Another slow news day today. The US equity market is only open for half the day. The disbursement of the next Greek aid tranche remains uncertain, with Samaras having finally sent a letter to the EU authorities backing the bail-out plan, but saying that “certain policies have to be modified.” It is not yet clear whether this will be enough for Germany. I think it shows that Samaras is keen to appear to be a tough negotiator but he has a weak hand and will probably fold if the EU decides to force the issue — so I expect the next tranche of aid to be disbursed one way or another.

I am presently short EUR/USD, Brent Crude and the S&P 500. Each trade is showing a profit. The question is how long I should stay short. I have used a regression of S&P 500 EPS on the index level to see what the index is pricing for earnings, and the answer, whatever time period you use, is that it is pricing quite a decline. Yet earnings remain high and US consumers are spending. Leading indicators are mixed, rather than negative. This is making me nervous. Markets are pricing a recession in Europe and a growing probability of a disaster, and also a slowdown in China. I think China will keep the show on the road and that disaster will be averted in Europe, although a recession will not. So I wonder how much further the S&P 500, in particular, has to fall. With no solution imminent in Europe I am going to stay short for the time being but I need to take the danger of a stronger US economy seriously. It is something of a consolation that, as economic data flow improves, the prospect of further monetary easing in the US recedes.

The US Gross Domestic Income (GDI) number for Q3 is out. In recent years, GDI has been gloomier than GDP, and the latter has tended to be revised down towards the former. The Q3 figure was +0.4%, compared to +2% for GDP. Perhaps there is more underlying weakness in the US economy than the recent flow of data suggests. 

Finally today, a correspondent asked yesterday whether I was familiar with Austrian economics (having spoken to some economists who had never heard of it), and I thought I would include my response. I do not know a huge amount about it and would be grateful, as always, for any corrections to my view:

“You make a good general point — there is a lot of ignorance among economists. This would not in itself be a problem if each economist confined himself to his area of expertise (many biologists probably could not give a full account of the state of biology, for example), but many economists seemingly feel qualified to opine of on the state of economics without much understanding of schools other than their own.

I am aware of basic ideas of the Austrian school and have read Eamonn Butler’s primer on the subject, and a friend of mine is something of an enthusiast — we have some good debates, although generally about particular issues of the moment rather than school-vs-school. I have found that some ideas that originated with the Austrian school — such as marginal utility theory and credit cycles — are useful. And there is no doubt that mainstream macroeconomics was stuck down a back-alley before the economic crisis. But mostly I think what is useful in the Austrian school has found, or is finding, its way into mainstream economics, or at least into my world-view. What appear to be fundamental tenets of the Austrian school — that printing money will result in price increases, for example — have been wrong in the past few years. And I disagree with some of its tenets on the desirability of recession and deflation. A return to a gold standard would mean periods of deflation, and I think deflation is very damaging. Letting recessions run their “natural” course is cruel and unnecessary.

The most important point is that I have found a traditional Keynesian analysis — using an IS-LM model — to be a very good predictor of what would happen in the crisis and afterwards. It predicts that economic growth will remain relatively depressed and that interest rates will not rise significantly. Paul Krugman actually made these predictions early in the crisis, and he has been right. Economic growth remains depressed and US interest rates, in spite of continual predictions that they will rise to unpleasantly high levels, are presently heading for all-time lows. It is my job to make money by taking bets on such things, and Keynes has helped me to make the right ones. Of course, if some other theory becomes more useful, I will back that — I have no loyalty to any economic theory. But while Keynes remains useful, I remain a Keynesian.”
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