Lies, Damn Lies, & Economists
The sky is falling, the sky is falling…if you believe what some economists are saying about future inflation in the US rising exponentially due to the government’s large injection of money into the economy. But since most economists haven’t really got much right recently, why should we listen to them this time? The fact is, we shouldn’t.
First, lets address the accuracy of economists or more specifically lack of accuracy. According to economics Nobel laureate Paul Krugman, “…most work in macroeconomics in the past 30 years has been useless at best and harmful at worst.” Economics is not a forecasting science, contrary to the use of most economists by business and finance. Economics is a social science that looks at the behavior of people, groups, and systems for allocating resources (of which governments, money, and finance are players). We generally don’t ask anthropologists and sociologists to predict the future, then why are we asking and relying on economists to light the future for us? Social sciences are best used for asking “why” things happen or people behave a certain way, not “how” they will in the future.
Economists look at past behavior and actions to created models of how they think one or a couple aspects of the economic world operates. These models have to simplify the world and make many assumptions to be useful for analysis and prediction. Sometimes they work, sometimes they don’t. But it is a giant leap to go from a model that simplifies the world to look at isolated aspects of the economy to predicting real world behavior and market actions with the limitless number of aspects and variables.
If this simplification wasn’t challenging enough to the practical use of economic models, it gets worse. The real weakness in economics models built in the last 30 years for business and finance is that they are based, at least partially, on two flawed theories–the rationality of humans and the efficient market hypothesis. Without getting into the details of these concepts, the flaws are easy to see.
- First and most importantly, humans do not behave economically rational much of the time. If anything, the economic randomness of the last two years provide a good example of that; thus the rise of behavioral economics (combines psychology with economics). Why is this important for this discussion around inflation? Because the theory of high future inflation relies on models that try to predict what will occur when the government injects trillions of dollars into the economic system, as it recently has. What these models neglect to take into account is the psychological aspect of the economy losing $13 trillion in value over the last two years, much of it felt by individuals in the decreased value of their homes and savings (yes, @ $4T in value has come back, but the pain still exists). Also, the money supply as measured by M3, which the government uses as the most comprehensive measurement of how much liquid money is sloshing around the country is collapsing. Unless the government injects enough money into the system to return home and retirement portfolio values back to previous highs, inflation will not increase dramatically because consumer demand and lending will remain low due to non-rational, psychological reasons.
- Secondly, the efficient market hypothesis falls apart because it relies on the rationality theory and player manipulation, government intervention, and asymmetrical information can never be fully removed from the system, so the market can never act as freely as is theoretically possible.
Lastly, economics is not a blind science. There are many different economic schools of thought that influence the viewing, analysis, and interpretation of economic systems by economics. So no model based on past data can accurately predict the future when economists can not agree on what actually occurred in the past.
So my recommendation is to take every economist’s prediction with a grain of salt because they are basing their predictions on simplified models of the world that may rely on faulty theories. I offer this advice as a trained economist, not to bash the field of study put to protect it’s future value to society. For as long as history is recorded people have sought out oracles and prophets for insight into the future. There is northing wrong with seeking this advice (I guess), just please don’t put economists in this category.
*Note to inflation junkies and your addiction to gold…the gig is up! Unless the world economy completely collapses into another dark ages, gold does not have any real value (and may not have any value then either). Gold has not moved up or down with the economy and government intervention as is predicted in so many “rational” models. The value of gold is mostly a function of behavioral, psychological based influences.
