Tag Archive for 'John Hempton'


Gold vs. US Treasuries

John Hempton writes:

We live in a strange world – the 10 year US Treasury is trading with a 2.63 percent yield.  The market is presuming that there will not be much inflation in those ten years.  However if there is deflation (as per Japan) then the 10 year will wind up being a very good investment (see my blog post on Japanese bond yields from the perspective of a Japanese household).

At the same time gold is appreciating very sharply – from $950 per oz to $1250 in the past year – and from $800 two years ago or $450 five years ago.  On the face of it the gold price is predicting inflation.

Try as I may – I can’t see any reason why both those prices are correct.  I have long held the view that prices are mostly sort-of-rational … [s]o either there is a theoretical way in which both these prices can be correct or even my weak version of the efficient market hypothesis is spectacularly wrong.

and then asks

My first question thus is can anyone tell me why these prices could possibly be consistent?  Is there a rational reason why the bond market is pricing low inflation and the gold market seemingly pricing high inflation?  Does anybody have the ingenious world view in which both these prices are correct?

Since Blogger rejected my comment over at John’s site as being too long, I may as well reproduce it here. I don’t know about “correct” and I’m no finance guy, so my first point is that  I have no freakin’ clue.  Nevertheless, here are five, somewhat contradictory ideas, three of which might fit in a weak EMH world …

Idea #1) Yes, yes, your whole post was predicated on some weak version of the EMH. However … Treasuries, despite what the arch-conservatives are saying, are unlikely to be in a bubble (see idea #4 below).  It might (and only might!) even be impossible for them to be in a bubble.  On the other hand, gold can experience a bubble (to the extent that you concede that bubbles can exist at all).  Just because it can doesn’t mean that it currently is in one, but if it is and treasuries are not, that would partially resolve your dilemma.

Idea #2) Gold, as a commodity, is a affected by global phenomena, whereas US treasuries, while obviously still influenced by global pressures, are more sensitive to the US economy than is gold.  This statement will become more true over time as the US economy shrinks as a share of global GDP.  Therefore, perhaps you should deduce that markets are predicting low inflation or deflation for America, but quite high inflation for the world as a whole.

Idea #3) Gold, as a commodity, partially co-moves with other commodities, many of which are seeing price increases because of real, observable events in their markets (Chinese construction, Russian drought, etc).  Perhaps it is being dragged up by those (this augments idea #2).

Idea #4) In the broad market for USD-denominated investment-grade bonds, there has, I believe, been a net contraction in supply despite the surge in US government borrowing.  This is the private-sector balance-sheet correction.  One might argue, from something of a monetarist point of view, that (disin|de)flation is occurring in the US precisely because the US government is not expanding its borrowing fast enough to replace the private-sector contraction.  I mentioned this briefly the other day.

Idea #5) Another non-EMH idea, I’m afraid:  Both the USD and gold enjoy safe-haven status.  An increase in generalised fear (Knightian uncertainty, unknown unknowns, etc) will shift out the demand for both at all price levels.  To the extent that such a dynamic exists, I suspect that it ebbs away only slowly and, while elevated, is susceptible to rapid increases in response to events that would, in normal times, not affect people so much.

Update 11 Oct 2010:

James Hamilton on essentially the same topic.


The Australian Election (3 days past and the ball is still in the air)

[For any non-Australians, in the absence of Bryan Palmer and his once-magnificent-but-now-absent ozpolitics.info, John Hempton’s “guide to the Australian election for non-Australians” gives a fair overview]

[Update 25 Aug 2010: If you’re looking for reasons why the Labor Party did so poorly, I’ve had a go a listing them in my next post.]

A week and a half before the election, I noted (with no originality) that things weren’t looking good for Labor.  In the days immediately before, with the polls having started to improve again for Labor, I was predicting a narrow Labor win, possibly with the Greens taking the balance of power in the Senate (although I was skeptical on that front — I actually put the higher probability on the Coalition still having control in the upper house).  Perhaps I should have paid more attention to the polls!

As I type (AEC website updated at 24/08/2010 7:40:18 PM), the Australian Electoral Commission (the fully independent body that decides on electoral boundaries and conducts Australian elections) is estimating the results as:

  • 70 : Australian Labor Party
  • 72 : The Coalition (Liberal Party, Liberal National Party of Queensland, The Nationals, Country Liberals)
  • 1 : The Greens
  • 4 : Independent
  • 3 : Too close to call : Brisbane (QLD), Hasluck (WA) and Corangamite (VIC)

The ABC’s ever-superb Antony Green (a nerd’s nerd of the highest calibre) is currently making the following prediction for the final result:

  • 72 : Labor
  • 73 : Coalition
  • 1 : Greens
  • 4 : Independent

The four independents are Bob Katter, Tony Windsor and Rob Oakeshott (all ex-National Party) and Andrew Wilikie, an ex-Military and Intelligence official.

Tony Abbot has made a claim that since the Coalition got the most primary votes, they should be allowed to form government.  The counter argument is that in Australia’s system of preferential voting, to the extent that national vote tallies matter at all, it should be the two-party preferred total that counts, and on that basis Labor is in front (numbers here).

At first glance it would seem like the three ex-National Party independents will allow the Coalition to form a minority government, but it is not that simple.  For one thing, infrastructure in general, and telecommunications in particular, have long been issues of key concern to to National MPs.  Labor’s NBN plans would provide greatly improved services to those constituencies, while the Liberal’s policy would largely ignore them.  Farmers are not exactly enamoured of the mining industry, either, and so I suspect wouldn’t have the same opposition to the natural resource tax as the Liberal party.  Rob Oakeshott is also making noises along the lines of reforming parliamentary democracy as we know it in Australia:

Continuing his call to reinvent the parliamentary system, Mr Oakeshott said his preference was for a cross-party cabinet and indicated he may not support either side of politics if a cross-party cabinet could not be formed.

When asked if his fellow independents shared his view on “consensus politics” and his example of Kevin Rudd serving as foreign minister in an Abbott government or Malcolm Turnbull serving in a Gillard government – he said he would find out “in detail” today and how hard he would be pushing for the idea.
[…]
Looking ahead to today’s talks, Mr Oakeshott said “if we are just fluffing around, if we are just building a minority government with a bit of plus plus plus from the cross benches I’m not interested”.

“This is about trying to get to at least 76 and yes, if this doesn’t happen, if it doesn’t fly, if consensus can’t be reached we will go back to the position of three [independents] and Adam Bandt as well, making a decision on red team or blue team getting across the line in that context I’m not interested, I’m not going to play,” he said.

However, Mr Oakeshott would not rule out a cabinet position if consensus could be found.

Mr Oakeshott said elevating the role of committees, imposing deadlines on response times to recommendations and allowing private members bills to be brought to vote were critical issues for him.
[…]
Private members bills should be voted on and added he also wanted to see private members business “having some authority within the parliamentary time table”.

“If there is some sentiment for exploring creative options where this is about not political parties, not a red team or a blue team, this is about 150 members of parliament, building a majority with a focus on being able to get through some of the key national issues in this country, I’d be interested in having a conversation,” he said.

Mr Oakeshott called on the “traditional arch-rivals” to stop “pretending to be fighting to the death over ideology when they are actually more often than not in agreement on most issues”.

There is no love lost between the Coalition and Andrew Wilkie (who resigned from the Office of National Assessments in 2003 over (alleged) misrepresentations of the case for war in Iraq and Afghanistan), either, so they’re unlikely to be able to count on him.  But with Mr Wilkie’s strong stand against Pokies, he’s not likely to be all that keen on Labor, either.

Just to make things more interesting, even if Labor does form government, they won’t be able to pass any of their signature pieces of legislation for the better part of 12 months anyway, as even though the Coalition lost the balance of power in the Senate to the Greens, that won’t take effect until 1 July 2011.  If the Coalition forms government, you can therefore expect an absolute flurry of legislation between now and 30 June 2011 as they try to squeeze through everything they want before being forced to negotiate with the Greens in the Senate.


Just a smidgen more on US healthcare reform

My previous comment on US healthcare reform, which was actually a comment on the current Australian system, got quite a few eyeballs thanks to John Hempton’s shout-out.  Anyway, I thought I’d highlight a couple of new developments for my little audience.

First, Republican Senator Olympia Snowe (of Maine), who sits on the Senate Finance Committee, has said that she will vote in favour of the suggested bill being proposed by that committee’s chairman, Max Baucus.  That is good for the Democrats as it will provide valuable political cover.  It’s no guarantee that she will vote in favour of whatever the Senate as a whole end up producing, or for whatever the Senate and House then negotiate as the final bill, but it’s still a significant move and the probability of her voting for those later versions has just increased.

Second, we have the fact that the healthcare insurance industry has recently done an about-face, from actively promoting reform to actively fighting against it.  Nate Silver points out why:

Take a look at what’s happened to the share prices of the six largest publicly-traded health insurance companies since Labor Day, which was about the point at which the Democrats appeared to regain their footing — at least up to a point — on health care.

Weighted for market capitalization, these insurance stocks have lost 11 percent of their value since Labor Day, wiping out about $10 billion in value. And that’s understating the case since the major indices have gained 5-8 percent over the same period — the insurance industry stocks are underperforming the market by just shy of 20 percent.

So why have they tanked in the stock market?  Nate suggests two reasons:

Firstly, the individual mandate has been weakened to the point where it’s arguably a tokenish provision. There are good, policy reasons to be worried about this, although the insurance lobby’s reasons for being opposed — they’ll have less guarantee of an incoming phalanx of high-margin customers — are not necessarily the same as the public’s at large. The second factor is that the Baucus bill in certain ways treats the insurers fairly harshly, both taxing them directly as well as levying a surcharge on high-cost insurance plans.

I’d also suggest that the compromise version of the public option (that it be in the bill, but with states able to opt out if they wish [Paul Krugman, Talking Points Memo]) will have scared the insurance companies and investors as well.


The limits of shorting a stock

At the end of a brief post wrapped around this advertisment by the not-strictly-declared-bankrupt-yet-but-certainly-nationalised Kaupthing Bank, John Hempton observes:

I considered shorting Kaupthing several times – but did not (in part because of the cost and difficulty of borrowing the shares). Banks like Kaupthing might be insane criminal organisations – but they were also impossible to short because they might stay solvent longer than you… Three doublings and your short has become very painful – even if you are paid in the end. Add to that a 25 percentage point borrow cost for the shares and there was little chance of making money unless you shorted right at the end. Oh, and your profit (if any) was realised in Icelandic Krona – and they turned out to be worth much less than you would have hoped. It is hard to make money of this stuff – even when the end-outcome is obvious.

I do wonder how those three reasons — the market can stay insane longer than you can stay solvent, the cost of borrowing, and the fact that it was in a minor currency — rank and interact with each other for the market as a whole for short selling stock.  Given the involvement of Icelandic banks in the credit boom and — I assume — similar borrowing costs for shorting across “well developed” financial markets, the case of the Icelandic banks might arguably represent an opportunity to back out the scale of the minor-currency impediment.


A description of Australia’s healthcare system

John Hempton has gotten to it before I did and written it far better than I would have anyway.  Have a read.  Although I agree that Australia’s system is much, much better than America’s current system or any of their proposed frameworks, I would add three negative comments about Australia’s system:

  • Medicare payments to GPs for a consultation by a patient are determined centrally (at the federal level) and have not increased with inflation.  At first that meant that GPs shortened each consultation to fit more people in per day, but in the long run served, I believe, to reduce the supply of GPs and as a result pushed people with minor ailments to hospital emergency rooms.
  • I don’t know if it is better or worse than other countries, but the administrative overhead in the state government health departments is surprisingly large, even to me.  I am led to believe that adminstrators and middle-managers exceed more than 50% of the staff of Queensland Health (and that does not include admin staff on the wards).
  • The federal-state funding arrangement in Australia is a real problem.  I don’t know whether the best policy is to put all health care in federal hands or to grant the states more revenue-raising posibilities, but something does need to happen.