Comments on: The implications of a downgraded US A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: breezinthru Wed, 20 Apr 2011 03:43:43 +0000 @EconomistduNord

You must have just got out of the wrong side of the bed this morning and it has followed you into the afternoon.

Felix pointed out the errors in Krugman’s suppositions, even to the point of suggesting a G-Zero paradigm shift in the world’s economic relationships.

For what it’s worth, I’d argue with the last sentence of the article which states that there isn’t anything that America ‘can’ do to alter that course. It would be more correct to state that there isn’t anything that America ‘will’ do.

I think there are actions that could be taken that would, in a decade or so, restore America’s position atop a unipolar world economy, but those actions would be drastic.

There is no reason for us to engage in those drastic measures because we already had six decades in that pinnacle position and during that time our system of government, law and finance failed miserably at keeping even our own house in order.

By: EconomistDuNord Tue, 19 Apr 2011 17:11:36 +0000 World’s stupidest opening paragraph:

“Paul Krugman, looking at Japan, says that today’s S&P news is “no big deal”, based on the fact that Japanese long-term interest rates stayed low even after the country was downgraded in 2002. But of course if the fate of the US over the next 9 years is remotely similar to the fate of Japan over the past 9 years, that’s going to be a very big deal indeed”

That’s like saying, “Paul Krugman says those raindrops we felt are no big deal, but if they turn into a gigantic hurricane then it is a big deal.”

Um, duh.

That drive who looked at you funny is no big deal. But if he goes insane and slams into you killing your whole family, then it is a big deal.

Talk about setting up straw men. Come on Felix, you’re smarter than this kind of Kudlow-worthy BS argument.

By: NewsLady Tue, 19 Apr 2011 16:22:23 +0000 What a vague and misguided column. We’ll start with the vague:

“That said, however, there is a silver lining if you look hard enough. “Efficiency”, after all, is a nice way of saying “fragility”. As a general rule, the more efficient something is, the easier it is to break.”

What is that supposed to mean? Why would an efficient system be less robust than an inefficient one? Maybe I’m missing something, but I don’t even see how that would be true even on a physical level. But presumably you are assuming it is true physically, then extrapolating — on the basis of nothing — to say it must be true economically.

Which means WHAT? Got any EXAMPLES?

Does anyone?

If a system is efficient, it is likely to be widely adopted, and it must then be robust to withstand the heavy demand. That’s all I can think of, and it’s the opposite of your conclusion.

Now for the misguided: “national debt ratios naturally tend to go up rather than down, unless and until some kind of external constraint is imposed by the markets and/or ratings agencies.”

Really?? Congress has nothing to do with this “tendency” at all? I guess they must be like the 300-lb. man who eats 6,000 calories a day and blames his weight on hormones. Can’t help the “tendency.” That would mean the unthinkable — accepting responsibility.

By: TFF Tue, 19 Apr 2011 15:17:06 +0000 “In that real world, interest rate normalisation would need only to reach 3.5% before 1 tax dollar in 3 would go to servicing that debt.”

That’s not precisely true, nb. The government is running a large primary deficit. Debt service flows directly to borrowing.

Time for the Treasury to issue eternal zero-coupon bonds. They would increase in value, according to a floating interest rate, but pay no interest and never mature.

By: Greycap Tue, 19 Apr 2011 12:30:01 +0000 Christofurio, The risk-free rate is important theoretically because it is the return of a hedged portfolio. However, it has never been an observable traded asset, and historically LIBOR has been a close proxy than treasuries (the treasury rate usually being farther below the risk-free rate than LIBOR is above.)

To actually execute a hedge on which arbitrage depends, one has to lend or borrow at market rates that are not risk-free. Thus, even if one could observe the risk-free rate, its use in a pricing formula would only be an approximation. Post 2008, one has to jump through all sorts of hoops to construct a discount curve, and maintain more of them (the price of a derivative in a collateralized portfolio being observably different from the price on a stand-alone uncollateralized basis.)

Treasuries are more important for commercial banking in the real economy, where they are used as lending collateral – commercial entities do not have access to insured deposits. As this collateral becomes riskier, the banking system becomes more fragile and susceptible to runs; exactly contra Felix’s theories.

By: dWj Tue, 19 Apr 2011 02:04:23 +0000 Christofurio: More generally, all those parameters are kind of inferred from every derivatives price. Note that “implied volatility” is entirely derived from options prices (not vice versa). The major role of Black-Scholes is to provide some guidance toward interpolating the price of one derivative from the price of a bunch of other ones.

By: dWj Tue, 19 Apr 2011 02:01:56 +0000 > That said, however, there is a silver lining if you look hard enough. “Efficiency”, after all, is a nice way of saying “fragility”. As a general rule, the more efficient something is, the easier it is to break. So if we want to move to a more robust world with fewer major crises, there will necessarily be a price to pay in terms of global efficiency loses.

Insofar as “efficiency” and “fragility” are uncorrelated in the world we observe, it’s a selection effect; if something is inefficient, why wouldn’t we fix it? Perhaps because it’s more robust. If something is fragile, why wouldn’t we fix it? Perhaps because it’s efficient. In econospeak, we’re moving along a frontier.

The last sentence of your paragraph, then, seems quite likely — if we want more robustness, we have to give up some efficiency. Hence the sentence before that, as well. There is no silver lining, however, in exogenous efficiency losses that have no robustness benefits, and there is nowhere here where you actually argue that there are robustness benefits to the loss, in particular, of a global reserve currency.

The second sentence of the paragraph was presumably designed to appear as though it came from left field, and boy did it.

By: guanix Tue, 19 Apr 2011 00:54:31 +0000 Christofurio: Observe option prices, assume put-call parity, and back out r.

By: Christofurio Mon, 18 Apr 2011 23:54:30 +0000 What will become of the Black-Scholes formula if the US Treasury gets an S&P downgrade?

Any use of the Black-Scholes formula requires a value for “r,” the risk-free rate of return. My understanding is that T-bills have provided a proxy for r.

What happens if they don’t anymore? If every instrument in the world is recognized as some risk, “r” will presumably remain in this and other formulas, but will have to be defined in some new manner.

Anybody have any idea (a) how that would be done and (b) how much of an upheaval, at least within the smallish world of financial mathematicians and modellers, this will create?

By: frit Mon, 18 Apr 2011 21:49:27 +0000 “And there’s precious little that the US or its legislators can do about it.” Well, I suppose the could exacerbate it in all kinds of ways, by, for example, defaulting on the national debt for short-term political gain. Or engaging in absurd levels of brinkmanship on the issue.