another way, so even if I’m right I’m wrong. Sorry.”
Seeing Mike’s comment below, I see what you did there, now.
Because you have already admitted several times you made a mistake with the bet on your blog and various other places, but Krugman continues to say you haven’t admitted you were wrong, even though he doesn’t see any need to ever read your blog anyway since you don’t have anything worthy of his attention to say?
Murphy, you’re a slick cat. My first reaction was this has to be related to Krugman’s mea culpa on deficits in ’03. And lo and behold, here’s Krugman from a few years ago:
“The second was circa 2003, over the Bush administration’s use of the illusion of victory in Iraq to push through more tax cuts, even though the optimistic budget projections used to justify the first round had proved completely wrong. It’s worth pointing out that the situation was not at all like the present, where I support temporary deficit spending to deal with a depressed economy; the Bushies were pushing permanent tax cuts that had nothing to do with economic stimulus, and did so at a time of war with no offsetting spending cuts (and then pushed through an unfunded expansion of Medicare too). This struck me at the time as banana-republic behavior, and still does.
However, I wrongly believed that markets would look at it the same way, and that they would lose faith in American governance, driving up interest rates on our debt. Instead, bond investors discounted the politics, and acted as if they believed that America would eventually pull itself together and start behaving responsibly. The jury’s still out on that, but clearly my short-run prediction proved wrong.”
And by the way, I still don’t think Krugman “would agree that the above was a candid acceptance of our mistake, and drop the subject.”
Great post.
I like your response, better. Good job.
forgot to include the link to Krugman’s post referenced above:
http://krugman.blogs.nytimes.com/2010/09/01/mistakes/
You spoiled it too early..
😉
Because when the price inflation of which you were speaking finally does arrive, you can point people to this post and show that you understood the reason why it was going to happen, whether or not you got the timing correct.
You likened the Fed’s actions to a Banana Republic because the only reason price inflation hasn’t been so dramatic in the official CPI is because the Fed has been paying the banks, with printed money, to park their reserves.
As soon as that is no longer “profitable” to the banks, in paper dollar terms, they will lend all that money into the economy, at which point price inflation will ramp up as you predicted.
The Fed is paying interest rate of .25%/year on excess reserves. That’s not high enough to discourage lending or borrowing. The interest rate is not the reason banks are holding excess reserves.
Amazing that 25 basis points is sufficient to contain a “dollar collapse” and hyperinflation. In June 2004, the fed funds rate was 1%. In June 2006, it was 5%. So for two years, the Fed raised rates. Wonder why they did not simply stop at 1.25% since that was apparently sufficient to maintain price stability.
The fed funds rate is the rate at which banks lend reserves held at the Fed to each other overnight, uncollateralized. Comparing the fed funds rate to the rate the Fed pays member banks to *not* make loans and simply sit on reserves is not apples to apples.
Also, the economic outlook was quite different from 2004-2006 than it is presently. Given an environment with high uncertainty, I don’t think it is implausible that a riskless 25bp profit would be more attractive than a substantial number of risky loans. I’m not suggesting that this policy is the only thing standing between manageable inflation and hyperinflation, but I wouldn’t be shocked if it was having a substantive impact on lending.
Then the question would be why do at all if it is insignificant…
And the fact that some 1.8 trillion actually sit in excess reserves instead of being loaned out answers it directly, doesn’t it?
Should you really be saying that?
I mean, the biggest bond investor is the Fed itself, and it isn’t really intending to make a profit out of this, it just monetizes government debt, so the fact that bond rates are not rising is simply a matter of displacement. As private investors eased themselves toward the door (some funds are forced to hold bonds, they can’t find the door) so the Fed just kept buying.
Hmmm, I would suggest that most Austrians predicted [A] the Fed would use QE as an excuse to monetize debt and give some free money to government, and some free money to the big banks, and [B] this new money would wash through and prices would start rising, and [C] rising prices plus the potential of unlimited future QE would reduce international confidence in the US dollar.
In terms of [A] we can absolutely say that debt monetization has happened, and is real. Money printing to all intents and purposes. However, the Fed has not gone completely nuts, as I’ve posted before:
http://research.stlouisfed.org/fred2/series/PPIACO
Note the right hand side of the graph has a horizontal patch around 200, this is no accident, what you see there is someone trying to maintain a target. This means that QE was not unlimited, and in future won’t be unlimited, the Fed are serious about keeping the currency stable, they don’t suck as much as we thought.
Moving to [B] we have a lot of new money that has not had such a big effect on prices as everyone expected. The new money has to some extent just sat in bank reserves, and also to some extent gone into things like paying for food stamps (i.e. keeping food prices high) and the banks are collecting interest on those reserves, discouraging them from moving that money. Let’s not forget that the banks also made massive losses on mortgage defaults, and those government-backed institutions Fannie and Freddy needed government intervention to prevent complete implosion. If you search around, the FNMA’s hold or guarantee about half of all mortgage debt (something like $5 trillion) which in principle is debt backed by the taxpayer.
Thus, you have new money tipping into banks from the Fed, at the same time as you have collapsing debts (which if Mark-to-Market was operational would be realized on balance sheets) causing losses that have to be carried by someone.
Getting to [C] there has been some loss of purchasing power of the US dollar, in an International context, although not as much as you might expect. The Euro has been trashed by their own debt disaster, Japan has deliberately trashed their currency and China stubbornly refuses to float their currency, but commodity-backed currencies like the Australian dollar and Brazilian real came up in value, and the Yen would have risen in value without interference. In addition there have been a bunch of bilateral central bank agreements (e.g. Australia and China) for the specific purpose of bypassing the US dollar.
Let’s not forget, Krugman predicted this:
He predicted that more than 12 months ago and none of those things have happened. I think eventually Germany will leave the Euro, but it will be a well organized exit, not a hasty panic.
I don’t think it’s true that “the biggest bond investor is the Fed itself”. It may be that if you look at how our current year’s deficit, a large percentage of the associated Treasury securities have been bought by the Fed. But the correct metric is what percentage of the total outstanding debt is owned by the Fed, and I think that percentage is relatively small. I may be wrong though.
Why is that a good metric? Aren’t we talking about the change that happens as a consequence of policy?
Some pension fund that purchased 20 year government bonds back before the crash, and intends to sit on those to maturity, is hardly relevant in the context of market reaction to QE.
Well, the price of bonds is dependent (in the loanable funds market) on the supply of bonds and demand for bonds, so the extent to which the price of bonds is affected by the Fed is determined by how much of the demand for bonds is due to the Fed. The issuance date of a bond is irrelevant to that question.
So on any given day, the price of bonds is determined by the bonds changing hands on that particular day, not by bonds sitting on the shelf waiting to mature.
You started by saying, “the correct metric is what percentage of the total outstanding debt is owned by the Fed”
Now you say, “the price of bonds is affected by the Fed is determined by how much of the demand for bonds is due to the Fed”
The demand is generated on the day not in total. Thus, rate change of Fed holdings is the key metric.
I think it’s essential to point out that raising the price of worthless or “troubled” assets for the elite should count as “inflation”.
Yeah, we have a problem in Australia that a large fraction of the banking industry sits on mortgage debt, but houses in most of the major cities (especially Sydney) are irrationally overpriced.
I paid $350k for a half-way clapped out wood frame house with cracked concrete tiles on the roof, a smallish block, a bit of plastic cladding around the outside and some random mix or asbestos panels and very old coconut fibre plaster. Surprisingly, the value of this place has probably risen to $400k just in the past 4 years, and that’s not counting the $10k I spent putting real electrical wiring into it (replacing the cables from the 1950’s that were literally falling apart) and the $5k I spent on a new sewer line to replace pipes that were also falling apart.
That’s what is considered entry level housing in Sydney, we have homeless people on most street corners and in most of the city parks. We have homeless kids sleeping on trains.
No government wants to be the one responsible for a correction in mortgage debt…. so they do anything and everything to keep prices high. They throttle the supply of land, they introduce all sorts of whacky building codes, regulations, permits, inspections, licenses, protection orders, you name it.
I talked to one of the girls at work, and she explained she is paying about $150 per week for a place to stay in the city. I asked if that was for a room in a shared house, she said, no, no, that’s for half a room, which she shares with another girl also paying the same amount.
Rationally as a home owner, with a decent sized debt, I should be voting for inflation, and also for greater market interference to keep prices high. However, as a nation we need the opposite.
The reason I got into debt is because I figured that there will come a time when the powers that be simply can’t help themselves and will print money to get themselves out of the mess they got into. This is guesswork of course, but there’s no value trying to guess the market, we don’t have a market, we have policy makers.
Just replying to myself here… check out this graph of mortgage delinquency in the USA:
http://www.russell.com/helping-advisors/img/dashboard/Mortgagedelinquencies.gif?ver=18
In signal engineering we call that a step function. I dunno what economists call it but in the scheme of things, the past three years have been no change. No noticeable recovery, nana, ziltch.
And this is why we ascribe to Austrian Economics; human behaviour is unpredictable; human beings are a lot stupider (or more evil) than we originally thought back in ’08. Economic laws, however, are most definitely not unpredictable. I look forward to your victorious blog on doomsday, Mr Murphy. As you implied, you were not wrong, merely early.
I think it is fair to work on the principle that humans are self interested, and gather what information is available to them, but on the whole don’t have good information.
There will be cases where this is wrong, you might come across a person with very good information and also great public spirit, but that’s sufficiently rare that as a first approximation ignoring that guy won’t mess you up too much.
On this point, I recommend to you this video:
The Birth of the Austrian School | Josep T. Salerno
http://www.youtube.com/watch?v=dZRZKX5zAD4
Salerno develops the concept of all economic activity beginning with the individual very well.
It explains all prices.
(He solves the diamond-water paradox in this video. It’s pretty cool.)