Economic forecasting isn’t merely difficult, it’s next to impossible. But that hasn’t stopped many well-educated economists from calling their shots.
Irving Fisher’s mathematical approach to economics and finance is still praised today. But his equations didn’t stop him from proclaiming that “stocks have reached what looks like a permanently high plateau,” just nine days before the crash in 1929.
In 1930, John Maynard Keynes predicted that in 100 years, technological advances would have us working 15 hours per week. There’s still a bit of time on that clock, but the prediction is looking rather foolish.
It’s easy to set aside any one prediction. Maybe we should. We can’t, however, deny Keynes’ lasting impact on economics. The most prestigious universities teach Keynesianism and other math-centric approaches to the discipline. This mathematical approach was supposed to bring clarity. Instead, a slew of highly credentialed (and highly influential) Keynesian economists have made so many incorrect predictions, it beggars belief.
Arthur Okun graduated from Columbia University. He taught at Yale and headed the Council of Economic Advisors to President Lyndon B. Johnson. In his 1970 book, The Political Economy of Prosperity, Okun reasoned, “The persistence of prosperity has been the outstanding fact of American economic history of the 1960s. The absence of recession for nearly nine years marks a discrete and dramatic departure from the traditional performance of the American economy. .... When recessions were a regular feature of the economic environment, they were often viewed as inevitable. .... More vigorous and more consistent application of the tools of economic policy contributed to the obsolescence of the business cycle pattern and the refutation of stagnation myths.”
The business cycle did, in fact, continue.
Paul Samuelson graduated from the University of Chicago and Harvard. He taught at MIT, the Sloan School of Business, and the University of Chicago.
His 1985 textbook Economics stated, “Every economy has its contradictions .... What counts is results, and there can be no doubt that the Soviet planning system has been a powerful engine for economic growth.” The 1989 version of the book claimed, “Contrary to what many skeptics had earlier believed, the Soviet economy is proof that… a socialist command economy can function and even thrive.”
The USSR crumbled shortly thereafter… but Keynesianism survived.
Paul Krugman graduated from Yale and MIT. He’s taught at MIT, Stanford, Berkeley, the London School of Economics, and Princeton.
Infamously, he wrote, “The growth of the Internet will slow drastically, as the flaw in ‘Metcalfe’s law’—which states that the number of potential connections in a network is proportional to the square of the number of participants—becomes apparent: most people have nothing to say to each other! By 2005 or so, it will become clear that the Internet’s impact on the economy has been no greater than the fax machine’s.”
Krugman’s response has been rather humorous. He first claimed it was an attempt to be fun and thought-provoking. He now claims to not even remember writing the statement.
Imagine that.
Presumably, Krugman behaves like billions of others and uses the internet countless times a day. Every step in this argument was incorrect. But his failed prediction is apparently not an indictment of his reasoning. It’s a forgettable triviality.
Perhaps I’m being unfair. Forecasting technological innovation is difficult. Let’s try something with established importance: oil.
On June 27, 2008, Krugman wrote in The New York Times: “Regulating futures markets more tightly isn’t a bad idea, but it won’t bring back the days of cheap oil. Nothing will. Oil prices will fluctuate in the coming years—I wouldn’t be surprised if they slip for a while as consumers drive less, switch to more fuel-efficient cars, and so on—but the long-term trend is surely up.”
That day, oil traded above $140. It soon plummeted. And despite nearly two decades of inflation, oil has yet to top that nominal high.
Perhaps I’m still being unfair. Speculators can appreciate the difficulty of predicting price movements for a single commodity. Let’s review a Krugman prediction about the market more generally (his self-identified specialty).
On November 9, 2016, he wrote: “It really does now look like President Donald J. Trump, and markets are plunging. When might we expect them to recover? Frankly, I find it hard to care much, even though this is my specialty. The disaster for America and the world has so many aspects that the economic ramifications are way down my list of things to fear. Still, I guess people want an answer: If the question is when markets will recover, a first-pass answer is never.”
Between Krugman’s prediction and the Crash of 2020, the S&P 500 more than doubled and the Nasdaq more than tripled.
Is this the best Keynesianism has to offer?
Many believe that Krugman is now more of a political commentator than a serious economist. That might be true. But economists at the highest level of power haven’t been more prescient.
In 2004, New York Federal Reserve economists Jonathan McCarthy and Richard Peach published a paper denying the US housing market was in a bubble.
The Harvard- and MIT-educated Ben Bernanke surely agreed. In July 2005, he responded to a question about a housing bubble by stating, “Well, I guess I don’t buy your premise. It’s a pretty unlikely possibility. We’ve never had a decline in house prices on a nationwide basis. So what I think is more likely is that house prices will slow, maybe stabilize—might slow consumption spending a bit. I don’t think it’s going to drive the economy too far from its full employment path, though.”
After problems arose, Bernanke was asked if they would remain in certain localities or spread nationally. He reasoned, “You can see some types of speculation: investors turning over condos quickly. Those sorts of things you see in some local areas. I’m hopeful—I’m confident, in fact, that bank regulators will pay close attention to the kinds of loans that are being made, and make sure that underwriting is done right. But I do think this is mostly a localized problem and not something that’s going to affect the national economy.”
From March 2006: “Our examiners tell us that lending standards are generally sound and are not comparable to the standards that contributed to broad problems in the banking industry two decades ago.”
From January 2007: “I have described several ways in which the Fed’s supervisory authority assists it in performing its other functions. In my view, however, the greatest external benefits of the Fed’s supervisory activities are those related to the institution’s role in preventing and managing financial crises.”
From February 2007: “Our assessment is that there’s not much indication at this point that subprime mortgage issues have spread into the broader mortgage market, which still seems to be healthy. And the lending side of that still seems to be healthy.”
From May 2007: “Given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited. .... Importantly, we see no serious broader spillover to banks or thrift institutions from the problems in the subprime market; troubled lenders, for the most part, have not been institutions with federally insured deposits.”
From July 2007: “The global economy continues to be strong, supported by solid economic growth abroad. US exports should expand further in coming quarters. Overall, the US economy appears likely to expand at a moderate pace over the second half of 2007, with growth then strengthening a bit in 2008 to a rate close to the economy’s underlying trend.”
But you know what actually happened next: problems in the US subprime mortgage market were not “contained,” and the US economy tanked. The global economy went into crisis.
In response, the Fed expanded its balance sheet to $2 trillion by purchasing toxic assets. Bernanke stated, “I think we would like to bring the balance sheet back to what it was before the [2008] crisis, something under a $1 trillion or less.” But the Fed’s balance sheet steadily climbed to over $4 trillion.
Flash forward to COVID-19, and now the Fed’s balance sheet is just under $8.6 trillion.
I’m sure Keynesians and the like would explain away all the above. But recent events show that their myopia remains a serious problem.
In October 2022, Bernanke won the Nobel Prize in economics for his research on banking and financial crises.
In March 2023, Silicon Valley Bank collapsed. The US suffered the second-largest bank failure in its history without any warning from the Fed.
Did current Fed employees not read the former chairman’s Nobel Prize-winning research? Did it provide no meaningful guidance?
While academics, economists, and central bankers find ways to pardon their own errors, investors must navigate them.
I’m sure you’ve noticed storm clouds on the horizon.
It’s unclear how bad things will get. But we should recall that in 2017 Janet Yellen (Brown and Yale) predicted that we wouldn’t see another financial crisis in her lifetime. Given everything we’ve discussed, her words are less than comforting. Even Team Soft Landing now projects a “mild recession” to begin later this year.
Lobo Tiggre, the independent speculator, has written about the reasons why economists who pay more attention to their models than the facts of reality make such consistent mistakes. As he likes to say:
Caveat emptor.
KJ
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