Brad DeLong's Semi-Daily Journal (2004)

"It is not clear that it reduces the size of the bubble, even if it does succeed in pushing asset prices down." The disagreement here, I'm guessing, is over what is meant by "bubble". If it is a bubble, then fundamental values fall less than asset prices, yes? A bit circular, I know, but that's what happens when we start trafficking in terms like "bubble".

So how do you attack a bubble, assuming you can be sure one exists? Do you just talk it down (like Greenspan almost did in his "irrational exuberance" talk)?

Perhaps there's a fundamental disagreement with the rate of unemployment that is culturally acceptable.

Weighting unemployment differently might change the analysis somewhat...still it's hard not to read this without shaking one's head and blinking hard.

How do you attack a bubble? If speculators can inflate bubbles by taking risky positions (like long bonds) funded by rolling short loans at low interest-rates, what's wrong? The low short rate, or speculators ability to take huge risks, often with the money of (happily unknowing) others? Remember the S&L crisis?

Puzzling, there is no broad inflation in producer or consumer prices. There is indeed little price leverage in the economy. Of course, I wish we would finally begin to pressure OPEC by urging decent energy conservation measures. A decline in energy prices would be nice indeed. But, there is no general price rise in the economy and no reason to expect such a rise.

Why should the Federal Reserve raise interest rates? General growth is fine, but the labor market recovery from recession has been the poorest in 50 years. Not only is there scant job creation, but wages and benefits are barely keeping up with inflation and even falling for middle class workers. Unemployment insurance is quickly running out for former workers. What is the "Economist" after. Who the heck determines when the prime asset of Americans, homes, is too highly valued? Rising home values have been the major comfort for millions and millions of Americans these last 4 years. Let the "Economist" worry about England. Phooey.

Isn't that what the Fed did in the late 1990s? Raise interest rates to pop the stock bubble?

As for housing prices is there really a bubble? If one compares renting for over $1000 per month with buying, then one could pay 8% interest on $100,000 condo and still buy it for less than rent. If the interest rate were only 4% one could pay $200,000 and still get almost the same deal as a $100,000 house at 8%. Yes people could lose money on the property value, but still save over renting. Higher interest would burst the bubble if the house were sold, but if the rates were locked it would still be a good investment.

Tony Daniel -

There is ample global demand for wood and wood product -

http://www.nytimes.com/2004/01/29/business/worldbusiness/29furniture.html

China's Furniture Boom Festers in U.S.
By CHRIS BUCKLEY

LECONG, China - The main street of Lecong is a five-mile Vegas-like stretch of gaudy showrooms and exhibition centers, factories and cavernous warehouses, leather suppliers and timber yards, all dedicated to making and selling furniture.

Until a decade ago, this town, in Guangdong Province in southern China, was mostly rice paddies and sugarcane fields. Now Lecong, which promotes itself as the "furniture capital of the world," is a sales hub for the province's booming furniture industry, with 3,500 furniture stores and wholesalers representing many of the 6,000 or so furniture factories in the surrounding Pearl River delta region.

Much of the growth has come from exports. In the last eight years, China's total furniture exports grew about 30 percent annually, to about $7.3 billion last year, and more than half of the exports came from Guangdong.

But the boom that transformed Lecong has now drawn Chinese-based manufacturers into the biggest antidumping case ever brought against a Chinese industry by American manufacturers....

I used to read the Economist's macro and monetary stuff. I was always very weak in macro, and even that is rusty now. But the Economist has raised so many monetary alarms in the past decade that came to absolutely nothing, and the ratio of flip commentary to serious analysis based on any kind of data is so high, that I ignore it all now.

If I have made a foolish decision, I am sure some one here will correct me.

Anne,
Is your post regarding global demand for wood based products related to my query yesterday regading rising steel prices? Am I missing something here?

Tony -

The increase in selected commodity prices seems to be demand driven and not driven by dollar weakness. [Oil price increases are being driven by the combination of strong demand and OPEC market cohersion though the weak dollar is set out as a smoke-screen.] However, there is little reason to believe increases in commodity prices can be sharp enough to spark consumer price inflation. The key to price appears to me labor costs, and labor costs are too well contained.

I'm hardly an expert, but my impression is that raising interest rates would put more downward pressure on prices than on fundamental values, and, more importantly, keep prices from getting truly ridiculous.

And my recollection of the stock market bubble was that Greenspan *tried* to talk it down ("irrational exuberance") unsuccessfully, but backed down from actually raising rates high enough to matter because he took a lot of flack for it, and unfortunately popularity was important to him (which kinda defeats the purpose of giving the Fed political autonomy).

But I'm just a layman when it comes to economics. So other than raising rates, how *do* you attack a bubble?

I don't think that the interest statements are about inflation or stimulating the economy, they are about stabilizing the dollar (high interest rates make the dollar more attractive.)

Think about it: OPEC promised to keep oil at about $27/bbl, but is leaving it at $33-34 right now because the dollar has fallen, and they buy stuff from the Euro Zone and Japan too.

The Dollar is about $1.25/Euro right now.

If it fell to $2/Euro, we'd probably be paying about $45/bbl of oil, and the rest of the world couldn't sell to us.

The crash would spectacularly ugly.

Of course, I'm not an economist, I'm an engineer, so YMMV.

"The increase in selected commodity prices seems to be demand driven and not driven by dollar weakness."

Gold is and has been in a tight range with the euro for almost two years now - it really is dollar weakness and not demand which is causing the dollar value of gold to go up.

"Think about it: OPEC promised to keep oil at about $27/bbl, but is leaving it at $33-34 right now because the dollar has fallen, and they buy stuff from the Euro Zone and Japan too."

Please. OPEC will is charging as much as they possibly can with no thought of the value of the dollar. Dollar value is a smoke-screen. All we need is a tougher government stance on energy conservation and energy prices will come down. OPEC will always charge every nickel possible.

....

Regulating asset prices strikes me as a foolish goal for a central bank. There is no general inflation in the economy. Why should the Federal Reserve work to lower housing prices and reduce the wealth of millions? How could the "Economist" know there is a housing bubble? My house? Your house?

http://www.nytimes.com/2004/01/27/business/worldbusiness/27gold.html

Rising Rand Takes a Toll on Gold Earnings
By NICOLE ITANO

JOHANNESBURG - Soaring gold prices have sent mineral stocks surging, but in resource-rich South Africa there is one place that soft glow may not show up: the profit columns of companies that mine gold.

Analysts say that earnings at South African gold miners for the last quarter of 2003, which will be released this week, will rival the poor results of the third quarter. Both quarters were battered by the two-year advance in the rand.

Though the currency has weakened this month, its overall strength virtually canceled the benefits of high gold prices to miners in the last quarter, and the rand remains volatile.

Indeed, the 28 percent appreciation in the rand from 2002 to 2003 actually reduced by 15 percent the price in rand that South African producers received for their gold....

Anne,
If selective commodity pricing seems to be demand driven, how does one account fo the excess capacity utilization for domestic manufacturing? Or is this just a "benifit" of increased worker productivity?

If the dollar continues to fall, thereby increasing the cost of raw materials utilized by US manufacturers for domestic finished goods, inflationary pricing may well be in the picture.

Could it be possible that US corporations are deliberately trying to raise pricing to offset the deflationary pressure in the market? If the Fed raises short term rates at the same time, wouldn't this be an added "bullet" toward the deflation concerns?

Brad:

I'd be eager to hear an answer to Dan in Chicago's point. There could well be a bubble in the most speculative areas of the equity markets. Take a look at a stock chart of Taser Int'l (Nasdaq:TASR).

If indeed the economy is on a path to sustainable expansion right now, why shouldn't monetary policy be at an accomodative -- but not super-accomodative -- level, say Fed Funds at 1.5% or 2%?

(I don't know the answer or if we are reflating the bubble in equities, by the way.)

>How could the "Economist" know there is a housing bubble?

That one's easy, they made some logical assumptions:
1) People expect real estate to always appreciate.
2) People buy as much house as they can afford.
3) House affordability is a function of mortgate payments, not housing price.

If you assume all that, and given that interest rates have no where to go but up, then it is reasonable (though not necessarily correct) to expect that the market for housing will shrink when interest rates go up.

If demand for housing shrinks significantly, the price can be expected to drop (basic supply and demand).

So there is a real possibility of declining housing prices.

The question is how likely is this eventuality.

anne: "Regulating asset prices strikes me as a foolish goal for a central bank. There is no general inflation in the economy. Why should the Federal Reserve work to lower housing prices and reduce the wealth of millions?"

I think this was the same sort of talk that kept Greenspan from preventing the last bubble (there was no general inflation in the economy then either). I don't think the Economist wants the Fed to *regulate* asset prices, just to do something before they get out of hand and start a cycle that feeds itself.

Are you of the opinion that bubbles are not preventable, or that the Fed is not the one to prevent them, or that a bubble is not a danger right now?

Oh dear. I think it is quite hard to know where there is a bubble till the pop. Cisco at a p/e above 150 was awfully expensive, but Merck was at a p/e of 20 as 2000 began. Still, I thought there was a stock market bubble but would not have used interest rate policy to burst what I thought.

Houses are not nearly as liquid as stocks. Housing prices are stickier. Housing prices in Houston are not housing prices in Chicago, and prices increases are different neighborhood to neighborhood. I would expect housing prices in Boston to hold current value over a 10 year period, but they could fall some for a while. Why should the Federal Reserve target Boston housing?

Anne,

If you take the CRB commodity price index and convert it to euros, you’ll find that it has been moving sideways, in a pretty big range, over the last several months, or over the last 3 years, either way you want to view it. I don’t know why, under that circumstance, you would argue that dollar weakness is not a factor in boosting (dollar denominated) commodity prices.

Demand is surely a factor, but so is supply. Chile shut down a good bit of copper production during the commodity price slump in the late 1990s. Alcoa continues to close down high priced capacity, simultaneously reducing supply and its own costs (good trick). I don’t think Alcoa is alone. (In Suskind's book, O'Neill says he brokered a deal among aluminum producers to jointly cut output.) Among farm commodities, supply is surely a factor. China’s grain belt flooded last year. France’s and that in much of the rest of Europe withered from heat. BSE has pushed cattle prices down, true, but that has caused some odd up-again-down-again prices for other meats.

So again, demand is surely a factor, but I think in the case of commodities, there has been considerable effort at reducing excess capacity, just in time for the recovery of demand, and that the dollar is magnifying the impact of both supply and demand factors for US purchasers.

There is plenty of global demand for wood for furniture, but there is a growing manufacture of furniture in China. So, wood prices can be increasing as Chinese furniture makers buy American wood and ship furniture back to American home buyers. But, labor costs for furniture makers are not increasing and labor is a more important cost than wood. The dollar has not lost any value relative to the Chinese Yuan, so why should furniture prices be rising much for imports or domestic furniture?

If you look at capacity utilization by stage of processing you get a very different impression.

At the crude level it is 84.2 above its long term average.

At the intrmediate level it is 78.1%

At the final product level it is 71.5%

the differences reflects a couple of things.
One is the impact of Chinese demand for industrial raw materials. a second reflects that we have built no capacity at the raw material level for years. Capacity growth ahs actually been negative for some raw materials.

I believe strongly in the old saying that the shortages everyone sees 5 years down the road never materialize. This reflects the point that markets over react and almost always over - under invest. For years investment has been channeled into hi tech at the expense of basic industry.
So now we have a surplus of high tech capacity and a shortage of basic industry capacity. that is one reason why metals and oil are now providing stock market leadership.

K Harris -

"So again, demand is surely a factor, but I think in the case of commodities, there has been considerable effort at reducing excess capacity, just in time for the recovery of demand, and that the dollar is magnifying the impact of both supply and demand factors for US purchasers."

K always convinces me! Again, the dollar has lost value against the Canadian and Australian dollars and South African Rand. Three commodity exporters. Yep!

"lower housing prices and reduce the wealth of millions"?
Reducing housing prices could be seen as a normative good if you
accept that there are lots of people, especially in east/west
coast areas, who didn't buy before the prices took off. Now, for
some people home-ownership is a receeding goal,
looking less and less doable every year. Lower the
wealth of millions vs. give other millions a better
chance to "buy into" the ownership class: maybe
you could make the argument that it was worth it.
BTW... how likely ARE housing prices to drop in
absolute terms, in areas like NY, DC, SF, LA?
It just doesnt seem possible to many... I think it
is, but I have a hard time articulating just how it
would go down. A little help?

ANNE:The price elasticity of supply for south african gold is negative.

The south african mining companies do not try to maximize short run profits. Their production fuction is driven by an adequate profits model.
What they actually try to maximize is the life of the mine. So when the price of gold rises they mine lesser quality ore -- the constraint on SA
mines output is how much ore they can lift a mile or two up the few shafts and they mine several tons of ore to get one ounce of gold. By mining the ore that is just barely profitable at current prices they are acting to maximize the total gold taken out of the ground over the life of the mine.

consequently, South African gold mines profits are never a function of current gold prices.

Look at the housing market demographically as well as geographically.

Last summer we sold our big suburban house and moved into a townhouse for two reasons:

1. We anticipated interest rate increases that seemed more imminent than they were would depress housing prices, or at least the rate of increase in housing. We wanted to put the money into stocks. (I know, predicting interest rates is folly. Should have played the currency markets.)

2. Nearing retirment age, if not retirement, we don't need a big house and prefer the convenience of a ranch townhouse. (So now I'm running an HOA, which ain't convenient, another story.)

Last week there was a news note that older baby boomers are downsizing their housing, confirming what we have done. We usually do things a few years before the baby boomers follow our example, and I think that if energy prices, real estate prices and home owners insurance costs continue to soar, more empty nesters will downsize. And if more people feel less secure about their retirement nest eggs, they, too, will downsize, getting rid of 3rd vehicles and other junk in the process.

So, to me, this suggests there will be prolonged weakness in bigger, higher-priced housing, while demand for 2-bedroom condos with spas will increase in demand and price, regardless of interest rates.

Finally, we also own a 2nd home in the mountains, and as baby boomers downsize in the city, might they invest in retirement properties at the same time, increasing the price of resort properties?

Final, final. What's happening to farm land prices in response to rising farm commodities prices? They've been depressed for years, and this may be a time to buy as a lot of people want out and prices could go up for some time.

The Economist always wants to raise interest rates, the monetarist scum. It's their stock answer to everything.

There is some thought that as the baby boomers retire they will slowly begin to sell off assets, and asset prices will be limited for years. Oh well.

Originally posted to _The Economist_ in reply to a "Buttonwood" article on this subject:

"The answer to Buttonwood's puzzling paradox of ever-low Treasury yields lies, I think, mainly in the IT investment of boom years gone by.

While the potential productivity enhancement of heavy IT spending was partly masked by the boom years and the tendency of bosses to hire first and ask questions later as long as business is good, the recent difficulties in the US have meant that bosses are now under some pressure to turn potential productivity into actual productivity.

The result has been the strong measured productivity gains of the last year, which point to a large disinflationary bias having been placed into the system.

So strong growth merely means steady employment and minimal wage pressures, a weak dollar merely means import substitution or pressure on foreign firms to cut margins, etc.

And behind it all remains the looming figure of AG, whom the markets still see as capable of jacking up rates radically if any sign of consumer inflation actually _does_ appear.

As long as even feverish growth doesn't outrun the pace of productivity improvements and Greenspan remains as a second line of defense, yields simply will not return to historical levels.

Bernard Guerrero"

The Economist is just speculating about how to handle the situation based on their speculations that others are speculating.

I would advise the Fed to ignore such speculations.

I don’t know. Is pre-emption wise? Does that expose oneself to charges of economic imperialism?

Forecasts are made to be broken. Speculators create opportunities. It's dangerous to forecast and speculate, and we all do both, using the best incomplete information, including media stories, we have.

So if you're reading speculation that anticipation of inflation will drive interest rates up, how will you as an investor, employer, business owner, corporate executive or politician (Fed official) react to make the forecasts wrong? Can private parties or politicians do anything to keep inflation and interest rates low? Do they want to?

Absent from the comments is any question about the validity of the US Government's official CPI figures. If you don't heat your house, eat, send your kid to college, go to the doctor, service your car, buy a house, buy stocks, buy bonds, or buy commodities, then yes, inflation is low. The government's official figures are manipulated. One certain benefit for our idiot rulers is that officially low inflation rates make YoY GDP growth look better.

The Fed is concerned about asset deflation.

The best rationale the Fed has for a rate hike is to save the US dollar.

The inflation the Fed usually addresses with interest rate hikes is wage inflation. There is little chance of that in the next year. Now if the Dems win in 04 and come in with a jobs program, then look for interest rates to move back up.

bakho, what about attracting and retaining investor enthusiasm for the US dollar?

Rates are artificially low to pump up the bubbles. Savers are getting nailed with the current rates. The worthless rate for cash investment has forced savers to buy risky and inflated financial assets. It's not going to be a happy ending. Our socialist elites work through their pals in government to manipulate the financial markets for their own gain.

"The best rationale the Fed has for a rate hike is to save the US dollar.

Posted by Phil"

Pfffft. Let the dollar sink like a stone. The productivity figures indicate that there's plenty of slack in manufacturing, so all you're going to see is imports losing market share (or European managers cutting their margins), no real inflation to speak of. The Asians will sell Treasuries and the Fed will hoover 'em up. End of story.

Bernard Guerrero

Bernard Guerrero on Phil's

"The best rationale the Fed has for a rate hike is to save the US dollar."

The consensus opinion is that Fed policy on the dollar is optimized for a "soft-landing" rather than "sink like a stone".
But (along with your "Pftt") your rendition is far superior poetry.
Still, I don't see the Hoover vacuuming up Treasuries...I don't see the Asians (Japan esp) continuing with the Treasuries either. There are just too many of these things around for them to be valuable. Now oil, on the other hand ...
I see old factories trying to compete with state of the art ("imports losing market share". This is not happening in the auto industry).
So the sink you are talking about is pretty deep. And like Phil says "It's not going to be a happy ending."

"I see old factories trying to compete with state of the art ("imports losing market share". This is not happening in the auto industry)."

Not so. I'm seeing the aggregate level of cash incentives staring to fall (a small drop, to be sure, but it's there), and the pressure and overhang in the used market is getting weaker. More importantly, though, all manufacturers have plant in all locations as a hedge. I do recall seeing a report that a German looking to buy a Merc would be better off getting one shipped in from the US at this point. :^)

Bernard Guerrero

Bernard Guerrero
I must be on a different planet. Sorry. Here on Mars, then, we have GM sponsoring, no less than a $50M lottery. Yep just press a button and see if you win one of these (GM vehicles)suckers.
Demand and market share is so good that they almost decided to throw in a Toyota for variety but had 2nd thoughts when somebody mentioned that Chrysler had lost it's #3 position for a while last year.
Ah, but that was then and this is now.
And here is Here dammit.
Grab yourself a good auto site and paste it to your bookmarks. There is a wealth of useful information about the US economy in terms of America's favorite product. The Big Three are finance companies now. They lose money making cars. It is all Finance now.
"Aggregate levels are starting to fall ...a small drop to be sure"
Pulleeese...don't torture me.