Response to Papola regarding Matt Ridley’s “Rational Optimist”

Mr Papola,

So this book sets forth in an articulate and fashionably empirical manner, the merits of a blythe and unconcerned stance towards the future.

Is it not relevant to our assessment of the author and his thesis that he was the former Chairman of Northern Rock, a financial institution whose recklessly optimistic funding model was to lead to its spectacular failure and to be one of the catalysts for bank failures and runs in the UK?

I find it unbelievable that a guy who obviously does not tend to think about what might go wrong (such being a part of the duties of the Chairman) learns nothing from such an experience, and instead writes a book celebrating this stance towards life!

Life is not linear, and extrapolation from the past is rarely a good guide to the future. Libertarians, and those sympathetic to their cause would do well not to associate with charlatans and failed prophets.

Posted in Uncategorized | Leave a comment

Weaker crude should lead to stronger growth ahead

Crude has lately shown the weakness I expected back in March.  I believe this is the beginning of a new cyclical bear market that relates both to a change in the resource intensity of growth ahead (especially in China) as well as a surge in supply – both of shale gas (a story that by now is well known) and in shale oil (a story that is still very much under-appreciated).  The weakness we have seen to date should in itself be sufficient to lead to a boost to global growth, and if sustained – as I think likely – this should certainly lead to a cheerier tone to the mood in commodity consuming nations.

Of course the bears have seized on this as an indication that we are again seeing a repeat of the events of July-December 2008, but I am pretty sure that they are dead wrong. 

I wrote in September about a likely rotation in global growth away from commodity producers towards commodity consumers.  Nature once again seems to be smiling upon us.  Let us hope She continues to do so.

The chart below shows crude prices (inverted) versus the Citibank index of economic surprises in G10 economies.  Crude prices are lagged four months – recent weakness suggests growth ought to start surprising to the upside, perhaps starting in September.



Posted in Uncategorized | Leave a comment

How should one think about the credibility of institutions?

One especially interesting question today is how one should think about the credibility of institutions when it comes to understanding and prognosticating about the macro situation and outlook.

Today’s world emphasizes very highly the perceived requirement to justify one’s judgement of people and services based on criteria that one can persuade oneself and others are objective – people consider ‘track record’, standing amongst peers, and broader social influence as important factors in deciding whether to pay attention to a particular analyst.  The problem is that the world is complex, and at any one time many factors are at play, so that it is a matter of discernment to be able to assess who is really good compared to who is merely popular, or just got lucky once.  The sheer volume and intensity of information tends to blind us to the importance of history and context, which the astute self-marketeer will exploit, focusing only on their hits and playing down, if not denying their misses.

So acknowledging all of this, it is interesting to see how other market commentators respond to the latest offering of the BIS.  Under previous management, the Bank for International Settlements was one of the few institutions – official, or otherwise – to correctly diagnose the problems in the credit market that developed in the run up to the Feb 2007 – Dec 2008 period of unravelling.  Most of those who are today happy to take credit for their market call were right for the wrong reason (viz Roubini, who expected a typical emerging-market style crisis in the US triggered by a widening current account deficit and which would have led to a dollar collapse, rather than a very sharp dollar rally), with Marc Faber, Kurt Richebacher and Jim Walker being some notable exceptions.

William White has now retired from the BIS, and it is under new leadership.  Nonetheless, the proper attitude towards this body perhaps ought to be one of seriousness and to the extent that it does not accord with one’s views, a degree of self-questioning to consider whether – given their correct understanding in the past – they might perhaps have identified some phenomenon at work unknown to the analyst.

Instead, in response to their reasoned setting forth of the risks to the present very-easy monetary policy pursued by the developed world, we have a simple dismissal – apparently on the grounds that things are so difficult now that we cannot possibly afford not to act.  This appears to be a highly arrogant dismissal of many decades work on the limited practical usefulness of monetary policy to pursue active management of demand – amongst other things, long and variable lags mean that central banks tend to act late, and then do too much, in the bust going on to set the seeds of inflation during the next upswing.  In those circumstances, once a downturn has happened there is a very real danger from excessive activism.

There have been many panics and depressions since the Industrial Revolution, but there has only been one as bad as the Great Depression.  (There was another depression beginning 1873 that lasted for a couple of decades; it is usually known as the Long Depression, but was on occasion also called Great).  There were some peculiar circumstances involved that ought to make it the subject for a longer post at some stage.  But one has very thing grounds indeed for the popular habit of always worrying that we are on the verge of entering a new Great Depression (repeat of the 1930s).

A man who was honest, and rational, and concerned only with discovering truth would recognize the need to place the present episode into the greater context of business cycle history, and would refrain from trying to panic people into thinking that we are on the verge of a repeat of the 1930s until at the very least they have set forth the evidence for their case and seen it ignored.  Since I must assume that those of differing views are certainly honest and rational, I am utterly puzzled by their shrillness.

As statistical studies have consistently demonstrated the very poor record of most economists in navigating the business cycle, an honest man should be more humble about the strength with which his views are held and acknowledge the possibility that he may well be wrong, and consider the implications if so for the relative merits of his favoured policy.

Also, one ought perhaps if one wants to be taken seriously as a commentator give people some reason to take one seriously.  Anyone can explain all the reasons why what has happened in the past was inevitable, and why only fools would have failed to see this, but it is not so easy to sense what is about to happen before it unfolds.  And even if one is right, it may not be so easy to persuade people that one is correct.

I had a certain experience of this as I turned bullish German fixed income as the latest leg of the European crisis began to unfold, unknown to almost all mainstream commentators.  At the time, the headlines were full of stories about inflationary risks due to energy prices and QE2, and the ECB was in full-blown rate-hiking mode.  Yet it was quite possible to see beyond this, and realize that the wheels would not stay on in Europe, and that the ECB would soon be cutting rates.

More recently, I observed on 31st March 2012 (with crude prices close to their highs) that despite the panic at the time about the risks of an Israeli strike on Iran, and the possibility of an upward explosion in crude prices, we would likely see “crude and related energy prices to come down sharply, pushing down headline inflation” (and breakeven inflation rates too, especially for short dates).  This is exactly what has unfolded (below I show a chart of crude prices vs 1 year break-even inflation, with the top for both being c. March).


The timing of these calls was not merely fortuitous – a great deal of work and thought went into identifying them.  I could go further back too, but I do not wish anyone to think that I might be marketing myself here.  And of course I have gotten some things wrong too – for example, I thought from Sep 2011 to Feb 2012 that we might have seen more or a selloff in fixed income than we actually did, whereas bond yields actually moved sideways to lower.  The point is that one doesn’t when investing need to get every move right, but make sure that one makes more than enough from the right calls to pay for a wrong call now and then.  Given that bullish EURIBOR bets in May 2011 paid out 10:1, one mildly bad call is not the end of the world.

So in conclusion, my broader point is that if one writes about markets and economics, and particularly if one harshly criticizes policymakers and other commentators, one ought to have some coherence and accountability to one’s views.  One ought to spell out the implications of one’s variant perceptions and views for the future path of real and nominal variables in both economics and markets (in pattern terms, at least), and then in some months time go back and look to see what happened.  If one is right, then there is at least a  pat on the back; and if wrong, then one can at least learn from the experience.  However, I am not sure if this is the mentality of most others.  It sometimes seems often more to be about ego gratification and self-aggrandisement than about learning and the pursuit of truth.

My opinion is that we will look back from a couple of years time and see that with the benefit of hindsight, monetary policy in the developed world certainly was too expansionary and that it would have been better had it been tighter.  I suppose the path of nominal and real bond yields will tell me if I am right: I suspect 30 year UST yields – both nominal and real – will move sharply higher from here.  (Micro-term, and from a trading-perspective, one needs to trade the zig-zag, but I do think we are in a good location for longer-term bearish bets – especially if one expresses in a way that is not exposed to the convexity).

— Some supplemental comments – originally posted to Historinhas blog – follow

  •  Cantillon Blog says:

    June 25, 2012 at 8:38

    So is your position that things would have been just fine if only the Fed had eased quickly enough in July-Sep 2008?

    What do you think about the clear evidence of sloppy lending during the 2002-2007 phase, such manic lending historically almost always associated with excessively easy monetary policy?

    What do you make of people who warned in early 2008 that a terrible deflationary episode was coming? These people being not in the habit of doing so idly, and having had great track records over many previous business cycles. If somebody predicts a building is going to burn down, and it does despite some others insisting it is perfectly safe, shouldn’t you pay attention to those who warned of it before it happened? You might pay some attention to those who – once the building ignited – warned that it was not being extinguished quickly enough, but it strikes me you would pay more attention to those who told you it would catch fire before it happened, particularly since these observers gave the warning because they saw conditions that have typically preceded Great fires throughout the ages.

    Therefore I am puzzled at your unwillingness to consider the role of easy money preceding the bust, although of course I realize this does not entirely fit with your narrative.

  •  Cantillon Blog says:

    June 25, 2012 at 8:49

    Messrs Steve and Nunes,

    I certainly have read Mr Steve’s comment.

    So far, all I see is name-calling, without much of an argument.

    The BIS is staffed by economists, so of course they have not succeeded especially in identifying inflection points in markets – that is not what economists do. I do not hold them up as a paragon of forecasting virtue for the near term, but merely point out that in the past they have been right about the only thing that mattered – ie the bigger picture – when almost everybody else was wrong.

    I personally do see my role as identifying inflection points, and therefore – as I wrote in brief form on my blog, and in longer form elsewhere – I did correctly identify the downturn in Europe starting in May 2011, as well as the turn in industrial commodities (actually I nailed the downturn commencing May – July 2011, the bounce from Dec – Feb, and the renewed leg down from Mar 31 2012). One can sometimes get things wrong of course, but the point is that in the general envelope of things the BIS have been more right than most other forecasters, and I think they continue to be so.

    So I think you owe them more than just namecalling – if you believe that they got the credit bubble diagnosis right for the wrong reason (which seems to be implicitly your view), then you ought to set out your case more thoroughly. Also, if you are setting out your stall as a superior prognosticator of macro trends (which I suppose you are, by criticizing them in such harsh terms) you ought to be transparent about it – set out your expectations for economic and market variables including what would prove you wrong. And then if reality doesn’t match up to your expectations, you can at least learn from it and inform your readers of what modifications you need to make to your ideas.

    This is what I understand to be the spirit of true science. Of course it may be more entertaining merely to throw rotten tomatoes, but I wonder if that will be a truly satisfying use of time.

Posted in Uncategorized | Leave a comment

Fear not, Brave Sentinels of Reflation

My friend and sparring partner, David Glasner, over at Uneasy Money is sounding the alarum regarding the recent correction in 1 year implied breakeven rates, which have recently turned negative.  He views this as reflecting what he sees as the Fed’s abdication of responsibility, and a sign that Bernanke is leading us to disaster.

Might I point out first of all that the one year sector of the TIP curve from which this rate is calculated is hardly the most liquid or heavily traded (since most investors, when they think about protection from inflation, are looking to the distant future, rather than to a horizon that can be more easily forecasted).  We have only two bonds of this maturity – the 0.625 TIIs of April 2013, and the 1.875s of 7/13; and in general one should note that the yields on particular securities are always subject to distortion by questions of idiosyncratic supply and demand, such that only two securities of approximately this maturity will not give us a good picture of the general state of expectations.

This being noted, the key point is that 1 year inflation expectations and implied breakeven rates are heavily influenced by commodity prices given their innate volatility, and not just their direct impact on the CPI (via gasoline, and food), but also their indirect influence via influencing producer costs in ways that may ultimately be reflected in the CPI.

If, as I understand he thinks, it was wrong for central banks to panic over the influence of commodity prices on the CPI as crude went ballistic into the summer of 2008, then it is wrong to panic now about the mechanical impact of falling energy prices on CPI over the next year.

What we have is to a large extent good deflation resulting from a calming of turmoil in the Middle East, the diminishing prospect of an Israeli strike on Iran, a switch from crude oil to highly abundant domestically-produced natural gas and the still-neglected prospect of a massive increase in supply of crude oil from shale oil – in the US, and elsewhere.  Serious people are now openly discussing the possibility of North America (ie including Canada) becoming self-sufficient in energy production, something that should certainly change the geopolitical map, in ultimately a positive direction.

We have also a shift in the commodity intensity of growth in China – there are only so many empty cities you can build, as well as a slowdown.  This may well presage some adversity ahead for commodity producers (I wrote a year ago about the likely challenges that Latin America would face as commodity prices sold off), but for commodity consumers, the commonsensical view is correct, rather than that of the sophisters and economists – in other words cheaper gasoline is a good thing, and will continue to boost real consumer incomes and confidence.

Here is a chart showing 1 year breakevens and crude prices on the same chart:



Now, correlation is not causation.  One could make the argument that some great deflationary wave is causing both a collapse in commodity prices, and a collapse in breakevens, and will ultimately lead to the kind of growth-deflationary horror that he implicitly thinks starts to become likely.   But if making this argument one would need to address competing explanations, such as the points I make above.  One would also need to bet one’s credibility to back this view.  If it turns out that in the US there is no such collapse in growth, then one must be prepared publicly to admit that one was wrong, and that one must therefore revisit one’s framework.

Speaking of track record, I did write on 31st March – as crude prices and breakeven inflation expectations were close to their highs that I expected just these events to happen:

“I am not in the very near term concerned about breakeven expectations and headline inflation becoming unhinged since I expect crude and related energy prices to come down sharply, pushing down headline inflation.  Although this will impact shorter-dated breakevens most heavily, it will tend to weigh on the back end of the curve too”.

So far I have been proven right.  I wonder if I will be right about my conclusion in that piece:

“Longer-term though I rather think that the inflation hawks will turn out to be right.  I shall make a note in my diary for April 2015 and we shall see whether Dr Krugman’s dismissal of inflationary concerns turns out as well as his cheering-on of the inflation of a bubble in housing.”

Posted in Uncategorized | Leave a comment



By OECD PPP BRL is 18% overvalued (it seems a lot more when you visit, so I hear) and MXN is 71% undervalued.  The latter for obvious reasons, but they probably won’t get worse and might get better.

Amazing how obvious major new trends can be, even to journalists.  Ie the herd is often right.  I guess prospective weakness in Brazilian economy (consumer credit, iron ore and crude prices) and worsening trend in Latam politics on the one hand, and the beginnings of an improvement in political situation in Mexico + relocalisation now China starts to get quite expensive (and troublesome) as a place to produce.


“Stars appear to be increasingly aligned for an economic outperformance” by Mexico, a report in May from Nomura Securities concluded. “A changing of the guard is slowly but surely taking place.”

The reversed fortunes of Latin America’s two largest economies are a sharp contrast to the euphoria over Brazil’s prospects as recently as 2010, when the economy grew 7.5 percent in the last year of President Luiz Inácio Lula da Silva’s government.

Posted in Uncategorized | 1 Comment

Boudreaux is not unfair on Sir Samuel Brittan

From a facebook discussion, in relation to the following:-

Boudreaux’s letter seems very fair to me. “[Krugman's column] should be read on the basis of its evidence, not on its alleged ideological baggage. ” That’s the whole point – Krugman is explaining what we need to do to slay a dragon that does not in actuality exist, and Sir Samuel is encouraging him in his delusions. Outside of the peripheral countries – which have their own specific problems – it is not true that “there is an ever-widening pool of unemployed people and of unused capacity”. The pool is diminishing at a solid pace, although the level remains on the high side.

Also, Sir Samuel does not mention a more important part of the problem, which is regulation – particularly of the labour market. Look at the difference in performance between relatively free states in the US and heavily regulated, poorly governed ones. Similarly – the reason why youth unemployment especially is so high in peripheral Europe is not some market-originated inside-outside phenomenon; it is because of a very heavily regulated labour market. In 2002 Germany was the sick man of Europe; they undertook reforms; it was very painful; but it has paid off. Any honest and true discussion ought to at least tackle these questions.

Posted in Uncategorized | Leave a comment

Entelechy vs equilibrium – is morphic resonance the concept to make Lachmann’s critique of Mises more generative ?


This is a vital but difficult topic that constitutes an essential part of the variant perspective on the economy and markets I have formed after observing and participating in them for a couple of decades.  This is my first stab at writing something public on the topic – I will need to return again and again to elaborate, refine and illustrate these ideas:

  • Marshallian approach – system of partial equilibrium.  short medium and long run
  • post-Walrasians – complete contracting across all scenarios.  but assumes away the very aspects of the situation that we are interested to understand – true risk, Knightian and plu-Knightian radical uncertainty (where even the structure of the problem is unknown) and true learning.
  • Rothbardian reading of Mises – equilibrium is like the mechanical rabbit being chased by the dog.  We never reach it, but the economy is always tending towards the equilibrium implicit in the current state of affairs.
  • Lachmann (and to an extent GLS Shackle) – in a kaleidic economy, equilibrating forces are always overtaken by unexpected change, and so how can one speak of a tendency towards long-run equilibrium.   Accused by traditional Austrians of nihilism, because if one accepts his beliefs, what really can one say about the economy?

I believe that Lachmann and GLS Shackle strike us as disconcerting mostly because of our insistence on a linear conception of proximate cause and effect.  If one returns to older conceptions of causality at multiple levels, including the operation of field effects, one avoids the false dichotomy of either the swirling kaleidoscope or the clockwork economy, and is liberated to once again speak of the obvious order in the economy (after all, most of the time, ‘Paris does get fed’) without denying its essential characteristics of ignorance, uncertainty and change.

Lachmann does actually speak of the importance of trade fairs, journals, and organized stock markets in co-ordinating expectations, and there is obviously a connection between Sheldrake’s emphasis on habit and the role of habit and routines in various schools of institutional economics.

I am somewhat at a loss as to how best to elaborate this insight further in only a few lines, so I shall return to it when I have more time.

Here are some key snippets from Prof Bruce Charlton that help make sense of the applicability of Sheldrake’s approach to fields beyond those Sheldrake discusses in his books (emphasis mine):

Perhaps the single most important thing I am getting from my readings of Rupert Sheldrake and ideas of morphogenetic fields, morphic resonance etc – is an awareness of how limited was my view of causation.
I had a very linear view of causation resembling a series of idealized billiard balls colliding: A hits B making it move and hit C; or A causes B causes C.
I term these causal chains.
This was always at the back of my mind when doing science – that for science to be potentially testable and potentially useful it ought to have clear causal chains.
As a theorist it was my function to suggest causal chains which were aimed at being reasonably correct descriptions of highly selected bits of reality; but much simpler than reality therefore being comprehensible and predictive.

I don’t think there is anything wrong with trying to do this, except that – in the usual way for humans – I come to believe that what I did was the only thing that could properly be done; so that I would evaluate all knowledge on whether or not I could reduce it to clear, simple causal chains; and to assume that that which could not be so reduced was not comprehended and so was useless.
(This seems to me the great hazard of expertise of any sort – but especially intellectual expertise. That having trained oneself into specialist cognitive expertise, that becomes the dominant and most authoritative mode of thought, and the exclusions and assumptions which underpin that mode of thought fail to be recognised as exclusions and assumptions; such that they are taken to be facts and discoveries…

But I have found that there is another way of thinking, in terms of fields, which is qualitatively different from causal chain thinking, yet is similarly clear and simple and predictive.
It is not that field thinking is more true, necessarily, nor better (both causal chains and fields are extremely simplified models of reality, both are gross reductions of reality) – but that field thinking is at least as true, and has different applicabilities – so that problems not amenable to causal chain thinking may yield to field thinking.

However, field thinking is qualitatively different from causal chain thinking, and they cannot be combined; one can merely decide which mode to use in a specific situation; or use them hierarchically (typically with fields regarded as primary and general, and causal chains as secondary, specific, and local).
This is the deepest reason which Sheldrake’s ideas are not as influential as one might expect them to be.
Even when a scientist is convinced of the validity of this mode of thinking, he finds that it is incommensurable with his existing knowledge – which is in the form of causal chain thinking.
The scientist can place his own causal chain thinking inside a larger, inclusive framework of field thinking, perhaps – but that will not affect the nature of his own specific knowledge and work.
Field thinking is thus experienced as abstract and optional with respect to his day-to-day practise.
The alternative is, for someone with experience and expertise, too radical to contemplate – to discard everything he ‘knows’ and re-explain it in terms of fields.
To give-up and start again!
Yet this seems neither necessary nor sensible; since causal chain thinking has been very useful in many situations.

Before I began thinking in terms of fields as the main cause of things, then I had pretty much a ‘billiard ball’ model of causation, of one thing as causing another in long chains of cause and effect.
But now it seems to be obviously impossible to account for the regularities of the world in terms of such chains of cause and effect; because there are innumerable interacting chains of causation in the world, and each chain is exquisitely sensitive to the specifics of its initial event – such that imprecisions expand with each step in the chain or with distance from the cause – to become chaotic and/ or noise overwhelms the signal.
We could never make sense of the world (or so it now seems), could never predict or control things, if reality really was constituted from vast numbers of interacting causal chains.
Isolating, studying and understanding one specific linear causal pathway out of dozens which also interact is futile (looking for a needle in a haystack), yet studying them all would take too long and even if we did then how could we understand the vast possibilities for interaction including the interaction of imprecision and error?

Only if these multiple specific and interacting causal pathways are ordered by larger scale principles (fields) could we make sense of such overwhelming complexity and indeterminacy as the world present.
For the world to be understandable, predictable and controllable I therefore think that (if we insist on such meta-explanations – as apparently I do) we rationally need to assume a metaphysic which begins with form, where forms are finite (in principle), and where we ourselves begin with an inbuilt knowledge of (at least some) forms.
Sheldrake emphasizes that we understand the world (when we do understand it ) in nested hierarchies.
So we understand biology in terms of living things, the various families, order, species etc, individual organisms and their organs, cells and the cellular components.

But for such understanding to be more than detached factoids, the explanation must include (whether implicitly or explicitly) form, fields, or principles of organization which descend from the higher to lower levels.
Such forms are not detected, nor discovered, they are recognized.
Once recognized they can be used. If there has been an error, and a form falsely recognized and ascribed, then they imputed forms will not be very useful – will lead to internal contractions, failed predictions, inability to control.
And it seems that the different sciences, the different specialties, and sub-specialties within science, could never amount to anything ordered (anything comprehensible) unless they were in nested hierarchies of fields.
Lacking this, the different scientific disciplines or specialisms (such as the scores of branches of ‘neuroscience’ or ‘brain science’) are incommensurable, atomic factoids (as, in practice, they currently are).
So, instead of merely accumulating findings ad infinitum, science needs to proceed in a theoretically-informed fashion, recognizing that facts are worthless unless organized by form: form structuring fact-finding, facts and what count as facts.

Posted in Uncategorized | 3 Comments

Reflective Coherence vs naive trend-following and conventional economic thinking

An author known as an evangelist for trend-following posted the following:-

Caught this ominous line: “Two-thirds of all U.S. houses have mortgages. Of those, an estimated 21 to 29 percent of the mortgages are underwater, or up to 16 million houses. When prices finally do rise, we can expect many of these no-longer-underwater owners to put their houses up for sale. If only one in three do, that is another 5 million homes in inventory.”

in relation to the following link:-

Somebody (LT) commented in response that the charts of the homebuilders – the XHB ETF, and components LEN and TOL were at 3+ year highs, indicating that this was of more significant than the columnist opinion.

In response to this, and to my comment, the evangelist wrote that “rising home builder stocks is one issue and homeowners underwater is another issue. Two separate facts in their own right. Deal with both as they are…right?”

I thought this was fascinating, because it is a very clear illustration of the fragmentation and absence of coherence in the way moderns tend to think about financial markets.  I believe that the inference one draws from an isolated fact regarding inventory will depend very much on what other beliefs one holds regarding the housing market.  Facts have no meaning outside of a broader context.  So that the emotional tone ‘ominous’ is unlikely to be associated with one’s interpretation of this fact if one chooses to take into account the technical picture of the homebuilders.

What does inventory mean? To the extent that there is no new picture demographically, and people continue to occupy a similar sized space and are not moving back with family, it represents a desire for somebody else to bear/manage the price and depreciation risks of ownership. It takes time for entrepreneurs to set up organizations allowing institutional capital to invest in residential property, but it is certainly happening. See the report in Marc Faber’s Gloom Boom Doom report by the founder of Sabre Value fund.

The response was that for those who are trend-followers there are no inferences to be drawn – one ought just to trade the market for what it is and accept that any  trend can end tomorrow.

It is a very much representative of our age that people look at the fundamentals in a fragmented, partial way, not considering the significance of an isolated observation in the context of the overall picture, and lacking a drive for coherence in peoples’ beliefs across different domains.  For a modern one is long the market because one’s model is bullish, and one sees no contradiction in talking to others about how awful the fundamentals seem to be.  Talking about the fundamentals is just like sport, and has no greater significance than that.

One can contrast this to another, more classical, approach that insists on finding coherence in our beliefs across domains, related and unrelated.  If the technicals are bullish, and the fundamentals appear to be bearish then, bearing in mind the proven ability of the market to forecast fundamentals, it seems likely that one is overlooking a nascent improvement in fundamentals that is as yet below the perceptual threshold for more traditional participants and commentators.

A participant who understands enough that he realizes markets have a tendency to trend, but not so much that he takes into account the tendency of markets to forecast future fundamentals is throwing away possibilities for learning.

Posted in Uncategorized | 1 Comment

Just how accountable are the inflation doves?

Our good friend over at Historinhas wrote a year ago expressing satisfaction at the presence of uber-doves on the Bank of England MPC.  Posen was quoted as saying the following:-

“The Bank of England‘s leading dove has predicted that inflation will tumble to 1.5% by the middle of next year as George Osborne‘s austerity drive and the underlying weakness of the economy stifle consumer spending.

In an interview with the Guardian, Adam Posen admitted he had sleepless nights over his call for more money to be pumped into the economy and said he would not seek re-election to Threadneedle Street’s monetary policy committee if his view turned out to be wrong.

Posen said: “If I have made the wrong call, not only will I switch my vote, I would not pursue a second term. They should have somebody who gets it right and not me. I am accountable for my performance. I’m holding my nerve because it is the right thing to do.”

Despite surprises in global growth to the downside since this interview (the European crisis coming as a shock to most commentators, although not to this one ), UK inflation has fallen from 5% yoy last year to 3.4% yoy at the end of Q1 2012 (vs consensus expectations of 3.1%).  JP Morgan expect inflation to reaccelerate later in the year to 4% annualized, or 3% yoy (with core inflation near 2%) – another year of inflation significantly above target.

The doves keep very quiet about their forecasting errors.  I think it is hard to attribute the likely significant overshoot in headline inflation to drastic changes to the stance of monetary and fiscal policy since the Posen interview, although certainly these have probably been in the direction of being somewhat easier than expectations at that time.

At what point does a blip become a trend, I wonder.

I do think likely very much lower energy prices will put pressure on headline inflation in the medium term, but I think longer-term we are early in a period when inflation will turn out to be persistently higher than expected based on models calibrated to the previous regime.  Over the course of months and quarters, lower gasoline prices will tend to support consumer disposable incomes.

I am not banking on an apology from the doves, but it would be nice if their expressed confidence appropriately reflected the rather thin supporting evidence for their dovishness.

When inflation continues to exceed target despite a soft economy, is it the inflation doves or the hawks who are insane?  I would say neither, but those who continue to place their faith in econometric models that have had a terrible track record of predicting turning points and those who have no previous successful record of forecasting to back their over-confident pronouncements.

Posted in Uncategorized | 2 Comments

The 1930s were a consequence of credit not equity market developments


I would like to do a longer post on this at some point, but would like to make just a quick observation on how I have found it useful  to think about developments from 1929 onwards.

America has been blessed as a nation, and one can find most things one needs within the country.  For many Americans, what happens abroad is simply of little relevance.  This has tended for many years to shape the culture, such that there is a general neglect – even at the highest levels – of the influence of international developments in shaping events at home.  The narrative of the 1930s depression in the US has tended in cartoonish form to link the stock market boom of the 20s to the depression that followed, and the depression is often thought to have been both caused and triggered by the stock market crash of 1929.

Scott Sumner, a man who, for both good and ill, is very much a product of his era, succumbs to this narrativeBecause there seemed to be no apparent immediate real economy effect of the 1929 stock market crash, he denies that there was any financial market crisis until 1931, when there was a wave of US bank runs that had severe contractionary effects on the real economy.  This fits nicely into the narrative he wants to paint, which is that depressions and downturns are caused entirely by overly tight monetary policy during the bust (and not at all by fundamental misalignments induced by prior overly easy monetary policy during the boom).  He is a man of his era, because this stripping of context, and wanting to view events as being the linear product of direct causes is very much a feature of left hemisphere consciousness (as described by Iain McGilchrist).  He actually goes on to accuse all previous authors of having misunderstood the situation, accusing editors of neglect of their duties in allowing such sloppiness to pass by unchecked.  Such an absence of humility is quite a sight to behold!

Unfortunately for him and – given the likely appeal of his kind of thinking to a broader audience – for us, he is very much mistaken.  It simply isn’t right to look only at the US equity market when, as Martin Armstrong points out, the bond market was very much bigger and the great preponderance of issuers went on to default, in one way or other.  October 1929 was when the Bank Austria (central bank) cut off discount window financing to the BodenKreditAnstalt and forced it to merge with Credit-Anstalt.  It was the failure of the new entity that was to kick off the acute phase of the crisis in 1931.  So there is a direct continuity between the events of 1931 and those of late 1929.

I reproduce a couple of comments I made to his blog here.  He does not really respond to these.

25. March 2012 at 11:48

Scott Sumner – the bond market in the late 20s was bigger than the stock market, and almost every sovereign issuer ended up defaulting. The private sector didn’t fare so well either. So you might want to look at credit spreads rather than equity prices. Obviously if the market is closed to new issuance and to refinancings, that starts to become a problem some time before the situation gets bad enough to reach the stage of bank runs.

One should also consider the international aspect, since Europe was in many ways the epicentre of the crisis. The BodenKreditAnstalt had trouble financing itself as early as October 1929 when the Bank Austria (central bank) closed the discount window. The forced merger with Credit-Anstalt created the new entity that was to kick off the acute phase of the crisis in 1931.

So I do not understand why you write with such certainty that there was no crisis until 1931. The fire ignited in 1929 but was not noticed till some time later.


25. March 2012 at 11:54

To say there was no crisis in the US in 1929 is like saying there was no peripheral crisis in Europe in 2007. The whole thing was one rotten episode that took its time to spread. But in 2008 it was inevitable that the recognition of trouble in the US would inevitably lead to recognition of underlying problems down the line in Europe, no matter how aggressively the ECB eased. The problem wasn’t that the ECB tightened too much, and didn’t ease enough. The problem was that trusting German Landesbankers had lent money at stupidly low interest rates to countries that didn’t make good use of the money nor have an alternative financing source when the Germans awoke. All the liquidity in the world isn’t going to make that problem go away.


26. March 2012 at 17:57

The 1987 equity market crash was in part a recognition of trouble that had been brewing in the bond market since the beginning of the year. This being said, the credit market stayed open. That is really the key point, and the reason why 1931 should be seen as part of the same episode that began in 1929, just as the European peripheral crisis of 2011 should be seen as having begun in 2007-2008.

It is astonishing that somebody can speak of linkages between financial markets and the real economy without giving any evidence of understanding the tremendous importance of the credit markets.

  • Cantillonblog
    28. March 2012 at 17:19

    Dr Sumner – why do you plot the stock market when it is the credit market that matters for assessing whether there is a fincancial crisis or not, and the credit market was larger than the stock market?

    The European credit market was where the crisis began.

    You don’t consider the inability of the BodenKreditAnstalt to finance itself the beginning of the crisis? Why not?

  • Gravatar of Cantillonblog Cantillonblog
    28. March 2012 at 17:21

    Dr Sumner would you care to enumerate in history those instances that saw the bursting of a bubble in the credit market where the central bank acted sufficiently fast and vigorously that everything worked out fine and there was not hell to pay?

  • Posted in Uncategorized | Leave a comment