Pests in the Garden of Green Shoots


Nouriel Roubini must be reading up on Green Lantern spectragnosis: "Green shoots or yellow weeds?" Roubini asks in a long article (free reg. req.) describing "double dip W-shaped recession" and other potential dipsy doodles. The chairman of Roubini Global Economics, whose mid-decade bearishness on real estate and credit was ignored at the time but has since earned him honors as the second greatest public intellectual on Planet Earth, refers to a "trifecta of risks," then lists a quadrafecta and a decafecta of support for that trifecta.

These days some folks are seeing the light at the end of the bottom that is turning the corner, and Roubini acknowledges that some signs look positive. But like the teen math geek in a Hollywood film who can't get the Air Force to believe his crackpot theory about global-warming aliens, Roubini says they caught a shark, not the shark. Some red meat:

Let us leave aside that the optimists – including Bernanke, Greenspan and 80% of sell side research—has been repeating the refrain that the housing slump will bottom out soon since early 2007 (while totally missing its bust that started in mid-2006) and have been proven wrong quarter after quarters for all of 2007, all of 2008 and all of the current 2009.  The reality is that, in spite of all the talk of green shoots in housing there is very little evidence for it so far and home prices need to fall at least another 15 to 20% before they bottom out.

Also plenty of complex carbs for monetary policy buffs:

Sixth, the rapid and massive monetization of fiscal deficits—that has been pursued by central banks this year—is not yet inflationary in the short run as there are massive deflationary forces in the world given the slack in goods markets and labor markets; also the collapse in the velocity of money implies that the excess liquidity has been so far hoarded by banks in the form of excess reserves.  But if central banks don't find a clear exit strategy from  very easy monetary policies—that have led to the doubling or tripling of monetary base in the US alone—eventually either goods prices inflation and/or another dangerous asset and credit bubble will ensue when the global economy gets out of this severe recession. And some of the recent rise in equity prices, commodity prices and other risky assets prices is already clearly liquidity driven rather than being fully justified by the improving economic fundamentals.

Inflation may indeed become the path of least resistance for policy makers as it is easier to run the printing presses and cause inflation rather than pass politically difficult tax increases or spending cuts in Congress or other legislative bodies. But inflation is not a cheap solution to high public debts and the debt deflation problems of the private sector. If central banks were to allow the inflation genie out of the bottle allowing expected inflation and actual inflation to rise from low single digits to high single digits to double digits at some point a painful Volcker-style recessionary disinflation policy (like the one in 1980-82) would have to be implemented to break the back of inflation expectations and bring back the inflation genie expectation into the bottle.

Odd as it sounds, fear of higher interest rates right now makes you an optimist—because higher interest rates imply that there is actually demand for something. That's not always the case: As the reference to 1980-1982 (ably discussed in this Reason piece by Robert Samuelson) makes clear, recession, inflation and high interest rates can go hand in hand in hand. But at the moment, deflation expectations are so high that harebrained schemes like this one are being publicly discussed. I'd like to see some ultra-sophistical economist make the case that the smart move right now would be to let interest rates rise. This article doesn't do that, but it's got 9,700 grim words to kick off your three-day weekend.

NEXT: Appeals Court Says Cigarette Makers Are Racketeers

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  1. That last bit blows me away…some people might think his idea is absurd, but hey, the idea of negative numbers was considered absurd once, too, so that means he’s right!!!

    This joke teaches college? Oh, it’s Harvard, never mind.

  2. home prices need to fall at least another 15 to 20% before they bottom out

    It’s funny to hear this from a guy who then goes on to talk about inflation.

    I seriously doubt we’ll let home prices fall much more – there’s too much psychology involved. We’re much more likely to see inflation so that, while the real value plummets, housing prices stay basically constant.

  3. Mr. Clarke,

    He was also an economic adviser to Bush II…’nuff said.

  4. Or you could read that NYTimes article by Greg Mankiw and go kill yourself 🙂

  5. “home prices need to fall at least another 15 to 20% before they bottom out…”

    “It’s funny to hear this from a guy who then goes on to talk about inflation.”

    Both can happen simultaneously (and IMO probably will).

    Demand for credit-supported assets (real estate, vehicles, etc.) will continue to decline as credit becomes increasingly scarce. As supply remains unchanged, prices in this part of the economy are very likely to fall.

    Demand for non-credit-supported goods and services (haircuts, diapers, breakfast burritos, regular unleaded, etc.), isn’t likely to change much, but as the money supply expands, prices in this part of the economy are likely to rise.

    Whether you call the aggregate end result deflation, or inflation, I don’t care… I know how I’m investing my money, and it’s not in auto manufacturers or home builders.

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  7. The inflation consensus has taken over in high finance and industry. It’s the same story in Weimar Germany 1920-3. “The Inflation Consensus.” Everybody agreed that if we could just print more money we’d be richer.

  8. Mankiw is a well respected economist, a major critic of the stimulus and auto bailouts, higher taxes and regulation,a a staunch supporter of free trade and his article on inequality is well worth reading. While he accepts the keynesian notion that the government should stimulate during bad times and have an expansionary monetary policy, he believes that we should do so with tax cuts. I happen to disagree with him on this, at present I agree more with Mr. Roubini, that in the present you want to be very cautious of inflation. But I know much less about economics than either of them, so I wont let my preference in politics lead me to call him a joke, or fashionably beat up on Harvard. By the way he was actually using the student suggestion as a way of illustrating that as a matter of theory a negative interest rate is possible.

  9. What this guy settles on is inflation of the money supply; a process well underway. The velocity of money has collapsed, which is causing price deflation in bubbly assets such as real estate. Employment is plummeting, so I don’t see any floor in sight in this price deflation. At some point, though, all of those printed dollars are going to come home to roost in the form of inflation in prices. The Fed is stuck.

  10. Is “velocity of money” a term of art? What does it mean?

  11. Mr Cavanaugh Sir,

    Wikipedia is my friend. Maybe it doesn’t like you.

    The velocity of money is the average frequency with which a unit of money is spent in a specific period of time. Velocity associates the amount of economic activity associated with a given money supply. When the period is understood, the velocity may be present as a pure number; otherwise it should be given as a pure number over time. In the equation of exchange, velocity of money is one of the key variables determining inflation.

  12. Velocity is the ratio of nominal income to the quanitity of money. V = Py/M. P equals the price level, y is the real volume of goods and services produced, and M is the quantity of money.

    Of course, the more famous way of putting it is MV = Py. The quantity of money times how often each dollar is spent on final goods and services each year is equal to the average amount of money spent on each final good or services (the price level) times the real volume of final goods and services produced.

    Velocity is also the reciprocal of “k,” which is the amount of money people choose to hold relative to their income. V = 1/k and Md = kPy. Ms=Md in equilibrium, so Ms = kPy. Rearrange and Ms */1k = Py.

    Py is nominal income, total spending in the economy.

    So, there you go… monetary theory in a nutshell.

    If V and y don’t change, then in the long run, the price level is proportionate to the quantity of money.

  13. The only interest rates near zero are short term government bonds, FDIC insured deposits, and balances on deposit at the Federal Reserve bank. This are all low risk (because of government guarantees) very short term securities.

    Long term risky secutires, like BAA corporate bonds have interest rates closer to 7%. No where near zero.

    Anyway, if more people want to hold no risk, short term securities than anyone wants to supply, then the market response to that shortage is higher prices and lower yields. Why not negative? It isn’t like all interest rates will be negative. Just for people who want to keep open their options (liquidity) and don’t want to accept risk.

    Of course, it won’t happen because the government issues a low risk, short term debt instrument with zero interest–federal reserve notes.

    If the goverment charged people for holding currency (like the peculiar scheme described by Mankiw,) then this would no longer be a restraint on market clearing. If hand-to-hand currency wasn’t government guaranteed, say privately issued banknotes without deposit insurance, then maybe nominal interest rates on govenrment guaranteed debt could be negative.

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