Robert Schiller: Underconsumptionism And Asset Bubbles

[oldfart]

In a recent article Robert Schiller made a side mention of how an economy with a surplus of desired savings (i.e. in a liquidity trap, suffering from inadequate demand) could result in asset bubbles of existing real assets.

Parallels to 1937 by Robert J. Shiller - Project Syndicate

The article was basically about something else and this insight only got a couple of lines, but I find the insight fascinating.

We are in a liquidity trap with interest rates at the zero lower bound. The financial system is awash in savings people are trying to invest. Presently this is mainly being soaked up by government bonds, but the yield on short-term Treasuries is close to zero so people are looking for alternatives. Now if three year Treasuries (TIPS) were yielding a real rate of, say, 6%, then a lot of people would be content to hold them. But you don't make much progress on your retirement account compounding at 0.5% (it takes 124 years to double!), So there is a great interest in finding something, anything, with a better yield.

So where is the money going now? Obviously a big hunk is in the equities market and equities derivatives. Is the market oversold? Not as long as prices keep going up at double digit rates and there is an ample supply of new savings seeking investment. If nothing else, corporations will fuel the market by borrowing at rock bottom rates (or give up some of their hoarded cash) and buy back their own stock. This process can continue for quite a while (but not forever), and the more oversold the market, the bigger the Minsky moment when the music stops. But maybe large corporations have become so much more profitable in this depression that their capitalized profit flow keeps the ratios looking good. Is there a limit to cost savings and technology advances?

I guess some of the money is also going into real estate. With the overhang of unsold repossessed property, prices have just started a good recovery in the last year. Some money may even be going into commodities. Gold anyone?

So my question is this: When real interest rates are so low does this encourage the formation of asset bubbles, and what kind? How long will they last and how will they resolve, gradually or with a crash?

 

[Kimura]

It looks like the end result of QE has scared investors and portfolio managers into gold and other commodities. And since market participants believe this should increase aggregate demand, it’s increased stock yields and resulted in bond selloffs, as markets price in a greater probability of increased growth and less unemployment.

I think global austerity has decreased worldwide aggregate demand, especially in Europe where funding operates on a conditional basis, although their deficits are large enough to maintain some modicum of stability if they leave them as is.

US housing looks marginally better, and, if left to its own devices, will go into a cyclical upturn. We should see modest top line growth, a continued flat line of wages due to high employment, and the low discount rate will continue to benefit stocks, and hurt those that have to work for a living.

 

[oldfart]

It looks like the end result of QE has scared investors and portfolio managers into gold and other commodities.

I hear a lot of this in the financial news. My problem is this is what got Bill Gross fired. He started out with the correct analysis, that the expanded Fed balance sheet would not be inflationary or cause a rise in interest rates. Then he ignored his own expert's analysis and decided that when QE stopped, there would be a great run up in interest rates. Paul McCulley had it exactly right (see Krugman's blog today on Bill Gross for a link to McCulley's paper). The bad call started the controversy that led to his leaving PIMCO.

In retrospect, those who bought into this fantasy lost their shirts. Gold went down and bonds went up. In fact, Treasuries outperformed both gold and equities! It makes me wonder why financial types loosing hundreds of billions of dollars seem impervious to the experience, doubling down on the ideological cant that cost them the money in the first place.

And since market participants believe this should increase aggregate demand, it’s increased stock yields and resulted in bond selloffs, as markets price in a greater probability of increased growth and less unemployment.

To some extent inflationary expectations and expectations of long term interest rate increases are self-fulfilling, this could be true. But I fail to see how these expectations would increase aggregate demand. I know of no mechanism by which consumption, investment, or net exports would increase in response to those expectations in significant quantities when consumer demand is still weak, there is a lot of excess productive capacity and unemployment, and Europe is in the toilet. Higher interest rates might pull in more foreign financial investment, but with businesses sitting on trillions of excess cash, what real assets would the cash be invested in?

I think global austerity has decreased worldwide aggregate demand, especially in Europe where funding operates on a conditional basis, although their deficits are large enough to maintain some modicum of stability if they leave them as is.

US housing looks marginally better, and, if left to its own devices, will go into a cyclical upturn. We should see modest top line growth, a continued flat line of wages due to high employment, and the low discount rate will continue to benefit stocks, and hurt those that have to work for a living.

I agree. But what purpose was served by all the sadomonetarist hype?

 

[Kimura]

I hear a lot of this in the financial news. My problem is this is what got Bill Gross fired. He started out with the correct analysis, that the expanded Fed balance sheet would not be inflationary or cause a rise in interest rates. Then he ignored his own expert's analysis and decided that when QE stopped, there would be a great run up in interest rates. Paul McCulley had it exactly right (see Krugman's blog today on Bill Gross for a link to McCulley's paper). The bad call started the controversy that led to his leaving PIMCO.

Bill Gross should have known better. The QE meme/myth is a tough nut to crack. QE was a literal crop failure for the US Dollar. All it did was remove interest income from the economy. It basically handed capital gains to investors holding MBS and Treasuries, and we also had the wealth effect from unrealized capital gains in the bond and stock markets.

In retrospect, those who bought into this fantasy lost their shirts. Gold went down and bonds went up. In fact, Treasuries outperformed both gold and equities! It makes me wonder why financial types loosing hundreds of billions of dollars seem impervious to the experience, doubling down on the ideological cant that cost them the money in the first place.

Stupid is as stupid does.

To some extent inflationary expectations and expectations of long term interest rate increases are self-fulfilling, this could be true. But I fail to see how these expectations would increase aggregate demand. I know of no mechanism by which consumption, investment, or net exports would increase in response to those expectations in significant quantities when consumer demand is still weak, there is a lot of excess productive capacity and unemployment, and Europe is in the toilet. Higher interest rates might pull in more foreign financial investment, but with businesses sitting on trillions of excess cash, what real assets would the cash be invested in?

Good questions. Most of our clients dump money into government securities and various corporate bonds (investment grade and junk). I'm talking institutional investors and family offices not John and Joe Six Pack.

I agree. But what purpose was served by all the sadomonetarist hype?

Monetarism and austerity have a an almost cultish devotion. I mean, for the love of God, you think the Eurozone would have learned its lesson by now.

 

[bendog]

Interesting thread. Thanks.

I think QE and the feds' rate policies have been successful (how successful is another question) in helping reduce private debt levels while simultaneously shoring up the real estate bond market.

Total US debt 8211 Public Private Economics Help

In theory, anyway, as the fed tapers off buying real estate bonds and the real estate market gradually improves, some private money should go there. To the extent the equity rally is fueled by QE, then that should fall.

I have absolutely no idea whether consumer demand can sustain the recovery. I think the best case scenario is deleveredging continues, but demand for goods to replace existing goods and continue purchasing services produces low growth. I don’t see inflationary pressure, except on commodities such as food where demand increases faster than production. And why we can’t grow more corn and cows is beyond belief to me.