The strong euro, part 2.
A commenter named Mark Sadowski sent me this very useful info:
Another piece of the puzzle is core eurozone bond yields. If one looks at 10-year bond yields for Austria, Belgium, Finland, France, Germany, Luxembourg, and Netherlands you will observe that all have fallen by about 70 basis points since last June and about 30 basis points in just the last three weeks. For example the German 10-year bond was trading at only 2.78% as of today. I take this as a sign of falling inflation expectations in the eurozone. (The original comment included Sweden, but he later noted it was not in the eurozone.)
Now think about the media narrative. There is supposedly a collapse of confidence in the euro that is making the euro very weak. But here’s what puzzles me. When there really was a collapse in confidence in the Mexican peso or Thai baht during their crises, I don’t recall yields on long term Mexican and Thai bonds falling to 2.78%. Maybe the media narrative is worth reconsidering.
This reminds me of the international economics experts who told us that the US had to have a severe recession after our banking crisis, because most other countries have had severe recessions after their banking crises. Yes, but in the 1990s did Thailand and Mexico and Sweden see their currencies appreciate strongly in the teeth of their crises, as the dollar appreciated strongly from July to November 2008? To paraphrase James Carville–It’s the tight money stupid.
I know it’s hard for institutions to admit mistakes, but we need coordinated easing from the Fed, ECB, and BOJ. Blame it on Greece.
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20. May 2010 at 08:14
Why does it take so much more easing to produce inflation these days?
20. May 2010 at 08:18
Scott,
It’s interesting watching money demand increase right in front of your eyes.
1) 10 year German bonds were trading at 2.66% this morning. Keep in mind they closed at 3.72% on June 5th of last year. I’m not sure, but I believe this might be a record low. US 10 year bonds were trading at 3.24% this morning after closing at 3.36% yesterday and down of course from 4.01% on April 5th. And the five year TIPS spread closed at 1.70% yesterday.
2) NYMEX crude was trading at just over $67 this morning, down about 4% from yesterday.
3) The S&P European 350 (IEV) is off another 3% after falling 17% since mid April. The Dow Jones was off over 300 points earlier this morning.
Fascinating!
20. May 2010 at 09:22
All is forfeit.
Oil is down about 7% just in U.S. trading. I can’t understand how all this mayhem results from a few small countries governments going bust…
Why do central banks hate us so much?
20. May 2010 at 09:37
You know, everything has a real price.
So, really, you are arguing that oil is slow to adjust – and thus can be used to get information about the particular monetary policy. (kind of a lagging indicator)
This seems intellectually risky. It may be true, but for how long, and when? Do we really understand the undershoot and overshoot characteristics of this particular price?
20. May 2010 at 12:28
mlb: Low nominal rates by themselves are part of the reason for increased money demand, as the opportunity cost of holding non-interest bearing money is lower than it would be if nominal rates were higher. My suspicion is that since we haven’t had nominal interest rates and inflation this low for this long since the Depression, money-demand models estimated when opportunity costs (for holding money) were higher are underestimating this effect.
Think of a plot with opportunity costs on the horizontal axis and long-run money demand on the vertical axis. Suppose the demand curve starts out high on the left, but falls rapidly as you move right along the curve, i.e., the slope is negative but becomes less so as opportunity costs increase. If we spent most of the last several decades in the flatter region, we will probably estimate that the curve is much less steep than it actually is at low opportunity costs. It may even be the case that our econometric specification assumes the curve is actually a straight line. In either case, we’re going to be consistently surprised at how strong money demand is when opportunity costs fall even a little.
20. May 2010 at 13:27
R. Avent echoes your concerns:
http://www.economist.com/blogs/freeexchange/2010/05/global_recovery
20. May 2010 at 14:35
@Scott, some other possible (non ad) reasons that rates fell:
1) Basel 2 rules make holding sovereign debt the same as cash.
2) Normally, holding national debt raises liquidity risk more than holding cash, but central bank overnight rates are so low it doesn’t matter.
3) The european bank model is borrowing money from the central bank at extreme leverage ratios (40/1, 60/1, etc) and using that money to buy national bank debt.
4) The central bank is now directly buying national debt.
@Jeff:
Money is interest bearing nowadays, if you are a bank. In the US iirc cash reserves earn 0.25% interests, I am unsure about in europe.
@TonyD
“You know, everything has a real price.”
You know, I don’t think I believe this any more. Things only have opportunity costs prices. Also, we can only measure nominal prices relative to something (so number of dollars, number of chickens, etc). Real prices (price inflation adjusted prices) are just a myth, because there is no single inflation rate, many, many things move in price in many different directions.
The model of a price inflation is what we normally use to account for central bank actions, but it is a model with many weaknesses.
Weakness in that model:
1. There isn’t really a single price, or inflation rate.
2. Central bank monetary expansion (and contraction) has economic consequences beyond single price inflation that this model completely fails to account for.
3. Measuring price inflation requires a lot of slight-of-hand (hedonics etc) that make me wary of the accuracy of the number.
4. This model conflates AS consequences with AD ones and thus limits its usefulness in measuring central bank policy actions
20. May 2010 at 16:53
Number 4 should read “measuring the effect of central bank policy actions.
21. May 2010 at 05:15
@Doc: Reserves held at the Fed are bank assets, not liabilities. Money is currency plus bank liabilities redeemable at par. Paying interest on reserves effectively tightens money supply, as Scott has pointed out dozens of times. It does not directly affect money demand.
21. May 2010 at 05:43
mlb, Because we aren’t easing at all. Interest on reserves changes everything. Low rates reflect a weak economy, not easy money. M2 has actually fallen so far this year. We are not easing. It just seems that way.
Mark, Make that 1.6% on the TIPS spread, last time I looked. oops, I just checked again and it is 1.54%. Inflation is falling like a rock. So are real growth forecasts if we can believe the oil market. What does that say about NGDP?
I don’t want to oversell the danger here. The LEVELS of stocks and TIPS are similar to dates in 2009 where recovery was underway. What’s happened is that the signs of robust recover that were popping up in April, are being taken out of the market. Asset prices would have to drop somewhat more to signal an actual double dip recession, rather than very sluggish recovery–which is probably what is being signaled now. But every day we seem to be getting closer to the double dip.
JPIrving, I am equally puzzled.
TonyD, No, I think oil prices adjust immediately. I think they are falling in reaction to scaled back estimates of future growth worldwide.
Jeff, Yes, that is an excellent point.
marcus, Thanks, I added him to a newer post.
Doc merlin, You said;
“@Scott, some other possible (non ad) reasons that rates fell:
1) Basel 2 rules make holding sovereign debt the same as cash.
2) Normally, holding national debt raises liquidity risk more than holding cash, but central bank overnight rates are so low it doesn’t matter.
3) The european bank model is borrowing money from the central bank at extreme leverage ratios (40/1, 60/1, etc) and using that money to buy national bank debt.
4) The central bank is now directly buying national debt.”
Good points, but I can’t emphasize enough the importance of looking a a wide range of asset prices. Any single indicator (short of NGDP futures itself) can be misleading. But considering that bond yields, stocks, oil and metals are all falling, I fell pretty confident about my theory that AD expectations are falling.
I think Jeff is correct in his reply.