Monday, June 18, 2012

Economists, Weather Prediction and the Art of Alchemy

On Friday, my phone received an alert that dangerous thunderstorms were imminent with a 100% POP (probability of precipitation) of their occurrence.

Now, by my definition, 100% is pretty certain and so I was disappointed when the anticipated apocalyptic storm didn’t arrive.  At some point, the forecast changed to a 0% chance of rain and shortly thereafter, the rain arrived.

When the forecast was revised again to a 90% chance of rain and thunderstorms, the sun came out and that was the end of the rain for the weekend.

While I respect the science of meteorology, oftentimes the model that represents the earth’s weather systems is too complex for weather experts to predict with certainty.

A similar thought came to mind today as I watched an economist speaking with great certainty about how the global economic situation would play out over the next five years.

Unfortunately, like our complex weather systems our economic system is far too complex for a few models to properly understand and so when I hear an “expert” speak with certainty on where the economy is going, I look for something more realistic, such as the manner by which alchemists claimed to be able to transform lead into gold.

As this economist described his five year view, I was thinking “we can’t predict what is happening next WEEK and he has a five-year prediction”. 

Yeah … right.

Think of it this way.

Few experts foresaw the difficulties of the last four years (yes, SOME did see it coming and tried to warn the populace but they were shouted down by the recognized “experts”) and yet we continue to listen to how they believe they can predict the future. 

It’s like walking into an psychic’s office and having him / her ask you what you need and you think “You’re the psychic – don’t you already know?”.  

Oftentimes, we miss this important clue and rely on the self-described expert to continue to predict our future.

Meanwhile, in watching the performance of many economists over the last four years, the pattern has gone like this.

1. When monthly numbers come out, the “expert” extrapolates a trend from a single data point (which is impossible) and predicts that either difficulty will continue or that we are in the clear as far as difficult is concerned.

2. Political interpretation results in one of two options:

2a. If I am a politician in a governing party, I paint how the numbers project that recovery is underway no matter what the numbers really imply.

2b. If I am a politician in an opposition party, I paint how the numbers are taking us to doom and gloom no matter what the numbers really suggest.

3. When the following month’s numbers come out, they either exceed expectation if the numbers are good or are surprising if the numbers are bad.  Either way, the “experts” are surprised and extrapolate a new trend based on the new data point. 

4. Go back to step 2 and repeat the process.

When an expert is surprised once or twice, one can attribute that to lack of data, the need for improved models, etc.

When an expert is surprised repeatedly from month to month over the course of years, it then looks more like:

1. Incompetence

2. Excessive ego

3. Lack of real understanding

4. Inadequate models

5. Intentional misrepresentation, oftentimes to encourage spending and consumption, to reduce fear in the populace or to avoid difficult questions.

In any of the first four scenarios, it looks like no one is “driving the bus” and that the economic system, with a life of its own, will proceed in whatever direction its momentum is carrying it regardless of our efforts to predict or direct it.  The fifth scenario suggests an ulterior motive, which has its own complexities.

None of the scenarios is very comforting.

Unfortunately, people who don’t understand how the system works are at the mercy of advisors who make money no matter which way the economy goes.

Sadly, the same is not true for their clients who rely on these advisors.

Watching the Euro situation is a perfect case-in-point of how the experts attempt to predict things.

Experts who said that a specific result in the Greek election would be needed to hold the Euro community together applauded when they got the result.  Off hours trading went up as a result.  Then the experts realized that now that the right party had won, a coalition would be needed to actually make things happen and the market went down.  On top of that, once the coalition is in place, the actual difficult task of bringing major deficits under control would then have to be done and the market got even more jittery (especially given the fact that governments and effective deficit reduction plans are not common dance partners).

Throw in similar issues on a larger scale, like those in Spain, and the markets don’t know which way to turn.

Such lack of consistent, replayable, useful knowledge makes things even more laughable (and frightening) when someone appears on TV and claims to have the perfect crystal ball into the situation, especially when the word “bailout” enters the dialog.

Bailouts – The New “F” Word

Bailouts make the stock market happy.

Unfortunately, bailouts represent a deferral of a solution instead of a real solution and therefore should not be celebrated.  In fact, if the underlying causes for the debt issues haven’t been solved, bailouts should make people very nervous as the solution that will be required later will be more painful and complex than the current situation that was just avoided by using a bailout.

Bailouts in the 21st century have become the Hail Mary pass of the global economy.

Imagine if your favorite football team admitted to not having a game-day strategy outside of “we’ll do our best to hold on for dear life and go for the win in the final play of the game”.

That is a bailout.

Unfortunately, you don’t build many championship seasons when your primary strategy is the Hail Mary pass.

When the bailout comes, it’s like being maxed out on your credit cards and not being able to make a payment when suddenly your credit limit is increased.  You congratulate yourself for weathering the storm (even though you didn’t really do anything worthy of a reward) and you borrow money from your new-found credit to make your minimum payment.  Meanwhile, you live with the hope that everything around you will magically change so that the situation never happens again (even though you are not changing anything in regards to how you live).

You’ve not only not corrected what caused the underlying debt problem in the first place but in fact you have actually dug yourself deeper and yet you continue to hope that something will somehow change (with the exception of your own behavior and results) in order to create a brighter future.

When you find yourself in the same spot in the future, you act surprised and hope to get another credit limit extension and the cycle repeats.

Leverage or Be Leveraged

So when our economic advisor wins whether we win or lose, when economists can’t predict with certainty from one moment to the next what is happening and we can’t predict with certainty whether a politician is lying or telling the truth from one moment to the next, where can we turn?

We must take responsibility for understanding how the system works, to know how to maximize returns where possible (remembering that there is money to be made even in difficult times) and to learn how to mitigate risk.

Within the system, there are three types of people in the world:

1. Those who know where they are going.

2. Those who enable the ones who know where they are going or who benefit from their success.

3. The stepping stones, upon which the first two groups step on in order to manifest their destiny.

Which type are you?

How do you know?

If you are type 3, what are you doing about it?

When we rely on others too much, our future is tied to their intentions.

And frankly, I need more assurances of manifesting my future than to rely on that.

How about you?

In service and servanthood,


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