Samuelson: Less we know, better economy does

[question everything]

ROBERT J. SAMUELSON NEWSWEEK

Less we know, better economy does

June 22, 2005

If economics were a boat, it would be a leaky tub. The pumps would be straining, and the captain would be trying to prevent it from capsizing. Which is to say: our ideas for explaining trends in output, employment and living standards – what we call "macroeconomics" – are in a state of disarray. If you're confused, you're in good company. Only recently Federal Reserve Chairman Alan Greenspan confessed again that he doesn't understand why interest rates on long-term bonds and mortgages have dropped, just when the Fed is raising short-term rates. This is but one mystery.

(snip)

We once thought we understood consumer spending, the economy's mainstay. For decades, disposable income and consumption spending advanced in lock step. Americans spent a bit more than 90 percent of their after-tax income and saved about 8 percent to 10 percent. In 1959, consumer outlays were 92 percent of disposable income. The figures for 1969, 1979 and 1989 were 92 percent, 91 percent and 93 percent. Being so steady, consumer spending provided stability during recessions – in contrast to more sensitive investment spending for housing and business buildings and equipment. Since 1960, consumer spending has dropped in only two years; investment spending has dropped in 13.

But since 1990, consumer spending has changed. It's consistently outpaced income growth. In 2004, Americans spent 99 percent of their disposable income and saved only 1 percent. The main cause is the "wealth effect." In the 1990s, higher stock prices caused Americans to spend more; now higher home values (up 55 percent since 2000 to $17.7 trillion) are doing the same. So consumer spending increasingly depends on "asset markets" – stocks and homes – and not just income. Query: suppose the next recession depresses both stock and real estate prices. Would consumer spending fall and deepen the slump?

We don't know how much the world economy affects the United States – and vice versa. Economics textbooks once described the U.S. economy as mainly self-contained. Americans sold to each other; Americans' savings were invested mostly in American investments (stocks, bonds, bank deposits). Trade was small. Globalization has shattered this model. More industries face foreign competition or depend on foreign markets.

(snip)

Although I could extend this list, the message would remain: change has outpaced comprehension. Should we be worried? Maybe. What confuses us may threaten us. But here's an irony: the less we understand the economy, the better it does. In the 1960s and 1970s, many economists had confidence. They thought they understood spending patterns, could estimate "full employment" and propose policies to prevent recessions. What we got was high inflation and four recessions (1969-70, 1973-75, 1980 and 1981-82). Since then, we've had lower inflation, only two recessions (1990-91 and 2001) and faster productivity growth. Economists' overconfidence – and the resulting policies – may have weakened the economy. But its improved performance could also have other explanations: lower inflation; the good judgment of two Fed chairmen – Paul Volcker and Greenspan; the economy's self-regulating characteristics, and new technologies. It could be all of the above or dumb luck. We don't know.


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[Maple]

1. Globalization is certainly

changing everything.

American economists don't appear to have taken that into account.

All the cards are currently in the air, and accurate predictions won't be possible until the process is complete, and the cards have settled again...into a wholly new pattern.

[orwell]

2. Delusions of Grandeur

Economics as a "science" will always be a failure. What you are trying to do is predict human behavior in a very complex system with a tremendous amount of variables. What it all comes down to in the end is human psychology, not the strongest of bedrock on which to build your "cathedral."

As a friend of mine who was a mathematician, "economist," and stock market technician once observed, "I can never predict how stupid people can be."

[Maple]

3. Well that's nice

but has nothing to do with actual economics.

It doesn't change or disappear just because you diss it.

[orwell]

4. That Dog Don't Hunt

I've been trading markets for almost 25 years. Studying/knowing economic theory never made me one dime, nor anyone else I've known for that matter. Oh yes, I can argue econ with the best of them and frequently do. I've written stock market programs, was one of the first to develop money flow theory based on tick volume analysis, been on the trading desk at a hedge fund running large sums of money. I've seen all the "great econ gods" come and go. Mostly go. (Remember Milton Friedman and his great "Money Supply/inflation thesis? Do you remember when Wall Street waited breathlessly for the Money Supply releases, trading wildly on M1? Where is that now...no longer "operational"?)

In the end, it boils down to herd behavior, plain and simple. The rest is just after the fact heuristics. And yes, it is only my opinion, but one not without some hard experience. At the very least, I've earned the right to be opinionated. If I'm not right, I don't eat.

But, to each his/her own. More power to ya if you can get anything out of it. I gave up "religion" about 10 years ago.

[idlisambar]

5. the tip of the iceberg

It is currently fashionable to justify the lack of correspondance between neo-classical economic models and economic reality by turning to the notion that individuals do not behave as rationally as the economic models require. A lot of work has been done in trying to figure out the dynamics of irrational agents in simulated markets. This is a misguided approach. The problems with neo-classical economics run much deeper than just the whims and foibles of human psychology.

Economics as a science could be more successful than it is, though it would not likely ever be as successful as many would like. Were the cobwebs of neo-classical thought cleared a better overall picture of economics would emerge -- the big problem is that neo-classical economics gives the wrong prescriptions but its practitioners believe them with scientific certainty.

[orwell]

7. My Portfolio Just Mooned Me

A very good friend of mine has done some theoretical/experimental work in the area of irrational agents. He teaches Econ at the University of Santa Barbara. He has his math degree from the University of Chicago. We have had many discussions about this, seemingly irrational behavior by humans in "controlled" environments. At least he gets a paycheck. I can't make a dime off of any of it.

It has been noticed by commodities traders that the best "newbies" have a strong background in game theory. Maybe we should all be watching the World Series of Poker instead of listening to Samuelson et al. :)

Do supply and demand and their relative elasticities/intensities influence clearing price. No doubt. But in the end that is strongly influenced by human perception/mood/social environments, even possibly the phases of the moon. (Look at how often the stock market makes important turning points at a full moon.) In fact, one well-known and quite successful stock market wag, Arch Crawford, has been using "planetary influences" to "predict" the financial markets for decades with surprising success. I get back to my original statement. The complexities of economic modeling are worse than weather prediction. That is why it is so fraught with inaccuracy.

In the end, I try to KISS it (Keep It Simple Stupid.) I can't make money any other way, and believe me, I've tried.

Thanks for the post.

[idlisambar]

6. double post n/t