Arnold Kling  

Bubbles and Macroeconomics

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Comment of the Week, 2003-06-1... IRA's to the Rescue?...

In this essay, I discuss two alleged bubbles and what they might imply for U.S. macroeconomics.


Why do foreign investors invest so heavily in dollar-denominated assets and bear the risk of a decline in the dollar? Personally, I think it is because they are stupid. But that is not an appropriate answer for an economist to give.

If I were forced to pick an economic theory to explain the dollar bubble, it would be the theory of the safe haven.


For Discussion. I argue that U.S. macroeconomic performance is not threatened by the prospect of either the "dollar bubble" or the "bond bubble" popping. Do you agree?


Comments and Sharing


CATEGORIES: Macroeconomics



COMMENTS (37 to date)
Eric Krieg writes:

"If the dollar bubble bursts, it will reduce our wealth a bit (because of the rise in the cost of foreign goods), but the improvement in our trade competitiveness will help to increase output and employment."

Arnold, what should a person employed by an export oriented firm be hoping for, a continuation of the dollar bubble or for it to burst?

After all, a falling dollar makes us more competitive, but it hurts the markets to which we sell to.

Mcwop writes:

I would not describe the run-up in bonds as a “bubble”. I define an economic/financial bubble as something where assets become overvalued relative to some appropriate benchmark/measure. Bonds in the market are largely priced relative to interest rates (and future rate/inflation expectations) and their valuations are quite mechanical in these terms. If it is certain that the fed will raise interest rates soon, then you could sort of argue in favor of a bond bubble. However, the opposite appears true where the bias on rates is down to stable, and inflation is probably not going to jump significantly. Additionally, when the Fed decides to raise rates it is unlikely that the hike will come in one big chunk, but maybe 25bps increments. The same can be said of inflation (with the exception of an energy shock).

The downside for bonds depends on two factors: the duration of the bond portfolio held and how much rates get increased. A bond mutual fund (high grade corporate and gov bonds - yielding around 4%) with a duration of 4.5 years can be expected to lose 4.5% with a 100bps hike in rates, and 9% with a 200bps hike in rates. No loss is good, but this is not close to the losses suffered during the stock market bubble. What is the likelihood that the fed raises rates by 200bps in the coming year? What is the likelihood that inflation jumps by 200bps in the coming year?

Arnold Kling writes:

Eric, your customers are not going to be all that much poorer. The appreciation of their currencies is a positive wealth effect for them. In any case, the substitution effect toward your goods ought to be dominant. It should be a win for an exporter to have the dollar fall.

Jim Glass writes:

"Do you agree?"

Yes. The dollar's already down 25% and the average person hasn't noticed a thing. And the fall to date greatly reduces the risk of any traumatic plunge in the future.

As you note the US is unique as the country that issues the world's reserve currency in that its debts are denominated in its own money. This is very different from countries that suffer a big hit when their currency falls and their debts denominated in foreign money increase in domestic terms as a result. In a worst case we could even run the printing presses. I'd sure love to be able to pay off my credit cards with money I print myself.

As for T-bonds, the word "bubble" is being greatly overused these days. Sure their price is high but for obvious reasons, and that does not a bubble make. Domestically the economy is weak so rates are down so bond prices are up. Then internationally, look at the alternatives. Would you rather buy Japanese bonds paying 0% interest as their economy sinks below the sea?

Japanese bonds -- *there's* a bubble that could do some damage.

Bernard Yomtov writes:

Arnold,

It is not only domestic liberals who claim the country is going to hell in a handbasket. There is a substantial body of right-wing opinion that thinks that also, though for different reasons.

As for "Bush is a doo-doo head," well, "Clinton is irretrievably evil," was, and still is, a major component of conservative thought.

Most important, let me add that I find your remark that liberals think "America is bad," personally insulting and completely unjustified. One of the worst characteristics of conservatives is their tendency to accuse those who disagree with them of lack of patriotism, or worse. I am disappointed that you have joined in this slander, and think less of you for doing so.

Bernard Yomtov writes:

Can there be such a thing as a "bond bubble?"

The price of bonds has a fixed upper limit, after all.

As for the "dollar bubble," I was in Rome last month, and the dollar didn't feel all that bubbly to me.

Roach's article was written in Jan., 2002, when the dollar was 30% or so higher than today. I don't think anyone can claim it's heavily overvalued now.

David Thomson writes:

“It is not only domestic liberals who claim the country is going to hell in a handbasket. There is a substantial body of right-wing opinion that thinks that also, though for different reasons. “

Pat Buchanan doesn’t exactly count. The consensus conservative opinion is that President Bush is doing an overall good job. However, they are legitimately worried about Bush’s anti-free trade decisions and added welfare payments to the farmers. It is an exaggeration to say that these thinkers believe “the country is going to hell in a handbasket.”

“As for "Bush is a doo-doo head," well, "Clinton is irretrievably evil," was, and still is, a major component of conservative thought.”

I have always given credit to Bill Clinton for his courage regarding NAFTA and the Balkans crisis. Clinton is not irretrievably evil, but he has regrettably squandered his many God given talents.

“Most important, let me add that I find your remark that liberals think "America is bad," personally insulting and completely unjustified. One of the worst characteristics of conservatives is their tendency to accuse those who disagree with them of lack of patriotism, or worse. I am disappointed that you have joined in this slander, and think less of you for doing so.”

Arnold Kling can speak for himself. I was raised a Democrat Party and my mother is stunned by my Republicanism. Today, I do indeed argue that the national Democrat Party , deep in its guts, is nihilistic and hates the United States. The party of the Donkey seems unable to outgrow its Vietnam era infatuation with radical politics. A political party that has a Terry McAullife as its organizational leader is not worthy of respect. I puke my guts out whenever I see ex-KKK member Senator Robert Byrd appear on my TV screen.

The Democrat Party may have very well have saved civilization during WW II. It was Franklin D. Roosevelt who deserves credit for realizing that Adolph Hitler was a severe threat to the United States. The Republicans and their “America First” silliness could have resulted in an Axis victory. Also, the Republican Party disgraced itself during the fight for minority civil rights. The Vietnam years, however, warped the brain cells of the Democrat majority. They have never returned to planet Earth since that time.

Bernard Yomtov writes:

I wasn't referring to conservative critics of Bush but rather to people who see all sorts of dire things happening to the cultural/social/intellectual climate, as well as to those who view any action by government whatsoever as a step the road to national destruction.

Your view of Democrats does not surprise me, but it is additional evidence that many Republicans are simply unable to understand that it is possible to disagree with Republican ideas and still be patriotic.

It is astonishing that you can accuse Democrats of "infatuation with radical politics." Right-wing radicals have much more power in the Republican Party than left-wing radicals do in the Democratic.

And did you also "puke your guts out" when you saw Strom Thurmond on TV?

David Thomson writes:

“I wasn't referring to conservative critics of Bush but rather to people who see all sorts of dire things happening to the cultural/social/intellectual climate, as well as to those who view any action by government whatsoever as a step the road to national destruction.”

Please offer some specifics. You are mistaking Conservatives for Libertarians. We do not inherently believe that “any action by government whatsoever as a step the road to national destruction.” On the contrary, there are some duties best performed by the government. Our attitude is one of hesitation before granting government any further power over our lives. Government should the last option--and not the first when addressing our problems.

“Your view of Democrats does not surprise me, but it is additional evidence that many Republicans are simply unable to understand that it is possible to disagree with Republican ideas and still be patriotic.”

The national Democrat Party feels much more comfortable with the anti-Americanism of the French and Germans than they do with their fellow Republican citizens. Their tacit motto is “When in doubt, blame America first. Our country is usually in the wrong.”

“It is astonishing that you can accuse Democrats of "infatuation with radical politics." Right-wing radicals have much more power in the Republican Party than left-wing radicals do in the Democratic.”

Nothing could be further from the truth! The hard core right-wingers like Pat Buchanan are no longer members of the Republican Party. There are absolutely no Al Sharpton types who can attract a large number of Republican votes. The Republican Party of George W. Bush is one of moderate conservatism. “Right-wing radicals” have been thoroughly marginalized to the sidelines.


“And did you also "puke your guts out" when you saw Strom Thurmond on TV?”

I have no problem of forgiving people for their some of their sins of fifty years ago. My problem with Senator Robert Byrd revolves around his holier than thou self righteousness.

Bernard Yomtov writes:

I see. I am required to "offer specifics," whereas you are free to assert that Democrats are anti-American without offering a shred of evidence.

The "hard-core right-wingers" are not a part of the Republican party? Get a grip, David. They own the party. Check out, if you will, the Texas Republican Party platform, at

http://www.harriscountygop.com/sections/platforms/platform.asp.

This is the state party of Bush and DeLay, among others.

Is Pat Robertson not hard-core? Is Bill Pryor not an extremist?

Self-righteousness offends you? Me too. Have you checked out Rick Santorum lately? Bill Bennett? George Will? Orrin Hatch? etc.

Jim Glass writes:

"Can there be such a thing as a "bond bubble?"

The price of bonds has a fixed upper limit, after all."

It's not how high they can go but how far they can fall.

E.g. Japan is running the world's largest deficits issuing long bonds that pay 0.6% last I looked. What happens if economic "normality" ever returns there in the form of even modest positive inflation -- as everybody wants -- so interest rates go up?

I dunno, but this little calculator says that if rates go to just 2%, even 10-year bonds will lose up to 70% of their value. That's a heck of a lot more than the US stock market lost. And if rates go to 3%, ouch.
http://www.sjsu.edu/faculty/watkins/bond.htm

If rates start to go up in Japan will investors wait around in bonds to lose 70%, or will they bolt out? I just quoted Rudy Dorbusch under another topic here on the possibility of a run on Japanese bonds causing the next Depression.

Gee, playing with this calculator makes the "inflation cure" look positively scary. Why doesn't Krugman ever talk about this? I thought Dornbusch was his mentor or something.

dsquared writes:

Jim, where do you get that estimate from? I get from the bond calculator that a 5% of '13 (a ten year bond with a 5% coupon) is worth 142.58 when the market interest rate is 0.6% and worth 117.06 when the market interest rate is 3%. That's a drop of 17.8%; still pretty nasty if you were holding onto the bond that morning, but nothing like 70%.

.... ahhhh I see what's happened. You need to enter an interest rate of 2% into that calculator as 0.02, not 2. I can get the 70% decline by typing the numbers in rather than the decimals, but look at the "Present value of face value payment" box, which is zero if you type a value of 2 into the "Market interest rate" box. Not surprising given that you're discounting for ten years at a compound 200%!

dsquared writes:

I never reached the end of this article (which presumably had some reasoning in it of why a falling currency is not inflationary and therefore likely to make the Fed raise interest rates sooner and higher than it would otherwise have done), because I was laughing too hard at this sentence:

"Are you a citizen of a former Soviet republic trying to keep the criminals and kleptocrats away from your savings? Buy U.S. securities. "

Oh Arnold, you kill me, really you do.

dd

Jim Glass writes:

"Jim, where do you get that estimate from?"

I get numbers like this...

Face value: 1,000
Years to Maturity: 10
Coupon interest rate: 0.6
Market interest rate: 2.0
Bond value: 300

Ouch. Think of how many billions of dollars of bonds they are pumping into the structure of their financial system, with its trillion dollars of bad debts and all, to prop it up.

2% interest on a long bond isn't even a world with inflation. It's zero inflation at most. I'm having a hard time seeing how the inflation cure wouldn't be hari-kari.

I'm beginning to think Japan is in a "no way out" situation.

dsquared writes:

Yeh. You've accidentally entered a rate of 200% because the calculator is poorly coded. Look at the table below:

Present value of Interest payments: 299.99

****Present Value of Face Value Payment 0.02****

Bond Value 300.01

Bond Duration (yrs) 1.5.

The present value of a $1,000 payment in ten years' time at 2% discount rate is not two cents.

Face value 1000
Time to maturity 10
Coupon interest rate 0.006
Market interest rate 0.02
Bond value 874.24

That's a 12.5% loss.

Jim Glass writes:

I've got to say though that in the morning light, rather than at midnight, I don't understand why the principal would be valued so low. The interest is discounted to 30% value but the principal shouldn't be to anything like that in just 10 years, so the total value should be significantly higher.

I have to spend a little time earning my rent money, then I'll get back with better numbers.

Eric Krieg writes:

>>The national Democrat Party feels much more comfortable with the anti-Americanism of the French and Germans than they do with their fellow Republican citizens. Their tacit motto is “When in doubt, blame America first. Our country is usually in the wrong.”

Bernard Yomtov writes:

As I calculate, the interest payments are worth $53.896 and the principal $820.348. So $874.244 total.

Make it 5% and the value goes to $660.24.

Jim Glass writes:

To heck with paying the rent. Ah, I see D^2 caught this, so I owe corrected numbers.

Here's an easier to use calculator ...
http://www.smartmoney.com/onebond/index.cfm?story=bondcalculator
... and more realistic figures. Assuming an increase in rate from 0.6%, bond value as % of 100

Bond .... new rate
term .... 2% ..... 3% ..... 4% ..... 5%

30 yrs .. 68.6 .. 52.9 .. 41.1 .. 32.3
20 yrs .. 77.0 .. 64.2 .. 53.7 .. 45.3
10 yrs .. 87.3 .. 79.4 .. 72.2 .. 65.9

OK. Realistically if inflation/deflation goes to just 0% I'd think the long rate would have to go to 3% -- which gives losses on long bonds of 50% and on intermediates of 20%.

But 0% inflation is not an "inflation cure". If they engineer inflation of 2% they are still looking at losses of maybe near 70% on the long end and about 33% on intermediates.

So while this is not as bad as I posted before, it's still pretty darn bad -- it still looks scary bad to me considering how many of those bonds there are and what they are being used for.

And when just a "return to normalcy" in the sense of ending deflation could drop the value of long bonds by 50%, I consider that a bond bubble.

What the heck is the upside on these things that compensates for this risk?

As for me, no more posting at hours when obvious howling errors aren't obvious.

Bernard Yomtov writes:

Eric,

You say,

"it seems logical that Democrats need to be anti-American in order to advance their agenda. "

Conservatives have pushed for many changes in the country over the years.

Would you say that by definition this means that they were anti-American?

After all, if there is nothing wrong with America we don't need school vouchers. If there is nothing wrong with America we don't need to privatize Social Security. If there is nothing wrong with America we don't need tax cuts. If there is nothing wrong with America we don't need "faith-based initiatives." If there is nothing wrong with America we don't need to change our immigration policies. And so on.

To advocate change is not anti-American, Eric. It is an effort to improve America, and hence pro-American.

Is that really so hard to understand?

Eric Krieg writes:

Yes it is hard to understand. That's why you aren't getting it. Not a knock on you, just a realization that these issues are not easy to explain, nor understand. That why liberalism, which is so simplistic, has such a following.

When Republicans push for tax cuts, it is because we want to reward people for their hard work. It is because we believe that America works when people work, and that the person who makes the money should be the one to spend it.

Contrast this with Democrats, who wrap their rhetoric in class hatred. Tax cuts are nothing more than handouts to the rich. It is an inherantly negative argument, and pits one group of Americans against another, as do most Democrat arguments.

What are Republican arguments for Social Security privatization? That the current system is a ponzi shceme that cannot possibly work over the long term, and that a private pension system will increase growth and provide everyone with more retirement income. That is hardly America bashing.

The Democrat argument for Social Security is all scare mongering: throwing granny out into the street and such. Like anyone would ever let that happen!

How about Affirmative Action? Democrats argue that America is SO RACIST, that black people cannot get ahead without the government giving them a break. Republicans argue for a color blind society, to let the past be the past, and to look to a better future.

Issue after issue, Democrats make their argument based on the philosophy that "America is bad". Republcians push for change, but it is on the bedrock principle that the American people are basically good, and will take care of themselves if given the chance.

Bernard Yomtov writes:

Eric,

All you are saying is that you like Republican ideas better than Democratic ones. Fine. You are entitled to that view.

But my disagreement does not make me anti-American. That's what you don't seem to understand.

You claim liberalism is popular because it is "simplistic," yet somehow you do not see that this, aside from being false, is an insult to the same Americans you claim to revere. And do you really think that an ideology whose primary spokesman is Rush Limbaugh is NOT simplistic?

You parrot conservative claims about tax cuts. You want to reward workers, but in fact the tax cuts reward the wealthy and their children, workers or not. Between dividend tax cuts and elimination of estate taxes Republicans are creating a large group of people who will never have to work a day. When someone points out this fact, and it is a fact, you label it "class warfare," as though that changes the facts.

Drop the piety and sanctimoniousness, Eric. You believe certain things, but you should allow for the possibility that you may not have a perfect grasp of how the world works.

Eric Krieg writes:

>>But my disagreement does not make me anti-American. That's what you don't seem to understand. >You claim liberalism is popular because it is "simplistic," yet somehow you do not see that this, aside from being false, is an insult to the same Americans you claim to revere.>And do you really think that an ideology whose primary spokesman is Rush Limbaugh is NOT simplistic?>You parrot conservative claims about tax cuts.>You want to reward workers, but in fact the tax cuts reward the wealthy and their children, workers or not.>Between dividend tax cuts and elimination of estate taxes Republicans are creating a large group of people who will never have to work a day. When someone points out this fact, and it is a fact, you label it "class warfare," as though that changes the facts.>Drop the piety and sanctimoniousness, Eric. You believe certain things, but you should allow for the possibility that you may not have a perfect grasp of how the world works.

David Thomson writes:

“Is Pat Robertson not hard-core? Is Bill Pryor not an extremist?

None of the above people have been involved in a Tawana Brawley type scandal. Have we already forgotten Al Sharpton’s not so subtle anti-Semitic rhetoric that encouraged a madman to murder around five people in New York City? Also, are Robertson or Pryor running for President in 2004? Did I miss something in my local newspaper?

“And do you really think that an ideology whose primary spokesman is Rush Limbaugh is NOT simplistic?”

Rush Limbaugh does not speak for me. I have often taken him to task for exaggeration and intellectual carelessness.

“When Republicans push for tax cuts, it is because we want to reward people for their hard work. It is because we believe that America works when people work, and that the person who makes the money should be the one to spend it.”

Moreover, Republicans believe that the private sector usually best resolves our national problems. The state should be somewhat distrusted and employed only as a last resort. Why are Liberals infatuated with the nanny state? That is a very easy question to answer. Liberals want the power to decide what’s best for the rest of us.

“This is my experience with liberal friends. When Sept. 11th happened, instead of outrage, they said "Why do they hate us". Instead of grieving for their fellow fallen Americans, they worried about violence against Arab-Americans. Instead of watching Fox News, or even CNN, they've got the BBC on.”

Paul Krugman only recently bragged that many of his friends preferred the BBC over our alleged war mongering press. The national Democrat Party is still mired in the 1960s. Deep in their heart of hearts, they want to stick it to the “establishment.” The Vietnam era still defines their view of the world. They share Susan Sontag’s regret that she wasn’t born and raised in France. Liberal Democrats are ashamed of being American.

“The "hard-core right-wingers" are not a part of the Republican party? Get a grip, David. They own the party. Check out, if you will, the Texas Republican Party platform, at ....”

I live in Harris County and my own theological views are similar to the Unitarian-Universalists! These people are a minority and even they strongly adhere to the principle of the separation of church and state. Religious people have every right to advocate their beliefs---and I have every right to reject them.

Bernard Yomtov writes:

Eric,

Get a brain. I didn't say we are incapable of understanding the world. I said we should recognize that some things are complicated and not thoroughly understood, and so there may be honest differences of opinion. Our individual views on these sorts of matters might be wrong. This is not "post-modernism." It is common sense. That was my point.
David,

Sharpton is a rabble-rouser and a liar. Fortunately, he holds no political office. Do you suggest that the Democrats simply refuse to allow him to run in primaries? The Republicans didn't bar Buchanan or Robertson, and they, incidentally, got more votes than Sharpton will.

Is Robertson running for President? No, but he has, and he has been influential in Republican politics for years. Pryor isn't running for President either. But he has been nominated by President Bush for a lifetime appointment to the Federal Appeals court. That's a pretty powerful job, way ahead of anything Sharpton will ever have.

I'm not sure who you refer to when you say "these people believe in separation of church and state." It's not the Texas Republicans, whose platform explicitly pledges to do what it can "to dispel the myth of the separation of church and state." By the way the platform also defines the US as a "Christian nation," and it requires all party candidates to affirm their support for it.

I am not suggesting that religious people have no right o their views. I am suggesting that, based on the views expressed in this document, the people who wrote it are radicals. Read it and judge for yourself.

They do have gift for comedy, though, since the platform includes a demand that "our federal legislators vote only for balanced budgets."

David Thomson writes:

“Our individual views on these sorts of matters might be wrong. This is not "post-modernism." It is common sense. That was my point.”

Why are you ignoring Andrew Sullivan and Instapundit as leaders of conservative thought? You should also occasionally visit http://www.nationalreview.com/thecorner/corner.asp

National Review conservative authors are constantly debating issues such as illegal drugs and gay rights. Are you aware that every writer for the National Review believes in evolution? John Derbyshire recently described creationism as a pseudo science!


“Sharpton is a rabble-rouser and a liar. Fortunately, he holds no political office. Do you suggest that the Democrats simply refuse to allow him to run in primaries?

Of course not. However, I have every right to mention that Al Sharpton is among the leading vote getters for the Democrat nomination! I am, rightfully, appalled that he is so popular.

“The Republicans didn't bar Buchanan or Robertson, and they, incidentally, got more votes than Sharpton will.””

Once again, Pat Buchanan has long ago abandoned the Republican Party. In the last election, he ran as the standard bearer of Ross Perot’s former polotocal party. And what is this thing you have against Pat Robertson? I consider him a silly man, but not dangerous.

“I'm not sure who you refer to when you say "these people believe in separation of church and state." It's not the Texas Republicans, whose platform explicitly pledges to do what it can "to dispel the myth of the separation of church and state." By the way the platform also defines the US as a "Christian nation," and it requires all party candidates to affirm their support for it.”

Oh baloney! These people speak only for themselves. The rest of us barely pay them any attention. The “myth’ they are talking about is the radical liberal interpretation that falsely believes that religious values have no place in secular American society.

Eric Krieg writes:

Weird. I had a much lengthier reply to Bernard, and it seems to have been edited. Does that happen on this site?

Bernard Yomtov writes:

Sullivan hasn't been too kind to Mr. Bush lately, but in any case I hardly consider him a leader of conservative thought. Do you think Rick Santorum and Tom deLay, for example, hold Sullivan in high regard?

NRO is a joke. They use ad executives as their economic commentators for Pete's sake. They all believe in evolution!! That's the best thing you can say in their defense?

As for Buchanan and Robertson, I was merely pointing out that it is impossible to prevent peopel from running in presidential primaries, which both of them surely did, however embarassed you are by this.

Sharpton a leading vote-getter? There hasn't been a primary yet. Stop repeating obvious nonsense.

"These people" ARE the Texas Republican Party, David. I introduced this platform to support my statement that radicals were powerful in the Republican Party. You simply cannot deny that this platform is radical, and that it represents the thinking of a significant part of a very important state party.

Every time I point out a conservative stupidity you deny that it's important. Limbaugh? Careless. Robertson? Silly. Buchanan? Not a Republican. Texas Republicans? Not serious. Yet any Democrat anywhere who says or does something idiotic is immediately cited by you as a leading liberal thinker. You close your eyes to the stupidity of many right-wingers, and merely assert that Democrats are anti-American, etc. Well go ahead. You and Eric can continue in your willful blindness.

Jim Glass writes:

Back to bond bubbles, Japanese style. Some comments from the Barron's page one professional investors' roundtable story today:

"... the big trade here is shorting the JGB [Japanese government bond] ... It is the sell of a generation."

"We have a short position in Treasuries and a short position in the 10-year JGB. Like everyone else, I think there is a bond bubble..."

"The Japanese bond market is the short of the century."

Bernard Yomtov writes:

What about currency risk?

If Japanese interest rates rise, won't the yen appreciate against the dollar? Then the shorts may be looking at a Pyrrhic victory.

Jim Glass writes:

"What about currency risk?

If Japanese interest rates rise, won't the yen appreciate against the dollar? Then the shorts may be looking at a Pyrrhic victory."

If we're just talking about investmet risk within normal bounds I'm sure those pros know how to hedge currencies, and I leave them to take care of themselves.

But if we are talking about systemic risk, or "calamity risk", to the Japanese economy, then Dornbusch in the item I linked to before told how a stampede out of Japanese bonds to avoid a busting bubble could produce a run on the yen that puts Japan in the next Great Depression. If he thought that was plausible I hardly have the qualifications to argue with him.

I note that the current issue of the Economist reports that there is now concern that rising interest rates could produce a bond price plunge that impairs the balance sheet of the Bank of Japan itself, it is buying so many bonds. The propsed remedy being suggested is legislation turning Japanese gov't bonds into "adjustible rate" bonds -- at least those held by the BofJ. Things are really getting bizarre over there.

Bernard Yomtov writes:

Jim,

Sorry. I can't find your link to Dornbusch. Could you repost it?

Thanks

Jim Glass writes:

"I can't find your link to Dornbusch. Could you repost it?"

Sure.
http://econ-www.mit.edu/faculty/dornbusch/editorials.htm

_"Two Big Risks for the World Economy_, December 2001.

One risk being a $161/b price for oil due to the coming conflict in the mideast, which risk seems to have eased for the moment, while "The second mega-risk scenario involves a Japanese financial meltdown..."

JT writes:

I don't know if this thread is still alive but I read Jim Glass' comment about Japanese bonds losing 70% of their value and thought, "no way can that be true." Yes way.

The fact that Japanese bonds have very low coupons makes a ton of difference. Take a 30 year bond with a coupon of 0.2%. What int rate would it take to reduce that bond's value to 30 (par=100)? A measly 4.45% rate, easily believable. A similar 20-year bond would require a rise to 6.5%. So Jim's estimate is a worst-case scenario but we are talking about a major impact if rates were to rise.

JT writes:

To follow the thought from my previous post, raising the inflation rate would also raise bond yeilds, leading to devestation for bond portfolios. Wouldn't that be a problem for Krugman's "printing press" solution to Japanese deflationary concerns? Anyone know if he's addressed that issue? If not, it's about time he did so.

Jim Glass writes:

"Wouldn't that be a problem for Krugman's "printing press" solution to Japanese deflationary concerns? "

I think so. According to the last issue of the Economist the Bank of Japan thinks so -- it has bought so many bonds it is concerned that its balance sheet could be impaired by rising rates that come with inflation.

Krugman gives no indication of having considered the notion.

JT writes:

Jim: Thanks. I'm hoping for further confirmation that Krugman hasn't addressed this issue but I more and more have the impression that PK is one of those people who thinks he's smarter than he really is. Isn't one of the precepts of economics that you shouldn't automatically declare a party's actions incompetent without having tried to understand their motivations and thinking?

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