Economists invariably cop the tag of belonging to the pessimistic science since jokingly it is oft said by way of an introductory welcome to the podium …….Please welcome .......... who has successfully predicted 14 of the last two recessions.
Economic reputations suffered a further blow since most failed to predict the global financial crisis or identify sufficiently the consequences of the prior rising bubble.
There are notable exceptions but invariably their prior records are patchy enough to reasonably conclude this was the one prediction they just happened to get right at the right time. This patchiness is not surprising since bubbles don’t figure in economic or monetary theory nor are they included in the sophisticated economic models. Economics was never a science but is the art in dealing with the erratic human behaviors which can routinely make miserable fools of economic forecasters based upon rational outcomes. You spend most of your time looking in the rear vision mirror for any reflections indicative of the way forward.
I remember early student days full of debate on contemporary issues such as tariffs, subsidies, basic wage increases, international trade and regulatory issues for a banking system and so on. Today there is far more complexity and global interaction to consider, but I remember then many appalling decisions made in Australasia when life was simpler. Neverthless there are always lessons you can learn from studying past trade cycles, even to go far back to the great depression.
One aspect worth noting about the great depression is the assumed degree of speculation attributed by governments of the day and subsequent commentators. But if you undergo a thorough analysis of the prior trading conditions you find speculation was not nearly as rife as is commonly assumed. By way of example if you take the various PE ratios ( earnings to stock price ratios) for companies in the various industry sectors just before the massive fall in stock values you find a degree of normality that today would not cause undue concern. Lurking behind the bland facade however was the leveraged investment companies with their investments in overly valued utility companies which caused all of the havoc. Once values and profits fell in that one industry sector alone highly leveraged investments companies had to sell their shares to pay the margin lender. The same pattern happened with the individual investors in the Management Investments whose worthless investments meant they had to sell their remaining stock holdings in other sectors to cover their margin lending. Then the government talked simplistically about all of the greedy speculators as the only cause for an overvalued market which helped perpetuate the next downward spiral famously known (and still fearded )double dip. Most of the self perpetuating downward spirals were driven by leverage and subsequant sentiment but not substance that culminated in a collective fall of 89% with all of its accompanying misery.
After my studies and during my subsequent career I have almost always been responsible for forecasting economic indices and have endeavored as far as possible to follow economics which I have found both to be very interesting but equally frustrating.
When I first studied Keynes and Samuelson dominated our textbooks.
Keynes was one of the first philosophical economists who insisted economic theories must lead to fairer more ethical outcome for everyone. Keynes’ views were no doubt forged from his desire to avoid a repeat of the great depression where he held onto his shares and subsequently lost his fortune along with many others. Throughout his life he remained a colourful witty character devoted to the arts, nature and conservation to the extent he was miles ahead of his time. His highly developed mathematics gave way to theories suggesting the need for the creation of a strong regulatory regime to prudently effectively use both monetary (supply of money and interest rates) and fiscal policy (government spending and taxation) to help iron out inevitable economic imbalances were adopted in Australia.
In the USA Economics was to eventually turn away from Keynes to a different route with the rise in power of the economic monetarists who suggested you only need to vary the volume of money in circulation (money, bank deposits in demand and related interbank deposits with overnight liquidity)and interest rates to effectively control imbalances between supply and demand.This suited successive governments and business since it involved less regulatory resources and ensuing compliance as was proposed by Keynes and others. These ideas inevitably filtered through to Australia as the economy in the USA seemed to be traveling well.Subsequently the USA rode out the Savings and Loan fiasco and the Dotcom bubble but only at the expense of a burgeoning debt burden.
However fortuitously our economy in Austrtalia was to benefit enormously from increased taxation revenue derived from a mining boom wisely squirreled away in reserves for a rainy day,( some since released for a number of stimulatory measures) our close ties to the expanding Asian region and because we invested in a more effective regulatory regime following our largest corporate collapse in Australia - the demise of HIH.
At that time officials at APRA – The Australian Prudential Regulatory Authority correctly concluded that any large bank, financial, insurance or related entity could fail and with sufficient negative sentiment bring down the entire economy with them. They set about regularity changes to improve and more closely monitor solvency ratios and risk management practices with quarterly reporting requirements for all of our major institutions which caused a considerable amount of angst within the business community. These factors, inclusive of the tyranny of distance aspect which separated us from the sharper end of the pencil where all of the sub prime action was taking place ensured our lucky escape so far to date.
Recently in the US I was disappointed to see mooted bank regulatory changes are to be confined to increasinging capital requirements rather than ensuring unregulated derivatives are separated out and excluded from cover under their banking licenses.
Even Hedge fund billionaire George Soros and Berkshire Hathaway’s Charlie Manager are calling for urgent limits on credit-default swaps- one of the prior subprime culprits. These instruments are unnecessary since there already exists regulated conventional insurance products able to cover risk. The current banking structure leaves those large institutions in the same vunerable position as existed prior to the crisis. I hope there is change in heart.
Longer term my prediction is for continued weakness in the USA dollar to ultimately lead to higher inflation and inevitably higher interest rates. But in the medium term as Fed Chairman Ben Bernanke (who co incidebtally did his PHD on the trade cycle which involved studying Keynes and the great depresion effects )correctly points out U.S. interest rates will be kept low for quite some time, because of prolonged weakness.
Meanwhile if the American economy does stabilize and begin to give grounds for some genuine hope of a rebound, which I earnestly hope it will, then I also predict there will be an abundance of born-again Keynesians to poke up their heads from under a winters burrow.