Friday, December 2, 2022

Waller courage

While the rest of the Fed climbs on the maybe-anvils-might-fall-from-the sky climate financial risk fantasy, Chris Waller has the courage in Haiku-simple prose to state that the emperor has no clothes. 
I cannot support this issuance of guidance on climate change. Climate change is real, but I disagree with the premise that it poses a serious risk to the safety and soundness of large banks and the financial stability of the United States. The Federal Reserve conducts regular stress tests on large banks that impose extremely severe macroeconomic shocks and they show that the banks are resilient.
Granted, in my view stress tests are a lot less reliable. Stress tests didn't uncover the weakness that led to the pandemic bailout, so there is no hope of them assessing climate risk. The Fed is, let us not forget, fresh off of a second huge bailout in a pandemic their stress testers never considered, and a consequent fiscal-policy inflation that their forecasters never imagined. The "transition risk" crowd got the sign wrong on what happens to oil company profits if you restrict fossil fuel investment. A "how did we screw up so badly" effort seems more important. But we need not fight about this issue. Different logic leads to the same conclusion. 

Chris is right that it is completely obvious that "climate risk" does not conceivably imperil the financial system, or at least not with more than infinitesimal probability and a lot less than other dangers --- war, sovereign debt collapse, pandemic, etc. 

Bravo, Chris. A reckoning of this highly political move will come. Yes, the Biden administration wants a "whole of government" effort to restrict fossil fuels and to subsidize windmills, photovoltaics and electric cars (so long as they are built in the US), but the Fed is supposed to be politically independent. Because, you know, administrations and Congresses change. I suspect caving to this pressure will cost the Fed a lot. 

Monday, November 28, 2022

California homeless math

From WSJ 

California Gov. Gavin Newsom ....recently put a temporary freeze on $1 billion of state grants for city and county homelessness programs....the measures would have reduced homelessness statewide by 2% between 2020 and 2024

[California has] more than 116,000 residents sleeping on the street on any given night.

California has dedicated some $15 billion toward the issue since the start of the pandemic.

$15 billion / 116,000 =  $129,310.34

2% x 116,000 = 2,320. $1 billion / 2,320 = $431,034.48

Thursday, November 10, 2022

The second great experiment update

 Our great experiment in monetary economics continues. 


The news of the moment is that inflation might--might--be peaking. I just present the CPI to make the point, but there seems to be a lot of news suggesting that inflation is easing off. Jason Furman's twitter is a great source of up to the minute detailed data and analysis suggesting this view. 

Of course this could also be a blip like August. And new shocks could come along. But let's explore what peaking might mean. 

Friday, November 4, 2022

Academic Freedom Conference Opening Statement

Opening remarks, Conference on Academic Freedom

John H. Cochrane

Nov 4 2022

Welcome to the Academic Freedom Conference. I’m John Cochrane, one of the co-organizers of this conference.

First, let us offer thanks. Most of all, we thank the Stanford GSB and its dean Jon Levin for sponsoring this conference, and sticking with us through some turbulence. We also thank the institutions listed here for sponsorship, and several generous donors. We thank the organizing committee, which helped to identify and recruit speakers and consulted extensively. We thank all our speakers, and all of you, especially those who have traveled to be here. Most of all, Ivan Marinovic did all the hard work of putting the conference together. Thank you Ivan! 

I am, of course, not going to tell you what to say and not say. But any conversation is more productive if we focus it and try to keep to the point. 

We gather as a group that believes academic freedom is important and under threat. But we don’t fully understand the problem or what to do about it. So, we are here to share experiences in different universities, fields, and from a diversity of viewpoints, to understand and define the problem, and to find practical solutions. 

We are not here to have a philosophical discussion whether academic freedom is important, and whether it is threatened. We here start from the premise that the core mission of the scholarly community is to uncover new knowledge, to debate and refine knowledge, to pass on knowledge to the next generation, and more importantly to pass on the habits and norms of critical inquiry and scholarly debate that produce true knowledge. We here start from the premise that we are losing academic freedom, and that threatens this core scholarly mission. If those of you listening on zoom or the critics of this conference wish to debate these issues, go ahead and run a different conference. Every biology conference does not start with an evolution vs. creationism debate. Time is short, and focus will make us more productive. 

This is a conference on academic freedom, with a lesser emphasis on free speech of political opinions. Cancellation, ostracism, and disciplinary action for political opinions, and canceling outside popular speakers are in the news. But our core question is limitations on the scholarly enterprise of research, teaching, publication, fact-finding, logical analysis, and criticism. This enterprise is damaged when scholars are canceled for political opinions, or opinions on matters like university hiring and admissions. But our focus goes beyond this to emphasize less visible but perhaps more insidious restrictions on academic activity, including direct institutional actions, by self-censorship in fear, or by good people being driven out of the academic enterprise. 

This is a conference on academic freedom, and not free speech and censorship in the media, on twitter, and in the general society. That is an important political problem in our democracy, but it’s not the focus of our conference.  

This is a conference on academic freedom, and not centrally on the substance of contentious issues. We have some noted speakers who have been criticized for their views. But we’re here primarily to learn from their experience of censorship, not to debate the merits of the particular views and research findings that got them in trouble.

Academic freedom is a problem of institutions. Twitter-mob students are visible. But the key restrictions on academic freedom lie with university leaders, university bureaucracies, hiring and promotion procedures; and beyond universities to funding agencies, professional organizations, and journals. I hope we can discuss and remedy dysfunction in all these institutions. 

The nexus between politics and academic freedom is a deep and troublesome question.

We designed this conference to be non-partisan. Truth knows no politics, we thought; it is likely to unsettle verities on all sides, and we know many self-identified leftists as well as rightists and libertarians who are concerned. We don’t know and didn’t ask what your politics are. We did however, make a special effort to invite people who self-identify as politically left or progressive and concerned with academic freedom. We also made a special effort to reach out to many of the people who have criticized some of our speakers; among others Stanford faculty who publicly denounced Jay Bhattacharya and Scott Atlas. 

The non-response and refusals from this group was astounding, and surprising to us. If this group does not seem “balanced” to you it is by refusal to participate, not by lack of invitation. 

One prominent Stanford professor, active in university academic freedom issues, spoke for many, telling us “I can’t be seen on the program with right-wing nutjobs like.…” and named a few of our speakers. At an academic freedom conference. There’s half the problem in a nutshell.

There are now faculty protest letters and demands in the faculty senate that Stanford distance itself from this conference. Critics involved the media. They complain that we are “closed,” for restricting attendance when the room got full, and for restricting media to preserve space for participants, though these are routine for academic conferences. [The Stanford global energy forum of the last two days is explicitly “invitation only” without complaint, and without Bjorn Lomborg or Steve Koonin.] They complain about some of our speakers’s deplorable, to them, views. People with such views should, apparently, never allowed to speak on anything. They cherry pick one or two hated speakers, to declare us “unbalanced.” But have any of them looked up the other 35 speakers on the program?  The Chronicle of Higher Education declared this conference a “threat to democracy.” Even the Hoover Institution declined to support or co-host this conference, deeming it “too political.” 

The attempt failed. Stanford’s leaders have supported us, for which we are grateful, so we are still here. But young untenured faculty figured out they should not be seen here. Several more deregistered from the conference after we decided to stream the proceedings, citing fear of repercussions. 

The irony of trying to censor the free speech conference has not occurred to them. The hypocrisy of labeling this and only this conference “political,” and demanding that this and only this conference include “wider voices,” not the long list of highly one-sided political events at Stanford, [for example, the “Gender Equity and Justice Summit”] likewise escapes them. Well, I guess "logic" is not politically fashionable, but do we have to be so obvious about it?  

We were naive. Just in setting up a conference to talk about academic freedom, we got to experience part of the problem. 

I think we cannot avoid the elephant in the room. The threat to academic freedom is political, as it has always been. Free scholarship undermines narratives that sustain or are used to claim political power.  Though in the past this threat has come from both left and right, and though there are some dumb and illiberal restrictions coming from Republican state legislatures, the main threats to academic freedom inside the university, professional societies, and government agencies predominantly come from a particular far-left authoritarian political ideology, and most of the forbidden subjects today threaten their narrative.  

Well, I think so. Maybe I’m wrong. My point is, we should talk about this too.

Some organizational notes: 

You can say what you want, but you can’t talk as long as you want. Please abide by the time limits. Moderators, please be ruthless in enforcing time limits. Please leave ample time for questions and comments from the floor. That discussion is much of the point of this event. I anticipate there will be far more comments than we can accommodate, so I encourage moderators to take a group of 5 or so comments at a time. Panelists, please keep responses short. 

Each session will start on time, and end on time. At breaks, please return to the room promptly without being nagged, so we can keep to the schedule and everyone gets a chance to be heard.

Be aware that this conference is streamed, and video will be available later as well. We  originally preferred no recording and Chatham house rules. But various pressures make that impossible, and we realized there is no way to ensure privacy. So, we accepted the loss of spontaneity that a record imposes, in return for the transparency that it provides. It proves what is not said here as much as it records what is said. 

Covid still runs among us, and in a group this size there is a good probability that someone is infectious. Let this be a super-spreader event of ideas, but not of disease. If you are not feeling well, please do us all a favor and watch the live stream from out of the room. If you have any doubts, please take a test. (There are a bunch at the sign in desk.) In this tolerant free-speech group, let us respect people’s individual choices to wear a mask.

OK. Tell us what’s going on in your field, your university, your department, your curriculum committee, your classroom, your professional society, your journals, your funding agency, and tell us how we can work together to fix it.



Thursday, November 3, 2022

Academic Freedom Conference

On Friday and Saturday Nov. 4/5, the Stanford GSB Classical Liberalism Initiative will host a two day conference on Academic Freedom. Conference website here, and I copy and paste the schedule below.  The room is beyond full, so we can't issue more in-person invitations. Because of that and the threat of protests (yes, a loud group at Stanford wants to silence the academic freedom / free speech conference),  we will not be able to accommodate walk-ins. 

But the event will be live-streamed. If you want to watch, register here and we'll send you a link. 

This is a separate effort from the academic freedom declaration I blogged  yesterday, though many of the same organizers are involved. 

Academic Freedom Conference

Academic freedom, open inquiry, and freedom of speech are under threat as they have not been for decades. Visibly, academics are “canceled,” fired, or subject to lengthy disciplinary proceedings in response to academic writing or public engagement. Less visibly, funding agencies, university bureaucracies, hiring procedures, promotion committees, professional organizations, and journals censor some kinds of research or demand adherence to political causes. Many parts of universities have become politicized or have turned into ideological monocultures, excluding people, ideas, or kinds of work that challenge their orthodoxy. Younger researchers are afraid to speak and write and don’t investigate promising ideas that they fear will endanger their careers. 

The two-day Academic Freedom Conference, arranged by the organizing committee, aims to identify ways to restore academic freedom, open inquiry, and freedom of speech and expression on campus and in the larger culture and restore the open debate required for new knowledge to flourish. The conference will focus on the organizational structures leading to censorship and stifling debate and how to repair them. 

Schedule

Wednesday, November 2, 2022

Academic Freedom Letter

Some colleagues and I created an open letter on Academic Freedom. If you share our views, you are invited to sign. 

The bottom line: we call for universities and professional associations to adopt and implement the  Chicago Principles of free speech, the Kalven Report requirement for institutional neutrality on political and social matters, and the Shils report making academic contribution the sole basis for hiring and promotion.  

We include professional societies. That means you, American Economic Association and American Finance Association: With all your committees on improving the profession, you need one big one to defend the most important and imperiled part of the scholarly enterprise, academic freedom. 

The letter, below, is not as comprehensive and detailed as you might like, but we worked to keep it short. 

The official letter and list of signatories lives here. If you would like to sign, you can do so by filling out this form. It's moderated so may take a day or two for your signature to show. 

We are up to 626 signatures (11/3). When the number stabilizes we'll try to make a public fuss about the letter. 

Update: A special plea. I have several responses from left/liberal/democrat colleagues who say they would sign, but don't want to have their names on a letter that doesn't have enough other left/liberal/democrat names on it and does have well known deplorables. (How you know 626 people's politics is beyond me, but ok.) That reaction tells us a big part of the problem.  All along we have tried very hard to reach out to self-described left/liberal/democrat colleagues, who privately bemoan what's going on but are too afraid to be seen in public. But why not fix it: if some of you sign perhaps that will give courage for more of you to sign. Take it over, get together with your friends, add lots of signatures, make this your cause, prove that we can stand together for freedom! 

Restoring Academic Freedom

The mission of the university is the pursuit of truth and the advancement and dissemination of knowledge. A robust culture of free speech and academic freedom is essential to that mission: Intellectual progress often threatens the status quo and is resisted. Bad ideas are only weeded out by unfettered critical analysis. 

Unfortunately, academic freedom and freedom of speech are rapidly declining in academic institutions, including universities, professional societies, journals, and funding agencies. Researchers whose findings challenge dominant narratives find it increasingly hard to get published, funded, hired, or promoted. They, and teachers who question current orthodoxies, are harassed in person and online, ostracized, subjected to opaque university disciplinary procedures, fired, or canceled by other means. Employment, promotion, and funding are increasingly subject to implicit or explicit political litmus tests, including approval from bureaucrats seeking to impose a social agenda such as specific views of social justice or DEI principles. Activism is replacing inquiry and debate.  An increasing number of simple facts and ideas cannot even be mentioned without risk of retribution.

We're all supply siders now -- Summers and Poilievre

Larry Summers wrote an interesting oped at the Washington Post. Mostly, he still is of the adaptive-expectations ISLM view that interest rates must exceed current inflation before inflation will decline. (The issue here (blogpost) and here (paper).) But listen to this:

Questions of macroeconomic policy are not about values but judgments about the ultimate effects of various actions. As Fed chair during the early 1980s, Paul Volcker famously tamed out-of-control inflation at the cost of a severe recession. But he did so not because he cared less about unemployment or worker incomes than his predecessors did but because he rightly recognized that delay in containing inflation would only mean more pain down the road.

Would we all recognize common goals, but differences on cause and effect to get there.  

That’s why it’s vital that the Federal Reserve not waver. Chair Jerome H. Powell has vowed to impose sufficiently restrictive monetary policy to return inflation to within range of the Fed’s 2 percent target. The more confident that workers, businesses and markets are that the Fed will follow through on that, the less painful the process will be.

Within the conventional monetary policy community, praise for Volcker and the view, basically, that the Fed should focus on inflation and the labor market will take care of itself is sensible, but remarkably Reaganish. 

The tidbit that I found most interesting

Finally, the crisis of inflation should not be wasted. A bright spot in the dismal inflation period of the 1970s was the collaboration of Stephen G. Breyer (then counsel to the Senate Judiciary Committee), Sen. Edward M. Kennedy (D-Mass.) and the Carter administration on airline deregulation. In this era, high inflation should be a spur to regulatory changes — from addressing Jones Act increases in shipping costs, to strategic tariffs, to rules that force oil and gas to be transported via truck rather than pipeline, to punitive zoning restrictions — that will both reduce prices and make the economy work better.

As you know I've been preaching that "supply side" growth is the central problem and also the key to reducing inflation. Larry hasn't quite gotten to the latter, but this is the economist most identified with "secular stagnation," "hysteresis" and the view that all we need to do is borrow or print more money and hand it out to create growth. Now deregulation and the supply side is the key to growth. 

Larry is starting to sound like a Reagan Republican!  I'm sure he would say circumstances have changed -- that was ZLB (zero lower bound on interest rates), this is inflation. That's a consistent view. But inflation should wake us all up as it has Larry: All the old verities are over, there is only supply now, and that comes mostly from getting out of the way, as Larry recommends, not new "investments" of more borrowed money thrown down ratholes. 

*** 

Pierre Poilievre, the leader of Canada's Conservative party, wrote a great Oped in the National Post. Now that Liz Truss has imploded, perhaps Poilievre will become the international hope for a successful free market libertarian politician. 

Finance Minister Chrystia Freeland wants us to believe she has had an epiphany. After years of ignoring my warnings that Liberal deficit spending would cause inflation to balloon, followed by interest rates, she now claims to agree with me in a leaked letter to fellow ministers. Even her boss, Prime Minister Justin Trudeau, is uttering words unthinkable to him not long ago: “fiscal responsibility.”

The cost of government is driving up the cost of living. A half-trillion dollars of inflationary deficits have sent more dollars chasing fewer goods, which always leads to higher prices. 

We're all FTPLers (fiscal theory of the price level) now, some sooner than others. A clear explanation of how central banks create money and buy treasury debt follows. Then

 the Bank of Canada must pay interest — at the going rate. Because rates are now rising, the central bank is now losing money and will need a bailout from the federal government for the first time in history — something I predicted would happen two years ago. 

Fiscal constraints on monetary policy. Nice. 

Liberals like to say that all this inflation is the result of the Russian invasion of Ukraine. But less than 0.3 per cent of Canada’s trade is with those two countries, and the things that they produce are things we already have — food and energy. In fact, the higher commodity prices should have helped our resource-heavy economy, but for the fact that the Trudeau government has hit farmers with fertilizer tariffs and carbon taxes and blocked or bungled every single pipeline or LNG export terminal proposed in seven years.

Beside my thread, but an important point. His bottom line 

Instead of creating more cash, we need our economy to produce more of what cash buys: more food, energy and homes. That means removing gatekeepers that have made Canada the second slowest country in all the OECD to get a building permit. As prime minister I would challenge all three levels of government to work together to offer the fastest building permits in the OECD. This would mean going from 250 days to 28 days to beat the now first-placed South Korea....We would remove taxes and tariffs on farmers’ fuel and fertilizer....Finally, we would reform our taxes to reward work, savings, and investment so our workers and businesses can produce more of the goods we need. 

Simply put, we would stop creating cash and start creating more of what cash buys: food, homes, energy, manufactured goods and more. That is the only path to bigger buying power for paycheques and savings.

FTPL and deregulation-focused supply side growth. Well, us free market libertarians are like Chicago Cubs fans, there's always hope!


Ip on FTPL

Greg Ip gives nice coverage of fiscal theory of the price level in the Wall Street Journal.. 

I'm sad he left out Eric Leeper's defining work, which really even more than Sargent and Wallace started modern FTPL. Eric described monetary policy with interest rates, not money supplies, and integrated FTPL with the now dominant new-Keyensian tradition. 

Naturally I'm a bit rankled by 

But FTPL is frustratingly difficult to apply to real life. 

and 

A theory that doesn’t predict inflation but explains it only after the fact by invoking hard-to-measure attitudes isn’t that satisfying, and certainly no better than mainstream macroeconomic models.

Well, that also means no worse than mainstream models. And I was publicly warning of inflation in April 2021, though I'm too much of an academic to make much of one data point. The FTPL analysis of the ZLB is, I think more convincing. 

Yes it would be nice if FTPL could tell you just when too much debt is too much. It would also be nice if the theory of finance could tell you just what a stock should be worth. And it would be nice if any theory, or the Fed itself, did a good job of predicting inflation. 

A nice nugget, 

 fiscal stimulus had some role in pushing inflation up, and as the Fed raises interest rates to combat that inflation, it will worsen deficits. Britain had to abandon deficit-financed tax cuts over fears they would drive inflation and interest rates higher. French Finance Minister Bruno Le Maire recently warned: “Central banks’ restrictive policies are ineffective if public finances continue to expand.”

It seems we're all FTPLers now. 

But I'm whining. For the length it's excellent. This is a hard topic and most journalists get things wrong.  And I am grateful for the publicity.


Friday, October 28, 2022

Economics Art

I was researching the European Stability Mechanism this morning for a paper on the evolution of the euro, and I ran across this gem of economics art on the ESM webpage.  


Put on your mechanical engineer hat for a moment. This is a set of gears that literally cannot turn. To say nothing of the wisdom of putting belts on gears. Perhaps this is a subtle cry for help? 

(The ESM is sort of europe's internal IMF that can lend money to strapped governments with conditions.) 
  

Tuesday, October 25, 2022

Truss Tragedy

(at Project Syndicate)

The Liz Truss Tragedy

The former British prime minister’s downfall holds important lessons for growth-minded policymakers in the United States, Europe, and elsewhere. While her diagnosis of the country’s economic problem was spot on, she fatally mismanaged both the politics and the messaging of her policy response.

STANFORD – Liz Truss’s stint as British prime minister is over, but she was right that the United Kingdom needs growth. Her downfall is tragic, because growth is the only path out of the country’s economic dilemma. 

The UK is surprisingly poor. Its GDP per capita is just $43,000, compared to $60,000 in the United States. The average British home is one-third the size of the average US home. Worse, the country’s economy is not growing. Its GDP per capita is lower than it was in 2007. Productivity – the underlying source of economic growth – has been flat for over a decade. 

The UK desperately needs supply-side reforms. Surging inflation tells us that demand-side stimulus is a spent force. 

Inflation Expectations

 


From Torsten Slok at Apollo Global Management. The picture says it all, but Torsten's commentary is especially good: 

Inflation will be coming down over the coming quarters. This is what the Fed is predicting, that is what the consensus is expecting, and that is what we are predicting. The problem is that this has been the forecast ever since inflation started going up in April 2021, see chart below. Given how systematically wrong inflation forecasts have been over the past 18 months, there are good reasons to be cautious about the current forecast.

It is also how market expectations have evolved. Is inflation inherently unpredictable? Are we collectively in thrall of the same wrong model? Does "expectation" mean the same thing in models and surveys? Are market risk premiums really important?  

Friday, October 14, 2022

More UK finance regulatory failure

In previous blog posts here and here, I criticized UK financial regulators for missing simple leverage and margin requirements in UK pension funds. To be clear, I don't criticize the people. The point is, if after 10 years of intense regulation, a group of really smart and dedicated people can't see plain old leverage, the whole project of regulating risks is broken. And it's not just the UK. The Fed bailed out money market funds in 2020. Again. 

I insinuated the regulators were not paying attention. I was wrong. It turns out they were paying attention. Which makes the failure all the more stark.  

In Friday's Wall Street Journal, Greg Ip writes 

In 2018, the Bank of England investigated whether a big rise in interest rates would trigger a cascade of forced selling by bond investors, destabilizing the financial system. The answer was no, 

That they did think about it, and they missed it anyway is even more damning for the regulate-risks project. 

Nobels and financial crises

 (At National Review)

What This Year’s Nobel Economists Can Teach Us about Financial Crises

This week, economists are celebrating the Nobel Prize given to Ben Bernanke, Doug Diamond and Phil Dybvig for their work on banking.

Bernanke pointed out that banks matter. In the Great Depression, banks failed, and there was nobody left who knew how to make new loans. The economy contracted, not just for lack of money or for animal spirits of investors, but for lack of credit. Diamond and Dybvig wrote the classic economic model of bank runs, which shows how banks can fail even when they are “illiquid” rather than “insolvent.” The logic works like this: The bank has invested our money in illiquid projects, so if I suspect others are going to run to get their money out, I run to get mine out first before it’s all gone. 

But it is no insult to say that these are not eternal verities. The papers were written about 40 years ago. Each was the launching pad for a vast and important investigation. Indeed, Nobel Prizes largely recognize that sort of lasting influence on subsequent work. But that subsequent investigation opens new possibilities. Newton is no less profound for having been followed by Einstein. Each also sought to understand the world as it was, which is how one should start. But there are other possibilities for how the world might be — and how it might be better. 

Monday, October 10, 2022

Mind the store

On the same page in today's WSJ:

One third of DC bus riders don't bother to pay the fare. Also in New York

The State Department is so dysfunctional that processing visa requests takes years

In New Delhi, an appointment for a nonimmigrant visitor visa takes more than 800 calendar days, or nearly three years; for a student visa, nearly 450 days. The Cato Institute found that more than half of U.S. embassies and consulates world-wide have a waiting time greater than six months for a visitor or business visa appointment, compared with 1% before the pandemic. More than 1 in 4 have a waiting time of a year or more.

In March Congress enacted the EB-5 Reform and Integrity Act of 2022 to streamline the immigrant-visa process for foreign investors who commit significant capital to the U.S. But that reform is swamped by slow administration. U.S. Citizenship and Immigration Services advises applicants that 80% of cases (excluding Chinese nationals, who take even longer to process) are resolved within 52 months, or nearly 4½ years.

A central part of the immigration problem is that asylum claims languish in courts for years. And regular criminal courts also take years. Either spend the money to administer the laws, or change the laws (immigration and visas in particular) to not require administration that we can't provide.  

These are just two tips of the iceberg of general incompetence in many parts of our government.  Not all: I've had some pleasant interactions with very well run low-level government offices lately. It can be done. 

Wanted for the elections: politicians who will campaign simply to administer competently and remedy dysfunction. Efficient government offices, court systems, transit systems and so forth are also crucial infrastructure. Don't lead new grand causes, just mind the store. 

 

Thursday, October 6, 2022

UK finance fable update

Update to my previous post on the UK treasury imbroglio: 

The Bank of England explains, saying about as much as I did. Pension funds levered up, lost money when treasury prices fell, needed to post collateral, and then started selling en masse. The explanation starts with lovely central-bankerese (my italics): 
Against the backdrop of an unprecedented [really? Literally never?] repricing [translation: fall in prices] in UK assets, the Bank announced a temporary and targeted intervention on Wednesday 28 September to restore market functioning in long-dated government bonds and reduce risks from contagion to credit conditions for UK households and businesses. 

It goes on to a hilarious graph to explain how you lose money when you borrow to lever up a portfolio:

Why is this so funny? Notice on the left hand side a gap between assets and liabilities, yet in the fourth bar there is a positive "capital" bar.  Accounting 101, assets = liabilities, including capital. I guess UK regulations operate differently. 

But enough fun, let's get to the point. In answer to my question, roughly "you're supposed to be this great gargantuan regulator, how could you miss something so simple?," the bank offers, deep in the report, this: 
The FPC has previously identified underlying vulnerabilities in the system of market- based finance, a number of which were exposed in the ‘dash for cash’ episode in March 20202. The Bank and the FPC strongly support and engage with the important programme of domestic and international work to understand and, where necessary, address those vulnerabilities.

The FPC conducted an assessment of the risks from leverage in the non-bank financial system in 2018, and highlighted the need to monitor risks associated with the use of leverage by LDI funds. 

It's so nice you've been studying this. But then double, how did this happen? 

Tuesday, October 4, 2022

Out of the box risks

Policy Tensor on the consequences of a Russian nuke (HT Marginal Revolution) was very interesting: 

Consider the least escalatory option, that of a “demonstration detonation”: Russian forces air-burst (to avoid the nuclear fallout that results from a ground detonation) a tactical nuclear weapon with sub-kiloton yield (ie, no bigger than a big conventional weapon) over uninhabited territory somewhere in south-eastern Ukraine. This would be consistent with Russia’s “escalate-to-deescalate” doctrine ... What happens then?

Precisely because it is such a dramatic break with precedent, even a demonstration detonation would radically change the character of the Russo-Western conflict over Ukraine. New Yorkers and Berliners etc, are likely to flee the cities. Everywhere, in Europe and America, supermarkets would likely empty within hours. Many local authorities may institute civil defense measures, even as federal governments everywhere urge calm. A widespread breakdown of law and order would be a real possibility; especially in America, where it would be attended by partisan passions and finger-pointing....

Not to bash a hobby horse, but the Fed, SEC, FDIC and so forth are now obsessed with climate risk to the financial system. Chatting with colleagues at the Fed, it is astonishing how much and how detailed the research is in to climate (really weather) scenarios, much of this directed by higher-ups. 

Today I will not criticize that effort. Maybe pianos do fall from the sky.  What is striking to me, verified in every conversation I have with people in these institutions (please prove me wrong!) is that nobody at these institutions is doing any analysis of any other risk. 

This seems like a useful one, for example. Any nuclear explosion is going to make the ATMs go dark. Is anyone at the Fed gaming this out? What if (when) China blockades Taiwan? What about a massive cyberattack on the banking system, a deliberate attempt to cause a run (Russian disinformation that a major bank has had all its account information wiped out, get your cash now)? A new pandemic that looks more like 1350 than the flu?  

Monday, October 3, 2022

Sowell Nobel Redux

Nobel Prize season is around the corner. Last year, I blogged in favor of Tom Sowell. I update, with some edits. 

Dear Nobel Committee: How can you not give the prize to Tom Sowell this year? 

Tom's work evidently merits a Nobel purely as a contribution to economics, covering many issues. But we can't ignore what year it is. Race is a forefront issue of our time. How can you not give the prize to the living economist who has written the most penetrating economic analysis of race? 

Yes, he's a free-market economist, and thus characterized as conservative. His deeply fact-based research is  uncomfortable to The Narrative. For example, groups that white people cannot tell apart have profoundly different outcomes in the US. Nigerian immigrants are among the highest achieving ethnic groups in the US. West Indians do well. Asians of different waves of immigration and different countries -- Chinese, Laotians, Vietnamese -- show profound differences. Tom has thousands of such facts, impeccably documented. 

But you're the Nobel Committee. You care about Science, about facts, about logic, not about cheers from the Davos crowd. You care about issues that are important, as you should, but you do not care about embracing one or the other political narrative's answers to those questions. You care about the reputation of your Prize, for courageously recognizing great research, even if its surprising conclusions upset established orders. And, to your credit, you have given the prize to economists of widely different political enthusiasms through the years.  

Friday, September 30, 2022

A familiar finance fable in UK bonds

Guy Adams in the Daily Mail has an intriguing story of what's going on in UK bond markets.  It's intriguing because it's so utterly familiar. And it reveals that all the masses of regulation and armies of regulators aimed at preventing exactly this sort of thing from happening again and again have failed again. 

UC pensions take in contributions when people are young, invest them, and then pay out fixed amounts when people get old. They hold large quantities of government bonds, currently 1.5 trillion pounds per Adams. That's a good strategy: if you have fixed payments to make, invest in risk free assets that provide fixed payments, and ignore the mark to market. But it fell apart in a classic way. 

Leverage

As often is the case, however, they didn't have enough assets to pay out the promises. So... Lever up! Pensions used their government bonds as collateral, borrowed money, and invested that money in more government bonds or, to a lesser extent, in stocks or other investments. 

Thursday, September 29, 2022

Supply and inflation

 Mark Perry recently updated a fabulous chart: 

Not all inflation is the same. 

Some interpretations, from Mark. Tradeable (international competition) / non tradeable; government intervention / free market; durable goods / services: 

a. The greater (lower) the degree of government involvement in the provision of a good or service the greater (lower) the price increases (decreases) over time, e.g., hospital and medical costs, college tuition, childcare with both large degrees of government funding/regulation and large price increases vs. software, electronics, toys, cars and clothing with both relatively less government funding/regulation and falling prices. As somebody on Twitter commented:

Blue lines = prices subject to free-market forces. Red lines = prices subject to regulatory capture by government. Food and beverages are debatable either way. Conclusion: remind me why socialism is so great again.

b. Prices for manufactured goods (cars, clothing, appliances, furniture, electronic goods, toys) have experienced large price declines over time relative to overall inflation, wages, and prices for services (education, medical care, and childcare).

c. The greater the degree of international competition for tradeable goods, the greater the decline in prices over time, e.g., toys, clothing, TVs, appliances, furniture, footwear, etc.

d. From Twitter comments this week (2022).

*Thank goodness the government doesn’t subsidize TVs or toys, or toy TVs.

*Almost every line that went up, has had some type of government involvement, while the lines going down have more to do with capitalism.

*And as always, the more regulated, the more expensive things become.

There is a big distributional impact here. Less well off people buy more blue stuff, rich people more red stuff. 

The implications for greater protection, less immigration, industrial policy, and subsidies are pretty clear. 

Update:

I have been sloppy, about one of my own pet peeves. This graph is about relative prices, not about inflation.  

 

 

Sunday, September 25, 2022

WSJ stability oped -- full text

Now that 30 days have passed, I can post the full text of "Nobody Knows How Interest Rates Affect Inflation" in the Wall Street Journal August 25. A previous post has a summary with pretty pictures. 

***

A grand economic experiment is under way. Can the Federal Reserve contain inflation without raising interest rates much higher than they are now?

Conventional wisdom says that as long as interest rates are below the rate of inflation, inflation will rise. Inflation in July was 8.5%, measured as the one-year change in the consumer price index. The Fed has raised the federal funds rate only from 0.08% in March to 2.33% in August. According to the conventional view, that isn’t nearly enough. Higher rates are needed, now.

This conventional view holds that the economy is inherently unstable. The Fed is like a seal, balancing a ball (inflation) on its nose (interest rates). To keep the ball from falling, the seal must quickly move its nose.

In a newer view, the economy is stable, like a pendulum. Even if the Fed does nothing, so long as there are no more shocks, inflation will eventually peter out. The Fed can reduce inflation by raising interest rates, but interest rates need not exceed inflation to prevent an inflationary spiral. This newer view is reflected in most economic models of recent decades. It accounts for the Fed’s projections and explains the Fed’s sluggish response. Stock and bond markets also foresee inflation fading away without large interest-rate rises.

So which view is correct? In normal times, it’s hard to tell. Whether seal or pendulum, inflation and interest rates move up or down together in the long run, and they jiggle around each other in the short run.

Advocates for the conventional view argue that the Fed raised interest rates too little in response to inflationary shocks in the 1970s. Only when the Fed raised interest rates substantially above inflation for several years in the early 1980s, provoking two deep recessions, did inflation finally subside. The sooner we get to it, they say, the better.

Advocates for the stable view point to recent decades of steady inflation at zero interest rates in the U.S., Europe and Japan. When deflation appeared and central banks couldn’t move rates much below zero, conventional analysts warned of a “deflation spiral.” It never happened. Why should an inflation spiral break out now?

In both theories, expected inflation matters: If people expect higher inflation next year, they buy or raise prices today. The central assumption behind the unstable inflation-spiral theory is that people expect next year’s inflation to be pretty much the same as last year’s inflation—what economists call “adaptive expectations.” A driver who looks in the rearview mirror to judge where the road is will quickly veer off to one side or another.

The central assumption behind the stable theory is that people think more broadly about future inflation. They’re not clairvoyant, but they don’t ignore useful information and aren’t much worse at forecasting inflation than, say, Fed economists are. If a driver looks forward through the windshield, even a dirty windshield, the car tends to get back on the road.

Economists don’t know for sure whether the economy is stable or unstable, whether inflation can fade away without interest rates substantially above inflation. In that light, the Fed’s actions make some sense. If you really don’t know how interest rates affect inflation, it’s natural to raise rates slowly. Inflation may subside on its own. If not, you can keep raising rates.

If inflation fades, the conventional view will be seriously undermined. If it spirals, absent other shocks, the new view is in trouble. But a good experiment requires everyone to leave the test tube alone. Unfortunately, we are likely to see some new shock: a virus, a war, a financial crisis or a fiscal blowout. Inflation will then rise or fall for reasons having nothing to do with spirals, stability and interest rates.

Mr. Cochrane is a senior fellow at Stanford University’s Hoover Institution and an adjunct scholar of the Cato Institute. His book “The Fiscal Theory of the Price Level” is out in January.

Update: 

Economists wondering what the heck I'm talking about and where are the equations should read "Expectations and the Neutrality of Interest rates."