In response to Mark Thoma’s repost of Shiller’s “beauty contest” article in the NYT two weeks ago:
Shiller’s two-week old “frantic beauty contest” argument wasn’t worth the paper it wasn’t printed on.
The market crash was led by and dominated by problems in Europe and had very little to do with the S&P downgrade, other than as an illustration that the U.S. government also hasn’t got a clue, much less a plan, for returning to solvency… The S&P news might have been the proverbial “wings of the butterfly” driving the chaotic “market-weather” system wild, but it WAS “hurricane season” and if not S&P, something else would’ve started the storm.
The stock market tail is being wagged by the huge bond market dogs. We are reaching the end of a 30-year bull market in bonds. Interest rates have been falling consistently from 1982-present, but now have almost no room to fall further. The much smaller stock market is being wagged violently because a whole bunch of bondholders at the Emperor’s dinner party have finally conceded that he really doesn’t look good with no clothes on, and they now fear losing the shirts off their backs to cover his new wardrobe bill.
As a result of this belated realization that the Eurozone financial sector is once more deeply insolvent… that our 21st-century Titanic really is going to sink despite all the hubristic “financial engineering”… credit seized up when everyone jumped into the non-Euro lifeboats. Mountains of money (literally, if you think of it in terms of printed $1 bills or 1-Euro coins!) are jumping all over the world. Some are seeking safe-haven shelters, others need to cover rampaging liquidity problems. Totally “unexpected” (yet obvious in hindsight) events are catching huge numbers of traders and hedge funds off guard, causing margin-call collateral damage across a number of markets.
And that’s just the most immediate list of crisis issues! We live in interesting times…
Even the bondholders who emerge with their principal intact can expect only minimal interest, and also only minimal capital gains over the next decade. Particularly relative to the gains typical during the 1982-2010 period, the near future looks very grim. And those receiving their principal back from their “certificates of confiscation” will be the lucky ones! The market desperately needs a cleansing wave of defaults to dissuade lenders from taking even more foolish risks in the future. Some folks, who have made themselves examples of how not to lend, will have to be exposed for the frauds that they are, so that others will learn.
MEANWHILE, back in Shiller’s home country, there’s the emerging data that the U.S. economy recently slid back into recession. Businesses can feel it and astute traders can see it in the emerging data, but America’s economists and political leaders haven’t got a clue, much less a politically viable plan. So now we face huge new series of crises, at a time when we haven’t even seriously started to address the fundamental, structural economic problems that were exposed 3-5 years ago. One can only hope that this time, sensible voters get educated and demand real reforms, rather than letting the financial elites squander another crisis.
Amidst all of this, the S&P downgrade had nothing to do with anything, except in the minds of some politicians and economists. The T-bond markets totally ignored the news, except for TIPS pricing in an inflationary recession rather than a deflationary one.
The wonder is not whether there’s a volatile beauty contest going on in the absence of news. The wonder is that this market is as stable as it has been!
Had even one of these issues been on the radar in, say, 2004-2005, it alone would’ve dominated the news cycle and the markets would have swooned as much as they have so far.
As things stand, the two most obvious solutions facing policymakers are, on the one hand, to let bonds default and deflate the government-credit bubble directly at the direct expense of mismanaged capital, or on the other hand to print money and inflate everything away primarily at the expense of labor. The implications of those two choice result in starkly different valuations for corporate stocks, and the market can be expected to veer up and down wildly until the political outcome becomes more certain. It could be years yet.
So methinks Shiller should stop grasping at explanatory straws and get ready for the deluge…
A very apropos article: http://www.nytimes.com/2011/09/19/opinion/a-little-inflation-can-be-a-dangerous-thing.html?_r=1&nl=todaysheadlines&emc=thab1
Oddly enough, this morning’s New York Times carries an editorial by Paul Volcker (Federal Reserve Chairman 1979-1987). The message is basically “A little inflation is a dangerous thing” i.e. inflation is not an option for resolving structural economic issues. I believe wholeheartedly that Volcker is right, but….
His message is timed to remind the Federal Reserve’s Open Market Committee, which meets tomorrow and Wednesday to discuss further options for monetary policy easing, to maintain firm on price stability. Some committee members have indicated a willingness to tolerate price inflation in order to try to do more to reduce unemployment… although the last round of easing didn’t reduce unemloyment… Since recent data shows inflation running above the Fed’s preferred level in a cost-push spiral, Volcker’s editorial argues that the Fed should avoid further outright money printing.
Unfortunately, Volcker is not part of the policymaking apparatus, and I doubt whether those who currently wield power will appreciate his wisdom enough to follow his advice. Policy gimmicks are a lot more palatable to the banks than defaults and structural reforms. But time will tell!