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

[DrSpike]

Originally posted by Roland
DrSpike:

How is that different ? The only possible effect depends on how the loan deals are structured wrt interest payments and principal payments, and that is minimal at best.

Well, what happens to prices when excess capacity is liquidated ?

No. The effect of interest rates and the falling price level on the real value of debt are distinct. And the deflationary spiral cannot be broken by liquidating excess capacity. You have not said why it would. Noone to my knowledge has ever said it. I have made it clear what does and will break the deflationary sprial.

I am sorry if I have offended you, that was not my intention. I probably tend to get a little snappy when my lengthy efforts at explaining this fail miserably. There is something to my point above about respecting one's experience in the field though. We flatly disagree on a couple of points, and one of us is wrong. I am pretty good at debating, but when I get caught with a high price hooker and a kilo of coke holding a smoking gun over the body of a dead rival am I going to try and bend the truth in court? No, I'm going to get a professional to do it for me.

As to your other questions (and I should say now that I'm probably not going to have time to immediately respond to your objections to this information), I'll have a go, because they are good questions. In fact I asked Krugman about the first when he came to my country, because I felt it was pretty key in understanding how to prevent such spirals.

Partly the problem was structural in Japan; the attitudes of savers and the demographics within the country. This only put Japan more at risk than other OECD economies, it doesn't necessarily presage deflation. Then there was also the drive within the relevant institutions to keep to yen high when it wanted to depreciate in response to other changes within Asia (and I am _not_ getting into currency crises here - they are if anything more difficult than deflationary spirals). Policy was kept too tight for too long after the bubble burst. All of these things drove Japan into a very low inflation region where deflation not inflation was the potential problem, but monetary policy continued not to reflect this (to be fair there were price pressures that made a decision tricker than normal).

As to policy when the bubble was building I'll have to check this. All I remember is that Japan did nothing to burst the bubble, but as Greenspan commented recently it is tricky to decide what to do. I could do without his comments on the trend growth rate of the US and the new economy when considering the US (Stock Market) bubble - I think they pushed things along, but that is by the by.

As to your last questions should deflation start any stimulus is good whilst policy still has traction. If it starts to take hold yes, the measures to buy financial assets are good ones, and conform to what I have been telling you the right policy is, (particularly foreign currencies as has been observed in Japan) though one should be careful about public sector building up holdings of stocks.

You have read most of my article already, since I am lazy. The 4) points above in conjunction with a small discussion of recapitalisation of the banking sector and how that would help (help, not replace ) the right policy in breaking the deflationary spiral. It was a largely descriptive piece written to silence the dumbass journalists who day after day wrote pieces on the banking sector and overcapitalisation without mentioning that the problem was one of demand and that the measures they touted would do nothing by themselves. That is why point 1) makes this case quite clearly. Amusingly, all but 1 of my non-academic articles have been written in anger in response to rubbish that gets peddled at times.

Lol on the walking macro textbook. You know it is ironic, within academia I am far from conformist (I am leaving academia at the end of next year as well), but when I argue economics with non-professionals I nearly always end up defending orthodoxy. You see there is a reason it is orthodoxy, and there is a reason me and countless professional all say things like the points I have made on this issue in this thread. If you choose to challenge our ideas and hence further your understanding - great. If you choose to honestly believe that you have more insight than the economics profession, well, I'm afraid I find that a little foolish.

This is my last post on this issue for a while at least.

[Roland]

"No. The effect of interest rates and the falling price level on the real value of debt are distinct."

You're losing me there. Either you do not understand me, or I am indeed suffering from a misconception.

I owe 100. Nominal rate of 5 %. If we have inflation - 2 % I 1 year later owe a real 105/.98 = ~ 107 real.

Or put apart, I owe real 5/.98 as interest and 100/.98 as the real value of debt rises.

How are they "distinct" ?

"And the deflationary spiral cannot be broken by liquidating excess capacity. You have not said why it would."

I was just asking what would happen to prices. Well, what would ?

"I am sorry if I have offended you"

You haven't. I'm just not interested in trading academic credentials here.

Thanx for your answers.

"All I remember is that Japan did nothing to burst the bubble, but as Greenspan commented recently it is tricky to decide what to do."

Well apart from his cheerleading his repeated bailouts flooded the economy with excess money, and you got asset price inflation out of it. The BoJ did a similar rampjob as the US demanded economic stimulus. If you read the BoJ report I linked you'll see an almost 1:1 identity in the symptoms as well as the denial.

"If you choose to honestly believe that you have more insight than the economics profession, well, I'm afraid I find that a little foolish."

Not on most things. Yet I honestly believe that on the issue of bubble economies, yes. It was obvious from 1999 on that the "new economy" was a bubble - not just stocks, the economy itself. While the economics profession was doing things like trying to separate the cyclical from the structural component in increased productivity growth - maybe a case of not seeing the forest for the trees....

Honest, what is your profession's track record on spotting bubbles ? Dismal^3.

As an aside, economists usually make me hurt from laughing when they construe the law for economic analysis, but some have excellent legal insight - from the german literature I know this is especially the case in tax law.

[DrSpike]

Ok, that was reasonable, I'll respond.

Remember the value of the debt doesn't change but your capacity to pay the debt does. That's why prices/wage deflation has an effect distinct from that of interest rates. As I said earlier you should check out Fisher's work on the US in the 30s, since that is something you have indicated some interest in.

Hmm, you know, this debate almost looks like going somewhere now. I hope our exchanges have truly raised understanding of the issues for anyone that cares, either Roland or the guys no doubt following our remarks and ripostes with glee.

I should point out that many many prominent economists spoke out before March 2000 saying they felt stock market valuations were way out of whack. However, I do think the profession has some way to go on bubble economies..........but these are new issues in recent times. A cycle that looks like the one we've just had has not been seen for over 50 years in any economy.........and there is a limit to what you can draw from the 30s, with a very different global economy and, what is critical, still widespread inflation illusion.

And to be fair it is very easy to say well do something. What? Raise interest rates to burst bubbles? Using one instrument to hit two targets never ever works, both usually end up getting missed. Taxation as a bubble popper isn't good, there are too many lags in getting policy agreed. So what? Probably people in power like Greenspan should refrain from encouraging matters, or perhaps even try and talk bubbles into popping, but that's hardly a firm basis for policy.

[Roland]

"Remember the value of the debt doesn't change but your capacity to pay the debt does. That's why prices/wage deflation has an effect distinct from that of interest rates."

So you meant debt/ and debt service/ income ratios ? Ok, no issue there.

"A cycle that looks like the one we've just had has not been seen for over 50 years in any economy..."

I think the UK bubble in the late Thatcher years and the german reunification bubble were quite similar although the latter differs much on the fiscal side. Still Germany's growth pattern from 1988-1991 looks almost exactly like the US one from 1997-2000.

One extremely simple thing to do would have been to look at the accelerator effects. I tried this with just consumer spending and two levels of investment, and the result indicated a slump starting in mid 2000. Anyway it should have been clear that an accelerating growth rate of consumption can explain a (n investment) boom, right ?

"And to be fair it is very easy to say well do something. What? Raise interest rates to burst bubbles?"

Depends on the stage. What Greenspan could have done:

- no cheerleading
- continue the irrational exuberance line (problematic as the fed's independence is a joke)
- rasing margin requirements (more symbolic)
- raising rates to earlier levels after the LTCM bailout
- no massive liquidity injection for Y2K, or at least seeking to reduce the effect in M2 and M3 afterwards
- taking the current account deficit seriously

[Saras]

--"I should point out that many many prominent economists spoke out before March 2000 saying they felt stock market valuations were way out of whack. "

Thank you. I was encouraging everyone on this (not eve THIS, the old OWO boards ) board to write naked NASDAQ options back in 1999.

Geez, the terminal growth rates people used in DCF models back then - 15%, 18% 10%, sheesh

--"when I get caught with a high price hooker and a kilo of coke holding a smoking gun over the body of a dead rival"

Whoever said economists lead boring lives

[DrSpike]

I wanna talk to my lawyer!

[DanS]

"Whoever said economists lead boring lives"

I think he was stretching the truth about the "high price" part. He's an academic, for God's sake!

I remember the OWO threads! Co-Ed Naked Call Writing! Woohoo!

[DrSpike]

Well I'm only an academic for another year.........then it's "defect to private sector and use one's skills to get rich" time.

[Sten Sture]

The S&P500 futures closed today at 911 the buck... sounds good to me.


On the US Real Estate "bubble" most of the data that I have seen that refutes the domestic bubble arguement focus on the pervaisiveness of bubbly prices, and they are not widespread. We are certainly in a bubble (early postbubble) in the Bay Area; Boston and some other big city markets are somewhat similar, but the vast majority of Walmart shopping, NASCAR following, red, white, and blue Americans do not live in a real estate bubble. That will mitigate the effect of declining prices in some geographical areas. No doubt when the tight areas come under pressure, the media will report a housing price crash, but it won't be one that will dramatically effect median home prices or affordability.

Due to the low interest rates, home affordability in the States is close to an all time high. That is monthly house payments over income. A counter arguement to a bubble.


I am out of the office tomorrow - peace.

[Shi Huangdi]

Hey there Econo-people, how's it going? Hey could one of you explain what the rationing function of prices is? I am taking an econ class and I need to know it but it's not in the book.

[Adam Smith]

Been way too busy at work to get into this. A few thoughts before heading to bed.

1. I think Sten is dead on about why US is different than Japan. US banks marked loans to book pretty quickly, and US firms are (in)famous for dumping excess labor. Neither is true in Japan. Also the size of the real estate bubble is vastly different. Housing prices probably are not affected that much in Peoria. On the other hand, IIRC there was one point where the supposed market value of the Imperial Palace gournds was greater than all the real estate in California.

2. Annecdotal evidence that the housing bubble is runing out of steam. Two + years ago when we bought our house, houses in this neighborhood had multiple bids and were invariably gone in a day. The three most recent offerings were on the market for months.

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.

4. Lastly, consumers may have already discounted some of the effects of bubbles. If I hit the lottery, my consumption goes up, but not nearly as much as the increase in income would suggest. Reason is that I recognize this as a rare event. This is Friedman's Permanent Income hypothesis.


Roland:
I think most professional economists recognized that stock prices were out of whack, a silly statement by a fed governor not withstanding.


Shi Huangdi:
When prices increase people who value the commodityleast cease to purchase it, hence rationing by price. It is in your book somewhere.

[Roland]

AS:

"1. I think Sten is dead on about why US is different than Japan. US banks marked loans to book pretty quickly"

The banking sector per se is almost irrelevant. Risk management is the game, and no one knows how the GSEs, GE capital, the Wall Street speculators etc have placed and hedged their bets. It's the good old flood insurance game.

"Also the size of the real estate bubble is vastly different."

Don't know how vast that difference is. I think I remember one figure that put real estate "value" at 150 % of japan's gdp around 1988/1990; in the US the real estate value on household balance sheets is about 100 %.

Anyway I also think it's not as bad, but house prices have outperformed other prices by 3-7 % per year, depending on the numbers you use. For a couple of years. When they go into the other direction the consumer is dead.

If I have the time I'll look at the Fed's assets and lending stats; with all the equity extraction in the refinancing fun home equity should have shrunk further.

"I think most professional economists recognized that stock prices were out of whack, a silly statement by a fed governor not withstanding."

That's beside the point - the point is that the US economy was in a bubble.

[Ned]

Roland, In 1997-2000, there did not appear to be any "general" asset inflation in the US. It appeared to be somewhat confined to the stock market. The housing price rise seemed to be confined to geographic areas where those who were making money hand over fist from stock and stock options lived. As well, VC activity, fueled by the stock market, was highly active, but only in certain areas. The combination lead to housing price rises in the areas such as Silicon Valley, but not down on the farm.

I think current maliase is entirely attributable to the collapse in the stock market. The key to any recovery would be to see prices begin to rise - which means that profits have to rise. Given that most businesses have already cut costs, this means that demand must increase.

(The problems of Japan are similar, but more severe.)

How does one raise demand? Well certainly WWII taught us that massive increases in government spending is one way.

It is interesting that on talk radio here in the US many cite the example of WWII and suggest that one of the reasons Bush is trying to start a war with Iraq is to get the US economy moving again.

[Roland]

- US fiscal balance swung about 5 % of GDP in two years.

- As for house prices, the measurement is quite tricky. 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.

A 25-30 % overhang is a bubble IMO.

[Saras]

You need to fight BOTH germany and japan to get the same offects as WW2. Iraq is just too small.