Archive for the Category Forecasting


Was the dotcom mania “mad”? (And let’s lower the relative status of pessimists)

Tim Harford has a very good piece on bubbles in the FT.  This caught my eye:

Yet even with hindsight things are not always clear. For example, I first became aware of the incipient dotcom bubble in the late 1990s, when a senior colleague told me that the upstart online bookseller was valued at more than every bookseller on the planet. A clearer instance of mania could scarcely be imagined.

But Amazon is worth much more today than at the height of the bubble, and comparing it with any number of booksellers now seems quaint. The dotcom bubble was mad and my colleague correctly diagnosed the lunacy, but he should still have bought and held Amazon stock.

I wish I had bought Amazon in the 1990s, just as I wish I had bought Bitcoin at $12, when I was writing posts claiming that it was not a bubble.  But I didn’t, and given what I knew at the time there was really no reason for me to do so.  But what about the claim that “the dotcom bubble was mad”?  I do recall people saying that in 2002, after the bubble had burst and the NASDAQ fell to 1200.  But is that true?

The argument made in 2002 is that tech valuations made no sense unless you believed that tech companies would push aside old stalwarts like GE, GM and Walmart, and that companies like Apple and Amazon would become the most dominant corporations on Earth.  Well, hasn’t that happened?  Another argument was that you’d have had to believe that all the dotcom companies would be successful.  Actually, if you didn’t know which ones would be successful, it would have made sense to buy an index fund in the NASDAQ.

The NASDAQ peaked at just over 5000 in early 2000, but that was for just a very brief period.  The average “mad” dotcom investor would have purchased stock at some time during 1999 or 2000, probably at a NASDAQ level closer to 3500 or 4000.  NASDAQ is now above 7200, and if you add in dividends it would not be unusual for an investor to have doubled their money over 18 years.  That’s not particularly good for a risky investment, but it’s not horrible.  It’s a higher rate of return than T-bills, but lower than T-bonds.  But keep in mind that T-bond investors lucked out, as actual NGDP growth was far less than expected when T-bonds were yielding 6%, and if people had known what was going to happen to the US economy, yields would have been far lower in 2000.  Alternatively, if NGDP had grown as expected, the NASDAQ would be far higher today.

Just to be clear, even today it seems like the tech market was a bit frothy at the peak in March 2000, I’m not denying that.  But my point is that all of these judgments are provisional.  If people really believe that markets are irrational, they ought to be writing posts in the FT talking about the negative bubble of 2002.  What were those morons thinking when they sold tech stocks when NASDAQ was at 1200?  Were they insane? Were they idiots?  Instead, pessimism is intellectually respectable so the pessimists get off scot-free, while optimists are ridiculed for being wrong.  Why?

Here’s how the FT article starts out

“Prices have reached what looks like a permanently high plateau.” That was Professor Irving Fisher in 1929, prominently reported barely a week before the most brutal stock market crash of the 20th century. He was a rich man, and the greatest economist of the age. The great crash destroyed both his finances and his reputation.

The fact that Fisher’s wrong prediction had any impact on his reputation is a sad commentary on our society.  His forecast should have attracted no more attention than his forecast as to who would win the World Series.  Would Fisher’s reputation have been damaged if he got a baseball game wrong?

And if we really should trash people for their bad calls on the market, why isn’t Robert Shiller’s reputation damaged for his claim that stocks were overpriced in 2011, when in fact it was near the beginning of one of the great bull markets in US history?  Why trash the optimists but not the pessimists?

And why aren’t the Chinese bears being called to account for all their predictions of a crash in the Chinese economy, or of 3% average real GDP growth during the decade of the 2010s?

Just to be clear, I’m not saying anyone’s reputations should be trashed.  My complaint is that other people are trashing great economists like Irving Fisher with no justification at all.

Speaking of China, remember all those predictions that it would get stuck in the middle-income trap?  Read the following from another FT story, and ask yourself how often you read those sorts of things about Turkey, Brazil or other countries that are actually stuck in the middle-income trap:

Here, too, China is catching up. Chinese internet leaders Tencent and Alibaba have a combined valuation of $1tn. Add in another $200bn or so for Baidu, and Netease plus other listed or unlisted companies, such as Toutiao, Meituan and Didi, and the scale of the Chinese market becomes apparent. Trends emerging in China are beginning to shape the future of the global tech landscape. To its dominant role in the supply chain we can now add a “demand chain” aspect to the country. . . .

Massive investments in mobile broadband and a highly competitive handset market means that nearly all of China’s approximately 750m internet users use smartphones. Payments via QR codes, led by Tencent’s WeChat and Alibaba’s Alipay, are making cash obsolete. Dockless bikes line the streets of Chinese cities. The country’s physical infrastructure — roads, high-speed trains and airports — are facilitating as big a boost to consumption as President Eisenhower’s roll out of the Interstate Highway System in the US in the 1950s.

I have lived in Beijing for more than 20 years, yet only in the past year have I felt on returning to London or Silicon Valley that I’m going backwards in time. For urban residents, China is increasingly a study in frictionless living. Hopping on a bike, ordering a meal from a huge range of restaurants, paying for utilities, transferring money to friends — all can be done at the touch of a button. Internet services in the west offer increasing convenience no doubt — but nothing beats the experience in China.

What part of “developed country” is China not going to be able to do by 2035?  Be specific.

Don’t expect the future to be like the past

Garrett MacDonald directed me to a interesting article by Paul Donovan, chief economist at UBS.

What can we forecast about next year?

Among the many interesting points, this caught my eye:

The ups and downs of the economic cycle may be less violent than they used to be. Recessions are probably less recessionary in the future (see the July Chief Economists comment “Will recessions be less recessionary in the future”).

I often point out that the US business cycle has some very bizarre features:

1.  Expansions never last more than 10 years.

2.  There are no mini-recessions.

The first is bizarre because recessions seem to occur randomly, not according to any fixed cycle.  Expansions do not die of old age.  You’d expect some expansions to just randomly drag on for more than 10 years.  The second is bizarre because you’d expect that whatever process causes recessions (some sort of shock?) would create far more mini-recessions than sizable recessions.  Think about how there are far more small earthquakes than big earthquakes.  Instead, the United States NEVER has mini-recessions, defined as an increase in the unemployment rate of more than 0.8% and less than 2.0%.  That’s just bizarre.  (And even the one 0.8% increase was due to the unusual 1959 nationwide steel strike—normally there is almost no increase in unemployment beyond random noise, unless unemployment soars much higher.)

Before you respond with good reasons why these patterns are not bizarre, I’d like to point out that other countries such as Britain and Australia do have economic expansions that last much more than 10 years, and they do have mini-recessions.  So the US really is a very weird place.  But for some reason American economists don’t seem to pay much attention to this weirdness.

I’m on record as predicting that this will be the longest expansion in history, the first that extends for more than 10 years.  Now I’d like to go on record predicting that we will see some mini-recessions in the next few decades.  I don’t see any reason why we haven’t had them; other countries have them, so why can’t we?

Here’s another interesting point:

Economics can generally predict central bank policy. This is hardly surprising. Central banks – at least, the good central banks – are run by economists.

In the past I’ve argued that economists don’t blame central banks for recessions because central banks follow the consensus of economists, and economists don’t want to blame themselves.

Economists should not make forecasts.

In the past, I’ve argued that good economists don’t forecast, they infer market forecasts.

PS.  Here are 6 British mini-recessions, in each case with the unemployment rate rising by about 1%.

And here are three recent mini-recessions in Australia, in each case with unemployment rising between 1% and 2%:

Off topic:  Did Jesus once say: “Blessed are the beta males: for they shall inherit the earth”?  Scanning the recent news headlines, it almost seems like his prediction is coming true, after 2000 years.

PS.  Here’s an excellent USA Today editorial on Trump. The press has been way too soft on him.

How many times?

Here’s Tim Duy at Bloomberg:

It was supposed to be easy. When the Federal Reserve started hiking the federal funds rate, longer-term interest rates would rise. After all, they were at very low levels, restrained by a low-term premium. The “Greenspan conundrum” of the past two cycles, when long rates failed to respond in line with higher short rates, couldn’t happen a third time in such circumstances. But it didn’t work out that way. Short rates continue to gain on firming expectations of tighter Fed policy while long-rates stubbornly track sideways.

How many times does this have to happen before people stop assuming that higher interest rates represent tighter money?  In fact (as Duy suggests) a tighter monetary policy will often put downward pressure on longer term rates (relative to short rates):

We shouldn’t be surprised by the flattening yield curve. That is what typically happens during tightening cycles and there was no reason to think it would not be the case this time.

Longer term bond yields tend to track expected long-term NGDP growth, although of course other factors also play a role.  But expected NGDP growth is by far the most important factor, and largely explains why long-term rates are much lower than during 1972-81, when NGDP was growing at double digit rates.  And tighter money tends to slow expected NGDP growth.

The yield curve is one of the better predictors of the business cycle, but it’s not perfect.  The current yield curve is flatter than usual, but not flat enough to predict a recession.  (Research suggests that it would need to be substantially inverted to signal a recession is more than 50-50.) Given that stocks are doing quite well, I’d say that the consensus view of the financial markets is that a recession is unlikely during the next few years, but not impossible.

Duy also points to the continued undershoot of inflation:

Arguably, though, the Fed only reinforces expectations that 2 percent is a ceiling with its commitment to rate hikes even as inflation remains below that level. In fact, monetary policy makers appear dead set to continue rate hikes next month, and into 2018. The message sent is that they stand ready to snuff out any expansion that threatens to push inflation above 2 percent.

It’s difficult to evaluate Fed policy in isolation; one needs to consider the regime over an entire business cycle.  Thus the current sub-2% inflation rate is entirely consistent with the dual mandate, assuming that inflation is appropriately countercyclical (which is what the mandate implies.)  But in the past inflation has tended to be procyclical (in violation of the dual mandate), in which case current policy is inappropriately tight.

So how do we know if the Fed policy today is appropriate?  We don’t know, and won’t know until the next recession.  If inflation rises during the next recession, then current policy will have been appropriate—even though inflation is now under 2%.  If inflation falls during the next recession then current policy will have been inappropriately tight. Based on past experience, the latter assumption is more plausible, but again, current policy is exactly right if the Fed were taking its dual mandate seriously.  That mandate calls for slightly above 2% inflation during periods of high unemployment, and slightly below 2% inflation during periods of low unemployment.  And right now unemployment is well below average.  The dual mandate calls for sub-2% inflation at this point in time.

The crybabies who blamed economists for not predicting the financial crisis

Back in 2008, it seems like everyone from the Queen of England on down was blaming economists for not predicting the financial crisis.  I seem to recall that Bob Lucas pointed out that economic theory explains why economists cannot predict financial crises, so our failure to do so was a feather in the cap of modern economic theory.  I also seem to recall that lots of people rolled their eyes at his seemingly too clever excuse.

In the past I’ve argued that Lucas was exactly right, but in this post I’ll assume he was wrong.  I’ll assume the EMH is wrong.  Even in that case I’m going to argue the complaints were silly, just a bunch of crybabies.

So how do I respond to those people who are moaning that we didn’t warn them that a crisis was coming?  One answer is that some economists, such as Nouriel Roubini, did issue warnings.  But then the crybabies might respond, “But most economists didn’t warn us.  How were we to know that he was the one to listen to? The economics profession as a whole should have issued a warning, so that it was unambiguously clear to the public that a financial crisis was coming.”

To summarize, a few economists did warn the public, so the crybabies’ lament only makes sense if you assume that these people wanted the profession as a whole to offer a clear credible warning to the public.  Something that would be believed.

Were you the sort of person who believed in Santa Claus, and thought he would bring you a fairytale castle floating on a cloud, with unicorns prancing about in front?  If not, why would you make such a patently unrealistic demand of the economics profession?

You wanted us to warn you that a big financial crisis was coming so that you could sell all your stocks before they went down?  I ask this because a prediction of a severe financial crisis is implicitly also a prediction of a massive asset price collapse.  So the people complaining that economists didn’t predict the financial crisis are (whether they know this or not) effectively complaining that economists didn’t warn them that their 401k plan was about to lose a few hundred thousand dollars.

Let’s suppose we have a time machine and economists from October 2008 can go back 6 months in time, to April 2008.  They are told to warn the public that a massive financial crisis is coming in the fall.  They warn the public that Lehman won’t be bailed out, and its failure will trigger a rush for liquidity and a Great Recession.  What exactly would that warning have done, other than move those events up 6 months in time?  Then the crybabies would have asked why we didn’t warn them in October 2007 (assuming they didn’t lynch the economists for causing the crash.)

And as for those stocks you were going to sell if economists had warned you of the crash—just who did you plan to sell them to?  And at what price?

A better argument is that the economics profession didn’t warn the public that public policy was creating excessive lending, as Fannie and Freddie and FDIC and TBTF were creating moral hazard.  In fact, I did warn people I met about this problem (but I completely failed to forecast the financial crisis.)  Some other economists also warned about moral hazard, but not all.  But no one wants to listen to a bunch of killjoy economists on public policy questions.  It would be like blaming economists for tariffs, or rent controls.

When I explain to non-economist commenters what economic theory tells us about some public policy, they almost universally blow off my advice, unless it coincides with their pre-existing view on that particular public policy.  No one cares what economists think, so don’t blame us for areas where we have no control.  (Monetary policy is a different case; there the economics profession actually deserves far more blame than it’s gotten from the public.)

PS.  I see that Trump threw a temper tantrum when his aides told him that Iran had been adhering to the nuclear agreement.  We now have an administration with no ability to negotiate because no one trusts them to keep their word.  The focus of his top aides is not dealing with foreign crises but rather managing unnecessary crises created by an out of control and mentally ill president.  North Korea knows we’ll renege on any agreement we sign with them, and so a nuclear deterrent is their only option.  Meanwhile they show their population images of Trump threatening to destroy their country.

Meanwhile Trump has abandoned the utilitarian approach of the Obama administration and the slaughter of innocent civilians has been skyrocketing:

Airwars reports that under Obama’s leadership, the fight against ISIS led to approximately 2,300 to 3,400 civilian deaths. Through the first seven months of the Trump administration, they estimate that coalition air strikes have killed between 2,800 and 4,500 civilians.

Trump seems like excellent black comedy to me, but unfortunately there are lots of dead women and children for whom he is no joke.

PPS:  New Flash:  Americans horrified to discover Hollywood producer behaving like a President of the United States.  Hillary and Fox News particularly disgusted by this behavior.

PPPS:  Another gem:

Speaking over the phone, Mr Reich said he asked his friend whether other Republican senators were preparing to follow Senator Bob Corker and “call it quits with Trump”.

His source told him: “Others are thinking about doing what Bob did. Sounding the alarm. They think Trump’s nuts. Unfit. Dangerous.” . . .

“Tillerson would leave tomorrow if he wasn’t so worried Trump would go nuclear, literally,” he added.

“Who knows what’s in his head? But I can tell you this. He’s not listening to anyone. Not a soul.

“He’s got the nuclear codes and, well, it scares the hell out of me. It’s starting to scare all of them. That’s really why Bob spoke up.”

Trump ran for President as a crazy man, and we are shocked to discover he is governing as a crazy man?

In the long run we’re all rich, free and peaceful

It’s intellectually fashionable to be pessimistic, so let me push back with one of my occasional contrarian posts.  I’ll try to defend Fukuyama’s “End of History” hypothesis one more time.  Let’s start with peaceful:

1. A new study shows that the Kellogg-Briand Pact (1928), which outlawed war, has been highly effective. If you took history in high school, you might recall your teacher make fun of the touching naiveté associated with this utopian treaty.  Well it looks like Kellogg and Briand might get the last laugh.  First a bit of background.  The act was intended to change the rules of war.  Previously, countries were allowed to keep territory they conquered.  It was wars of aggression that were outlawed, not civil wars, not wars to prevent proliferation of WMD, not wars aimed at preventing genocide.  And wars of conquest (which were common throughout almost all of human history), have almost stopped happening (with Russia’s recent acquisition of the Crimea a notable exception, and even that was not particularly violent.)

So the world is getting more peaceful.

2.  It’s fashionable to say that freedom is a western concept, and Fukuyama’s prediction doesn’t apply to the rest of the world.  People point to China’s one child policy, or Saudi Arabia’s unwillingness to let women drive.  I’m with Zhou En Lai; it’s too soon to say.  China recently abolished its one child policy, and today Saudi Arabia granted women the right to drive.  Maybe progress will stop and no more freedoms will be achieved in the non-Western world.  But my hunch is that modern technology will gradually make the world more liberal, by beaming images of successful western societies to everyone who has a smart phone.

So the world will get freer, even if the past decade has been a mixed bag.

3.  Here’s Tyler Cowen expressing pessimism about economic progress in poorer areas:

Increasingly, it seems that many parts of the Western world might never “catch up,” including Greece, southern Italy, much of the Balkans and much of Latin America, in addition to Puerto Rico. One of the pleasing features of the 1990s, in retrospect a delusion, was the notion that proper policy and good multilateral institutions would bring most of the world into consistent, steady-state growth at a higher rate than what the wealthier countries could manage.

I agree with most of what Tyler said about Puerto Rico, including his view that’s it’s future currently looks quite bleak.  But I find this paragraph to be far too pessimistic, and not even consistent with the data:

a.  Since 2000, the developing world has grown faster than the rich world.  Yes, that’s partly China, but it also includes lots of other populous Asian countries.  And Asia is perhaps 70% of the developing world.  Parts of Africa have also done pretty well since 2000.  But what makes this claim especially dubious is his reference to “proper policy”.  Most of the developing world rates far below the US in economic freedom (including freedom from corruption).  And those few countries that score high on the good policy scale (such as Chile and Estonia) have had a pretty good couple of decades.  If you want an African example, compare the growth rate of Botswana and Zimbabwe in recent decades.

b.  Yes, there are good reasons (including culture) to be pessimistic about the near term prospects of Greece and southern Italy.  But in 1970 there were good reasons (including culture) to be pessimistic about Ireland.  You might say that the Irish were always capable of much better, as evidenced by their success in America.  But Greeks and southern Italians have also been quite successful in America.  You might argue that corruption will keep Greece and southern Italy poor.  Yes, but for how long?  China is much more corrupt than Singapore, and much poorer.  But Singapore is also ethnically Chinese, and rooted out corruption through a determined effort of the government.  Corruption is not baked into the genes of the Chinese people.  Might the Chinese government be able to root out corruption? I don’t know, but the current leadership seems to be making an effort.

My point here is that “never” is a really long time.  If Tyler had said that Greece and southern Italy would remain relatively poor for another 80 years, I’d have no reason to disagree.  But another 80,000 years?  Who knows?

In the early 1940s the Kellogg-Briand Pact look like a pathetic failure.  Now it looks like a success.  Yesterday, it looked like Saudi women would remain oppressed.  Today there seems to be hope that they might start achieving more equality.  The arrow of history is still pointing toward more wealth, freedom and peace.  The real risk we face is not stagnation, but rather a sudden crisis that catches us unaware, like terrorists getting a WMD.

HT:  Scott Alexander, who also linked to this mind-boggling article:

The number one food exporter in the world is the United States. The number two food exporter in the world is the Netherlands, 1/270th the size and mostly urban.

Update:  Maybe not–check out comment section.