rachel2w1w: Stock Making Money

Nick Rowe asks me three questions in his Worthwhile Canadian Initiative: If cows were money (a response to Brad DeLong):

Nick: If cows were money, an increased demand for milk would cause a recession. People would stop spending their cows to buy goods and services, because if you spend your cows you don't have as much milk. Was the recession caused by an excess demand for milk, or an excess demand for money?

Me: If the Federal Cow Reserve conducted expansionary monetary policy by selling cows in exchange for promises to deliver milk, then its open market operations in cows would have no stimulative effect on the economy: the cows it sold would not enter the circulating medium but would instead be kept in reserve to replace the milk that the Federal Reserve had bought. Since open-market operations that boost the money stock are ineffective, it is clear that the recession was not caused by an excess demand for money but by an excess demand for milk.

Nick: If gold bars were money, an increased demand for bling would cause a recession. People would stop spending their gold bars to buy goods and services, because if you spend your gold bars you don't have as much bling. Was the recession caused by an excess demand for bling, or an excess demand for money?

Me: If the Federal Jewelry Reserve conducted expansionary monetary policy by selling gold in exchange for other forms of bling, then its open market operations in gold would have no stimulative effect on the economy: the gold it sold would not enter the circulating medium but would instead be used as bling replace the bling that the Federal Reserve had bought. Since open-market operations that boost the money stock are ineffective, it is clear that the recession was not caused by an excess demand for money but by an excess demand for bling.

Nick: If dollars were money, an increased demand for savings would cause a recession. People would stop spending their dollars to buy goods and services, because if you spend your dollars you don't have as much savings. Was the recession caused by an excess demand for savings, or an excess demand for money?

Me: If the Federal Reserve conducted expansionary monetary policy by selling dollars in exchange for other savings vehicles like bonds, then its open market operations in dollars and bonds would have no stimulative effect on the economy: the dollars it sold would not enter the circulating medium but would instead be used as savings vehicles to replace the bonds that the Federal Reserve had bought. Since open-market operations that boost the money stock are ineffective, it is clear that the recession was not caused by an excess demand for money but by an excess demand for savings vehicles.

Now that that is clear, let me say that Nick's post is very good. He goes on:

It has almost come down to a semantic dispute.... e are arguing about the referential opacity of demand functions. If I demand milk, can I be said to demand the medium of exchange, if, as a contingent fact, the medium of exchange just happens to provide milk, and I want the medium of exchange only for its milk?

But it matters. Because the way you frame the cause of the recession may influence where you look for a cure.

If you say that the recession is caused by an excess demand for milk, you start looking for ways to either increase the supply of milk or reduce the demand. Can the government breed some goats, and increase the supply of milk that way? But if you see the recession as being caused by an excess demand for cows, you also start to think of other solutions. Perhaps the government could tax ownership of cows? Even, as a last ditch policy, make the cows stop giving milk? If you think of the recession as being caused by a shortage of milk, then taxing cows, or making the cows stop giving milk, look like totally daft solutions. They wouldn't cure the shortage of milk. But they would cure the recession. With a tax on cows, or if cows stopped giving milk, people would start spending their cows again.

But I also see the point of looking at it from Brad's perspective. An open market operation of cows for goats, where the government imports cows, uses them buy goats, and exports the goats, may not work. The total supply of milk is the same, and if cow's milk and goat's milk are perfect substitutes, people have no additional incentive to get rid of their cows to buy the goods and services that are in excess supply. If, at the margin, the demand for cows is a demand for milk only, the demand for cows will increase one-for-one with the increased supply of cows, if that increased supply of cows is the result of an open market purchase of goats. But why did the demand for cow's milk increase in the first place? Was it that all the goats went dry? Or might the increased demand for milk be a consequence of the recession, and so a consequence of the excess demand for cows? "I had better hang on to my cows, because I won't be able to sell my labour to buy milk in this recession!"

I don't know whether Brad is right about the shortage of other safe savings vehicles being the cause of the increased demand for money qua second best savings vehicle. But, even if he is wrong, this is something that might happen.... orrectly diagnosing the proximate cause of the recession as an excess demand for the good that happens to be the medium of exchange, even if that excess demand is not a demand for that good qua medium of exchange, lets us start thinking about radical solutions.

And we need to start thinking about radical solutions, because as history teaches us, and as this recession reminds us (and judging by the Eurozone we are going to be reminded again) stuff happens. Things go wrong. Safe assets become unsafe. Goats stop giving milk. And we need a monetary system that is robust in the face of human stuff-ups. A shortage of milk is a problem, but it didn't ought to cause a recession too. A shortage of safe assets is a problem, but it didn't ought to cause a recession too. And if it didn't cause an excess demand for the medium of exchange, as a contingent side-effect, it wouldn't cause a recession to compound the original problem. And it's just because those side-effects are contingent, and don't follow of necessity, that I insist on my way of framing the problem. A shortage of safe assets may cause an excess demand for money. An excess demand for money will cause a recession. We can break that first link in the causal chain, because it's only a contingent link. The second link follows of metaphysical necessity, unless we switch to barter.

What's the solution that could prevent an excess demand for the medium of exchange, and so prevent general gluts? Silvio Gessell? Barter on Ebay? Funny money systems where you can't hold a positive balance? God only knows. But we ought to start thinking about it. Quasi-monetarism (which is really Keynesianism too, if you are the sort of Keynesian that recognises that Keynesian economics doesn't make any sense in a barter economy) can be a radical approach.

The one thing this left out, I think, is that "money" becomes a first-rate savings vehicle and store of safe value only when nominal interest rates hit their zero lower bound.

Actually, it left out something else: in comments to Nick, Andrew Harless starts musing about money not just as a medium of exchange and a store of value but a unit of account...

Bianco on Mutual Fund Flows:

• The Wall Street Journal – Investors Pull Cash Out of Bond Funds

Mutual-fund investors continued to pull money out of bond funds in the latest week, and they weren’t just fleeing muni funds. For the first time in two years, they were also shedding corporates and Treasurys. The Investment Company Institute reported Wednesday that $1.66 billion flowed out of bond funds in the week ending Dec. 8, driven mainly by a $1.26 billion outflow from muni funds. Munis have suffered outflows for five straight weeks now, which is the longest stretch in two years. Of particular note, taxable bond funds lost $401 million last week, their first weekly outflow since December 2008. Equity funds saw losses too, down $1.4 billion last week. Long-term mutual-fund outflows totaled $3.25 billion in the latest week. The data marked the third week in the past month of net outflows for bond funds, which had seen a 99-week stretch of inflows following three months straight of outflows in the immediate aftermath of the financial crisis.

• MarketBeat (WSJ Blog) – Has The Great Bond Selloff Begun?: A Couple Thoughts

Mutual-fund investors are still yanking money out of bond funds, and they’re not just fleeing munis any more. For the first time in two years, they’re also shedding corporates and Treasurys…A new wrinkle in the latest data, though, is that taxable bond funds lost $401 million last week, their first weekly outflow since December 2008. Lest anybody think this is the start of the long-awaited great migration out of bonds and into stocks, equity funds lost $1.4 billion last week. It looks like fund investors are putting their cash in money-market funds, mainly. This is consistent with the broader sense that nobody’s making big bets on anything before the end of the year.

Comment

The weekly mutual funds described above are shown in the chart below. If this is the start of a great exodus from bond funds, then it only began last week as the outflows expanded beyond just muni funds.

Highlighted in the story above is one of the great misconceptions about bond fund flows. Bond mutual fund investors are not struggling with a choice between stock or bond funds. As we detailed here, the massive flows into bond funds came from 0% yielding money market funds. Only about 3% of the inflows into bond funds went into long-term Treasury funds. An over-sized amount went into short-term muni and corporate funds. In other words, the public traded a 0% money market fund for a 1% short-term bond fund. Even with the recent rise in rates, this has been a good trade for them so far.

We would argue if higher rates are going to chase mutual fund investors out of bond funds, they are not going into stock funds. Instead they would go back to 0% money market funds.

Stock funds have suffered 32 consecutive weeks of outflows, every week since the market highs in April. As we explained here, the public is not buying stock funds because they did in huge numbers earlier this decade and they are still sitting on losses. They are not interested in doubling down on a bad trade. Further market rallies will only reduce losses and not create the Federal Reserve’s much hoped-for wealth effect.

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rachel2w1w

Wednesday, December 22, 2010

Stock Making Money

Ben Sherwood - ABC <b>News</b> | Attack Video | Mediaite

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Ben Sherwood - ABC <b>News</b> | Attack Video | Mediaite

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<b>News</b> Conference by The President | The White House

Ben Sherwood - ABC <b>News</b> | Attack Video | Mediaite

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<b>News</b> Conference by The President | The White House

Ben Sherwood - ABC <b>News</b> | Attack Video | Mediaite

Neandertal Relative Bred With Humans - Science <b>News</b>

<b>News</b> Conference by The President | The White House

Ben Sherwood - ABC <b>News</b> | Attack Video | Mediaite

Neandertal Relative Bred With Humans - Science <b>News</b>

<b>News</b> Conference by The President | The White House

Ben Sherwood - ABC <b>News</b> | Attack Video | Mediaite

Neandertal Relative Bred With Humans - Science <b>News</b>

<b>News</b> Conference by The President | The White House

Ben Sherwood - ABC <b>News</b> | Attack Video | Mediaite

Neandertal Relative Bred With Humans - Science <b>News</b>

<b>News</b> Conference by The President | The White House

Ben Sherwood - ABC <b>News</b> | Attack Video | Mediaite

Neandertal Relative Bred With Humans - Science <b>News</b>

<b>News</b> Conference by The President | The White House

Ben Sherwood - ABC <b>News</b> | Attack Video | Mediaite

Neandertal Relative Bred With Humans - Science <b>News</b>

<b>News</b> Conference by The President | The White House

Ben Sherwood - ABC <b>News</b> | Attack Video | Mediaite

Neandertal Relative Bred With Humans - Science <b>News</b>

<b>News</b> Conference by The President | The White House

Ben Sherwood - ABC <b>News</b> | Attack Video | Mediaite

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<b>News</b> Conference by The President | The White House

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