What do supply-shock stories of inflation get wrong? If the price level is the inverse value of money in terms of goods, shouldn't we expect it to rise as the number of goods falls?
Supply shocks are relative price shocks. Can't make enough TVs? Then the price of TVs has to rise relative to restaurant meals, or wages. But why should all prices go up? That takes demand, people have enough money to buy the TVs at higher prices and everything else at the same prices. In all formal models of supply shocks, look hard and you will see that the government chooses to accomodate the supply shock with fiscal or monetary expansion, to choose the possibility that everything goes up rather than some go up and some go down. Inflation is the common component, the part of all prices (and wages, ideally) that goes up together. Inflation is about one price only, really, the value of money.
Suppose we exogenously delete the world's inventory of TVs, and hold all else equal. The naive monetarist view is that given an exogenous money supply M, M now chases smaller Y, such that P rises on aggregate (a tiny amount). This occurs even absent government accomodation.
It seems that for P not to rise, we need endogenous money supply, or P determined by factors other than the purchasing power of money in terms of goods and services.
What a detailed and insightful examination of bonds! This is much appreciated.
I started buying 30 year treasuries in 1995, and sold them all at their top in 2009-12. After that I increasingly concentrated on investment grade corporates, which until the debacle of 2020-22 were providing income similar and in some cases better, to some of the stock indexes.
Since then I have wondered where it is all going and where to go.
I shall further now reread this column at least once more and think of the comments Christine LaGarde made in the Financial Times this morning. She asserts that we are in a similar period to that of the 1920´s in three defined ways.
One question that was pulsing in my mind while reading the piece is that why bonds and stocks are treated so differently when it comes to investment decisions? In the universe of available of securities, market size for government and corporate treasuries are very much comparable to the market capitalization of US stocks. If it's roughly $55 Trillion for the stocks, then the market value for US public fixed-income instruments are roughly $45 Trillion (if we include agency, municipal and money markets).
So, thinking of the market portfolio only on the basis of equities leaves almost half of the public markets unaccounted for. Is it perhaps the reason why market beta is lacking when it comes to risk? In any case, I feel the market portfolio should include bonds appropriate to their market cap. I find it perplexing that market-capitalization-weighted stock ETFs are so popular but not bond ETFs. After all, both security universes are by and large occupied by the same institutionals. Perhaps, you can touch upon this paradigm?
John, brilliant exposition. In 1982, the 30 year treasury rate was about 13.75 %. Our partnership bought a thousand bonds and held them. We used the the coupons to finance hedged trades with derivatives. Our bellwether was CAPM to determine risk adjusted returns. Our philosophy; there is a Cauchy demon out there, undefined variance. Trade and invest so we know what the most one can lose is certain. As for the elusive alpha, over a long time horizon, our average alpha was ZERO just as the EMH would predict.
"Do you have assets such as a business, a job, or real estate? Are you a pension fund or endowment with a liability stream to fund? Then betas with respect to the market portfolio are not relevant." Betas with respect to a market portfolio may not be relevant, but in terms of returns on human capital, I suspect people and pension funds make implicit judgements about risk in terms of opportunity costs. Of course I could be wrong.
You ask, “What kinds of shocks generate a positive correlation, and what kinds of shocks generate a negative correlation?” Arthur Laffer wrote presciently that when stock and bond prices move together it’s because inflation expectations are changing. If the correlation is negative, growth expectations are changing.
What do supply-shock stories of inflation get wrong? If the price level is the inverse value of money in terms of goods, shouldn't we expect it to rise as the number of goods falls?
Supply shocks are relative price shocks. Can't make enough TVs? Then the price of TVs has to rise relative to restaurant meals, or wages. But why should all prices go up? That takes demand, people have enough money to buy the TVs at higher prices and everything else at the same prices. In all formal models of supply shocks, look hard and you will see that the government chooses to accomodate the supply shock with fiscal or monetary expansion, to choose the possibility that everything goes up rather than some go up and some go down. Inflation is the common component, the part of all prices (and wages, ideally) that goes up together. Inflation is about one price only, really, the value of money.
Suppose we exogenously delete the world's inventory of TVs, and hold all else equal. The naive monetarist view is that given an exogenous money supply M, M now chases smaller Y, such that P rises on aggregate (a tiny amount). This occurs even absent government accomodation.
It seems that for P not to rise, we need endogenous money supply, or P determined by factors other than the purchasing power of money in terms of goods and services.
What a detailed and insightful examination of bonds! This is much appreciated.
I started buying 30 year treasuries in 1995, and sold them all at their top in 2009-12. After that I increasingly concentrated on investment grade corporates, which until the debacle of 2020-22 were providing income similar and in some cases better, to some of the stock indexes.
Since then I have wondered where it is all going and where to go.
I shall further now reread this column at least once more and think of the comments Christine LaGarde made in the Financial Times this morning. She asserts that we are in a similar period to that of the 1920´s in three defined ways.
We all know how that ended.
Vic. Nice trade. Please see my post. I bought them in 1982.
One question that was pulsing in my mind while reading the piece is that why bonds and stocks are treated so differently when it comes to investment decisions? In the universe of available of securities, market size for government and corporate treasuries are very much comparable to the market capitalization of US stocks. If it's roughly $55 Trillion for the stocks, then the market value for US public fixed-income instruments are roughly $45 Trillion (if we include agency, municipal and money markets).
So, thinking of the market portfolio only on the basis of equities leaves almost half of the public markets unaccounted for. Is it perhaps the reason why market beta is lacking when it comes to risk? In any case, I feel the market portfolio should include bonds appropriate to their market cap. I find it perplexing that market-capitalization-weighted stock ETFs are so popular but not bond ETFs. After all, both security universes are by and large occupied by the same institutionals. Perhaps, you can touch upon this paradigm?
John, brilliant exposition. In 1982, the 30 year treasury rate was about 13.75 %. Our partnership bought a thousand bonds and held them. We used the the coupons to finance hedged trades with derivatives. Our bellwether was CAPM to determine risk adjusted returns. Our philosophy; there is a Cauchy demon out there, undefined variance. Trade and invest so we know what the most one can lose is certain. As for the elusive alpha, over a long time horizon, our average alpha was ZERO just as the EMH would predict.
"Do you have assets such as a business, a job, or real estate? Are you a pension fund or endowment with a liability stream to fund? Then betas with respect to the market portfolio are not relevant." Betas with respect to a market portfolio may not be relevant, but in terms of returns on human capital, I suspect people and pension funds make implicit judgements about risk in terms of opportunity costs. Of course I could be wrong.
You ask, “What kinds of shocks generate a positive correlation, and what kinds of shocks generate a negative correlation?” Arthur Laffer wrote presciently that when stock and bond prices move together it’s because inflation expectations are changing. If the correlation is negative, growth expectations are changing.