Semi-Daily Journal

Query: With interest rates already so low, isn't a 1/4 point reduction relatively large?

1/4 percent of 2 is greater than 1/4 precent of 8. However, the amount of interest reduction on $100,000 would be the same, $250 per year. No it is not especially large.

When AG worked with Clinton, he got all kinds of fiscal help in keeping spending down, reducing the deficit, etc. Now he is getting negative fiscal help from Mr. Bush. AG must be a Republican first and an economist second. How else could he tolerate such misfeasance without delivering a tongue lashing?

" I am a critic of the whole monetarist approach to the deflation problem. This includes Ben Bernanke, and of course Sir Alan...."

Who would be the same Alan working through interest rates. If Rob is reading this perhaps he would like to attempt an explanation of how the gentleman is able to make the "monetarist" connection.

Yeah, I'm no friend of Alan G, but the FT article was way off. Krauss must have a lot of friends in the bond speculation business who were caught out by the Fed, and since they all are geniuses, it must be the Fed's fault, right?

Yes, bakho. During the 1990's, I heard 'it's the Greenspan economy'. Now Clinton's gone, Greenspan's here, and things don't look so rosy.

Fed funds futures were pricing in an even split between the likelihood of a 25 bp ease and one of 50 bp the last days prior to the meeting. Mr Krauss and Professor DeLong came to different conclusions regarding what Fed officials were signaling, different by 25 basis points, but the thing that matters to the good functioning of financial markets is that markets have an accurate idea of what the thinking of Fed officials is going into the meeting. Unless the Fed starts easing in increments smaller than 25 bp, it is not a necessarily a sign of something being out of whack to have the market price in even odds of 25 and 50 bp and then have one of those turn out to be the result. If Fed officials were dead set on 25 bp, then a modest mistake in signaling was made. If minds weren't made up till the meeting got underway, then market pricing was an accurate reflection of Fed thinking ahead of the meeting. Mr Krauss apparently missed the dissent for a 50 bp ease. Good for Ed Hugh.

Mr Krauss is also apparently unaware of the common tendency of financial markets to overshoot. The price swings in the Treasury market that Krause sees as mahem are pretty tame stuff, given that it is probably the aftershock of an apparent end to easing.

Thanks K Harris

Since I have nothing special to add to what's been said, I would just jump in for a moment in my own self-defence.

I've defended Greenspan, I've defended Mary Feldstein, I've defended Gregg Mankiw, now do I do anything else other than apologise for the (relatively) rich and famous:

http://www.edwardhugh.net/bulgaria.html

I think it's fantastic to criticise, it's something old fashioned about intellectual integrity that bothers me.

That was of course Marty Feldstein, what a Freudian slip! Mind you, I am sure we would make a great double act in a 'drag queens' show together.

Edward Hugh

Please do comment on the 65 basis point rise in interest rates on the 10 year treasury note since June 13. Alan Blinder has been telling us there is a bubble in the bond market. I am puzzled.

For the sake of argument, what's a bubble?

"For the sake of argument, what's a bubble?"

It's when price of something goes up more than someone thinks it should. They're so easy to spot that you can identify 10 out of 3 of them, no problem.

K Harris

No argument. Good question. What is a bond bubble? Why have investors bid bond prices so high? Can an investor really expect to make a decent gain on a 10 year treasury at 3.1 or 3.5 or 3.75% Why do you think I am puzzled?

A bubble is when not only nobody want to buy at a price higher than the one you paid when you need that money, but every body else want to sell that kind of assets.

DSW

So, you know a bubble after the pop! I am quite concerned about the loss in income to bond holders that has resulted and will continue to result from low interest rates. We are net creditors, and the income loss is susbstantial. Older households in particular will be more limited income.

I don't know if there is a bubble in Treasuries. If a bubble is just prices in some market going up to a point past which they then go down, then there are bubbles all over the place and they aren't particularly damaging. If as Antoni Jaume suggests, a bubble is when nobody wants to hold an asset at a price at which that asset recently traded, then you still can't identify a bubble till after it pops, which would help explain why they can exist at all.

I think Blinder is really smart and I know he has made some impressive forecasts, so I worry when he worries. Still, one needs to use some metric to assess the conditions of markets, or one is just guessing. The steepness of the Treasury yield curve seems a good place to start. At 270 basis points from Fed funds to 10 year yields, the curve is pretty steep. That looks like evidence that holders of tens expect something to come along and erode the value of tens while they hold them. That would not be symptomatic of a bubble. The 65 basis point rise in 10-year rates since mid-June almost fully reverses the decline in rates since May 6, when the FOMC press release mentioned the (remote) risk of deflation. It also brings tens within about 20 bp of the average yield on tens for the 6 months prior to May 6. So if the bubble amounts to more than 20 bp, it must have persisted in a state of suspended animation for about 6 months from mid-October of 2002 to early May of this year. That steady performance is not what I usually associate with bubbles.

When Ed Hugh returns, he can remind me that I have the cantankerous habit of not seeing bubbles anywhere.

Well argued. Remember the point about lost income from low interest rates on bonds. Also, I am concerned about the drawing down of equity in homes for consumption. We appear to be reducing savings in a number of ways. Stephen Roach is suggesting that national savings will go to zero in the coming year.

Anne

http://www.morganstanley.com/GEFdata/digests/20030707-mon.html

Flashpoint?
Stephen Roach (Beijing)

There’s little concern about the mounting imbalances of a saving-short US economy. Nor are there any serious worries about the perils of a US-centric world. At least that’s the verdict that I take away from my recent discussions with investors, businesspeople, and policy makers around the world. That could be a dangerous oversight. The United States is rapidly approaching an ominous threshold -- a net national saving rate that is about to go negative. Could that be the flashpoint that sends a wake-up call to world financial markets? ...

"A bubble is when not only nobody want to buy at a price higher than the one you paid when you need that money, but every body else want to sell that kind of assets."

Well, most people think of a bubble as existing when prices are going up, which is when people do want to buy at the current price or higher.

The above is a better description of what happens when a bubble bursts -- but as that's after the fact, it's not much help in diagnosing whether a bubble exists beforehand.

The above also pretty much fits the description of any declining market to someone who bought near the top, though not every declining market is the backside of a bubble.

Re "bond bubbles", one may note that recent Japanese yields of 0.44% for 10-years and 0.79% for 20 years are the lowest in recorded world history, according to The Economist. Get out your bond price calculator and figure what happens to the price of the Japanese bond market if the "inflation cure" really is ever applied. If the US has a bond bubble going, the Japanese are riding in The Hindenburg.

BTW, regarding the possibility of "negative interest rates", recently auctioned Japanese 15-year floating rate bonds were priced to yield -0.55%.

"The United States is rapidly approaching an ominous threshold -- a net national saving rate that is about to go negative..."

The Japanese personal savings rate has also now dropped below the US personal savings rate, to only 2% and falling, says The Economist.

So for all the talk about it, it wouldn't seem that excess personal saving is causing their problems over there.

The problem is absence of investment supply, with an excess of investment demand.

I am curious about definitions of a bubble. Does it hae something to do with a price that continues to rise, despite consensus opinion that it is too high, because enough people expect the price to continue rising because they believe others will keep the price up, whether because they are delusional or are trying to get off at the last minute?

Gee - I hate to sound like a broken record, but let me ask again. Why do some many Bush apologists claim that the weak economy is due to "lack of investment supply"? It seems by any rational economic analysis, we have excess production capacity and weak worldwide demand.

How, exactly, will increasing the supply of capital available for investment help these problems?

I don't want to take sides in the investment supply/demand debate (except maybe to note that low interest rates ought to tell us something about the balance between supply and demand in the investment market), but I would like to point out a nice piece by John McAuley at Dow Jones Newswires about what is going on with capacity use and investment.

McAuley's starting point is revisions to the Fed's capacity use series in May, which cut the estimate of 12-month growth in capacity by 0.5%. The revision was due to lower than expected capital spending (based on ISM data). McAuley goes on to note that the slowing in capital spending has whittled 13.3% from GDP growth since the end of 2000 (can that be right?), by far the biggest such impact in the last quarter century.

Of course, the numbers in those columns the Fed publishes don't change reality on the factory floor, but they may educate us about that reality. If capital has been put in place at a vastly slower rate since the end of 2000, then presumably recent gains in productivity represent things like learning to use capital already in place - a process which eventually comes to an end. Once productivity growth slows along with capital spending, it takes time to fire it back up when confronted with rising demand. Gotta start that bothersome installation and learning process all over again. In the mean time, tossing more bodies at production, bringing in more imports or inflating away the value of wages are the only ways to meet higher nominal demand. At least some of the first option ought to show up in the mix.

It's a bubble well when prices are massively out of whack with value. The Nasdaq bubble was obvious even at the time and the housing bubble is obvious now. Bubbles are obvious - modest overpricing is not. Bubbles aren't that common (though we've seen our share of them in the last few years.)

Obvious to whom? Fed researchers are having a hard time finding evidence of a housing bubble, but you (Ian) see one. What does massive mean? Are housing prices as out of line now as the Nasdaq in March of 2000 (if at all)? Seems to me the view that bubbles can only be identified in hindsite is hard to overcome.