In my blog post on Helen Dale’s article on liberalism and technocracy, I asked who is an expert – how can we see somebody qualifies as such? The same question can, and should be, asked about “establishments” and “elites”. This is hardly irrelevant now that so many of our political champions/advocates are vehemently “anti-establishment”, but it is sometimes difficult to understand what they mean by that. Is Trump “anti-establishment”, even though he has been in office for three years now? Are true “anti-elites” the many University professors who criticize both the political and the business elites, in spite of the fact they themselves live in neighboring circles?
Martin Gurri thinks that behind the current waves of the anti-establishment movement stands the way in which public opinion has been disrupted by digital innovation, which has somehow leveled down the public debate. The Internet killed arguments “ex authoritate”, perhaps forever. The legitimacy of a given opinion or view used to stem from the fact its holder belonged to a certain institution; now, such a link between an institution and the authority bestowed upon ideas is becoming weaker and weaker. This may not be all bad when one reflects on the nature of elites. The reason people are on top is often simply that they have been there before. Gurri maintains that elites
are herd animals, who graze contentedly on the upper reaches of the institutions that sustain modern life. They are political people, government people, media people – members of some established order that amplifies their reedy voices into thunder, and wreathes their coiffured heads with high status and prestige. The most remarkable thing about them is how unremarkable they are, once they step down from their lofty perches.
Elites are there because they were there, so to say, and they tend to “export” themselves one field to another. For Gurri, they share
Such confidence makes elites think they are best: sometimes, they are simply more organized, more compact, more homogeneous- and therefore capable to keep their grip on society. Yet from the great Italian “discoverers” of elites theory, from Mosca and Pareto onward, such grip is seen as dependent upon the rest of society recognizing elites are on top because they should be. Whatever form legitimacy takes (from the divine right of kings to liberal democracy to socialism), it defines why a certain group ought to be enjoying political power at the expense of the others. Vilfredo Pareto thought that elites were complex networks which, far from being monolithic, had constantly to renew themselves by co-opting—by whatever mechanism—new talents to avoid degeneration and decline. Yet if they closed themselves down that decline can accelerate sharply. I think it will be interesting to see how this broad scenario applies to the current crisis of elites- and in the face of almost endless talk about “diversity”. Is it that the more Western elites became obsessed by talking up diversity, the less diverse in truth they became? I suppose this would be the (arch)conservative view. But at the same time, at least prima facie, it is hard to deny that elites have been better to spot and acquire talents on the outskirts of society in recent years than they have ever been.
Elites and experts do not perfectly coincide, but, in our world, because of the long wave of the Platonic dream—and also, quite frankly, of the fact of the ever-growing complexities of government—breed a worldview in which competence and knowledge (or the appearance thereof) is a key factor of legitimacy, they do somehow. An interesting perspective, in the face of the crisis of expertise and elites, could be that of elites that want to keep to avoid decline. It seems to me that this recent piece by Arnold Kling, annotating a conversation between Linkedin’s Reid Hoffman and Stripe’s Patrick Collison, can be read as such. Arnold’s tips may be enough for a business, or a think tank, or a university department – but not sufficient as a tip for the upper strata of society as such. Still, there is plenty of good advice there for a persona of responsibility – to avoid, first and foremost, her own intellectual decline (which may mirror society’s one).
The Fama Puzzle at 40
Fama (JME, 1984) was published 35 years ago, but the earlier — perhaps the earliest — appearance of the Fama regression is in Tryon (1979). While the puzzle has largely persisted since then, it has seemingly disappeared since the global financial crisis.
Figure 1: Ex post one year depreciation of euro/dollar up to 2007M08 against one year offshore US-euro interest differential (up to 2006M08).
Recall the puzzle: If the joint hypothesis of uncovered interest rate parity (UIP) and rational expectations –- sometimes termed the unbiasedness hypothesis — held, then the slope of the regression lines (in red) would be indistinguishable from unity. In fact, they are significantly different from that value. This pattern of coefficient reversal holds up for other dollar-based exchange rates, as well as for other currency pairs (with a couple exceptions). The fact that the coefficient is positive in the post-global financial crisis period is what we term “the New Fama puzzle”.
Interestingly, after 2006, the relationship flips.
Figure 2: Ex post one year depreciation of eur/dollar up to 2019M06 against one year offshore US-euro area interest differential (up to 2018M06).
In a revision to NBER working paper just released (No. 24342, posted 12/11), coauthored with Matthieu Bussière (Banque de France), Laurent Ferrara (SKEMA Business School), Jonas Heipertz (Paris School of Economics), we re-examine uncovered interest parity – the proposition that anticipated exchange rate changes should offset interest rate differentials, with data up to mid-2019.
This is one of the most central concepts in international finance. At the same time, empirical validation of this concept has proven elusive. In fact, the failure of the joint hypothesis of uncovered interest rate parity (UIP) and rational expectations – sometimes termed the unbiasedness hypothesis – is one of the most robust empirical regularities in the literature, vigorously examined since Fama’s (1984) finding that interest rate differentials point in the wrong direction for subsequent ex-post changes in exchange rates.
The most commonplace explanations – such as the existence of an exchange risk premium, which drives a wedge between forward rates and expected future spot rates – have some empirical verification, albeit fragile.
One key development prompts this revisit. First and foremost, the last decade includes a period in which short rates have effectively hit the zero interest rate bound. This point is clearly illustrated in Figure 1 where we plot one-year interest rates for a set of eight selected economies and the US. This development affords us the opportunity to examine whether the Fama puzzle is a general phenomenon or one that is regime-dependent.
Figure 3: One year yields on Eurocurrency deposits.
As shown in Figure 3, more recently — and since the first version of this paper — short rates in the US have risen above the zero lower bound. This allows us to test to the robustness of our findings.
We obtain the following findings. First, Fama’s result is by and large replicated in regressions for the full sample, ranging from 1999 to June 2018 (for exchange rate changes ending in June 2019). However, the results change if the sample is truncated to apply to only the most recent decade, the period for which interest rates are essentially at zero. For that period, interest differentials correctly signal the right direction of subsequent exchange rate changes, but with a magnitude that is altogether not reconcilable with the arbitrage interpretation of UIP. In other words, we obtain positive coefficients at exactly a time of high risk when it would seem less likely that UIP would hold.
The use of survey based expectations — thereby dropping the rational expectations hypothesis — data provides the following insights. First, interest differentials and anticipated exchange rate changes are positively correlated, consistent with the proposition that investors tend to equalize at least partially expected returns expressed in common currency terms (see also Chinn and Frankel (2019) for results 1986-2017).
Second, the switch in the β coefficient at the one year horizon arises because the correlation of expectations errors (defined as expected minus actual) and interest differentials changes substantially between pre- and post-crisis periods. This is important, as can be seen by examining the probability limit of the β’ coefficient in a Fama regression:
s+1 – s = α’ + β'(i-i*) + error
plim(β’) = 1 – [A] – [B] – [C]
[A] ≡ cov(covered interest diff.,i-i*)/var(i-i*)
[B] ≡ cov(risk premium, i-i*)/var(i-i*)
[C] ≡ cov(forecast error, i-i*)/var(i-i*)
covered interest differential = – [(f – s) – (i-i*)]
risk premium = f – ε(s+1)
forecast error = ε(s+1) – s
f is the forward rate for period +1
s is the current spot exchange rate
ε(s+1) is subjective market expectations of the future spot exchange rate (proxied using Consensus Forecasts survey data).
The decomposition for the euro/dollar β’ is shown in the Figure 4 below, for the 2003M01-2018M06 period (defined by the survey data). The components are shown as theoretical β’ + [-A] + [-B] + [-C], so as to add up to the estimated β’.
Figure 4: Decomposition of euro/dollar β’. [A] is brown, [B] is blue, [C] is green; black square denotes estimated β’, line at 1 denotes theoretical β’ under unbiasedness hypothesis. Source: BCFH (2019).
Exchange risk comovement with the interest differential does not appear to be the primary reason why the Fama coefficient has been so large in recent years (although the altered behavior of exchange risk does play a role). Rather, how expectations errors comove with the interest differential appears of central importance — that is the [C] component. This correlation changes because in the pre-crisis period, the dollar depreciated more than anticipated, while that is no longer true post-crisis. The size of the swing is partly due to the fact that interest differentials are now less variable (the variance has shrunk).
So far the change has proved durable despite the liftoff of short rates — at least in the US, Canada and UK. Whether this will continue to be the case remains to be seen.
Ungated version of the paper, here.
Bonus Quotation of the Day…
… is from page 426 of the late Jan Tumlir’s January 1984 speech at the Cato Institute – a speech titled “Economic Policy for a Stable World Order” – as this speech is reprinted in Dollars, Deficits, & Trade (James A. Dorn and William A. Niskanen, eds., 1989):
Indeed the difficulty for the economist may now lie in explaining why the world economy still functions at all, however dissatisfied we may be with its functioning. The answer is, of course, that there is a lot of ruin in any economy with a modicum of freedom. I am sometimes unsure whether it is actually an advantage of the capitalist system that it can take such an enormous amount of beating. If it were in the habit of collapsing more frequently, we would perhaps govern ourselves more prudently (and more cheaply to boot).
I’ve long argued that the economist’s standard assertion that government intervenes into the economy first and foremost to correct market failures fails spectacularly as a positive theory of government intervention into the economy. It’s far closer to the truth to say that government intervention into the economy is fueled not by market failures (as understood by economists) but, rather by the market’s astonishing success and robustness.
The market’s success at raising people’s standards of living creates the expectation that wealth creation is easy and normal while poverty is out of the ordinary. But of course historically poverty is the norm – and poverty so deep, unrelenting, and overwhelming that few Americans today can begin to imagine a condition so crushing. Because the market makes wealth so abundant and its production appear to be normal and easy to the point of being practically automatic – and because nearly all of the massive number of details of the intricate processes at work at every moment to create wealth are hidden from view – the market’s ‘failure’ to create heaven on earth is believed by many to be an unanswerable indictment of the market.
On top of this ‘problem’ is the market’s mighty robustness: tax it, saddle it with diktats, poison it with easy money, accuse it of being run by and for demons and devils, and the market keeps motoring along, improving the lives even of those who most hate it and who do the most to harass it. The market works less well than it would absent these intrusions, of course, but it still works surprisingly well. As long as, and insofar as, prices and wages are allowed to adjust according to the forces of supply and demand, the market’s robustness is Herculean. (The market is not, however, indestructible. Harass it too much and it will quit working.)
If the market truly collapsed completely more often, giving people a taste of what life is like without it, the world would have in it not only far fewer communists and socialists, but also far fewer “Progressives” and “conservative nationalists.”
The market’s true failure, in short, lies is its incredible capacity to succeed and to keep on keeping on. The market fails to prevent people from taking it for granted.
Market Talk – December 12, 2019
According to reports from Reuters, China is trying to propose a plan to promote Macau to be its next “Hong Kong” by building it into a world-leading financial center. China unveiled plans of creating a yuan-denominated stock exchange, as well as allocating extra land to Macau for it to grow. The region was a former Portuguese colony and will target companies from Portuguese speaking countries such as Brazil in order to avoid direct competition with China and the mainland.
Indian Parliament passed Citizenship Amendment Bill on 11-Dec-2019, which proposes to accord citizenship to illegal Hindu, Sikh, Buddhist, Jains, Parsis and Christian migrants from Pakistan, Bangladesh and Afghanistan. It, naturally, implies that migrants, who identify themselves with any group or community other than those mentioned above, from these countries won’t be eligible for citizenship. The bill also relaxes the provisions for “Citizenship by naturalization.” The proposed law reduces the duration of residency from the existing 11 years to just five years for people belonging to the same six religions and three countries. The bill covers six communities namely Hindu, Sikh, Buddhists, Jains, Parsis and Christian migrants from Pakistan, Bangladesh and Afghanistan.
The Indian government has prohibited gift imports through e-commerce portals except life-saving drugs and rakhi. The import of goods was earlier free and not subject to customs duties. The move will impact Chinese e-commerce web sites like Club Factory, Ali Express and Shein who are the largest users of this route.
The US reprimanded Pakistan Air Force chief for misusing F-16 fighter jets by undermining their shared security platforms and infrastructures months after the Indian Air Force shot down an F-16 jet of Pakistan Air Force during an aerial combat over Kashmir. Andrea Thompson, the then-undersecretary of State for Arms Control and International Security Affairs, wrote a letter to Pakistani Air Force Chief Air Chief Marshal Mujahid Anwar Khan in August over the matter.
The major Asian stock markets had a mixed day today:
- Shanghai decreased 8.72 points or -0.30% to 2,915.70
- Kospi increased 31.73 points or 1.51% to 2,137.35
- ASX 200 decreased 43.80 points or -0.65% to 6,708.80
- NIKKEI 225 increased 32.95 points or 0.14% to 23,424.81
- Hang Seng increased 348.71 points or 1.31% to 26,994.14
- SENSEX increased 169.14 points or 0.42% to 40,581.71
The major Asian currency markets had a mixed day today:
- AUDUSD increased 0.00241 or 0.35% to 0.68931
- NZDUSD increased 0.00003 or 0.00% to 0.65823
- USDJPY increased 0.5860 or 0.54% to 109.1310
- USDCNY decreased 0.04597 or -0.65% to 6.98293
- Gold decreased 5.54 USD/t oz. or -0.38% to 1,470.81
- Silver increased 0.013 USD/t. oz or 0.08%% to 16.9207
Some economic news from last night:
Unemployment Rate (Q3) remain the same at 2.3%
Core Machinery Orders (MoM) (Oct) decreased from -2.9% to -6.0%
Core Machinery Orders (YoY) (Oct) decreased from 5.1% to -6.1%
Foreign Bonds Buying increased from -511.1B to 235.8B
Foreign Investments in Japanese Stocks decreased from 394.0B to -200.4B
MI Inflation Expectations remain the same at 4.0%
External Migration & Visitors (Oct) decreased from 1.40% to 0.10%
FPI (MoM) (Nov) decreased from -0.3% to -0.7%
Permanent/Long-Term Migration (Oct) decreased from 4,290 to 4,120
Visitor Arrivals (MoM) increased from -0.1% to 0.0%
Some economic news from today:
Retail Sales (MoM) (Oct) decreased from 2.0% to -2.2%
Retail Sales (YoY) (Oct) decreased from -2.1% to -4.3%
CPI (YoY) (Nov) increased from 4.62% to 5.54%
Cumulative Industrial Production (Oct) decreased from 1.30% to 0.50%
Industrial Production (YoY) (Oct) increased from -4.3% to -3.8%
Manufacturing Output (MoM) (Oct) increased from -4.0% to -2.1%
UK elections went underway today, with still the outcome being unpredictable. The election results will be counted out in the morning. Yesterday, both Labour and Conservatives gave their final pitches with PM Boris Johnson saying his side was the only side who can bring Brexit forward.
France is gearing up for another round of strikes tomorrow over the proposed reforms of the pension plan and age of retirement.
According to the WSJ, Saudi Arabia is seeking to defuse the situation with Iran, with the Pakistani FM acting as a mediator between the two.
The US senate comittee has now officially signed off a bill which places sanctions on Turkey over thier recent purchase of the S-400 missile defense system.
The major Europe stock markets had a green day today:
- CAC 40 increased 23.39 points or 0.40% to 5,884.26
- FTSE 100 increased 57.22 points, or 0.79% to 7,273.47
- DAX 30 increased 74.90 points or 0.57% to 13,221.64
The major Europe currency markets had a mixed day today:
- EURUSD decreased 0.00204 or -0.18% to 1.11126
- GBPUSD decreased 0.00821 or -0.62% to 1.31169
- USDCHF increased 0.00346 or 0.35% to 0.98606
Some economic news from Europe today:
Thomson Reuters IPSOS PCSI (Dec) increased from 47.8 to 48.5
RICS House Price Balance (Nov) decreased from -6% to -12%
Germany Thomson Reuters IPSOS PCSI (Dec) decreased from 53.55 to 53.43
German CPI (YoY) (Nov) remain the same at 1.1%
German CPI (MoM) (Nov) decreased from 0.1% to -0.8%
German HICP (YoY) (Nov) increased from 0.9% to 1.2%
German HICP (MoM) (Nov) decreased from 0.1% to -0.8%
SNB Interest Rate Decision remain the same at -0.75%
PPI (YoY) (Nov) decreased from -2.4% to -2.5%
PPI (MoM) (Nov) decreased from -0.2% to -0.4%
France Thomson Reuters IPSOS PCSI (Dec) decreased from 43.69 to 42.49
French CPI (YoY) increased from 0.8% to 1.0%
French CPI (MoM) (Nov) decreased from 0.0% to -0.1%
French HICP (YoY) (Nov) increased from 0.9% to 1.2%
French HICP (MoM) (Nov) increased from -0.1% to 0.1%
Italian Quarterly Unemployment Rate decreased from 9.9% to 9.8%
Italy Thomson Reuters IPSOS PCSI (Dec) increased from 38.88 to 40.11
Industrial Production (YoY) (Oct) decreased from -1.8% to -2.2%
Industrial Production (MoM) (Oct) decreased from -0.1% to -0.5%
Deposit Facility Rate (Dec) remain the same at -0.50%
ECB Marginal Lending Facility remain the same at 0.25%
ECB Interest Rate Decision (Dec) remain the same at 0.00%
The US-China trade deal is close to completion, according to President Trump. “Getting VERY close to a BIG DEAL with China. They want it, and so do we!” he posted this Thursday. CNBC reported that US negotiators are ready to cancel the new tariffs and cut existing tariffs by 50% ($360 billion). With only three days left before the US imposes an additional $156 billion on Chinese goods, time is of the essence.
Bank of Canada Governor Stephen Poloz sees Canada’s economy expanding in the new year at a steady. Last week, the central bank voted to maintain the target rate at 1.75% where it has remained for over a year. Growing government debt, not just in Canada, is one of Poloz’s main concerns. “Experience shows that high debt levels can amplify the impact of a shock on the economy,” the governor stated. Poloz expressed concerns over global trade as well, stating that companies are dismantling supply chains in favor of cheaper, less effective, options.
Canada’s Conservative Party Leader Andrew Scheer resigned this Thursday. Scheer’s resignation comes after it was revealed that he used Conservative Party funds to pay for his children to attend private school. Dustin van Vugt, executive director of the party, may be forced to resign as well for similar reasons.
Brazil’s central bank voted in favor of dropping the target rate to 4.5%. “Essential conditions for sustained growth were laid down in 2019. Brazil is ready for a new development cycle,” stated Waldery Rodrigues, special secretary to Brazil’s Economy Ministry. Brazil certainly amped up efforts to build business, attract foreign and domestic capital, lower the debt ceiling, and solve the ongoing pension crisis. However, the pension dilemma is ongoing as are domestic conflicts such as the Amazon wildfires. Unemployment remains high at 11.6%, but is expected to decline in the new year. The government cited optimism about continued economic growth and predicts GDP to rise to 2.3% in 2020.
US Market Closings:
- Dow advanced 220.75 points or 0.79% to 28,132.75
- S&P 500 advanced 26.94 points or 0.86% to 3,168.57
- Nasdaq advanced 63.27 points or 0.73% to 8,717.32
- Russell 2000 advanced 12.89 points or 0.79% to 1,644.81
Canada Market Closings:
- TSX Composite advanced 7.29 points or 0.04% to 16,946.90
- TSX 60 advanced 1.56 points or 0.15% to 1,012.93
Brazil Market Closing:
- Bovespa advanced 1,235.87 points or 1.11% to 112,199.74
The IEA report was released this week which was contrary to the OPEC optimism for demand.
The oil markets had a green day today:
- Crude Oil increased 0.4992 USD/BBL or 0.85% to 59.3943
- Brent increased 0.4959 USD/BBL or 0.78% to 64.3858
- Natural gas increased 0.0381 USD/MMBtu or 1.68% to 2.3095
- Gasoline increased 0.0032USD/GAL or 0.20% to 1.6422
- Heating oil increased 0.0141 USD/GAL or 0.73% to 1.9477
- Top commodity gainers: Wheat(2.16%),Steel(13.28%),Ethanol(1.90%), and Natural Gas(1.68%)
- Top commodity losers: Cocoa(-9.37%), Oat(-5.03%), Baltic Dry (-4.93%), and Orange Juice(-0.97%)
The above data was collected around 12:40 EST on Thursday.
Japan -0.02%(-2bp), US 2’s 1.63% (+2bps), US 10’s 1.88%(+9bps);US 30’s 2.24%(+2bps), Bunds -0.32% (-0bp), France 0.03% (-1bp), Italy 1.34% (+2bp), Turkey 12.10% (-8bp), Greece 1.39% (-61bp), Portugal 0.41% (+5bp), Spain 0.47% (+4bp) and UK Gilts 0.82% (+5bp).
- US 30-Year Bond Auction decreased from 2.430% to 2.307%
- US 4-Week Bill Auction increased from 1.500% to 1.540%
- US 8-Week Bill Auction increased from 1.520% to 1.540%
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