Remember your economics courses in college? Dull, dry, and you were always trying to figure out what the theory and mathematics had to do with reality beyond what you learned from the world that, in most cases, supply and price were inversely related? So much of the rest of the courses seemed to be simply unrelated to the real world.
It amazes me that these economists are always quoted in the newspaper talking about the economy, when many of them know so little about the economy. Outside a very few of them such as Robert Schiller, Nouriel Roubini, and a very few others had the slightest idea in 2006 or 2007 that we were on the verge of an economic catastrophe. For a wonderful critique of economics see Yves.
This brings me to a larger question: can a discipline that cannot predict be a science? If a science suffers a massive failure, would you not think that there would be significant questioning of the practice and theory? As Yves asked, would you trust your health to a doctor whose record of failure to diagnose serious diseases was nearly 100 percent wrong and with such a record saw no reason to change? Why would a “change” agent/leader fill all the important positions with uncritical and probably unaware acolytes of the failed paradigm?
To put it in the language of this blog, economists may be creative, but it is in the production of dangerous fiction (for those that have lost significant sums in their retirement accounts, “pornography” might be a better term).
Can economics be salvaged and what will it take? What say you?
January 12th, 2009 at 2:25 pm
I disagree that economists didn’t see this coming. The imbalances in the US economy in particular were / are too big to ignore. You can’t spend more than you earn indefinitely –whether you’re an individual or a country.
Virtually all economists I read / talk to spoke about a coming shock or if not shock, correction — it was just that no one knew exactly how this would play out.
But the double deficits of the US (current account and fiscal), were huge on the radar screen as were the subprime mortgages.
I’ll admit I mostly read Canadian economists’ thoughts, but I’m sure many American economists were talking too — it’s just that no one wanted to listen to “the dismal scientists’” reports.
January 12th, 2009 at 2:38 pm
Wendy,
Thanks for the comment. I do not know about Canadian economists. Could you please share some of the names and the posted articles where they predicted the collapse of the US mortgage market and the global recession that is now threatening depression. These economists and their writings certainly deserve more exposure.
Many economists wrote about US double deficits, but in 2006/07 very few linked this to a vast overspending in personal and corporate debt predicting that it would result in a financial collapse and global stock market drops of 40-50% that would draw China and India in a massive recoupling.
I know because I have been predicting this since 2006/07 as Rich Florida can attest (he will remember well my predictions on housing during that time frame and my bankable recommendations!). I had discussions during that time with a number of academic economists and they laughed at me. In fact, they made me decide to put a large amount of money in late 2007 where my mouth was. In 2008 I was very amply rewarded.
Again, I would love to see papers from various Canadian economists that substantiate your point.
PS: There is no doubt that European economists (and thankfully Canadians occupy a position in between Europe and the US), PostKeynesians, some Marxists, and iconolasts were more prescient. Almost none of these in the US are in prestigious universities. Rather they have been shunned.
January 12th, 2009 at 2:53 pm
Benoit Mandelbrot is probably where you should look for a refounding of economics as a science. Mandelbrot of course is best known as the father of fractal geometry. Mainstream economists seem to me to be captives of a set of assumptions Mandelbrot demonstrates are invalid in something like the way Copernican cosmology was demonstrated to be invalid by Newton & Galileo. These assumptions are baked into most economic models as a way to manage complexity, but they break down (horribly) when applied to the real world. In contrast, Mandelbrot looked at real price movements (e.g. cotton) and devised his fractal approach based on the observed patterns. Now, which approach seems more scientific?
I’m neither economist nor mathematician enough to do his thoughts justice particularly in a short comment. A very accessible book for anyone interested: “The (Mis)Behavior of Markets: A Fractal View of Risk, Ruin, and Reward”, by Benoît Mandelbrot and Richard L. Hudson (Basic Books, 2004).
January 12th, 2009 at 4:27 pm
There is no doubt that European economists (and thankfully Canadians occupy a position in between Europe and the US), PostKeynesians, some Marxists, and iconolasts were more prescient.
Yeah, but these guys are permabears. They’ve predicted 10 of the last 5 recessions.
All of the social sciences suffer the same problems as economics. If there is a difference, perhaps the other disciplines have a more modest scope.
I’m glad that you made money from your prediction. What’s your next prediction?
January 12th, 2009 at 5:04 pm
I would recommend Nassim Nicholas Taleb’s book – Fooled by Randomness: The Hidden Role of Chance in LIfe and in the Markets (2004). Taleb is (was?) a trader who believes many of his peers confuse a run of good luck with personal trading skill. The basic problem being that the human brain is wired to look for patterns, in order to make the world more predictable. It is common to erroneously ’see’ patterns within a process that fundamentally is random, and to underestimate the risk of rare but truly bad events. Taleb has tried to incorporate his understanding of randomness into his trading behavior, and thus (as of 2004) found a modest degree of success as a trader.
Part of Taleb’s trading method involves getting investor’s insurance for the rare, truly bad event. I wonder whether he survived this past fall’s meltdown of the insurers.
January 12th, 2009 at 5:05 pm
Thanks to Ian and Buzzcut,
Absolutely, Mandelbrot’s ideas MUST go into the hopper, though perhaps more from an explanatory perspective. From what I have read they may not be as predictive, though they might predict moments of maximum instability.
Unfortunately, all I have to offer is doom and gloom for the near future. Were I to invest (and I am no professional or expert and don’t advise anyone to take risks as cash is a great alternative for the moment), I would be looking for the financials and stock prices generally to resume their decline (maybe play them through an ETF, though highly risky?). It will be a bumpy decline as the federal government will intervene repeatedly, but I don’t think further federal interventions will do anything but washout the common stock holders (and probably preferred, also).
I would guess retail and anything connected with retail and entertainment still has much more to drop. Essentially, the market needs to liquidate all of the buy-and-hold 401k/retirement investors (mainstream media besotted “fools”) before we can hit bottom. My guess bottom is about 4-6,000 on DJIA or 300-600 on S&P.
Ultimately, it is my belief that the government can not prevent the market from declining as there are no more bubbles that can be blown. More deeply, the new technologies have completely blown apart the nation-state as economy model used by monetarists, keynesians and others. Therefore the policies needed to prepare the groundwork for a new economic system must be different than those for the old system.
I would love to hear all of your thoughts.
January 12th, 2009 at 5:16 pm
re: Permabears
It is true that I have been calling recession for about 3-4 years not understanding how the bubble (especially housing and consumer durables in Calif) could continue to inflate. Fortunately, when USA attacked Iraq I bought oil, gold and emerging markets. Unfortunately in 2007 I got out and into the market three times. Out because I thought bubble had to burst, and then it legged up again and I went in…wash, rinse, repeat. Finally, the market began validating my thesis in about September of 2007. Then my mistake was believing that no one would pay attention to government intervention because it wouldn’t work.
A litany of mistakes, but all forgiven because I had the macrostory right.
What you are pointing out is that we all need to make sure that we recognize when our macronarrative is no longer operative.
Martin
January 12th, 2009 at 7:11 pm
Yawn. A broad field of study within which a subset attempts to forecast the future and fails.
The problem isn’t economics, its the arrogance of forecasting in a world filled with unknowns.
Whether it’s predicting the weather, climate change, technological innovation, finance, there’s an arrogance that belies an ignorance which will eventually prove the forecaster’s undoing.
Economics is not immune from this phenomena, but neither is it defined by it.
January 13th, 2009 at 12:05 am
Wow! Lots of commentary.
Here’s one statistic that says it all: LIBOR is at a multi-year low. Translation: THE CREDIT CRUNCH IS OVER.
I will say it first. The economy is already bouncing-back and will go from a slow uptick to a volcanic eruption when the full-effect of the bailouts, rate-cuts, tax-cuts and massive global government stimulus programs hit in full-force. What will this mean? Ridiculous short-term unsustainable growth and probably another bubble but it will still be 2 steps forward, 1 step back, ie, A NET POSITIVE.
If the Fed and governments had acted last Spring when BS collapsed, as they should have, instead of waiting until we were on the verge of a depression, a lot of the rockiness could have been avoided. Even still, things look good. Mortgage rates are at an all-time law and housing prices are down, so expect another run on real estate.
But, most of all, let’s hope that government continues to be a player and assumes a new role as friend and profiteer in the economy as a financier instead of living solely on the liability/cost side. That’s the secret to achieving a broad and shared prosperity by combining the best interests of the bleeding hearts and the free market capitalists.
January 13th, 2009 at 12:38 am
Hayden,
Hope you are right, but believe you are wrong.
My guess is that the US govt is destroying our economy with helicopter drops of money.
LIBOR and the rest of these numbers are now meaningless as they are rigged by Fed bailouts. But let’s check in six months.
January 13th, 2009 at 5:34 am
Larry Elliot is the economics writer for The Guardian.
He has been writing for years about how unsustainable the boom years were.
His blog is at:
http://www.thegodsthatfailed.co.uk/
January 13th, 2009 at 9:34 am
Ultimately, it is my belief that the government can not prevent the market from declining as there are no more bubbles that can be blown.
Well, there is one more bubble, already existing, and it is in US Treasuries.
The Chinese and Japanese governments have made a killing over the last year as their massive holdings of existing T-bills have become much more valuable. The Chinese could easily fund their stimulus just from the profits of their T-bill holdings.
Of course, then they couldn’t hold the value of the yuan artificially low, and their mercantile trade policy would fall apart.
The bubble in T-bills is good in that the feds can borrow at some stupid low interest rates. It is bad in that, when it pops, it is going to make borrowing costs much, much higher in the future.
January 13th, 2009 at 12:23 pm
I think that bias can not be understated in economics. eg. There are billions of $ at stake when we consider tax cuts as good US economic policy. Also, “Taleb is (was?) a trader who believes many of his peers confuse a run of good luck with personal trading skill” To think anything else would have required sacrificing for a common good. Show me an employer who would have kept a trader for two seconds with that kind of philosopher.
In addition, I believe that the run from bubble to bubble is indicative of excess capital seeking safe havens in the world. There is always a need for investment in the world, but the creation of value is difficult and risky work. Most money does not want to go there. While the last 6 years saw an expansion, the fall has been deep because so much of the creation of value existed no where except on the balance sheet.
January 13th, 2009 at 7:55 pm
Martin, I would say let’s revisit this in 9 – 12 months, it will take a quarter or so for all the governmentally driven tidal wave to come to shore and another quarter before it begins showing-up in the numbers after it hits the real economy. As for the helicopter dropped-in cash, there simply was no choice. But the real question here will be where does that money end-up. If it ends up the hands of entrepreneurs, it will translate into real and sustainable economic growth over the long-term. On the other hand, if it gets doled-out and scoffed-up in transactional profits and bonuses, leading only to short-term consumption, we will be in for another economic roller-coaster. At some point, money needs to stop flowing into the bank accounts of executives looking to make windfall profits and short-term stock-option plays and into viable businesses.
Let’s look at Apple as a case study. Apple is run much more like a privately held company than a publicly traded one. It’s CEO founded the company and is committed to product development and a vision, Jobs is not making decisions based on stock prices and options. We need more companies like Apple and Google who are founded by visionary entrepreneurs and grown via vision and passion. There are plenty of other less sexy examples as well. We need less wheeler-dealers making money on transactions and more visionaries creating innovative products and services; or new conceptual designs. Better mouse-traps.
January 13th, 2009 at 8:53 pm
Thanks to all of you for your views.
Hayden none of this bailout money is going to entrepreneurs. I agree we need to encourage entrepreneurship.
As for the banks, the bank executives need to fired, the equity and bond holders wiped out if the bank has negative value, and those with loans to the banks need haircuts. Only by creative DESTRUCTION can the old corrupt and incompetent be wiped away so that the process of growth can start again.
As a Leftist I find that I believe in capitalism more than the mainstream supporters of the current system of crony capitalism.
Crackpot capitalism in my book is when people believe that a debt crisis can be solved by massive issuance of even more debt without writing off the old stuff. Good after bad!
January 14th, 2009 at 8:59 am
As a Leftist I find that I believe in capitalism more than the mainstream supporters of the current system of crony capitalism.
I agree completely. I also agree about allowing “creative destruction” to happen.
One economic theory about why recessions happen is that, over an economic cycle, certain sectors get overbuilt. The economy needs time to realocate the resources from the overbuilt sectors to the ones with increasing demand.
Seems to me that this explanation explains our current economic difficulties. Because of low interest rates, many, many sectors of our economy became overbuilt earlier in the decade: homebuilding, finance, automaking, casual dining
, etc. These sectors need to cut back, and other sectors need to take the lead.
Targeting the overbuilt sectors with incentives and subsidies does nothing to get them rightsized. Perhaps the government could provide funds to retrain people (which they already do), but other than that, there’s not a lot they should be doing for the homebuilders, automakers, brokers, etc.
January 14th, 2009 at 11:45 am
Martin,
Thanks for the your perspectives and questions you bring through this site. What economists do is too diverse to critique broadly (note the recent article in the The Economist on young economists to watch (Dec 30, 2008.) It showed, in particular, how experimental methods and new behavioral models are weaving their way through multiple subfields. Things change, but sometimes it is a generational process.
That aside, the reason for my post was to offer up a very local perspective. We focus on the Dallas city and MSA economies for the municipal government. We don’t do national forecasts, but try to understand what broader trends mean for us. I reviewed what our office was saying about housing and economic implications in recent years. I found two articles in our newsletter, one from May 2005 and one from November 2006 (www.dallas-ecodev.org) The essence of those was that there appeared to be serious regional bubbles in housing (Southwest, Florida and Northeast), but since Dallas had not experienced rapid appreciation we were not likely to see major declines when/if the bubbles burst. We were interested in the revenue impact of a correction and we did not address or hint at the international chain reaction that would follow. Honestly, I don’t know if we would have been able to take it much further. (Fortunately, our housing market has performed as predicted with level prices or small declines so far, but our developers are facing the same credit restrictions felt nationally.)
Still, if our humble team of meatball economists saw enough to entertain the idea of bubbles and collapse shouldn’t there have been others, in their local economic spheres of influence to see the same and identify what it meant for their stakeholders? I bet even if all the regional economists were on the ball for their markets, collectively we could have missed the big picture.
Perhaps in the case of real estate forecasting (and the links to other parts of the system) it might be another example of how important it is to take a bottom up approach. There may be an analytical disconnect between the regions where the real economy happens and the abstract we call the national economy. The Fed with a regional network didn’t appear to catch this either. They had all the data in the world, but maybe they lacked the system and focus to put together the pieces (their purview was national monetary policy afterall.) A system that networked local teams of analysts and tried to synthesize a roll-up might help in the future. We wouldn’t need a complete, integrated theory, just a good analytical framework, a little technology and some common sense.
January 15th, 2009 at 12:27 pm
Hi Martin,
Sorry to be so long in responding — been swamped. Anyway, what I said, or meant, was not that economists predicted this once-in-a-lifetime-financial crisis. But that there was serious concern over unsustainable practices in the US starting with the current account and fiscal deficits, as well as the sub-prime borrowing, and zero-down-borrow-105% value mortgages being offered.
Trying to remember who was saying or writing this two years ago is hard. Here are a couple examples of general concern about the US situation.
http://www.bcbudget.gov.bc.ca/2005_sept_update/bfp/11_tb_The_Economic_Forecast_Council,_2005.htm
http://www.cucbc.com/publications/economics/pdf/interestRateForecast/march%2007.pdf
I should have added before, your question about the state of the Economics field is a good one.
Thinking about the history of the Economics as a field, I’m not sure that the profession and their tools are really designed to be predictive, so much as to offer great tools and ideas for understanding what happened post-facto. Analysis of past events provides great context for understanding current and future ones, but not in a predictive way. But, many have tried to force Economics into a box where it doesn’t fit — soothsayers.
January 16th, 2009 at 4:02 pm
Can’t we all just get along? Oh, sure variety is the spice of life and all that, but what does it really matter if you can trot out the exception (Larry Elliot, Yves Smith, Nouriel Roubini, Niall Ferguson, Ambrose Evans Pritchard, and some others) that proves the rule (Economics as a field of study is as bankrupt as the US economy), when the facts will out that the United States is in the absolute worst economic crisis EVER? Economics, particularly the branch that espouses neoclassical theories, is useless to try and understand how we got here, where we are, and where we are going.
Try history instead. It’s a hell of a lot more insightful and informative because it gives you a picture of reality (what motivates people, how they act, the forces they react to) and if you’re smart enough you can actually see patterns and begin to apply it to society at large. Unlike economics, which is useful only when you control for all variables and you postulate perfect information, perfect competition, etc, etc.
So as economists reassure us that we’re in a recession and they see it ending sometime in the second half of 2009, maybe early 2010, you should be thinking: BULLSHIT. Sure people will argue and try to point to the contra indicators that say the credit crisis is over, the stock market is stabilized, the USD is still reserve currency of favor, unemployment is in historical normal ranges, people are still buying American cars, Chase had a profit (what a good use of those TARP funds), entrepreneurship thrives in a recession, the housing market has bottomed, mortgage rates are at an all time low, gas is less than $2 a gallon, and so on, and so on.
But all of that is just plain nonsense. A statistician might say it’s all spurious. In reality, the fun (for all you sadists) is just beginning. The post-war American dream of every generation building on the successes of the previous generation is on hold. It’s done. Game over. Time’s up. Music’s stopped. Piper must be paid. Choose your favorite metaphor. But the facts remain, the United States economy is entering an unrecoverable (in the near term 5-10 years…pray tell not longer) slide into massive destabilization. You can forget about doing better than your parents did. And your children can forget about doing better than you did. People need a massive collective reset. Washington needs an even more massive reset.
You can’t print money until the cows come home and expect to sell the guarantees on that money to sovereign wealth funds without them getting mad as hell when they realize they’re holding a bag of shit. Oh but the Fed call that Quantitative Easing. I call it mortgaging our future, or worse.
You can’t sustain consumption when real wages are declining, the savings rate is negative, and the second largest credit issuer in the country is ratejacking. Shouldn’t that be a crime like carjacking? What’s the difference really?
You can’t rebuild an economy laden with $$ trillions in debt, no wage growth, no job growth, extreme concentration of wealth, rampant fraud and mistrust, and no viable long term systemic means of creating long term (100+ years) value. If you subscribe to the labor theory of value instead of marginal utility, look at the facts and quickly you’ll see we’ve created a perfect storm of anti-value creation (is there such a thing? hmm.)
It’s time somebody started listening to historians. So, Martin, I think you’re spot on. While most are still drinking the neo-classical economic Kool-Aid(TM), it’s time for a great economic awakening. But forget about economists leading us to the promised land. They’re hopeless.
And by the way, I’m not a pessimist…I am a realist, but sometimes the truth hurts.
January 17th, 2009 at 5:36 pm
Hi Nicolai and others,
This thread is going away now, but the comments have been brilliant. I appreciate them all.
Nicolai you are unfortunately more correct than even you believe. Strap on your crash helmets, tighten seat belts, assume fetal position this is going to be one heck of a ride AND we don’t know when it will end — unfortunately.
Martin
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