2 Market Measures of Risk Show Improvement

Mark Perry Carpe Diem September 7, 2010

Professor Mark J. Perry's Blog for Economics and Finance

The charts above over the last 12 months of: a) the Bloomberg U.S. Financial Conditions Index (data here) and the S&P 500 Volatility Index (data here) show that the financial markets went through a rough patch in May, June and July of slightly elevated risk, but have now recovered to the conditions that prevailed in the spring. The recent improvements in these two daily market measures of risk should probably mean that the chances of a double-dip recession are much less likely now than at any time over the last four months.

14 Comments: At 9/06/2010 10:16 AM, VangelV said...

The recent improvements in these two daily market measures of risk should probably mean that the chances of a double-dip recession are much less likely now than at any time over the last four months.If we assume that you are right we should be looking at a major decline in the bond market because there is no reason for investors or traders to hang on to bonds that pay nothing in the way of interest when they could do better in equities. That would drive rates higher and put pressure on the early stages of a weak recovery, making it more likely that you are actually wrong.My main concern is still with the fundamentals. I see no argument that can be made in favour of a sustained recovery because of the massive amounts of debt and malinvestments that have yet to be cleared out of the system. No matter how we try to spin the story, the American banks are insolvent because they are sitting on a mountain of non-performing loans that have yet to be written off because they are supposedly insured by the Federal government. If we argue that the implied backing of the US government makes the banks solvent we still need to transfer those bad loans to someone who will have to pay the bill. Ultimately, that someone is the US government and the taxpayer. But if we see another trillion or so of debt added to the balance sheet why would lenders who buy treasuries not ask for compensation for the extra risk they are being asked to take? Unless I am missing something, there is no way out of this mess that will not require a massive devaluation of the USD, a write-down of bad debt, rising interest rates, increased taxes, or a combination of the four.

At 9/06/2010 11:45 AM, Buddy R Pacifico said...

Why havn't stocks dropped more with all the emphasis on a double dip? Corporate earnings have been consistently good.What we need now is to lower one of the world's highest corporate tax rates (US) so that a lot of these earnings are invested at home.

At 9/06/2010 1:30 PM, Benjamin said...

Buddy-I think the corporate income tax should be eliminated. It has become a minor revenue source for the federal government, hardly worth enforcing anymore. Multi-nationals can offshore profits for tax purposes anyway. But what we need now is an aggressive, confident Federal Reserve, more than anything else. Japan has experimented with a strong yen and zero inflation for 20 years. The result has been an economy that expanded at 0.8 percent annually (less than statist France!), and 75 percent declines in property and equity markets. There is the irrefutable track record of tight-money policies. The siren song of zero inflation and strong dollar are dangerous utopian pipe dreams. Japan has paid the price of conservative central bankers, who pettifog and issue sermonettes about inflation. We are paying the price too.

At 9/06/2010 2:00 PM, PeakTrader said...

I think, it's safe to say Dr Perry is correct that a double-dip recession is less likely.We need enough liquidity to get the most productive and greatest wealth-generating workforce back on track to full employment. So, the spectacular economic boom, since 1982, can continue.If we had a leader like Reagan, U.S. real growth would be 4%, with 2% inflation, by now, after a V-shaped recovery.

At 9/06/2010 2:16 PM, PeakTrader said...

We need to stop this game where the Fed creates money, while the Administration and Congress destroy it.

At 9/06/2010 3:17 PM, VangelV said...

But what we need now is an aggressive, confident Federal Reserve, more than anything else. No we don't. What we need is for the Federal Reserve to be shut down and to eliminate the legal tender laws. Japan has experimented with a strong yen and zero inflation for 20 years. The result has been an economy that expanded at 0.8 percent annually (less than statist France!), and 75 percent declines in property and equity markets. There is the irrefutable track record of tight-money policies.Japan never had tight-money policies. Its government went on a spending binge that created all kinds of new but unnecessary infrastructure and piled on debt that threatens to ruin the lives of its citizens. Its weak growth period was the result of actions taken to prevent the liquidation of bad investments. As a result, the weak banks and corporations were allowed to survive. Their subsidies allowed the weak corporations to hang around and weaken the profits of the better run companies, which were forced to pay higher taxes to support the bailouts. The siren song of zero inflation and strong dollar are dangerous utopian pipe dreams. Japan has paid the price of conservative central bankers, who pettifog and issue sermonettes about inflation.We are paying the price too. You have not paid much at all. Unlike Japan, the US government relies on foreigners to buy most of its debt and to finance its trade deficits. When those foreigners demand higher rates USTs will no longer be seen as a store of value and the USD will collapse. Currency rallies should be sold and profits should be used to buy the dips in the gold market.

At 9/06/2010 3:21 PM, VangelV said...

We need enough liquidity to get the most productive and greatest wealth-generating workforce back on track to full employment. So, the spectacular economic boom, since 1982, can continue.A reversal would mean increased interest rates and a collapse of the bond market. How will the economy recover if rates are going up? Why would lenders accept low rates if the economy is booming and equities offer a better return? If we had a leader like Reagan, U.S. real growth would be 4%, with 2% inflation, by now, after a V-shaped recovery. Reagan talked a better game than the one he played. While he understood the principles that would make the US a much stronger nation he sold his soul and compromised with the Democratic Congress. By doing so he never reversed the decline. It is too much to expect that any current Republican or Democrat leader being able to get the economy out of the mess that it is in without reducing the size of government by 90% or so, calling the troops back home, and cutting taxes to the bone.

At 9/06/2010 4:04 PM, Benjamin said...

Vange:I did a little research on the NYT archives. By HEDRICK SMITH, Special to the New York Times (The New York Times); Financial DeskDecember 13, 1984, ThursdayLate City Final Edition, Section A, Page 1, Column 5, 1503 words[ DISPLAYING ABSTRACT ]Treasury Secretary Donald T. Regan charged today that Paul A. Volcker's ''remarkably tight'' management of the money supply was slowing economic growth and hurting the Christmas shopping season. This was the Administration's most extensive and pointed public criticism of the Federal Reserve chairman in months. The Federal Reserve System, the nation's central bank, is an independent agency that is not directly answerable to the President. Mr. Regan, answering reporters' questions, said it was ''possible but not probable'' that the current economic lull would turn into a recession. He forecast slight improvement during the next six months but said it would probably be mid-1985 before the economy returned to the 4 percent growth rate that the Administration is counting on to help reduce Federal budget deficits."For the record, the annual rate of inflation in 1984 was 4.3 percent--double or triple the rate now. Now, we are near deflation, but we have to listen to pettifogging by the likes of Richard Fisher, Dallas Fed President, about the perils of inflation. BTW, I am no leftie. I am just sizing up the political fault lines here. Why are some Fed members sermonizing about inflation now?

At 9/06/2010 6:58 PM, morganovich said...

neither of these 2 indexes are meaningful.bloomberg is just a yield spread model that fails to function when yields are heavily manipulated or when short term interest rates approach zero. it has very little useful correlation with the markets and exhibits not forward predictive ability that i am aware of.VIX is not a risk measure at all. vix is always low at market tops, and high at bottoms. it's just implied volatility from CBOE options. it has absolutely no forward predictive value either for markets of for the economy. it's just a gauge of current fear.

At 9/06/2010 8:32 PM, VangelV said...

For the record, the annual rate of inflation in 1984 was 4.3 percent--double or triple the rate now.If we used the same method to calculate current inflation levels as we did in 1984 we would see that the current rate is higher than what we experienced in 1984.The difference comes from the change in the definition of consumer inflation. In 1984 the BLS used the premise that CPI should be based on the price changes of a fixed-basket of goods that were related to maintaining a constant standard of living. That changed when Greenspan, Boskin, and other argued that such an approach overstated inflation because if the price of steak rose people would buy more hamburger or chicken and by doing so offset the increase in their cost of living. Although this violated the CPI concept the politicians in Washington jumped on the chance to make the numbers look better, even if they were inaccurate because the reduction in CPI inflation was reduced artificially by resorting to methodological tricks. The incentive to lie was obvious. Congress could reduce the outlays for the cost-of-living adjustments for Social Security payments, get to borrow at lower rates, etc. Now, we are near deflation, but we have to listen to pettifogging by the likes of Richard Fisher, Dallas Fed President, about the perils of inflation.You are nowhere near deflation. While the price of some asset classes fell as they should have the price of essentials like food, energy, health care, tuition, insurance, property taxes, etc., have mostly gone up.BTW, I am no leftie. I am just sizing up the political fault lines here. Why are some Fed members sermonizing about inflation now?Because, unlike you, they can see the writing on the wall and are scared of the dollar going over the edge. The action in the gold market is telling us that people are scared about the fiat currency and are questioning the use of treasuries as a store of value. The Fed members know that and see a scenario in which an improving economy triggers a collapse in the municipal bond market that could take treasuries down as well. They have seen how much money the Fed has used to buy bad mortgage backed papers from the banking sector and how much of the gold that the treasury was holding was swapped with other CBs so that it could be sold into the open market to manipulate bullion prices. With the current gold pool breaking down they know that the danger of hyperinflation is a lot closer than most can imagine so they are protecting their future reputations by speaking out now.

At 9/06/2010 10:50 PM, Benjamin said...

Vange-Why do you confuse Japanese deficit spending with monetary policy?The yen is an incredibly strong currency. They have zero inflation, and occasional bouts of deflation. That has killed their stock and property markets. And your statement that inflation is higher than reported is just BS. The BEA GDP deflator is under 2 percent also. Tight money is nice in theory. The track record is misery, misery, misery.

At 9/07/2010 6:54 AM, Paul said...

"Tight money is nice in theory. The track record is misery, misery, misery."Especially for guys like Benji who want someone to bail him out of his bad real estate investments.

At 9/07/2010 7:10 AM, VangelV said...

The yen is an incredibly strong currency. They have zero inflation, and occasional bouts of deflation. That has killed their stock and property markets.The Yen is strong because it is heavily borrowed by hedge funds and banks that want to speculate and do not want to worry about having to come up with cash to pay interest. if you borrow Yen for a decade at zero percent and have the ability to keep refinancing it means that you don't have to worry about negative cash flows that come from interest payments. The BoJ has not been tight and has not done anything to strengthen the Yen. In fact, it has been buying USTs in order to keep the Yen from rising in the face of all that buying. Obviously, the hedge funds are hoping for a collapse of the Yen so when they finally pay their debts off, they will do so with money of far lower value than when they borrowed at near zero percent. And your statement that inflation is higher than reported is just BS. The BEA GDP deflator is under 2 percent also. My statement is valid. When you use exactly the same method as was used under Carter/Reagan the CPI number comes out to be higher today than in 1984. When you do a valid comparison you can't use a different methodology and pretend that nothing has changed. Tight money is nice in theory. The track record is misery, misery, misery. Except that the theory is invalid. When people are broke they will not use easy money policies to buy more crap that they don't need. They will simply try to survive by paying off their debts for as long as they can before they can dig themselves out or have to admit that their efforts are futile and that they are better off by declaring bankruptcy and starting over again. As we debate this the true money supply is at an all time record, corporate borrowing is higher than it was before the correction began, and government debt is significantly higher than at any point in history. The gold markets are telling us what we need to know. While they have been going through severe corrections at certain technical points when the commercials have been taking money from the speculators gold has been going up steadily against the USD, housing, stocks, and bonds. This means that people are having doubts about the viability of many of the fiat currencies being used today. Eventually those doubts will destroy the UST market and the USD and will take most paper money down with them. That is why you should be looking to purchase gold and gold producers and stop fantasizing about the merits of destroying the currency even faster by loosening monetary policy further.

At 9/07/2010 9:14 AM, morganovich said...

vangel is absolutely correct about the inflation measurement. 18984 CPI is not comparable to the current one. the method is very different.the substitution effects he cites are accomplished by geometric weighting of consumption.we modeled this ourselves by taking a basket of 100 goods each priced at $1 and having them fluctuate in price (and use the new prices to start the next round) but always keep their sum at 100. run it for 10 iterations and see what you get. the basket still costs 100, but the "CPI" you report will show deflation. geometric weighting produces disinflation as an inherent artifact of the methodology.the "great moderation" we have seen is not low inflation, it's just bad math. alternately, if this methodology is the correct one then inflation in the 70's was more like 4%.our current deflationary fears are entirely an artifact of this bad math. v-alas, this has been explained to benji at least a half a dozen times. his memory is like an etch a sketch. it's not going to get through to him. he's too wedded to this idea that monetary policy is currently "tight" despite it being looser than any time in US history.

2 Market Measures of Risk Show Improvement

Related Articles