The Daily View: Wealth Inequality and Bond Market Liquidity

Today’s idiot: ‘The problem isn’t that we’ve been slaves to free markets’: Joseph Stiglitz interview

Unlike Thomas Piketty, whose recent bestseller Capital in the 21st Century argues that capitalism makes rising inequality inevitable, Stiglitz insists the system can be fixed. ‘Widening and deepening inequality isn’t driven by immutable economic laws,’ he says. ‘A well-functioning market economy doesn’t only create jobs, but should also generate increases in income that are shared.’

But it kinda is immutable. In a free-market system, as the economy grows, certain individuals and companies will have a disproportionate impact , and it’s reasonable to assume/expet that those entitles and individuals will be richer than the mean. We are spreading the wealth…look how much entitlement spending has grown in the past decade alone. We also need to take into account the role of IQ, too, in that maybe some people are falling behind not because of greed from the top, but because they may not be smart enough to acquire the skills necessary for gainful employment.

People Are Worried About Bond Market Liquidity

Smaller trades, higher price impact, more flash crashes: It all sounds exactly like equities. Human traders are being replaced by algorithms, and algorithms are weird. They move fast, for one thing, and they are flighty. They open up the possibility of seven-sigma events: Electronic traders can turn off their algorithms, unlike classic human dealers. If you want to sell Treasuries, and the buyers have reached their risk limits and turned off their algorithms, the price can crater in the time that it takes you to call up Pimco and say “rates have blown out, wanna buy some bonds?”

Beyond the short-run where liquidity could matter, the importance of liquidity tends to be overstated. Asset classes, whether they be stocks or bonds, always gravitate to some ‘fair value’, regardless of how liquid the underlying market is. Low liquidity can create wild moves in the short-run, but in the long-run it matters less. Look at Enron for example, a highly liquid company that within just a couple years went from being worth $50 billion to zero. High liquidity couldn’t override it’s non-existent fundamentals. Or look at how AOL went from being a small, thinly-traded stock in the early 90’s to eventually buying-out what was biggest media company in the world, Time Warner, in a $162 billion merger. So while the treasury market may behave like a roller coaster, the destination depends on fundamentals. If somehow we have hyper-inflation, then the bond market will reflect that, regardless of the liquidity. It could be 100 treasury bond contracts or 100 billion . Doesn’t matter.

In the short-run, low liquidity may mean that if someone wants to sell he won’t get as good of a price than if there were more liquidity, or if he does sell the price will fall a lot more than if there were more liquidity. But what happens in these situations is if the price deviates too far from the fundamentals, someone will always step in and buy. It it only takes 100 contracts to make the price of some bond market fall x%, it should only require 100 to make it go back up x% by virtue of price & volume symmetry. It’s not like the low volume only works in one way; it helps both bulls and bears.

Sharp selloffs in U.S., Europe bond markets remain a mystery, U.S. risk watchdog says

A medium term treasury bond (7-10 years) tends to be 50% as volatile as the S&P 500. A long-term bond (30 years) is about 30-50% more. Just as indexes can fall a lot, such as in 2008, so too can treasury bonds. The distribution of treasury bonds returns has a fat tail, meaning there are have long periods of inactivity punctuated by sudden volatility and price decline. It’s not a mystery that requires a committee to solve – its just the way long-term bond markets work.