GDP, M&A, EBITDA, P/E, NASDAQ, Econo-thread Part 11

[Colonâ„¢]

And the central bank doesn't lend directly. It merely manipulates the rate at borrowers borrow from lenders, and hence manipulates the money supply.

Huh? What is the discount rate for then?

And isn't it all about real value? If you lend at minus 1% but there's a deflation of 2%, you still make a real profit, right?

To reiterate on the Taylor rule point. Policy is not set by just by the Taylor rule, period. The Taylor rule happens to _replicate_ the actual policy for some periods of time (understandably not at the peak and trough of the cycle). As I said it is useful, because it provides some intuition. But the BOJ and the govt did not handle policy well; whether the BOJ followed the Taylor rule isn't relevant.

I really should find that chart, but it wasn't just "some" period but in Japan's entire history since the bubble burst, comparing it with the period in the US since the bubble burst.
Never said the Taylor rule is fundaments of the CB's policies but it does show they reacted similarly to changing economic conditions.

3. Consumers are best thought of as making large purchasing decisions (eg housing) based not on income but on expected future wealth. The relevant measure is not debt to income but debt to expected future wealth. The implications of this behavior are that any positive or negative effects are spread out over many years, and so are more managable. Also, increases in expected future wealth, which may not be reflected in current income, would increase demand for housing and provide a possible explanation for the bubble.

I'd agree that the best explanation is expected future wealth, but I don't think that's the best indicator of a bubble nor does it indicate the durability of rising house prices. Income/price seems to make a lot more sense to me because I don’t really see a reason why housing costs should make up a larger share of households’ budget as they grow richer. And it would seem to me that when accelerating price growth coincides with peaking debt/income it indicates that the boom isn’t sustainable.

[DrSpike]

The central bank doesn't lend directly to firms and individuals, that is the point. You said above: "I don't see why a central bank couldn't lend money paying a fee instead of receiving one. It's not like it can't print the money to finance this."

And that slides neatly into why your next point contains an error in analysis. Sure if I lend at minus 1% with 2% deflation the real rate is 1% (-1 - -2%), that's fine. But I'm better off holding my original sum in cash (or invest it at 0%, same thing) with the same projected deflation rate.

Rational lenders will not lend at negative rates, ever.

[Colonâ„¢]

Originally posted by DrSpike
The central bank doesn't lend directly to firms and individuals, that is the point. You said above: "I don't see why a central bank couldn't lend money paying a fee instead of receiving one. It's not like it can't print the money to finance this."

And where do you see me saying that CB's lend to non-finance?

And that slides neatly into why your next point contains an error in analysis. Sure if I lend at minus 1% with 2% deflation the real rate is 1% (-1 - -2%), that's fine. But I'm better off holding my original sum in cash (or invest it at 0%, same thing) with the same projected deflation rate.

Rational lenders will not lend at negative rates, ever.

Banks will lend at positive real rates, because that's how they make money, always.

[DrSpike]

"And where do you see me saying that CB's lend to non-finance?"

You didn't. But I took that to be your misconception since it makes no difference how large a negative rate the CB lends to institutions at. But of course your misconception was not that but the one you just repeated.

Look, this debate is ludicrous.

I'm a banker (no, a _banker_). I have £100. I have 2 choices.

Choice 1) Lend at -1%, with a real return of 1% with 2% deflation.

Choice 2) Keep the £100, with a real return of 2%.

Which choice do I make? It ain't rocket science.

[Ned]

Dr. Spike, If the value of money is declining, the Fed is effectively paying member banks real interest at the rate of inflation on the reserves its holds even though the nominal remains at zero. However, if the value of money is declining, the opposite is true.

This suggests that to maintain a balance that is slightly inflationary, the Fed ought to pay interest on deposits - at least to the level of deflation, and perhaps a little more.

For example, if deflation is -1%, the deposit interest rate could be 1.5%.

Even though Fed Funds rate would greater than the deposit interest rates, the prime rate may decrease due to reduced bank costs.

Finally, the Fed could introduce "negative" discount rates by simply charging, for example, 1% on overnight loans to acquire reserves that return 1.5% - an effective -.5% interest rate even though all rates are nominally above zero.

What do you think?

[DrSpike]

Remember, the point is here that we have deficient demand. The usual recourse is monetary policy. But in the situation under discussion nominal rates are 0 without the GDP gap being closed, which removes the main channel for monetary policy transmission.

Regardless of what happens between the CB and financial sector, the financial sector has to want to lend at negative nominal rates, which will never happen, period.

[Roland]

"The central bank doesn't lend directly to firms and individuals"

You could always change the mandate. Or ignore the mandate, like the Fed....

[DanS]

"but the vast majority of Walmart shopping, NASCAR following, red, white, and blue Americans do not live in a real estate bubble"

Amen, brother Sten!

[DanS]

"One estimate I ran across today was IIRC a 47 % rise since 1995, compared to overall inflation of just 17 %. Can dig it up tomorrow if needed."

47% rise? Hmmm... That figure seems a little high. I would have expected some temporary rise above and beyond inflation, if due to nothing else than increased demand. But 47%? ...

[Roland]

Dan:

http://www.ofheo.gov/house/2q02hpi.pdf

Look at page 10. Up 39 % over the last five years by that measure. The index itself is listed on p 43.

I don't understand why you are in such steadfast denial about house price inflation.

Btw that report of course denies there's a bubble. But for ****in' **** accept the fact of fast rising prices.

[Colonâ„¢]

Quoting Stephen Roach

There’s one key aspect of the above that does represent a change in my thinking -- that America is now in the midst of a property bubble. I haven’t come to that conclusion lightly. Two piece of evidence have pushed me over the edge: First, the sleuths at The Economist report that inflation-adjusted US house prices have "risen more in real terms since 1997 than in any previous five year period since 1945." Second, there’s an excellent study by Dean Baker of the Center for Economic and Policy Research (CEPR) that comes up with a perfectly reasonable way of assessing whether this surge in house prices qualifies as a bubble, or not. The CEPR test hinges on the relationship between housing rents -- the intrinsic returns on the asset -- and market-clearing home prices. Baker finds that inflation-adjusted house prices have risen by about 30% since 1995 -- literally three times the cumulative 10% rise in the real rental index over that same period. In fact, this gap between house-price and rental inflation has never been wider in the post-1975 history of these data. If that’s not a bubble, I don’t know what is.

Besides, I fail to see why the concentration of such house price growth in certain regions would be any advantage. If anything the blow of a crash will be all the heavier to those regions.

[DanS]

Thanks for the helpful report, Roland.

"I don't understand why you are in such steadfast denial about house price inflation."

When was I in ever "such steadfast denial about house price inflation"? I've said that 47% seems a little high, that's all.

The report shows that we are a little over the since-1980 number of 4.75% appreciation per annum. (15% over the last 5 years?) I guess I fail to see a bubble in those numbers. Or at least nothing that would cause drastic declines in price, leading to widespread economic disruption.

Looking locally, the 15% appreciation last year for DC was entirely warranted. DC is becoming a much nicer place in which to live by the year and there is a lot of immigration. I would imagine that these gains are from very depressed prices.

The 4.75% appreciation overall is interesting and we could discuss the components. So is the geographic distribution of the appreciation.

[Roland]

Compare it to overall inflation.

[DanS]

I DanS'ed you about DC.

Regarding comparing it to inflation, we can discuss the 4.75%, which is about 1% real per annum using CPI-U or 1.5% real per annum using the GDP IPD.

The recent moves have to be taken in the context of a longer time horizon.

[Adam Smith]

Capital stock data tell about the same story on appreciation:

Residential, in bil
1995 7,784,245
1996 8,195,300
1997 8,646,303
1998 9,191,838
1999 9,780,516
2000 10,471,177

Source: Bureau of Economic Analysis

Colon:

The CEPR test hinges on the relationship between housing rents -- the intrinsic returns on the asset -- and market-clearing home prices. Baker finds that inflation-adjusted house prices have risen by about 30% since 1995 -- literally three times the cumulative 10% rise in the real rental index over that same period. In fact, this gap between house-price and rental inflation has never been wider in the post-1975 history of these data. If that’s not a bubble, I don’t know what is.

Did the study include implicit rents on owner occupied housing, or actual rents paid? Two reasons why actual rents paid might not be a good measure.
1. Do renters rent the same types of houses that owners buy? I doubt it, especially at the high end.
2. Owners get a tax break, which lowers the implicit rental price and is probably not reflected in a pure rental index.

My take is that is for some neighborhoods in the DC suburbs which are in very high demand (ie great schools) the bubble is about 25 percent.