Economists versus Punters
Everybody is adamant they know how to pick the winner in a horse race. Some people stake money on a horse simply because they like the name of the horse, its number or the colour of the jockey’s uniform. Just after staking their money, people are much more confident of their horse’s chances of winning than they were immediately before laying down that bet.
Why do they gamble? They gamble for the excitement and the hope of winning money. Most of them lose their money but a few with just blind luck, win.
Gambling is about luck, but betting isn’t. Betting is about two things: psychology and information. A punter, who bets, spends all his time gathering information, about the horses’ pedigrees, past and recent performances and how the horses have fared on various distances against other horses and how they had performed on different tracks and weather conditions, what they’ve been doing in training earlier in the week, what feed they have been given, how much the jockey weight when he got up in the morning.
All the information the others can’t be bothered with or unable to get or absorb. Then he pools it, works out the odds and watches what the other gamblers do. If the odds are too high, he usually bets on it, whether he thinks it will win or not.
These punters tend to win more often but not every time as their models do not have access to all the relevant data such as the condition of the horses during the race or the mindset of all the bookmakers, horse owners, trainers and jockeys.
The influential minority play a key role for they place pressure on the horse trainers and jockeys to ensure a different outcome than what is expected and gain financially in the process.
Applying economics for the person in the street is like gambling on the horse races, everybody has an opinion and everybody sounds like an authority, and nobody gets it right.
Economists are like the punters they are also gathering relevant data and putting it in their mathematical model. The test is which data to collect, which values should be applied and how to interpret the results. The big question is; do they have access to all the relevant data? Models, at best, produce answers consistent with the assumptions put into them.
No individual, committee or computer program would ever have all the information needed to construct an economic order, even if a model of such order could be revised.
Stock markets have existed since Roman times, when state-chartered companies carried out many of the functions of the empire such as issuing stocks and bonds. It wasn’t till the 1960’s that the study of financial markets started to be integrated with the rest of economics.
The economic life is permeated with uncertainty and that is why people are puzzled about the failure of so many brilliant academic economists to anticipate financial crises. Public officials cannot be expected to be completely candid at all times but should not make misleading statements of any foreseeable crises.
Many leading macro economists and prominent finance theorists simply kept silent as the storm gathered and broke, feeling it was the prudent course to take. Although that is worrying, what is more disturbing is the fact not only were warning signs ignored until it was too late but they did not prepare any contingency plans in how to deal with the financial crisis.
If the real world were accurately described by economic textbooks, there would never have been a financial crisis, the Great Depression would not have happened. The economy would instead be either in equilibrium, or rapidly returning to it, with full employment, low inflation, and sensible priced assets.
Of course, the real world is nothing like that. Instead it has been mostly in disequilibrium, and in near-turmoil and prone to breakdowns as it moves through the cycles.
Although some people find economics technical and boring; but whether we like it or not the impact of the global economy has an effect on all of us, touching our lives in every way. The policies influence the value of our currencies in our pockets, the price of the groceries we buy, how much it cost to fill up our cars, the wages we earn, the interest we get on our savings accounts, and the health of our pension funds.
You may not care about economics but it will have an impact on whether you can retire comfortably, send your children to university, or be able to afford your home.
It is therefore important to study the economic trends and have the knowledge to prepare your portfolio for the next financial cycle. By being innovative with your financial knowledge it will ensure that you stay in the driver’s seat.
Empirically tested mathematical models were developed to predict future trends. The models are a good step in the right direction in making economics more scientific. By studying the data obtained from these models economists are able to predict what could happen in the future. There is a small group of economists that knows what is going to happen and write and talk about it. They are all extremely smart, have PhDs from prestigious universities, and are generally decent, honest people trying to do their job well.
However, they have to overcome two obstacles namely; the herding instinct and the pressure from the policy makers.
The herding instinct is quite strong among people, at first they do things according to their own interest but over time they have a tendency to imitate their friends and colleagues. This tendency increases until something breaks it up.
Scharfstein-Stein- “The underlying model idea is that if you do something dumb, but everybody else is doing the same dumb thing at the same time, people won’t think of you as stupid, and it won’t be harmful to your reputation.”
Economists might feel proud about the advances in economic science over the last seven decades since the Great Depression, but that doesn’t mean that there has been unanimity about how crises should be handled.
Despite the massive resources spent, the world leading economists still have it wrong. There are three reasons for this. There are some that are pretty happy and their current thinking that no fundamental change is necessary. Others rightly predict what is going to happen but in fear of ridicule or by the pressure from politicians they don’t tell people the truth, but rather the ‘good news’ which the people prefer to hear.
The second reason is the data they are using is wrong because almost all economic data gets revised later. Therefore, the real-time data which they are using is subject to change. They should use data and prices that are not subject to change which contains reliable clues about the future.
The third reason for being wrong is the same as in betting on horses. The influential minority controls the wealth of the earth, the media and the leading politicians. Their influence distorts the data and makes the mathematical models less reliable.
If economists were merely wrong at betting on horse races, their failure would be harmlessly amusing. But central bankers have the power to create money, change interest rates, and affect our lives in every way-and they don’t have a clue.
People who want to know about forecasts are mostly concerned about recessions as it affects the availability of jobs and unemployment during a downturn in economic activity.
Unfortunately, economists are no use to them as they make lousy soothsayers. Economists are unfortunately more philosophers than scientists as they struggle to inform us what happened during the past year, let alone in the year to come.
Economists promised that through fine tuning fiscal and monetary policy, rebalancing terms of trade and spreading risk through derivatives, market fluctuation would be smoothed out and the arc of growth extended beyond what had been possible in the past.
When the world economy went into freefall in 2008, so did our beliefs. The policies of the IMF and the U.S. Treasury had made the crises far worse than they otherwise would have been. The policies showed a lack of understanding of the fundamentals of modern macroeconomics. As a society, we have now lost respect for our long-standing economic gurus.
The panic of 2008 however revealed the economic emperors wore no clothes. Only massive government interventions involving bank capital, interbank lending, money market guarantees, mortgage guarantees, deposit insurance and many other expedients prevented the wholesale collapse of capital markets and the world economy.
Central banks targets inflation and jobs which are both lagging indicators in economy. Lagging indicators can tell you only about the past, not the future. Unemployment is usually at the lowest level just prior to a recession, and inflation is usually the highest in the throes of a recession. Coincident indicators tell you about the present.
To look ahead to what’s going on in an economy one must use leading indicators such as building permits, growth in the money supply, average hours worked and the yield curve.
After obtaining a building permit one hires builders who build the house. Once the house is completed you buy appliances and furniture. Building has a huge positive effect on many other parts of the economy. Knowing whether building permits are rising or falling gives you a pretty good advance on where the economy is heading.
The yield curve is the spread between the interest rates on the ten-year Treasury note and the three-month Treasury bill which is found on the back page of The Economist. It is simple to use and significantly outperforms other financial and microeconomic indicators. An inversion of the yield curve predicted every recession in the past forty years and since 2012 the yield curve is in a sharp decline.
These leading economic indicators are the most useful, and they are generally ignored by leading economists. Investors who focus on them will find themselves ahead of the game.
However, the central banks are distorting inputs into the economy and leading indicators.
The Global economy is one in which the dynamic process of integration among national economies has succeeded. Business people have to consider a single global economy as part of their decision making. They have to factor in global trends before making any practical decision to invest or not to invest in a venture.
But the world economists focus on their own national economies rather than a single global economy. The absence of a single global economy is because it is at odds with the economist discipline. The key analytical point of international economists is not how a single economy performs, but how many economies deal with each other.
The lesson we obtained from studying economics is that there are no easy answers in economics. Fortunately, economic science has not stood entirely still. A new paradigm has emerged in the past twenty years. The new thinking comes with a healthy dose of humility; many practitioners acknowledge the limitations of what is possible with the tools at hand.
They are discovering that complex systems arise spontaneously, behave unpredictably, exhaust resources, and collapse catastrophically.
‘Microeconomics concerns things that economists are specifically wrong about, while macroeconomics concerns things economists are wrong about generally.” –P.J. O’Rourke, Eat the Rich.
I believe that if the economists understand the value of demographics they can identify some key economic trends which affect our lives, businesses, and investments during our lifetime. Demographic data can help identify macro and micro trends. One the small side, it will show that people spend the most on potato chips at the age of forty-two, and deflation can set in when more people retire than enter the workforce.
Economists think no one can predict longer-term trends because the world and technologies are changing faster than ever. The truth is we have new information on demographics that we never had before, which makes predicting the long-term economic trends easier than predicting shorter term trends. It is the best leading indicator as people do predictable things as they age.
Demographics show that young people cause inflation as they cost everything and produce nothing. As the new generation enters the workforce, businesses have to invest in workspace, equipment, and training. Conversely, older people tend to be more deflationary. They spend less, downsize in major durable goods, borrow less, and save more. They don’t require investments in new infrastructure like offices or larger homes, or in more education; they ultimate leave the workforce an
d downsize to smaller homes or even nursing homes. This stands in contrast to young people who require massive investments in education, office space and technology as they prepare for and then enter the workforce.
Andre Klopper