Category: Economics

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Economics

[2413] Looking for inverted yield curve

There have been talks of recession hitting the United States again. Extremely shocking manufacturing data from the US today is probably partly fueling the talks.

Although prediction is a risky game, there are various indicators one can use to gauge the likelihood of a recession. One of them is the US treasury yield curve.

An inverted yield curve may signal a recession, or at least some kind of pessimism in the market. The reason is that market participants will expect rates to go down during a recession. Future inflation rate meanwhile is expected to decrease as demand dies down. With those expectations, the bondholders will not require too high a returns.

Now, despite the talks, the current curve is sloping upward.

As you can see, the three yield curves in the last few weeks have been well behaving, unlike the one about 3 years ago just after the peak of the financial crisis. The September 2008 yield was inverted up to 2-year term.

So, there is no recession in the current yield curve. At least, not yet. Quite the contrary (unless we will be seeing stagflation), there is considerable inflationary expectation beyond the 5-year term relative to now; it is a pretty steep curve. That may suggest some kind of recovery.

Nevertheless, looking at the yield curve right now might be flawed, just because the Federal Funds Rate is already close to zero. Given that the US is possibly in a liquidity trap, the yield curve cannot be inverted.

Still, a relatively flat curve could be used as a signal of recession, especially if liquidity premium theory is taken into account. If the curve keeps sinking like it has for the past few weeks (so far, it seems to be due to flight to security phenomenon), we could be seeing a flat yield curve in a couple of months. Then, the case for recession will be stronger.

Of course, the curve should be viewed in context of other data for one to have a more educated guess about the future.

Another story is that the yield curve has been sinking lower and lower. The market is telling S&P something: S&P has got it wrong.

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Economics

[2411] Malaysia’s long-run growth, 1955-2010

There is a famous graph depicting how real growth of the economy of the United States of America has been remarkably constant over time. It is remarkable in a sense that history deviates little from such constant growth rate. I was reminded of this after reading a post by Karl Smith at Modeled Behavior.

I had not seen the Malaysian version before and so, I decided to draw it myself.

It does not exactly replicate what the famed US graph replicates. Rather, this is the natural log of the Malaysian nominal GDP instead.

As you can see, the long-run growth rate is pretty much constant. The straight line that cuts through the series is the approximated long-run nominal growth rate (specifically, from 1955 to 2010. Why did I choose that particular period? The data at the IFS of the IMF goes only as far back as 1955. I could draw the real GDP but since real GDP growth will not deviate much from nominal GDP in terms of natural logarithm, I thought nominal values are good enough).

Smith suggests that government policy does not matter in the long-run. I do not share that view but certainly, the tendency for growth to revert to a certain long-run growth rate is remarkable. Perhaps, what is more interesting are the deviations from the long-run growth.

More relevantly, growth from 2008 to 2010 were lower than the long-run trend. That was caused by the global financial crisis.

It is worth noting that the economy might be still operating below its potential, if the black line is a potential output growth to start with. In other words, there is an output gap. Yes, this is despite the great PEMANDU says and whatever their plans are.

For those who claim the growth post-recession is all thanks to the Najib administration — let us pretend a little that their narrative is the right one right now — this is something they can chew on. Even with the base effect producing what seemed to be spectacular growth, the Malaysian economy is possibly still operating below potential.

With the possibility of a double dip coming, we could see a lot of excuses from Putrajaya soon. Claim the credit but cut the blame.

Another interesting point is that the economic condition in the 1960s might have been Malaysia’s worst within the 55 years period when compared to the long-run trend. It also reaffirms that the 1990s were among the best years.

What is mind boggling is that the Asian Financial Crisis does not register. I tend to believe that the crisis of the late 1990s was more severe than the recession of the late 2000s. I may need to check my premise.

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Economics

[2409] Yet another day to panic

It was earlier this week when CNBC (or was it Bloomberg?), several economics and finance commentators were highlighting the supposedly inconsistency of S&P’s downgrade of US debts. They showed that several other European countries had higher probabilities of defaulting their obligations than the US, yet these European ratings were higher than that of the US. One of the countries was France.

Yesterday, the French finance minister had to come out to defend the state of the French economy and government finance.[1] Rumors about Société Générale are flying around.[2] And the global markets tumbled just as some thought we were out of hole that was Friday and Monday. As the Asian markets open today, there seems to be a kind of pessimism as everybody braces for a bad day yet again. Yesterday, before the French fright set in, was a swallow, and it did not make a summer.

It is unclear what is driving the fear in the market at the moment. Sure, some pointed out specific events but at the end of the day, it is all a guess. There are no real definite concrete events that one can say, those are the actual causes of the fear. Nobody really knows. Right now, there are so many uncertainties that the markets do not know what to fear and being prudent, they fear everything.

Even its own shadows.

This perhaps highlights the Austrian belief that not a single person is able to process all available information in a timely manner, which is a strong defense for the free market.

Nevertheless, it seems that the markets are fighting rumors more than anything else right now. Money is moved based on the petty rumors, without its truth reasonably checked. Better safe than sorry, maybe. Although speculation itself is useful in testing the truth value of certain statements that might be true in the end, it can also be a kind of self-fulfilling prophecy, turning statement with its initial state as false to true.

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[1] — PARIS (Dow Jones)–The French Finance Ministry Wednesday said speculation that the country is about to lose its triple-a rating is “totally unfounded. The three [ratings] agencies have confirmed there is no risk of downgrade of the French rating, and these rumors are completely unfounded,” an advisor for French Finance Minister Francois Baroin told Dow Jones Newswires. [William Horobin. French Finance Ministry:Rumors On France AAA Totally Unfounded. Wall Street Journal. August 10 2011]

[2] — PARIS (Dow Jones)–Societe Generale SA (GLE.FR, SCGLY) said Wednesday it has asked France’s financial markets watchdog Autorite des Marches Financiers to investigate the origin of rumors that caused the bank’s share price to plunge more than 20% at one point in hectic trading Wednesday. Societe Generale asked the AMF to “open an inquiry into the origin of these rumors, which are extremely harmful to the interests of its shareholders,” the bank said in a statement. [David Pearson. Societe Generale Seeks AMF Probe Of Market Rumors . Wall Street Journal. August 10 2011]

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Economics

[2408] Market inefficiency and rating agencies

And so, S&P has decided to cut US debt rating, essentially stripping the T-Bills of its risk-free status from S&P’s perspective.[1] This is likely to trigger other agencies to follow suit. Theoretically, this has wide implication because risk-free asset is an important basis in asset pricing.

Although the cut is expected, I am maybe dissatisfied at the wide influence of rating agencies. Yields of the debt were relatively low before the cut despite everything that we know. What will make me positively dissatisfied is if yields increase after the cut. We will have to wait for Monday for that.

In that case, increase in yields after the announcement of the cut will feel artificial. It will feel inefficient in terms of information dispersion.

It will be dissatisfying because market players will mainly react to the cut rather than directly to the financial health of the issuers.

Perhaps through some kind of procedure or programming demanding risk-free status, the downgrade by S&P may trigger a rush out of the bonds (to where is a harder question to answer). If the S&P did not issue a downgrade, yields will probably be low still. So, the implementation of the rule that funds have to hold the highest rated debts rated by these agencies divorces its outcome from what an ideal free market outcome.

I would think a more efficient approach would see market players responding to the quality of the bonds even before S&P’s announcement. Yields should have gone up before the announcement. This has happened in some way as reported by the article at the New York Times, but not with the speed that I think is identifiable to efficient market in terms of information.

One could say that S&P is part of the market. One could say that S&P reacted to the health of the issuers and market participants only reacted accordingly by trusting S&P as the arbitrator of ratings, never mind the credibility of S&P and other rating agencies after the subprime crisis. S&P with its specialized skills helps distribute the relevant information as efficient as it can.

But the ideal outcome will not rely on just S&P, or any one rating agency. There are thousands if not millions of players out there. An efficient market would preempt any decision by these rating agencies: after all, the information these agencies rely on are very public information. Yields should have gone down earlier before the announcement.

If yields rise on Monday, that may suggest that rating agencies have too much power to decide on behalf of the market, a market which is more diverse than a couple of rating agencies. It will also suggest that the market is inefficient. To put it more clearly, an efficient market would have these agencies lag behind market sentiment, not the other way round.

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[1] — WASHINGTON — Standard & Poor’s removed the United States government from its list of risk-free borrowers for the first time on Friday night, a downgrade that is freighted with symbolic significance but carries few clear financial implications. [Binyamin Appelbaum. Eric Dash S.& P. Cuts U.S. Debt Rating for First Time. Wall Street Journal. August 5 2011]

Categories
Economics

[2406] Better food stamp and the wider context

The Malaysian government may introduce what seems to be a non-tradable food stamp program to combat high food prices. The goal behind it is noble. While that is so, it must be noted there are at least two ways to improve the outcome of the program. Moreover, the issue of high food prices should be assessed more holistically.

First, tradable food stamp will likely improve recipients’ welfare more than mere non-tradable arrangement can. Tradability will widen the recipients’ choice set and give them the opportunity to smooth their consumption. Furthermore, they may not always require subsidized food. Tradable stamps will allow the recipients to exchange the stamp for other items of need or even cash. Such exchange tradable stamps will widen the welfare-improving effect of the program by implicitly covering those who are not explicitly covered by the program. Whatever the price of sale of the stamp, it is will be lower than the face value of the stamp for otherwise, the stamp will be worthless. This essentially means the uncovered purchasers of the stamps will also be subsidized.

Second and perhaps the natural expansion of the first option is a direct cash transfer. From public finance perspective, this is likely to be the most efficient solution within the restrictive goal of enhancing the welfare of specific group of individuals.

Regardless of the costs and benefits of food stamp, high food prices in general is a wider issue. The wider context is important.

One context is the fuel versus food debate. Government policy on biofuel may have inflationary effect on food prices. As reported by Reuters in March 2010, the biofuel policy was supposed to start in June 2011.

The other more pressing context is monopoly of foodstuffs in Malaysia. Exclusive monopoly and quota granted to specific entities on various foodstuffs cause the very problem that the food stamp program aims address.

There are plenty more examples demonstrating contradictory and convoluted government policy.

Perhaps the problem of high food prices is better addressed by undoing unproductive government interventions in the food market. These interventions benefit only specific parties instead of the wider public. Without these interventions and with a little bit of luck, the rationale for food stamps might disappear. More importantly, public welfare can be improved without spending too much public money.