What does the Money Market looks like? 2

In macroeconomy, the link between money supply and inflation was established. Why do we need inflation? Wouldn’t gold standard do? Apparently, if the mandate of the federal reserve is to defend a gold peg, they can do it by letting the employment and inflation fluctuate. In the 20th century, what they discovered is that this constraints would break during crisis time such as the 1930s and the 1971 (the Nixon Shock). Someone wrote a paper looking at he 20th century history through the lens of finance, and proposed the idea that should they moved away from the gold standard at appropriate time and allowed the economy breathing room, those world wars could have been avoided.

On the one hand, a gold standard based monetary policy would exert depressionary pressure on the economy. On the other hand, too much money printing would result in hyper inflation. So the mandate of federal reserve is to target a moderate inflation rate (the newest target is aggregated 2% inflation annually) while maintain a high employment rate.

There are three tiers of monetary policy. Lowering interest rate, such that all the assets with future cashflow would have be evaluated at a higher current price, which would lend itself to higher borrowing power. All the debt can also be refinanced at a lower rate, which makes it easier to service. The second tier of monetary policy is put things onto federal reserve’s balance sheet. This is a relative new style of monetary policy started since the 2008 financial crisis. Now the COVID stuff brought about the third tier monetary policy: minting new money.

In the most traditional view of financial system, banks are the only intermediary between the money printer and those who need it. However those days has long gone. Interest Rate Swaps, Credit Default Swaps and a slue of other instruments plays the role of striping away risk from a set of cash flow. Theoretically, bank is the only institutions capable of issuing credit, but that is clearly no longer the case with all sorts of shadow banking.

On a side not, why during the 2008 financial crisis and the 2020 covid crisis, there is no inflation risk even with all the QE and money printing? because the money printing barely made up for the decreasing in credit market.

The game of monetary policy is to maintain a balance between debt accumulation and earnings stream. The most idea situation would be the newly minted money or credit goes to activities which create a new set of cash flow, i.e. expanded the economy. However, most of the time people use the money for financial instrument purchase such as housing. The worst case scenario would be all the newly created money/credit goes into financial instrument without expanding the economy at all. That way, the price of financial assets goes up but would also set the stage for a eventual crash.

When it comes to bubble, it is actually no one’s fault. When the music playing, you have no choice but to dance. That is the only rational choice. Check out this Mervyn King interview. In the beginning part of the interview, he reflected how even though all those people at the Bank of England can see trouble brewing in the background, they can’t really do anything about it because if they raised the interest rate, and no one else does. Then given the FX mechanism for importing inflation, then that would be a losing bet. The problem with a system like this is that even though you can see the tsunami coming your way, you can’t really do anything about it because the only rational choice is to keep doing that would inflame the situation. Also Perry G Mehrling’s Money View is quite informative when it comes to understand crisis.It look at the system from a market maker’s perspective.

When it comes to investment, the Ray Dalio’s all weather fund has a interesting thinking framework behind it. In his mind there are two drivers for asset valuation increase. One is inflation, another is growth. The price is set by the expected growth and a sudden price change would result from changes in expectation. When the growth rate is greater than expected, then equity does better. When the growth rate is lesser than expected, then bond does better. A contigency table approach is used to be future proof. Sort of like there are known forces to drive the price up, structure the portforlio such that no matter which force takes the upper hand, over all, the return from this entire portfolio is the same regardless of the circumstances.

My intuition is that the entire setup is way too self-perpetuating. During the upward phase of the cycle, the most minis-cure source of income can be multiplied manifolds but the only real place to place that debt is non-productivity increasing element of the economy such as the real-estate. As a player in that system, that choice isn’t really yours to make because that is actually the only rational choice at that point. The real productivity increasing activity has near zero yield. One of the common complaint during the downside of the cycle is that the line of liquidity vanished overnight. Of course they would vanish overnight, they should not have been there in the first place.WHO THE FUCK DESIGNED THIS SYSTEM TO BEGIN WITH?

Why when anything is formalized as a system, there is always an impulse to overdone it? What can be said in 10 pages just have to be said in a 1000 page book. What could have been a reasonable credit system would be magnified to the extend it is.

Here is where I come down at the economic life: there is going to be a group of people who shape the economic system into a modern one. They can win big or loose big. I am going to stay out of it.

One thing really stunt me is that everything in financial system feeds on each other, no wonder it go through violent cycles. For instance, when the Fed cut the interest rate, banks generate more creditwhich eventually made its way into asset market, rasing the prices for financial assets. Not only that, the asset pricing scheme, which is based upon the discounted cashflow model, would raise all asset prices cross the board since the time value of money, ie. interest rate is lowered. the action of lowering interest rate manifest itself multiple times through out the system, and every component feed on one another in a possitive feedback. Who freaking comes up with this system?

Coronavirus crisis lays bare the risks of financial leverage, again

Crises reveal fragility. This one is no exception. Among other things, coronavirus has revealed fragilities in the financial system. This is unsurprising. As before, reliance on high leverage as a magical route to elevated profits has led to private profits and public bailouts. The state, in the form of central banks and governments, has come to the rescue of finance on a gigantic scale. It had to do so. But we must learn from this event. Last time, it was the banks. This time we must look at capital markets, too.

The IMF’s latest Global Financial Stability Report details the shocks: falling equity prices, soaring risk spreads on loans and plummeting oil prices. As usual, there was a flight to quality. But liquidity dried up even in traditionally deep markets. Highly-leveraged investors came under severe stress. The pressures on the financing of emerging economies have been particularly fierce.


The scale of the financial disarray reflects in part the size of the economic shock. It is also a reminder of what the late Hyman Minsky taught us: debt causes fragility. Since the global financial crisis, indebtedness has continued to rise. In particular, the indebtedness of non-financial companies rose by 13 percentage points between September 2008 and December 2019, relative to global output. The indebtedness of governments, which assumed much of the post-financial crisis burden, rose by 30 percentage points. This shift on to the shoulders of governments will now happen again, on a huge scale.


The IMF report gives a clear overview of the fragilities. Significant risks arise from asset managers as forced sellers of assets, leveraged parts of the non-financial corporate sector, some emerging countries, and even some banks. While the latter are not the centre of this story, reasons for concern remain, despite past strengthening. This shock, the report states, is likely to be even more severe than envisaged in the IMF’s stress tests. Banks remain highly-leveraged institutions, especially if we use market valuations of assets. As the report notes: “Median market-adjusted capitalisation is now higher than in 2008 only in the US.” The chances that banks will need more capital is not small.

Yet it is capital markets that lie at the heart of this saga. Specific stories are revealing. The Bank for International Settlements has studied one weird episode in mid-March when markets for benchmark government bonds experienced extraordinary turbulence. This happened because of the forced selling of Treasury securities by investors seeking “to exploit small yield differences through the use of leverage”. This is the type of “long-short strategy” made infamous by the failure of Long Term Capital Management in 1998. It is also a strategy vulnerable to rising volatility and declining market liquidity. These cause mark-to-market losses. Then, as margin is called in, investors are forced to sell assets to redeem loans.


Another story elucidated by the BIS tells of emerging economies. An important recent development has been the rising use of local currency bonds to finance government spending. But when the prices of these bonds fell in the crisis, so did exchange rates, increasing the losses borne by foreign investors. These exchange-rate collapses worsen the solvency of domestic borrowers (notably businesses) with debts denominated in foreign currency. The inability to borrow in domestic currency used to be called “original sin”. This has not gone, argue the BIS’s Augustin Carstens and Hyun Song Shin. It has just “shifted from borrowers to lenders”.


Yet another significant capital-market issue is the role of private equity and other high-leverage strategies in increasing expected returns, but also the risks, in corporate finance. Such approaches are almost perfectly designed to reduce resilience in periods of economic and financial stress. Governments and central banks have now been forced to bail them out, just as they were forced to bail out banks in the financial crisis. This will reinforce “heads, I win; tails, you lose” strategies. So vast is the size of central bank and government rescues that moral hazard must be pervasive.

The crisis has revealed much fragility. It has also demonstrated yet again the uncomfortably symbiotic relationship between the financial sector and the state. In the short run, we must try to get through this crisis with as little damage as possible. But we must also learn from it for the future.

A systematic evaluation of the frailties of capital markets, comparable to what was done with banks after the financial crisis, is now essential. One issue is how emerging economies reduce the impact of the new version of “original sin”. Another is what to do about private sector leverage and the way in which risk ends up on governments’ balance sheets. I think of this as trying to run capitalism with the least possible risk-bearing capital. It makes little sense. This creates a microeconomic task — eliminating incentives for the private sector to fund itself so heavily via debt; and a macroeconomic one — reducing reliance on debt to generate aggregate demand.


The big question now is whether the essential systems that keep our societies running are adequately resilient. The answer is no. This is the sort of question the OECD’s New Approaches to Economic Challenges Unit has dared to address. Inevitably, it has created much controversy. Yet it is admirable that an international organisation is daring to do so at all. The crisis has shown us why.

We cannot afford complacency. We need to reassess the resilience of our economic, social and health arrangements. A focus on finance must be an important part of this effort.

China’s economy can only grow with more state control not less

China’s People’s Daily recently announced major new guidelines to improve the economy’s market-based allocation mechanisms. These measures signalled Beijing’s determination to liberalise the economy and implement supply-side reforms that will strengthen the private sector. They follow several years of slowing growth and surging debt, both likely to be made worse by the impact of the Covid-19 pandemic.

Mainstream economists have long called for Beijing to improve China’s market mechanisms, and they have deplored the rolling back of the private sector over the past decade. But despite years of supply-side proposals and repeated reform pledges, there has been little evidence of a substantial reversal in the trend towards greater government control of the economy.

This shouldn’t surprise anyone. Over the long term, Chinese growth might indeed benefit from a stronger private sector and a more market-oriented economy. Yet in the near and medium term, this approach will do almost nothing to address either the real causes of China’s slowdown or its growing reliance on debt. Nor would it diminish Covid-19’s economic effects.

This is because China doesn’t have a supply-side problem. It has a demand-side problem, which the coronavirus pandemic has only made worse. What is more, the rolling back of the private sector in recent years is a consequence, not a cause, of China’s underlying demand-side problem.

Until this problem is resolved, it will be almost impossible for Beijing to reverse course and overturn the trend towards greater government involvement in the economy.

Economists have known since at least 2007, although perhaps they have forgotten in recent years, that China has an extremely unbalanced economy. At the heart of this imbalance lies the very low share of income that ordinary households retain of China’s gross domestic product, compared with that of local governments, businesses and the very wealthy.

At roughly half of GDP, it is among the lowest of any country in history. As a result, sustainable household consumption, typically the largest component of overall demand in a large economy, also drives a very low share of total Chinese demand.

This low consumption has knock-on effects on private-sector investment. Most private investment goes either to increase export capacity or to serve consumption. Yet exports were never going to persist as a major source of growth in a large economy such as China’s, and today its prospects are dimmer than ever. At the same time, the relatively low share of household consumption constrains private investment too.

In other words, the healthiest sources of demand — consumption, exports and private-sector investment — are together unable to generate the level of growth that Beijing considers to be politically necessary, which until recently was deemed to be 5 to 6 per cent.

So what are the other sources of growth? In China’s case only two: infrastructure investment and real estate development.

With China already massively overinvested in infrastructure, only the government will directly or indirectly promote more. Meanwhile the real estate sector, with nearly one-quarter of all urban apartments already empty, is also crucially dependent on state support. Because an economy in which resources are allocated by market forces is unlikely to devote much effort to either sector, the only way to keep growth high is via more state support.

This is why the state has played and will continue to play an expanding role in China’s economy. As long as Beijing requires growth that is substantially higher than the economy’s real, underlying growth rate (probably around half reported growth rates) China has no choice but to expand the government’s presence. This will also reduce the market’s role in allocating resources.

Market-based reforms, no matter how aggressively implemented, will not drive sustainable growth in China. An economy in which the market allocates resources and capital can generate high growth rates. But only after Beijing completes a politically difficult but necessary redistribution of wealth — and with it power — from local governments and elites to ordinary households.

Local elites have long resisted this. But without it, promises to reduce government control in China’s economy and to increase the role of the markets will remain empty. Until demand is rebalanced, only expanding the government sector and increased debt can guarantee high levels of growth.

The writer is a finance professor at Peking University and a senior fellow at the Carnegie-Tsinghua Center

  1. the methods economists utilize to analyze a problem is worthy of attention. First, they have an observation. For instance, why money seems to go from developing economy to developed economy? Then, device a dynamical system that is as simple as it can be to explain the observed pheromone. There are all kinds of interesting toy models, island economy with only 2 agents etc.
  2. Futures market as a price discovery mechanism. The method they used to mitigate risk is thoughtful. You have to put up collaterals if you want to trade in the future’s market. Therefore, if your circumstances don’t allow you to carry out the transaction in the future, then you would be kicked out of the market before that risk is realized. This market solution to mitigate risk is something could be applied to other problems.
  3. Derivatives are insurance with specific trading constraints. The idea of a housing price put is quite practical. I wish we can have similar products here.
  4. Dynamic heading is a reasonable concept. Every time interval, your hedging strategy can be adjusted, and cash-flow reconstructed.
  5. Looking at the demographical trend, I have one question. There is not gonna be enough workforce to keep the system going. They probably need to adapt some sort of immigration scheme to get workers from Africa, and the Muslim population.
  6. I agree Michael Pettis’ definition of rich country and poor country. The former have infrastructure, institutional or hardware that allow people to create more value. Chinese government can pretty much set the GDP number to whatever they deemed reasonable, coz the way they compute that number is how much money they invested in. That is a horrible way of computing output. For instance, a bridge to nowhere would not cultivate more productive output, but it is computed as part of GDP. He thinks that the optimal amount of hardware investment is where the population can generate commensurate amount of productive output. China has long passed that point. There might not be enough cash-flow to service the accrued debt.
  7. Financial Suppression. A term coined by Michael Pettis and I can feel it. The inflation just went out of control, money today is by no means money few years ago. There are no investment instruments other than housing. Investment overseas is banned since 2016.

摘 要: 在新冠肺炎疫情背景下,特别是近几年主要发达经济体的经历与实践显示,低通胀对于央行货币政策操作和理论框架提出了挑战,也动摇了通胀目标制的理论基础。通胀既是央行观察经济金融状况的终极变量,也常是一个中间变量。传统的通胀度量会面临几个方面的不足和挑战:较少包含资产价格会带来失真,特别是长周期比较的失真;以什么收入作为计算通胀的支出篮子;劳动付出的度量如何影响通胀的感知;基准、可比性(comparability)和参照系。当前不少国家的货币政策面临着不能有效达到通胀目标的问题。需要明确要达到的目标,以及如何对目标进行测度。测度对于经济社会而言是相当复杂的,可能需要更广义的通胀概念;如何对通胀进行测度,值得进一步深入的研究。

关键词: 通胀率 货币政策 可支配收入 物价指数 资产价格
































Since he referenced Richard Koo, i went and checked him out. He cut his teeth during the Latin American debt crisis, and then was invited to a Japanese research institute during the Japanese lost decade. His main contribution is the idea of balancesheet recession. Here is a nice interview of his.

I actually watched a NHK documentary on postwar Japanese economy after that, very nicely done. First impression: US plays such a major role in Japanese monetary/development policies. When the war first ended, the alies want to make it an agricultural industry, any war related production is prohibited. Then the cold war come along US feel that they could use Japanse as a counterbalance to Russia in China, weaponary production are encouraged all of a sudden. During the war, Japnan caltivated engineering talents who almost could not find work in the post war economy until the higher ups decided that they want to invest in heavy industry. When Japanese auto industry get too popular, the US workers get upset and US forced Japan to lower their interest rates, against their own best judgement. Because when Japanese interest rate is lowered, there would be more credit in the system, there would be assumption by the japanese people. Hopefully, those consumptions include make in US product. Also the inflation would make it more expensive to make things in Japan, raising the price of make in Japan product. Althogh people in Japan has already realized that they could not keep the interest rate that low for any longer, the 1987 stock market crash happened, and leaving JP central bank with only bad options. During the boom years, Japanese businesses accrued huge amount of debt because they feel the bubble would go forever. Actually if you look at that documentary, you would realize that the speculators are the same group of people, in China, HK, Singapore, US or Japan. This is a side note, i would develop later. In 1987, the central bank of Japan feel that they could no longer just let the bubble grow and they raised the interest rate. The stock market crashed, so does the real estate valuation. When the asset price goes down like that, in the balancesheet, all those companies with debt would seem insolvent although they do have the income stream to service that debt. That is what Koo calls balancesheet recession.

For nearly 2 decades, all what companies did was to pay off their debt. The economy is mostly supported by government presurement. Yet the toll is much more than that. On a psychology level, people must feel like that couple in “The Necklace”: one mistake, enslaved themselves for the decades to come. Even after they paid off all their debt, they would never be endebted again, slowing down the economic development. Another is literally a generation of people wasting their lives. An entire generation of Japanese people who can’t be integrated into the society, with nothing better to do than to wait for their death. That is the real tragic part of the entire thing.

Koo’s idea of balancesheet recession is that during this kind of recession, govenment has to increase its spending in order to provide companies income stream to pay off their debt as soon as possible. Only after the companies has sorted out their balancesheet, can the government begin to sort out its own. I also watched Koo’s accessment of China’s situation, he seems to suggest that we are doomed to get into the middle income trap. He suggested the leadership heed Deng’s words: hide ones strenghth, bide one’s time. Wait until China goes through the middle income trap, and then flex its muscles. Becase at that time, the country would be strong enough to set the rules. Not a minute before that moment. Yet here we are, an agressive deplomatic team, an agressive expansary policy that is begged to be pushed back against. How stupid they leadership is?

Let me develop an observation of mine: the society is made up with different human spieces. For instance, the speculators of a society are pretty much the same human being, just in different nationalities. Essentially, economical policies seems to favor one kind of people other the others. In that NHK interview, all those executives seems to look back and regret they did not do what they know was the right thing to do. Are we really capable of independent judgement? Seems to me that is hard to comeby. For instance, the digital currency stuff. While I prefer to stick with cash, because it does not leave a trail of transaction records that can be analyzed and figure out who I am as a human, it is really no longer a choice. The ATM machines are no longer maintained by the banks due to the costs associated with it. Venders refuse to collect cash, institutions move their entire accounting facility online etc. The situation is such that while I have my preferences, there is really no longer an opportunity for me to carry out my prefered choice, rather, all I have to do the same thing as does everyone else. THAT IS HOW A BUBBLE GET ITS MOMENTUM. If you look at the interviews of those people who facilitated the Japan bubble, you will see that they know exactly what the right course of action is, yet they don’t have the avenues to carry out the right choice while the wrong choice is the one require zero effort.

I remember Meltzer talked about how one should make life decisions independed of government or fed policies that probably is the best approach to life. While as an aggregate, opportunities avail themselves in a temporally limited fashion, therefore, debt and credit policies are extremely important for an aggregate. For instance, India develop its software talent, Japan develop its automotive industry etc. For industry building at that level, monetary policy is the only way to go, yet for individual develpment, I don’t think opportunities are temporally concentrated. Rather, it is more depends on your judgement. Judgement is something that comes with time.