Unfocused vacation musings on money – part 3

I am going to keep this short and make just a few observations.

The Egyptian tragedy – fix the economy please  

Cato’s Dalibor Rohac has a good comment on Egypt. This is a bit of it:

“What needs to be done? First, the country’s unsustainable fiscal situation calls for decisive action. That means the subsidy problem must be addressed. Subsidies account for one-third of the total public spending in Egypt — more than education and healthcare spending combined. Unfortunately, the benefits of subsidies accrue mostly to wealthy Egyptians — those who buy a lot of the commodities that are subsidized.”

I think one of Egypt’s biggest problems is massive trade restrictions and the subsidies obviously are part of that story. The trade restrictions are not only directly economically harmful, but it is also a major source of corruption. As always excessive regulation leads to corruptions as the public in general tries to “circumvent” these restrictions by bribing customs officials.

Should China combine Fisher and Frankel’s ideas? 

As I was writing my piece on Chinese producer prices yesterday I got the idea that maybe China should try to combine the ideas of Irving Fisher and Jeff Frankel. Frankel wants to target the product price (PPT), while Fisher suggested his Compensated Dollar Plan (CDP). The idea with CDP was that the Federal Reserve (that was Fisher’s example) should revalue or devalue the dollar versus the gold price dependent on the development in the price level. Hence, if the price level rose by 1% the dollar should be revalued by 1% and similarly if prices dropped by 1% then the dollar should be devalued by 1%. The purpose was to use this mechanism to stabilize the price level.

Similarly the People’s Bank of China could introduce a Compensated Renminbi Plan. However, instead of using the gold price as the policy “instrument” the PBoC could manage the RMB against a basket of industrial metals such as copper, aluminum and steel. Then the RMB could manage the RMB against this basket (with a fluctuation band) to stabilize Chinese producer prices around a 2 or 3% level path. That would mean that the RMB would be fixed, but rather managed against a basket of industrial metals. Hence, the RMB would be gradually revalued or devalued to hit the targeted producer price level. With a fluctuation band and forward guidance from the PBoC most of the adjustments would probably be market determined. That could ensure both a fair predictable development in the RMB and provide nominal stability.

Come to think of it – maybe it should be the Fisher-Frankel-Hall standard. Hall for Robert Hall who suggested the ANCAP commodity standard. ANCAP stands for ammonium nitrate, copper, aluminum and plywood.

Finally it should be said that this is not a variation of my (and Frankel’s) Export Price Norm – industrial metals is the input to the production in China rather than the output.

Fed SF sounds very Friedmanite – yields are low because inflation expectations are low

Read this:

Long-term U.S. government bond yields have trended down for more than two decades, but identifying the source of this decline is difficult. A new methodology suggests that reductions in long-run expectations of inflation and inflation-adjusted interest rates have played a significant role in the secular decline in yields. In contrast, standard statistical finance methods appear to overemphasize the effects of lower risk premiums and reduced uncertainty about future inflation.

Nikkei rebounds, but what about inflation expectations? 

The recent rebound in the Japanese stock market has been pretty impressive and combined with the gradual and continued weakening of the Japanese yen it could indicate that the Bank of Japan is regaining some credibility. However, looking at inflation expectations it seems like that is not entirely the case. Hence, inflation expectations remain well-below 2%. Therefore, the BoJ should certainly not be complacent. It might be that the stock market is doing great, but the BoJ cannot declare victory before inflation expectations hit the targeted 2%.

Keynes 1923 on the ‘hot potato effect’ (or maybe hot coffee effect)

Monetarists stress the importance of the so-called hot potato effect in the monetary transmission mechanism. During my vacation reading I came across Keynes’ description of the hot potato effect from A Tract on Monetary Reform. See here:

Keynes potato 1

keynes potato 2

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1 Comment

  1. Hi Lars,

    The Bank of Japan also looks at a detailed survey of Japanese consumers it conducts quarterly. That survey shows inflation expectations have remained unchanged in the past 2 quarters at 3%.

    That could be why the Bank of Japan doesn’t care much to “do more”. It could be considering the bond market (including the inflation-linked bond market) as a source of temporary noise, rather than an accurate forecaster.

    Remember that this market may not be an “accurate forecaster” for now, because the JGB market is now dominated by only one big seller – the MOF – and one big buyer – the BOJ. The traditional players are being crowded out since the BOJ decision on 4th April, as the BOJ is now buying 70% of the gross issuance, and more than the entire net issuance of JGBs.

    Ultimately, this policy is about boosting inflation expectations among the general public, as Japan is a huge, closed, domestic consumption driven economy (which wasn’t driving it much during the deflation years).
    It is this segment that needs to “buy into” the BOJ reflation policy, not the bond market (since that is now quasi monopolized between the MOF and BOJ, and they can do whatever they want, essentially).

    Racy Japanese magazines are now full of “offers” advertising real estate, urging people to “take advantage” of low fixed rates before they start rising and inflation kicks in.

    That is why I don’t particularly worry so much about the whole bond market signal story. The consumers are more important than the “niche” that trades bonds. This relatively small group (compared to the number of people working in other industries) doesn’t matter anymore. They mattered under the old “German Bundesbank” regime at the BOJ, but not anymore. The BOJ and MOF have taken over this market, which had a good time during the long deflation years (and JGB bull market).

    Abenomics is practically the closest thing to “QE for the people” that some have suggested in recent years.

    At least that is my impression.

    Best regards,



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