Typography

Imagine waking up in the morning and checking the hockey scores, news, the weather, and how much the central bank has adjusted the gold content of the dollar overnight. This is what a 21st century gold standard would look like. Central banks that have operated old fashioned gold standards don't modify the gold price. Rather, they maintain a gold window through which they redeem a constant amount of central bank notes and deposits with gold, say $1200 per ounce of gold, or equivalently $1 with 0.36 grains. And that price stays fixed forever. Because gold is a volatile commodity, linking a nation's unit of account to it can be hazardous. When a mine unexpectedly shuts down in some remote part of the world, the necessary price adjustments to accommodate the sudden shortage must be born by all those economies that use a gold-based unit of account in the form of deflation. Alternatively, if a new technology for mining gold is discovered, the reduction in the real price of gold is f...

In his first blog skirmish , Ben Bernanke took on Larry Summers' secular stagnation thesis, generating a slew of commentary by other bloggers. If the economy is in stagnation, the econ-blogosphere surely isn't. I thought that Stephen Williamson had a good meta-criticism of the entire debate. Both Bernanke and Summers present the incredibly low yields on Treasury inflation protected securities (TIPS) as evidence of paltry real returns on capital. But as Williamson points out, their chosen signal is beset by static. Government debt instruments like TIPS are useful as media of exchange, specifically as collateral, goes Williamson's argument. Those who own these instruments therefore enjoy a stream of liquidity services that gets embodied in their price as a liquidity premium. Rising TIPS prices (and falling yields) could therefore be entirely unrelated to returns on capital and wholly a function of widening liquidity premia. Bernanke and Summers can't make broad assumptio...

Real t-bill and bond yields have been falling for decades and are incredibly low right now, even negative (see chart below). With an eye to historical real returns of 2%, folks like Martin Feldstein think that bonds are currently mis-priced and warn that a bond bubble is ready to burst. Investors need to be careful about comparing real interest rates over different time periods. Today's bond is a sleek electronic entry that trades at lightning speed. Your grandfather's bond was a clunky piece of paper transferred by foot. It's very possible that a modern bond doesn't need to provide investors with the same 2% real coupon that it provided in times past because it provides a compensating return in the form of a higher liquidity yield. [By now, faithful readers of this blog will know that I'm just repeating the same argument I made about equity yields .] Here's a way to think about a bond's liquidity yield. Bonds are not merely impassive stores-of-value, they ...

I learnt some interesting facts about inflation-linked investment products. To begin with Sober Look had an intriguing chart showing an inversion in the TIPS yield curve. Michael Ashton at Epiphany had an interesting explanation for this. Basically, short-dated TIPS begin to trade like gasoline futures . Like zero-coupon inflation swaps, TIPS are indexed to headline inflation, not core inflation. The most volatile component of headline inflation are gas prices, although in general large changes in gasoline prices will mean-revert to core inflation. We've had a large fall in gas prices, so near TIPS have fallen in value. More distant TIPS price in an expectation of gasoline reverting to core, and therefore are less sensitive to the fall in gas prices. Michael explains here why inflation swaps are a better indication of true inflation than TIPS. I learn here that the 5Y 5Y forward inflation curve is the market price for an inflation swap that starts in 5years and ends in 10 years...

David Glasner noticed a very interesting anomaly yesterday. In short, 5-year TIPS rates seem to be rising while 10-year TIPS have been falling. He encouraged his readers to do some investigating to find out why. See my findings below. Rather than using the constant-maturity TIPS yields as my starting point (which come with 5, 7, 10, 20, and 30 terms) I looked at actual TIPS yields. I was interested to learn that constant-maturity yields are not market yields. Rather, they are derived from a statistical method that smooths actual yields in order to compute a surrogate constant yield. Constant yields are useful because they provide continuity, but it is easy to forget that the market yields are the true parent data series upon which they are based. Below is a chart showing market 10-year TIPS yields for various TIPS vintages since 2006. click chart to zoom What is evident is that anomalies have happened before. While 10-year TIPS yields in general follow each other in the same direction...

Lars Christensen talks about the idea of setting a floor under inflation-linked bonds in order keep inflation expectations at some minimum level. It`s an interesting idea. Here is my comment: Interesting idea, Lars. One problem here is that the TIPS spread (I’ll use US lingo if you don’t mind) measures not only expected inflation but also the relative illiquidity of TIPS relative to Treasuries. It measures, in part, a liquidity premium. TIPS might fall to the central bank’s minimum buying price not because inflation expectations have fallen, but because the liquidity of TIPS relative to Treasuries has declined. This change in liquidity could be purely incidental. ie. it could be due to some unimportant technical change unique to Treasury markets. The result would be that the central bank buys up TIPS because it believes inflation expectations have fallen, when in actuality it is the liquidity premium that has changed. According to your rule, the money supply automatically increases, t...

Econbrowser has a post on inflation expectations as measured via TIPS spreads. This links back to an earlier comment I made on Glasner's blog , in which inflation swaps are posited as an alternative to TIPS spreads. Here is the comment from Econbrowser: "One might worry about characteristics in the TIPS market distorting the estimates of the real yields."  and  "The real yield curve starts at five years, so one can’t be sure what the real yield curve suggests for the horizon less than five years. "  Why not use zero coupon inflation swap prices? They (supposedly) don't suffer from some of the same distortions as TIPS (liquidity premia), and you can get shorter terms.  For instance, here is the 2 year inflation swap.  http://www.bloomberg.com/apps/quote?ticker=USSWIT2:IND Just subtract the 2 year swap rate from the nominal 2 year rate and you have the 2 year real rate.  See the Cleveland Fed's explanation of their methodology for measuring inflation exp...

Commented on David Glasner's Once Again The Stock Market Shows its Love for Inflation : The only problem here is the one that we talked about in a previous post (Unpleasant Fisherian Arithmetic) concerning the liquidity premium that assets carry. The reason for the rising TIPS spread could be (though not necessarily must be) that the liquidity premium on treasuries is shrinking relative to that of TIPS, and therefore TIPS are rising in price relative to Treasuries. This makes it hard to pass judgment on the hypothetical rate of return on capital.  Anyways, you have already commented on this problem in your paper: “One possible cause of distortion in the yield on TIPS bonds and in the TIPS spread during the autumn 2008 financial crisis is that the yield on conventional Treasuries was depressed because of a liquidity premium. Even though the ex ante real interest rate was likely negative, because TIPS bonds were perceived as much less liquid than conventional Treasuries, TIPS bonds c...