Inside investment: Fed not alone in its dottiness
Since the US Federal Reserve met in September the data has been tortured and every word pored over. Why are we in awe of the crystal ball gazing of supposed experts?
The old joke goes that God invented economists to make astrologers look good. But when the best and the brightest of the dismal science gather at the Eccles Building in Washington DC for a meeting of the Federal Open Market Committee, the financial world holds its collective breath. The federal funds rate sets the cost of capital in the US and the rest of the world.
September’s meeting was a non-event. The policy rate remained unchanged as it has been for almost six years, and the Fed still maintained its language about it staying there, “for a considerable time”. The taper, as was well trailed, was duly tapered down to the last $10 billion this month. With little else to latch onto, what got commentators exercised were some dots.
In one of five pages of summary economic projections designed to provide forward guidance, there is a ‘dot plot’. There are 17 dots, each one representing the anonymous view of one FOMC member, of future interest rates for the end of 2014, 2015, 2016, 2017 and in the longer run. What is most interesting is the degree of dispersion.
Join the dots
Three members of the FOMC expect next to no change in interest rates next year; there is a cluster of four dots at 175 basis points; and one outlier at 275bp. In 2017 the dots range between 37.5bp and 400bp. As another joke about economists has it: if you lined up all the economists in the world end-to-end you still could not reach a conclusion.
The FOMC and other economists do like to stare into a crystal ball, no matter how dark it is. In his latest book, The Map and the Territory, the former chairman of the Federal Reserve, Alan Greenspan, is in a reflective mood. It is a brilliant exposition that is well worth a read. But he still clings to the forecasting comfort blanket.
“Forecasting, irrespective of its failures, will never be abandoned. It is an inbred necessity of human nature. The more we can anticipate the course of events in the world in which we live, the better prepared we are to react to those events in a manner that can improve our lives,” writes Greenspan.
Balls, offal, birds and experts
He is half right. In much the same way modern economists use data, the priests of the Babylonians, Hittites and Etruscans used the variety meats of eviscerated animals to divine the future.
Roman augurs used to study the flight of birds. Those augurs could rescind laws or declare the election of senators invalid. The philosopher Cicero regarded them as the most powerful men in Rome. In spite of wondering whether two augurs passing in the street would cover their faces or burst out laughing, he was overjoyed to be co-opted into their ranks.
|It is a far, far better thing to have a firm anchor in nonsense than to put out on the troubled seas of thought
John Kenneth Galbraith
The Age of Enlightenment supposedly banished myth and superstition, at least for the educated, 1,700 years later. But Cicero recognized not only the desire to predict the future, but another innate human trait: deference to ‘experts’, and the power that brings. It is not just economists who are bad at forecasting. Bill Gates famously said in 1981 that 640 kilobytes of computer memory “ought to be enough for anyone”.
There is a book, still unread, in my study with the self-explanatory title, Useless arithmetic: Why environmental scientists can’t predict the future. Journalists are serial offenders in the crap prediction stakes. Celebrated Manchester Guardian columnist HN Norman declared in 1914: “It is as certain as anything in politics can be that the frontiers of our modern national states are finally drawn. My own belief is that there will be no more wars among the six Great Powers.”
No one knows
Norman could not know what the Black Hand was planning or what was going through the head of violent misfit Gavrilo Princip. What no one could know on the weekend of September 13 2008 was that HM Treasury would not bend to the will of Hank Paulson and the US Treasury Department, or that the implicit put of the US government backing the financial system would not be exercised for Lehman Brothers.
No demographic extrapolation of prior trends could factor in the Black Death or Spanish Influenza. But it is these events that really matter. They are unknowable. They cannot be anticipated or planned for. Relying on supposed experts and their forecasts is no joke. It is just plain dotty. It is best to end on an ironic but serious note from a truly wise economist, John Kenneth Galbraith.
“It is a far, far better thing to have a firm anchor in nonsense than to put out on the troubled seas of thought.” We should let the anchor slip, distrust the experts and learn to think for ourselves.