Category Archives: Financial Crisis

Dow will peak March 23…just after lunch!

Quoting from this CNBC article,

“The Dow Jones Industrial Average… will hit its peak on Wednesday, March 23rd, specifically “after lunch,” Robin Griffiths, the chief technical strategist at the ECU Group told CNBC.”

Such a claim (based on so-called “technical analysis” (cf. https://en.wikipedia.org/wiki/Technical_analysis)) is total and utter nonsense.  It would appear that the signal-to-noise ratio for this article specifically and much of CNBC content, in general, is close to zero.

Stocks have entered bear market territory, and any rallies from here are just opportunities to sell — not buy, a number of analysts have told CNBC.
cnbc.com|By CNBC
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Bank of Japan Introduces Negative Interest Rates

The Bank of Japan’s (somewhat counterintuitive) stated goal for implementing it’s new (negative interest rate) policy is “…to push down borrowing costs to stimulate inflation”. While I certainly do not claim or pretend to be a monetary economist, a policy that punishes savers and rewards borrowers doesn’t seem like a particularly good script for long-term economic success. I think it’s a tacit acknowledgment that the Japanese economy is struggling with deflation.  See https://www.boj.or.jp/en/announcements/release_2016/k160129a.pdf for the official policy statement issued by BOJ…

BOJ Introduces Negative Interest Rates for First Time
wsj.com|By Takashi Nakamichi and Megumi Fujikawa
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House of Debt

House of Debt – http://bit.ly/1rulBgN

This 1 hour long video (@ http://bit.ly/1rulBgN) featuring Amir Sufi (who is the Chicago Board of Trade Professor of Finance at the University of Chicago Booth School of Business) was recorded last Monday evening as part of the Myron Scholes Global Markets Forum at Chicago Booth. Here’s a description of his talk:


“The Great American Recession resulted in the loss of eight million jobs between 2007 and 2009. More than four million homes were lost to foreclosures. Is it a coincidence that the United States witnessed a dramatic rise in household debt in the years before the recession—that the total amount of debt for American households doubled between 2000 and 2007 to $14 trillion? Definitely not. Armed with clear and powerful evidence, Professor Sufi will discuss his forthcoming book, House of Debt, and how it reveals the Great Recession and Great Depression, as well as the current economic malaise in Europe, were caused by a large run-up in household debt followed by a significantly large drop in household spending.”

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The Economist: Essay on the history of finance in five crises

From The Economist:

“This week we publish an essay on the history of finance in five crises. They have a common theme: in each case the state increased the subsidies and guarantees it gave to finance—and helped set up the next crisis. Our cover leader points out that this is happening again. An American can now blindly put $250,000 in a bank, knowing his deposit is insured by the state. Finance, we say, should be treated more like other industries.”

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Political economy and the (inflationary) future

A particularly important “political economy” topic these days is the unprecedented extent to which the US federal government is spending money it doesn’t have.  The federal government has historically collected about 18.4% of gross domestic product (GDP) in tax revenues and spent roughly 21% of GDP on average.  Currently, tax receipts are lower than the long run historical average, thanks to the “Great Recession” (probably around 15-16% of GDP), and federal spending is much higher than the long run historical average (upwards of 25% of GDP).  The gap between what the government takes in and what it pays out is commonly referred to as the “deficit”; for the fiscal year just ended (on August 31, 2010), the total deficit was nearly $1.6 trillion.  The annual fiscal deficit gets added to the total “national” debt, which as of October 31, 2010 stands at $13.6 trillion (cf. http://www.treasurydirect.gov/govt/reports/pd/mspd/2010/opds102010.pdf). 

The national debt of the United States (as of 10/31/2010) is split into two categories:

  1. Public Debt ($9 trillion)
  2. Intragovernmental Holdings ($4.6 trillion)

Public debt is any money that is owed to investors, foreign governments, mutual funds, hedge funds, pension funds, foreign investors, etc.; i.e., in the form of US treasury securities.  “Intragovernmental holdings”, on the other hand, is money that the government borrowed from itself.  The major “source” for this is the so-called Social Security trust fund, as well as  other government-administered programs which happen to run “surpluses” in an accounting sense.  Of course, this money will have to be repaid in the future, and demographics ensure that the Social Security trust fund surplus will soon turn into a growing deficit in the absence of any meaningful reforms (e.g., the imposition of a higher age for eligibility, allowing for private accounts, etc.). 

I’ll finish by focusing attention on the public debt.  Nearly half of the $9 trillion in public debt (actually, $4.2 trillion) is held by foreign investors (cf. http://www.ustreas.gov/tic/mfh.txt).  China is the biggest holder of U.S. public debt – 21% of all public debt held by foreigners, in fact.  One can only wonder how this fact influences US foreign policy (since we “need” China’s dollars very badly), but I digress.  Lately, the US has been putting huge political pressure on China to allow its currency (the yuan) to appreciate substantially (cf. “China Currency Bill Advances”, 9/25/2010 WSJ).  If this happens, US products will become more competitive vis-à-vis Chinese products in global markets, but it will do so at the cost of leaving the Chinese with less dollars for buying our bonds.  Since we are in the process of exhausting China’s appetite and ability to fund our deficits, we now turn our attention to the Federal Reserve.  By buying public debt from the US Treasury, the Fed is effectively expanding the money supply while also providing the US Treasury with the dollars that it needs to finance the deficit; indeed, last Wednesday the Fed announced that it would purchase up to $600 billion in US Treasury securities as part of its so-called Quantitative Easing (QE II) program.  However, this Faustian bargain will most likely come at the cost of a return of inflation at some point in the future.  The good news right now is that there is hardly any inflation at all in the economy, so the Fed is betting that the future inflation related to its large scale purchases of Treasury debt won’t be “bad”.  I hope they’re right, but history and Milton Friedman tell me that this kind of movie has been played before and that it usually turns out rather badly (in the form of inflation; see “Milton Friedman vs. the Fed”).

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Hayek vs. Keynes Sequel “Sneak Peak”

In an earlier (January 27, 2010) blog posting entitled “‘Fear the Boom and Bust’ Hayek vs. Keynes rap video“, I reference and link to the very clever (and popular –  more than 2 million views on youtube.com) video production by filmmaker John Papola and economist Russ Roberts which compares and contrasts the ideas of two “famous” dead economists, John Maynard Keynes and Friedrich von Hayek.  Here’s a “sneak peak” of the “sequel” (hat tip to Russ Roberts):

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“Fat Tails” and implications for risk management

Yale mathematician and emeritus professor Benoît Mandelbrot passed away last week at the ripe old age of 85. Mandelbrot was most famous for his seminal work in the field of fractal geometry, but is also considered by many (e.g., Nassim Nicholas Taleb, the author of Fooled by Randomness and The Black Swan) as the “intellectual father” behind critiques of efficient markets models. Mandelbrot’s critique of efficient market theory was centered on the notion that actual return distributions are more “fat tailed” than would be implied by the normal distribution. Taleb provocatively argues in chapter 15 of his book The Black Swan that the bell curve (normal distribution), when applied to financial markets, is a “great intellectual fraud”. Taleb has also recently argued that “… the Nobel Prize for Economics (specifically, the 1990 awards to Harry Markowitz, Merton Miller and William Sharpe for their work on portfolio theory and asset-pricing models and the 1997 awards to Myron Scholes and Robert Merton for their work on option pricing theory) has conferred legitimacy on risk models that caused investors’ losses and taxpayer-funded bailouts…”, and that “investors who lost money in the financial crisis should sue the Swedish Central Bank for awarding the Nobel Prize to economists whose theories he said brought down the global economy” (see “`Black Swan’ Author Says Investors Should Sue Nobel for Crisis“).

While there is no question that Dr. Taleb’s narrative is brash and provocative, I am not convinced. Of course, he would argue that people like me who received their graduate training in finance during the past 2-3 decades have a vested interest in defending orthodoxy for its own sake. However, it’s only fair to also recognize that Dr. Taleb has a vested interested in defending heterodoxy for its own sake. It seems that Taleb seeks to discredit pretty much anyone who happens to disagree with him, not on the strength of the arguments that they marshall on behalf of “orthodoxy”, but rather on the basis of ad hominem arguments about how they can’t be taken seriously because they are intellectually biased a priori in favor of efficient markets orthodoxy.

I couldn’t have explained the implications of Benoit Mandelbrot’s research for financial markets any better than Dr. Ewan Kirk, who is Chief Executive for Cantab Capital Partners in Cambridge, UK, so I quote directly from Dr. Kirk’s letter to the Financial Times entitled “How Mandelbrot Caused Confusion“: “It is true that markets are very difficult to model precisely. Indeed, even after this simple transformation, there continue to be significant non normal features to markets and of course there are always “unknown unknowns” and “black swan” events. However, these issues are considerably more subtle than just presenting the 100-year unscaled daily returns of the stock market and implying that foolish theoreticians and practitioners are modeling the returns as a stationary Gaussian or normal distribution.” Also, the essay by Bob Gillespie entitled “Black Swans and Absurdistan” is worth reading.

In closing, I would like to point out two interesting videos from FT.com. The first video, “Inefficient markets and Mandelbrot“, features a debate concerning whether the impact of Mandelbrot’s legacy has been overstated. The other video, “Why ‘efficient markets’ collapse” is an interview with Mandelbrot recorded last year in which Mandelbrot explains his more than 40-year old critique of the “efficient markets” hypothesis and why new (i.e., Mandelbrotian) theories on price movement discontinuities are needed in light of the financial crisis of 2007-????.”

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