The Whacky World of Modern Economists

Economist: One who is exiled from dinner parties; a recluse, trapped in his own deluded sense of wishful thinking, unconcerned with debt…the people who "manage" the entire world’s finances…

"Most economic theories have littlepractical use in the real world."
– Walter Williams

Pity the poor economist.

He is a pariah at dinner parties. His conversation is dull. His face has no expression. His opinions are commonplace. He might as well be on reality TV. And so what if the world’s economies need to be "rebalanced?" Not only do we not know what it means, we can do nothing about it anyway.

If you spend 15 minutes a year trying to figure out the world economy, Peter Lynch used to say, you’ve wasted 10 of them. Peter believes in buying stocks. Keeping it simple, he believes in buying the stocks of companies he knows. That way, he figures, what he doesn’t know can’t hurt him.

Lynch ran a major equity fund in a bull market. He was lucky enough to get out before the bull market was over and smart enough to write books for people who were dumb enough to believe that stocks always go up in the long run. You didn’t need to convince them this was s Their gains were proof enough. You didn’t need macroeconomics, either; you just needed a bull market.

The poor macroeconomist gets no respect. Which is the way it should be; typically, he deserves none.

Generally, his employer determines the economist’s opinions. And typically, he is bullish. Neither the City of London nor Wall Street make money by helping people get rich. They make money by selling them financial assets. Economists are put to work persuading clients that assets will go up in price. Abby Joseph Cohen, for example, is paid millions of dollars each year because she is reliable, not because she is accurate. Her forecasts are always the same – shares will go up! Even government economists usually have a bullish bias; neither presidents nor prime ministers are re-elected on bad economic news.

Macroeconomists: Obvious Insights

What’s more, honest economists have few insights that aren’t obvious: You can’t spend more than you make forever, the old-timers would tell you. The dollar will go down in price if you print too many of them, they figured. If something gets too far out of whack, they predicted, it is likely to come back into whack sooner or later.

These insights are hardly enough to command much respect, let alone a high salary. So early in the last century, ambitious economists set to work creating a set of propositions that were not based on ordinary common sense – but on wishful thinking. Economists do not manage their own finances noticeably better than anyone else. But if given the authority to manipulate short-term lending rates, bank regulations and money supplies, they offer to "manage" an entire nation’s economy. And if central bankers of major nations are able to collude on policy, they believe they can manage the entire world!

These vaulting pretensions required undergirders at least as absurd as they were. Hurricanes blew across Florida in record numbers this autumn. Yet the prevailing wind among U.S. economists and ordinary citizens was delightful. Rebuilding would be good for the economy, they told us.

The price tag for America’s "war on terror" and the war against Iraq rises almost daily. Estimates over $200 billion are current. Those, too, are thought to be good things for the world’s largest economy. More defense contracts will be let. More people would be hired. More money would be spent on tanks, equipment and all the other paraphernalia needed to kill or avoid being killed.

The oil price hit more than $50 per barrel for the first time ever at the end of September. Yesterday, it broke $53. But even that is considered good news, at least according to the economists at The New York Times.

Every cloud now has two silver linings. Every disaster brings relief even before it happens. Every attack is met by an overwhelming counterattack of growth and prosperity. Drought, pestilence, famine and war – nothing is so awful that it doesn’t bring on a new burst of something wonderful.

Macroeconomists: Stimulus/Arson

Of course, if destruction really were so beneficial, it is surprising that economists do not encourage it. We still wait for a pair of them, armed with the courage of their convictions and a jerrycan, to burn down each other’s houses.

"Stimulus," they will say.

"Arson," we will reply.

Nor have we yet heard an economist propose the elegant solution put forward by a Daily Reckoning reader: Instead of waiting for a natural disaster or an attack by foreigners, bring our troops home from Iraq and put them to work blowing up our own cities!

But "stimulus" is just one of the twisted beams that hold up modern economics to ridicule. The "disappearance of whack" is another.

If Peter Lynch had tried his approach in the bear market of the 1970s, for example, today he might be just another poor schmuck, rather than an investment icon. Bear markets take down the stocks you know along with those you don’t; they maul the geniuses as well as the morons.

"The mean," an economist will tell you, is something to which things tend to regress. Prices progress in a bull market. They regress in a bear market. If something is far from "the mean" – the ordinary state of things – the economist guesses it will have to come back. "This can’t go on forever," he will say. And yet perverse and inexplicable trends have been known to go on for decades after the economist who spotted them reached room temperature. Still, the earnest economist of the past looked for things that were out of whack – either with the way they have always been…or with the way he thinks they ought to be.

But the new economists of the 20th and 21st centuries began to lose interest in whack. Things were no longer in it or out of it. They were merely what other economists had made them! Economies might be well managed or mismanaged, they thought, but they couldn’t be unmanaged. For they had no natural condition, but only a state of being engineered for them by other economists. If they wanted faster growth, they had merely to yank a little harder on the lever marked "growth." If they wanted less inflation, they might want to ease off. It was all a matter of how you ran the great machine! And if something went wrong – well, some economist must have made a mistake. Whack disappeared altogether.

Macroeconomists: Opposite Ends of a Channel

This is a convenient way to look at things now. Because if there still were a whack to measure against, the whole world economy would be further out of it than ever before.

The world’s two most important economies sit at opposite ends of a shipping channel. In one direction, ships head east loaded to the gunwales with geegaws and gadgets. As they make their way across the Pacific, they pass other ships coming back – empty. On one end of the trade are a billion Chinese making things at a furious pace. At the other, Americans enjoy the extraordinary lightness of being that comes with acquiring things without having to pay for them.

Asians work and save. Americans borrow and spend. The U.S. current account deficit – a measure of how out of whack the world economy has become – approaches 6% of GDP. The home of Anglo-Saxon consumerism isn’t much better. In the U.K., the current account gap is moving toward 3% of GDP.

If you asked a dead economist, "Something’s got to give," would probably be his judgment. "No nation can spend more than it makes forever," he might go on. "There must be a give for every take."

But we have been taking record amounts of goods from Asia – more than we can afford – and giving paper money IOUs in return. Asians have been giving all they can…hoping to recycle their IOUs into something valuable before the paper money sinks.

Living economists are not worried. It is just another thing to be managed, they believe. It does not seem to bother them that the Americans and the British are getting poorer. They do not concern themselves with the huge pile of debt built up by consumers and government; these too can surely be managed.

Here again, economists replaced the old, obvious insights of an earlier age with absurd new ones. Every previous economist who ever thought about it had come to the same conclusion: The way to wealth was to make sure outgoings did not exceed income. The self-evident corollary was that you needed to focus your attention on creating wealth, not spending it. It was production, not consumption, that made people rich.

Yet the new economists are not paid to worry…they are paid to flatter.

"America has the most dynamic, flexible economy in history," the lumps believed. "They sweat, we think," they said approvingly. "We are creating wealth at the fastest pace in decades," said their president.

What we are really creating is a world economy that is dangerously out of whack.

But who cares? When it blows itself up…imagine how stimulating that will be!


Bill Bonner
The Daily Reckoning
October 8, 2004

Today, an important number comes out of the Labor Department. It is the number of new jobs created in the month of September. The number is expected to be 150,000. If it is above 150,000, Bush will say his economic policies are working. If it is below 150,000, Kerry will say they are not. [As we go to press, the number has been released, and is, in fact, 96,000.]

The number is not really important to us; we don’t care what they say. Besides, we know the number does not really count new jobs anyway.

When an economist opens his mouth, a sensible man listens with suspicion. When the economist works for the government, he doesn’t listen at all. Today’s job report will be one part erroneous statistics gathered by incompetents, one part "adjustments" made by earnest guessers and one part pure humbug…

"These numbers from Washington always look better than they really are," says Walter Williams, because they are subject to what he calls "Pollyanna Creep" — methodological changes that tend to flatter whichever party is in power.

The numbers help re-elect politicians. They are intended to back up George Bush, for example, when he says the country is creating wealth at the fastest pace ever. (More below…)

Remarkably, people seem to believe him. Lured by ultralow interest rates and distracted by a circus of financial news, American householders are making the biggest financial mistake of their lives.

For half a century, from 1951-2001, house prices kept pace with inflation. Then, following the fastest rate cuts in history, real estate shot up. In certain "hot spots," houses have been gaining 30% per year. Throughout the nation as a whole, the gain has been closer to 10% – still three to four times the rate of inflation.

Americans mistook this increase in house prices for wealth…and began to spend it. Last year, the amount of "equity" they "took out" of their homes came to 6% of their incomes. That, along with tax cuts, is what has allowed them to continue spending money.

It is an elegant little trap, set by our own central bank…and enabled by central bankers in China and Japan. It allows Americans to believe what they want: that they are getting richer. Actually, they get poorer every year it continues; their expenses rise faster than their incomes.

Wealth from house-price increases, as The Economist realized this week, is phony. Real wealth comes from jobs, earnings, profits and savings. There are no shortcuts. No free lunches. No "adjustments" that turn consumption into savings or expenses into income. You still can’t get into heaven without dying.

We don’t know what today’s jobs report will show. The administration wants a number over 150,000. But sometimes the statistics don’t cooperate. Sometimes it’s the statisticians. Sometimes it’s life itself.


And more news, from Eric Fry in New York:

"The rampant growth of interest-only loans – coming soon to a sub-prime borrower in your neighborhood! – testifies to the excesses of this particular interest rate cycle. The nation’s mortgage lenders, having depleted the supply of credit-worthy borrowers, now troll for almost ANY borrower in an effort to maintain ‘growth…’"


Bill Bonner, back in Paris…

*** Last week, MoneyWeek asked a critical question: What are bonds telling us? Instead of going down at this stage of a recovery cycle, which almost everyone expected, they were still going up. Bonds have been going up, more or less, since Oct. 6, 1979. That was the day Paul Volcker, his fanny in the seat Alan Greenspan occupies now, told the world that the days of runaway inflation were over. From now on, inflation would drag around a ball and chain. And if it should attempt an escape, the "bond vigilantes" – large investors who kept an eye on inflation rates – would immediately sell off their bond holdings, force up yields and bring inflation back at the end of a rope.

Even as late as 1984, the vigilantes still worried that Volcker would turn his back. Anticipating a breakout, they ran bond yields up to 14% in the spring of 1984. Alas, they were wrong: Bonds soon declined again…and fell for the next 19 years. Bored, the vigilantes went to sleep. Then, on June 9, 2003, the long bond boom seemed to be over. Ten-year U.S. Treasury yields fell to less than 3.5%.

On that day, the bond vigilantes began to wake up. Alarmed by the current account deficit, as well as rising oil and commodities prices…they sold bonds. Yields rose 1% in the next 12 months. But then, suddenly, bonds headed up again. Have the vigilantes made another mistake?

Economists don’t know. Neither do we. But we’re sure of one thing: Someone has.

*** Ooh la la…

"How can we make this chart look attractive?" asked a friend in London.

"Turn it upside down," came the answer.

So we took the chart of the U.S. current account, measured quarterly, and turned it upside down. What we discovered first was that, reading left to right, time ran in reverse. This didn’t seem to make much sense, so we turned it over. Ah…now, what went down now goes up. But what we see is the same. Only it is now above the line, rather than below it. From around 1960-1983, the United States was neither a borrower nor a lender been to the rest of the world.

Some years we were a little ahead…some years we were a little behind. But look at the deficits soar in 1997! It looks like a chart of the Nasdaq without the crash. Instead of going down in 2000-2001, the deficits kept right on going up – at the same sharp angle. In the latest quarter alone, the deficit was $166 billion.

We only mention this because the chart shows what logic suggests: This can’t last. There has never been a bubble that didn’t burst. And we’ve never seen a line on a chart like this – going nearly straight up – that wasn’t followed by another line going nearly straight down. In stock markets, prices generally go back to where they began. Charts typically look symmetrical…a sharp, jagged edge up one side of the trend is followed by a sharp, jagged edge, more or less of the same angle, down the other side. What goes up fast tends to come down fast.

How this will happen in the globalized, debt-ridden world of 2005 and onwards we don’t know. But we would consider lightening up on dollars…and adding a few gold coins to your collection – just in case.

*** "Bush went to war for nothing," is the headline in today’s Parisian paper, Liberation.

The European press has an "I told you so" air about it. The latest report from the CIA accuses the Chirac government of having corrupt dealings with Saddam. This does not particularly worry the French; they could hardly imagine it any other way. More importantly, the report reveals to the world what everyone seemed to know already – if the Bush administration decided to kill Iraqis and remove Saddam from power just to protect themselves from "weapons of mass destruction," they made a big mistake.

On the other side of the Atlantic, people do not seem to care. As near as we call tell, even after the deaths of thousands of innocent people…and the waste of hundreds of billions of dollars…there is no sense of outrage among Americans.

Our view here at The Daily Reckoning headquarters has been aggravating to almost everyone. We are not opposed to killing people; we just like to have a good reason. When someone picks a fight with you, you’re happy to give him a good wallop. But usually, you need someone to attack you first – otherwise, the reason tends to fall a bit short and the gods of war go over to the other side.

It turns out the Bush administration had no reason at all to attack Iraq. Still, the average American seems to believe that the affair will work out somehow – like the current account deficit. Everything will go right for America, always has.

Americans are remarkably insouciant, we conclude. They worry neither about their wealth nor their souls.

*** A message from a relative in the Netherlands:

"There’s a Pilgrim’s museum in Leiden, maintained by some expatriate American, it seems. The Dutch don’t understand why anyone would want a museum about the Pilgrims; they had a hard enough time getting those religious fanatics to leave the Netherlands back in 1620, only finally succeeding by suckering them into believing their "Promised Land" lay in New Holland (aka New England). Why are we Americans so optimistic, naive and gullible? The trait has deep historical roots."

The Daily Reckoning