The Myth of the Slow Crash

[Chris Coles]

Re: The Myth of the Slow Crash

could someone explain to me how asset prices can NOT affect the economy?

It would seem you are not the only one to ask the same question.

September 5, 2007


Brown calls for asset transparency

Gabriel Rozenberg and Christine Seib


Gordon Brown called on the City yesterday to publish more information about the risky financial instruments that lie behind the credit crunch.
As a second British bank revealed its exposure to the US sub-prime crisis, the Prime Minister said that he would support international calls for greater transparency.


http://business.timesonline.co.uk/to...9.ece?EMC-Bltn

[Chris Coles]

Re: The Myth of the Slow Crash

Wonderful c1ue, best laugh I have had in years.

I may have confused others by writing about singing canaries when they should be hanging upside down from their perches. It just does not feel like the right time to start talking about completely collapsed assets so I thought singing ones sounded better.

[c1ue]

Re: The Myth of the Slow Crash

The Fed is unlikely to adopt the canary as its official mascot any time soon, but might it gain some favour amongst the FOMC members after Jackson Hole?

What? And displace the venerable head monetary lemming?

[GRG55]

Re: The Myth of the Slow Crash

could someone explain to me how asset prices can NOT affect the economy?

...When all the assets are in the hands of the top 1%, and the rest of us are squatters and buy our food at the company store?

Seriously, there's a gold mine of material that has come out of the Jackson Hole proceedings (building on Finster's post above). I read Ed Leamer's paper on housing and recommend it. Compare it to Bernanke's views on the same topic from his keynote speech at J.H.

Otmar Issing was an increasingly vocal critic of the Fed's policy regarding asset prices and bubbles through the latter Greenspan years. Dr. Kenneth Rogoff holds the view that asset prices may, in some circumstances, provide the Fed with better and more timely information than lagging (and heavily massaged) inflation and employment data. Even Bernanke made a note that the data the Fed relies on may be less useful at times like this. The Fed is unlikely to adopt the canary as its official mascot any time soon, but might it gain some favour amongst the FOMC members after Jackson Hole?

[jk]

Re: The Myth of the Slow Crash

Bernanke first appeared at Jackson Hole in 1999 with a paper arguing that central banks shouldn't target asset prices except when they affect the economy.

could someone explain to me how asset prices can NOT affect the economy?

[Chris Coles]

Re: The Myth of the Slow Crash

Ahhh, but asset prices are the canary in the inflation mine...

And the noise from the canaries is becoming quite deafening...............

[Finster]

Re: The Myth of the Slow Crash

Chris: Agree fully that one doesn't want to act prematurely. For me, iTulip sharpens the ability to anticipate, in a world where most investors react. This thread is getting long, but I appreciate that you, Finster and j.k. have hung in there and I value the dialogue. Finster's expectations might come true reading the following about Jackson Hole. Clips from the Sept 3 Independent out of the UK, edited for brevity (emphasis mine):

"The Federal Reserve heard a plea for a full percentage point cut in US interest rates in order to forestall a recession, as central bankers debated the fall-out from the housing market slowdown.
The Harvard University economist Marty Feldstein…arrived at Jackson Hole to deliver a warning that sharp declines in house prices in many areas of the country could trigger a much broader recession, if the Fed did not act.
Lower rates may trigger a period of high inflation, which would have to be dealt with over time, but this was the "lesser of two evils", said Mr Feldstein, whose National Bureau of Economic Research is the recognised arbiter of whether the US

..."What we need to do as central banks, and we are clearly doing that, is to help them in the deleveraging process," said Axel Weber, president of the German Bundesbank and a member of the European Central Bank's governing council, who spoke in Wyoming. "There is no underlying problem of solvency, it's one of liquidity. So swift action is needed."...
..."Addressing one of the underlying issues of the conference, Mr Mishkin (Fed Governor Frederic Mishkin) said the Fed should not use interest rate policy to prevent or prick bubbles in the housing market, but simply use its regulatory powers to ensure responsible lending and use rate changes to manage the wider economic consequences."

So here we have Finster's worst nightmare being advocated as sound policy. My reaction: To Feldstein - Maybe he should start a renominate "The Maestro" movement. To Weber - More than a few former hedge fund managers, foreclosed homeowners and economists (like Roubini) might disagree re: solvency problem. However, given CB's limited toolset, I suppose every problem must be defined as one of liquidity, with a monetary policy remedy, or CBs may appear impotent. To Mishkin - The Bernanke Fed is increasingly indistinguishable from the serial bubble-blower Greenspan Fed.

Clearly the visible political pressure on the Fed & ECB is rising very rapidly; one wonders just how much heat is being applied behind the scenes. Yikes! :eek:

Funny you should mention the Jackson Hole criticism. Just this morning there was a piece on Bloomberg, Fed, Blamed for Asset-Price Inaction, Is Told `Tide Is Turning':

Federal Reserve officials, wrestling with a housing recession that jeopardizes U.S. growth, got an earful from critics at a weekend retreat arguing they should use regulation and interest rates to prevent asset-price bubbles.

Otmar Issing, former chief economist at the European Central Bank, and Stanley Fischer, head of the Bank of Israel, were among guests at the Fed's summer symposium in Jackson Hole, Wyoming, to challenge the hands-off approach. ... ``The position that `this isn't an issue for central banks' has lost some support,'' Issing said in an interview at the gathering, which ran from Aug. 30 to Sept. 1. ``The tide is turning.''

By cutting rates to a four-decade low in 2003, the Fed inflated property values, Ed Leamer, head of an economic forecasting group at the University of California at Los Angeles, said at the conference. The ensuing housing slump, the worst since 1991, and the credit-market turmoil that followed, threaten to undo the six-year economic expansion.

``Central banks, probably on more occasions than they would like to admit, should respond to asset-price bubbles,'' said Fischer...

Bernanke first appeared at Jackson Hole in 1999 with a paper arguing that central banks shouldn't target asset prices except when they affect the economy.

Ahhh, but asset prices are the canary in the inflation mine...

[GRG55]

Re: The Myth of the Slow Crash

The Economist Intelligence Unit has published a report titled "Heading for the Rocks - will financial turmoil sink the world economy?" It contains some scenarios for the major economic regions. The link below...

http://a330.g.akamai.net/7/330/25828...he%20rocks.pdf

[Chris Coles]

Re: The Myth of the Slow Crash

The underlying problem is not the potential for any action by the FED, but the lack of a free marketplace for capital. At grass roots the industrial inventor is unable to access capital at any cost because he has no access to a free marketplace to obtain it. The same applies to a whole host of micro businesses that as a consequence, never get started at all. Just one example is the demise of the Mom and Pop businesses throughout the western world, not just the USA. So what happened instead is the rules for access to capital became much more onerous and complex and that left all the capital of the nation in the hands of the savings institutions and they in turn had to find somewhere to invest. That led to the numerous different financial vehicles that we see today.

When my grandfather, Francis George Coles was a Jobber on the London Stock Exchange, all he ever dealt with were shares in companies that were being set up to trade in some way or other. Some were risky ventures, others very sound businesses. But all the capital was available to use for trade. Working capital was readily available as long term 25 year bonds at about 4%.

Today, nothing could be further from the truth and most of the capital is mired in an illusion of trading between the financial institutions and governments, many of whom now hold major holdings in the trading companies of other nations.

In my humble opinion, nothing the FED can do will change the underlying problem, other than to force the imposition of free markets, and I mean totally free markets, on capital. And I do not believe that will even enter their minds until the whole edifice has completely crashed as their boss, the government itself, has such a vested interest in the ongoing success of the present system.

[GRG55]

Re: The Myth of the Slow Crash

Multiply your own diverse scenarios by the number of players, world wide, and you get total chaos with no single player certain of anything other than that no one knows who holds the biggest loss and has to make an immediate move to try and avoid total collapse. Perhaps the best advice is indeed to wait for someone else to make the first move.

If EJ is correct, (was correct), to re-start itulip, then the best strategy is to wait for several months at least until you can be certain that the dust has settled. Time is definitely not of the Essence here. The patient war chest will win the best bargains. Buying half way down will only serve to waste resources.

Chris: Agree fully that one doesn't want to act prematurely. For me, iTulip sharpens the ability to anticipate, in a world where most investors react. This thread is getting long, but I appreciate that you, Finster and j.k. have hung in there and I value the dialogue. Finster's expectations might come true reading the following about Jackson Hole. Clips from the Sept 3 Independent out of the UK, edited for brevity (emphasis mine):

"The Federal Reserve heard a plea for a full percentage point cut in US interest rates in order to forestall a recession, as central bankers debated the fall-out from the housing market slowdown.
The Harvard University economist Marty Feldstein…arrived at Jackson Hole to deliver a warning that sharp declines in house prices in many areas of the country could trigger a much broader recession, if the Fed did not act.
Lower rates may trigger a period of high inflation, which would have to be dealt with over time, but this was the "lesser of two evils", said Mr Feldstein, whose National Bureau of Economic Research is the recognised arbiter of whether the US

..."What we need to do as central banks, and we are clearly doing that, is to help them in the deleveraging process," said Axel Weber, president of the German Bundesbank and a member of the European Central Bank's governing council, who spoke in Wyoming. "There is no underlying problem of solvency, it's one of liquidity. So swift action is needed."...
..."Addressing one of the underlying issues of the conference, Mr Mishkin (Fed Governor Frederic Mishkin) said the Fed should not use interest rate policy to prevent or prick bubbles in the housing market, but simply use its regulatory powers to ensure responsible lending and use rate changes to manage the wider economic consequences."

So here we have Finster's worst nightmare being advocated as sound policy. My reaction: To Feldstein - Maybe he should start a renominate "The Maestro" movement. To Weber - More than a few former hedge fund managers, foreclosed homeowners and economists (like Roubini) might disagree re: solvency problem. However, given CB's limited toolset, I suppose every problem must be defined as one of liquidity, with a monetary policy remedy, or CBs may appear impotent. To Mishkin - The Bernanke Fed is increasingly indistinguishable from the serial bubble-blower Greenspan Fed.

Clearly the visible political pressure on the Fed & ECB is rising very rapidly; one wonders just how much heat is being applied behind the scenes. Yikes! :eek:

[Finster]

Re: The Myth of the Slow Crash

Given it was more market event than economic event can we infer Greenspan's motives for his liquidity injection response?

1. There was evidence that the market event was infecting the economy? Or...
2. There was no evidence of any impact on the economy, but Greenspan decided to pre-empt any chance of that? Or...
3. The Greenspan Fed saw protecting/supporting the equity market as within its mandate and an important responsibility?

I wonder if the current financial community view that the Fed "should" protect the stock market, and today's accompanying Pavlovian chorus of "cut the rate, cut the rate...", had it's genesis way back in 1987? Just a thought...

As a good a thought as any! We have no inside track on Greenspan's inner motives in 1987. I just view that response as benign in light of later policy actions. In 1987, the market had not become nearly so overvalued. In 2000, it had actually doubled after Greenspan's own famous 1996 musings on "irrational exuberance". Inflation did not skyrocket after 1987. After the 2000-2002 bear market, Greenspan's response produced phenomenal inflation, with commodity prices tripling, house prices going through the roof, and the most out-of-this world speculative credit bubble since 1720. With the repercussions we are seeing now.

All with no visible justification. By 2004-2005, the stock market was zooming skyward again, GDP data were robust, unemployment low, and inflation accelerating to the highest levels in decades, yet the easy money just wouldn’t go away. Greenspan was ever-so-grudging in "removing accommodation" in baby steps, and further incited speculation by being so predictable about it.

This is no mere 20-20 hindsight analysis. Plenty of analysts commented in awe on the credit bubble. The housing bubble was being tracked right here on iTulip. Even in officialdom, talk of a "world awash in liquidity" was becoming routine. Greenspan himself even cited "excessive risk-taking" as a potential danger, all while conducting policy that encouraged it.

In contrast, the 1987 post-crash response was … well … benign.

[Chris Coles]

Re: The Myth of the Slow Crash

Multiply your own diverse scenarios by the number of players, world wide, and you get total chaos with no single player certain of anything other than that no one knows who holds the biggest loss and has to make an immediate move to try and avoid total collapse. Perhaps the best advice is indeed to wait for someone else to make the first move.

If EJ is correct, (was correct), to re-start itulip, then the best strategy is to wait for several months at least until you can be certain that the dust has settled. Time is definitely not of the Essence here. The patient war chest will win the best bargains. Buying half way down will only serve to waste resources.

[GRG55]

Re: The Myth of the Slow Crash

...You bet. On the other hand, the 1987 crash was less of an economic event and more of a market event. Despite the worry that a depression would follow, it turned out to be of little consequence to other than folks who were levered up into the crash or sold stocks immediately afterward.

Even Greenspan would have to get good marks when he took the helm. His post-crash liquifaction was benign, as inflation continued to abate for several more years. It was sometime around the beginning of 1995 that things started to go really haywire. Reserve requirements were cut, the Boskin Commission dumbed down the CPI, we had the "Mexican Peso Crisis" bailout, and the Fed underwrote a 1920's stock market bubble redux.

Given it was more market event than economic event can we infer Greenspan's motives for his liquidity injection response?

1. There was evidence that the market event was infecting the economy? Or...
2. There was no evidence of any impact on the economy, but Greenspan decided to pre-empt any chance of that? Or...
3. The Greenspan Fed saw protecting/supporting the equity market as within its mandate and an important responsibility?

I wonder if the current financial community view that the Fed "should" protect the stock market, and today's accompanying Pavlovian chorus of "cut the rate, cut the rate...", had it's genesis way back in 1987? Just a thought...

[Finster]

Re: The Myth of the Slow Crash

Good catch! You are correct. That'll teach me for taking on the Shadow Fed Chairman...

Not trying to 'catch' you at all, GR. ;) In reading your posts, it looks like we are much in accord. If we differ on something here, it's well into in the nit zone ...

Volcker is lionized for his actions in the early 1980's, but weren't the conditions for the loss of confidence that led to the 1987 market crash created on his watch?

You bet. On the other hand, the 1987 crash was less of an economic event and more of a market event. Despite the worry that a depression would follow, it turned out to be of little consequence to other than folks who were levered up into the crash or sold stocks immediately afterward.

Even Greenspan would have to get good marks when he took the helm. His post-crash liquifaction was benign, as inflation continued to abate for several more years. It was sometime around the beginning of 1995 that things started to go really haywire. Reserve requirements were cut, the Boskin Commission dumbed down the CPI, we had the "Mexican Peso Crisis" bailout, and the Fed underwrote a 1920's stock market bubble redux.

[GRG55]

Re: The Myth of the Slow Crash

You are more familiar with this anecdote than I am, GRG55. But Bernanke writings have suggested that the blame lay in the Fed’s having been too slow to ease when the bubble popped, rather than for in its role in inflating it in the first place. This is in contrast to Greenspan, who in a (pre-Fed) incarnation identified the Fed’s blunder with the first cause. Gold and Economic Freedom Greenspan was right.

Good catch! You are correct. That'll teach me for taking on the Shadow Fed Chairman...

If Bernanke is a Volcker, then your scenario is well within the realm of possibility. There’s no denying the positive features of the getting-it-over-with-sooner-rather-than-later argument. But if he (as discussed above) believes the Depression was caused not by excessive Fed ease, but by too much Fed restraint …

Volcker is lionized for his actions in the early 1980's, but weren't the conditions for the loss of confidence that led to the 1987 market crash created on his watch?