The recent Japanese stock market rally and "correction" is
almost identical to the US experience of 1933. During that period
FDR was engaged in a policy of depreciating the dollar. One problem
with this policy was that asset prices move on new information.
Thus each day the dollar exchange rate had already factored in the
expected depreciation for all of 1933. FDR could only drive the
dollar lower by doing more than expected. Surprisingly, he was able
to do so fairly effectively, partly by pushing much harder than
almost anyone expected. By the time the
price of gold
had risen from $20.67 to about $28, Keynes said enough is enough,
and called for a halt to the policy. But FDR listed to George
Warren, and persevered until he reached $35/oz.
In October 1933 FDR was dissatisfied with the pace of inflation,
so he adopted a new technique, called the gold-buying program. The
details are unimportant; the key point is that it gave FDR a way of
sending the market signals that he wasn't satisfied with the pace
of dollar depreciation. Both Abe and FDR faced a similar
problem-they needed to send signals to the market that they weren't
satisfied, that they intended to do more than the markets
Here's where the title of the post comes into play. Markets knew
that FDR would either provide more signals of monetary stimulus, or
be silent. He certainly wasn't going to call for a stronger dollar.
During the gold-buying program of late 1933, the markets knew that
on each day FDR would either raise the official price of gold, or
leave it unchanged. It would not fall. The EMH predicts that on
days where the official price of gold was not raised, news would be
viewed as more contractionary than expected, and the free market
price of gold would actually fall. And that's usually what
happened. (All the details are available in my book, due out later
this year. BTW, the 1933
New York Times
commentary on daily movements in the dollar exchange rate were
consistent with the EMH; markets moved on
more positive than expected
policy announcements, not positive policy announcements.
Many pundits are surprised that after rising by 80%, the
Japanese stock market fell by 20%. "There wasn't much news." But
that's exactly the problem (as the NYT understood back in 1933) the
EMH predicts that no news will be bad news, when the only two
plausible outcomes are further stimulus signals, or nothing.
Yes, I've oversimplified slightly; there arguably was some bad
news out of Japan, as
pointed out recently. But the lesson here is still very important.
When a market is rocketing upward under a steady drumbeat of good
policy news, even a pause in that drumbeat will cause a market
setback. After all, markets expected the drumbeat to continue, or
at least placed a positive probability on that outcome. When it
stops, prices fall. The markets know that the only two plausible
outcomes are Abe calling for a weaker yen, or Abe saying he's happy
where things are right now. Abe won't call for a stronger yen, and
investors know that.
This is why I've been less optimistic about Japan than even some
Keynesians like Krugman and Stiglitz. I regard each day's level of
stock and exchange rate data as the optimal prediction of the long
run effect. And I see that market data indicating modest success,
but well short of 2% inflation, at least in 2014.
PS. The Dow rose about 80% in the first three months of of the
1933 dollar depreciation, then fell 19% in 3 days. Sound
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