Hope, hype and happenstance: Part II




Disclaimer
Ok . I didn't ask for permission to republish this cartoon, but I reckon I am giving it the best possible publicity here and the getting your message out there, as we shall see, seems to be all that matters.

Introduction

The primary purpose of my blog is prediction. From time to time I also include short discussions to further the understanding of the art of forecasting. Occasionally I indulge myself by taking a diversion into something such as how the broader planetary cycles manifest in other areas such as music. I don’t, however, usually devote space to my personal opinions on economic or political policy. This post represents a dramatic departure. It is not about astrology, nor is it about prediction; it is purely and simply about economic policy and hype.

One might think that hype and economics would be poles apart: one a function of psychological manipulation, the other of mathematics. But hype doesn’t automatically work. It won’t work if the evidence completely contradicts it. And it works best if there is a smattering of “scientific proof” (better known as misleading statistics) to convince. It works best of all when its proponents also fall for their own snake oil; when they read about each other’s statistical models and become as totally convinced of their own righteousness as American evangelical preachers.

Bubbles we have lived and loved
Remember the late 1990s? Remember the dotcom boom? If you weren’t such a victim of that particular bubble that you have conveniently blocked all trace of it from memory, you will recall how every newspaper and TV channel was full of the “new paradigm” that guaranteed infinite wealth for those brave enough to invest in a web-holding page with a fancy brand name and nothing else, and that the Dow would soon be at 36,000 on the back of the fact that profit was no longer an essential quality of a successful business. Sceptics were mocked as dinosaurs. No wonder so much of that particular hype was sustained even after the markets had peaked.

Profit eventually regained its role as the primary goal of any business model but soon we were hearing that it was property that could only ever go up. Economists, academics and consultants jumped on the latest (fee generating) hype bandwagon telling us how the UK population was rising, and that this would lead to limitless demand for houses (but see note 1). Other vested interests chipped in, to explain how gearing up on your property investments would make you as wealthy as an x-factor judge in your old age. And, if you had more money than you could possibly ever need to gear up your property investments, not to worry; you could gear up your private equity investments as well.

Whilst developers, property services companies and private equity groups have been shrinking like Alice after following the “drink me” instructions, many members of the public are still coming to terms with the fact that they were victims of this particular hype.

They are also only just coming to terms with the fact that “buying and holding” equities hasn’t quite materialised as the brilliant investment strategy that proponents suggested over the last 20 years.

That is all very well, you say, but these were all driven by market vested interests, the same situation can’t happen in the whole economy? There we have economic theory to underpin our actions. Hype won’t work if we have a truly solid foundation, right? Right! But, wrong! We don’t have anything like a solid foundation.

Economic theory is useless
As professor Willem Buiter pointed out in his FT blog of 3rd March 2009, (ages ago but actually at the time I wrote most of this- note 2) most economic theory is useless. The trouble is not that the mathematical models of economics fail in themselves; they are mathematically perfect and quite beautiful in their own way. But, as Buiter describes, they assume states which are for all intents and purposes practically irrelevant.

In this case the PhD mathematicians were so busy differentiating to the nth degree that they didn’t do the simple arithmetic. If they had they would have realised that at the rate per annum at which the hedge funds and traders were accumulating wealth, the whole GDP of the world would be in a few hands in less than 2 decades. So, unless you are a philosopher who believes that having got all the angels in existence onto your pinhead you don’t have a problem populating the other end of your pin, you logically have a practical problem.

And if you think that hype just restricts itself to market participants, you are destined to be disappointed and you probably haven’t noticed that the so called government is run by communications consultants. Simply, the leaders didn’t know, the traders didn’t care, and the spinners didn’t know or care as long as they got paid.

If you are a UK resident, you will recall the Gordon Brown promise of “no more boom and bust.” We’ve run an economy to ruin over the last decade on the basis of that little hype gem. Even just two years ago in March 2007, I sat in a financial services seminar while an “expert” showed us a series of graphs which “demonstrated how successful” the UK economy had been over the previous ten years. The room was full of representatives from the financial services industry, but no-one challenged a single premise on which this presentation was based. I sat there shaking my head in disbelief, but even I didn’t ask the 64 trillion dollar question “what element of that so called growth disappears when you strip out the effect of credit growth?” (Even Cassandra can be afraid to challenge the hype when representing her employer rather than herself).

But the UK in the 2000s was only a microcosm. The economic theory that underpinned the above bit of hype was only an extension of the prevailing theory about free and efficient markets and growth that has dominated US policy for the last 5 decades.

But you are probably asking “Now we recognise the hype of the last decades for what it was, why is there still a problem?” The problem is that, we are still buying into that hype and now we are the naïve recipients of its extension which is, at least, as dangerous as anything we have encountered before.

What is that is being hyped now? Keynesian solutions.

Keynes: another time another place, please
This is not a critique of Keynesian or New-Keynesian theory. Nothing wrong with these in their place; I can see (without a single mathematical model) the sense in what are essentially counter-cyclical government policies. Under conditions where the private sector has failed to allocate sufficient resources, no harm at all in a bit of public sector stimulation, a few periods of low interest rates etc. And of course that’s why the hype is working – because the theories are mathematically logical and perfectly justifiable under the right conditions.

The problem is this is most definitely not the time and place for stimulation. In my view the current situation is the opposite of the one Keynes envisaged.

For the last two or three decades, increasing cheap credit led the private sector to allocate too many resources to… well pretty much everything really. The US called this growth and attributed it to their economic superiority (and indirectly to the superiority of the prevailing economic models). The time for intervention was then, although the intervention required would have been the opposite of stimulation. Now, the credit drug fuelled party is ended we might have had a chance to get a much more sustainable allocation of private sector resources. Sadly that has not happened.

Instead, we are getting more and still more stimulation, all based on the principle that Keynesian economics is the right medicine for the condition.

There are a lot of lay people, not yet been exposed to the full onslaught of the hype, who are still saying, “how can these type of solutions help a situation where there is already so much debt?” No doubt all but the “criminally insane” among them will soon capitulate under the tidal wave of expert en-masse advocating the same solutions. How can the average lay person resist when even the professionals are in concord?

Do I have a better solution? Or, more to the point, as the spinners will ask “do I have a KISS solution they can sell to the masses? The answer is no. I can’t pick up the milk and put it back in the broken bottle anymore than the next person. But I am wise enough not to spill another bottle in order to hide the mess from the first. Until time travel becomes a reality, it is too late for solutions to problems that arose in the past.

Hope or happenstance: where we are going now
Buiter ended his blog entry with “I believe that the Bank has by now shed the conventional wisdom of the typical macroeconomics training of the past few decades. In its place is an intellectual potpourri of factoids, partial theories, empirical regulaties without firm theoretical foundations, hunches, intuitions and half-developed insights. It is not much, but knowing that you know nothing is the beginning of wisdom”. In any case it looks like the milk is mainly frozen in the bottle and is not spilling out as planned. That can only be a godo thing for the future. We can hope, but as we saw in Part i hope isn’t all its cracked up to be either.
Of course, it is also too late for me to be writing this. It is always too late when so many decades of spin have obscured reality to such an extent. So now the consequences will unravel as destiny decrees that they will. And that is where astrology comes into its own. For my views of that, see part three of this little series – happenstance.


Notes

1) though they failed to point out that population was not growing as fast as in the first half of the 20th century ( 38m to 50m from 1900 to 1950 (30% increase) and 50m to 60m from 1950-2000 (20% increase)) or that almost all the growth from 1965 to 2005 was in the over 60 age group ( hardly first time buyers), or that the late 80s house price increase was actually a lag effect of the 1970-80s inflation.

2)Yes, I got distracted by other matters. But no matter as you see the intervening weeks have been relatively uneventful.

3) I am not here questioning the bail out of certain elements of the financial system: unlimited for private and non-financial corporate depositors. Such action would be required to stabilise the whole system. Only the bail out of the whole failed structures.

Sources
Willem Buiter's Maverecon blog, Financial Times, March 3, 2009

Comments