Monday, December 27, 2010

An overview of the fall of 2010- for the Fed and China

The recent history of monetary policy in the U.S. and China were reviewed in two WSJ articles today.  These articles basically gave the answers to two questions on my fall final exam.

Starting with the article on the U.S.:

Summary: In November, the Fed went on another buying spree known as QE2 (quantitive easing 2).  This time around the Fed is buying more long term U.S.securities. The Fed's goal is to bring down long term interest rates to spur investing and spending.

However, 10 year Treasury yields reached their current 52 week low in Oct 2010 (at 2.33%) in expectation of the program, and have been trending up ever since. The 10 year Treasury opened at 3.4% today (12-27-2010).

Why did rates go up - exactly opposite of the Fed's goal? One possible explanation is that people think there will be much more inflation in the future, so they will pay less today for an IOU for a future amount (i.e. rate goes up). Another possible explanation is that fewer people want to buy U.S. long term securities right now - other investments are starting to look better (fewer buyers leads to lower price of bond, i.e. rate goes up).

It is easy to read too much into the recent movement in long term rate; rates are still at historically low levels, and would probably be higher had the Fed not acted.

So what did the Fed accomplish? According to the article, fears of deflation are falling - but some now fear inflation.  Evidence does not suggest inflation will be a problem any time soon, but perception matters. The Fed is paying a heavy price politically - and not just to domestic doubters.

Which leads us to international doubters:

WSJ 12-27-2010 "China Says It Can Subdue Prices" by Jason Dean

Summary: China is struggling with rising prices, particularly for food and housing. As a result they are raising interest rates and banks' ratio of reserves to deposits (reserves = cash which can't be lent out). China's goal is to slow down borrowing and growth - and hence prices.

An extra challenge for China is that they are raising rates while the U.S. is trying to lower them. This draws more investment funds or "hot money" into China. All those investors buying yuan to invest in China puts upward pressure on the yuan.  However, China is reluctant to let the yuan strengthen because its goods would then cost more in the U.S., and its exports would decline.

From Dean, "Chinese officials have openly criticized the Fed's quantitative easing, in part because they say it burdens emerging economies with potentially excessive capital inflows that could fuel inflation."

China may impose capital controls to keep "hot money" out and to make it easier for China to maintain the current yuan exchange rate. The article does not delve into which capital controls China is likely to impose but possibilities include: transaction taxes, exchange controls (limits on quantity of currency that can be exchanged), and controls on purchases of various financial assets.

Capital controls used to be frowned on by mainstream economists, but after the Asian crisis there is a begrudging consensus that capital controls may be a valid policy tool in some situations.

From Dean, the official inflation target rate in China has been raised from 3% for 2010 to 4% for 2011.

Monday, December 20, 2010

The Economist and "Life Begins at46"

The cover story of this week's Economist magazine is about happiness. Numerous surveys of happiness all over the world show that happiness depends on age - but not in the way you might guess.  My quick sketch below tells the story.

If you can just hang in there until your teenagers leave - life gets better. Alternative theories exist but that is my favorite (don't tell my kids). Other theories focus more on letting go of hopes and dreams and appreciating life as it is.

For more go to

Age and happiness: The U bend of life

If you don't have a subscription you might not be able to follow that link.

The Economist magazine is offering a free trial of four issues - I warn you, you might get hooked. Despite its name, The Economist is not an academic journal - it is more of a beefed up Time or Newsweek with a dose of humor. I often flip first to its sections on science and recommended books.

full subscriptions (not for students)

student subscriptions

Sunday, December 12, 2010

The causes of the financial crisis and the documentary "The Inside Job"

A good start to understanding the causes of the financial crises:

Katie Couric Interview of "The Inside Job" director Charles Ferguson 11-9-2010
(36 minute interview)

Charles Ferguson has the credentials to be taken seriously.  According to Steve Dollar (10-1-2010 WSJ article - see link below),

 "[Charles Ferguson] The 55-year-old software millionaire-turned-filmmaker, whose 2007 Iraq War documentary, "No End in Sight," earned an Oscar nomination, is no gimmick-prone Michael Moore. He's a former policy wonk with a doctorate in political science from M.I.T."

Even if you saw the movie, this interview provides perspective and answers a few nagging questions.

If you didn't see the movie (which I recommend) watching this interview might allow you to fake expertise at cocktail parties. No one is spared. Academic economists take a big hit too.

 A partial list of causes of the financial crises stressed by Ferguson include:

1. regulators' conflict of interest (high incomes once return to private sector)
2. economists' conflict of interest (large consulting fees and paid-for-papers - which go undisclosed)
3. politicians' conflict of interest (hard to write tough regulations for your sponsors)
4. poorly designed compensation packages - that reward earnings regardless of risk
5. board of trustees' lack of independence and motivation to protect shareholders - friends of CEO rubber stamp compensation packages. 
6. investment banks are NOT required to consider clients' interests -  an investment bank can sell financial instruments that they think will fall in value to clients, and then bet against those financial instruments without disclosing anything to their clients.
7. Congress promoting proliferation of mortgages ("homeownership for all" may sound good  as a political slogan but there are consequences).
8. adoption of free market philosophy without full consideration of implications

Some other places to look:

(WSJ) No Straight Answers in Sight by Steve Dollar (10-1-2010)

(WSJ) Hiding, Harboring, Hoarding at Harvard by David Weidner (9-23-2010)

In today's New York Times

Thursday, December 9, 2010

McKinsey and David Wessel

Video: Why trends matter
McKinsey director Peter Bisson explains the value of tracking global forces and how to build them into corporate strategy.

McKinsey audio podcast on increasing investment in emerging markets:

David Wessel's column in the WSJ is always a good read. He writes clearly and focuses on topics related to macroeconomics. Today, Wessel discusses a McKinsey report on global savings (Farewell to Cheap Capital, Dec. 2010). McKinsey is the "google" of think tanks - they attract the cream of the crop and do everything. The report's conclusion is not surprising - it is just handy to have numbers. Basically,  real interest rates are headed higher as China and emerging markets stop flooding the world with saving and start investing in their own infrastructure. While rich world households and governments are saving more, they are probably not saving enough to plug the gap. According to Wessel, McKinsey estimates that real long term rates may increase by 1.5%.

If you believe this will happen within 10 years then: 1. refinance that mortgage while rates are low if you can,  2. maybe wait to buy an annuity (higher rates are good for savers), and 3. count on slower world growth eventually.

Wessel's  article (Dec 9, 2010):

McKinsey written report on Farewell to Cheap Capitol (Dec 2010):

Monday, December 6, 2010

Bernanke on 60 Minutes, and Daily Show Response


An interview with Ben Bernanke, the Chairman of the Fed, aired this Sunday December 5th, 2010 on 60 Minutes. Bernanke endorsed making plans now to rein in the deficit in the long term, but not to start implementing those plans until the recovery is more secure. Bernanke discusses how an immediate drop in government expenditure or increase in taxes would further dampen the economy (from class: shift AD left) leading to more unemployment.

Bernanke estimated it could take 4 or 5 years until unemployment returns to 5 to 6%. He did not use the term natural rate of unemployment, but that is what he appeared to mean.  Bernanke expressed concerns about the ability of the long term unemployed to find jobs again.  Perhaps concerns about the long term unemployed explain why he suggests our new natural rate of unemployment is higher than it was before the "Great Recession" (previous consensus was about  4.5 to 5%).

The Daily Show (Jon Stewart) has fun with a Bernanke verbal fumble in this interview. The credit for this link goes to a commenter (thank you). Bernanke appears to contradict his earlier explanation of quantitative easing (QE). QE is the name for the Fed policy of buying financial assets with electronically created money to stimulate the economy and/or support key financial institutions.

Sunday, December 5, 2010

Growth of Wealth and Health

Thanks to Corby Drone, I can suggest a wonderful new video clip. Not only does is it reveal world history in the last two hundred years in two minutes, it stunningly demonstrates the power of a good graph. I have added it my list of favorite serious videos (on left).

It was recently posted on Mankiw's blog.

Wednesday, December 1, 2010

The multiplier for fiscal stimulus

Boskin makes a  strong case against using fiscal policy to end recession:.
Prognosis: Congress should just focus on getting its long term accounts in order.

Michael Boskin WSJ 12-1-2010 on the multiplier and fiscal stimulus