Wednesday, February 10, 2016

The ‘Chart of Doom’

I have no idea how popular this idea is, but I saw a headline for it on more than one news site this week (they must have a good publicist). The original source is a blog called Market Daily Briefing, it was picked up by Daily Reckoning in a post entitled “The Chart of Doom: When Private Credit Stops Expanding …”, and from there by AOL.

The chart in question is this:


This is the sort of cute piece of data that financial professionals often pass from one to another.

I think the story they’re trying to sell here is that if private credit fails to keep growing there will be a recession.

For my part, I think this fits in with some things I’ve stressed before — false positive and false negatived, hyperbole, and data scaling.

First off, let’s start with the hyperbole. How is the reader supposed to feel when they see “doom”, “three down, two to go”, “rocket ship … returns to Earth”, “bailouts”, and “lousy”. Whoever put this together is pushing your emotional buttons.

Second, note the data scaling. There isn’t any. Even though these should all be logged because they no doubt display compounded growth. Additionally, the “three down, two to go” point doesn’t mention that there are three big numbers (that presumably matter more), and two smaller ones (that presumably matter less).

Then there’s the positives and negatives. Clearly, there’s a (true) positive for the U.S. in 2008 or so. There’s also a small one (well, who knows really, since the data isn’t logged) for the U.K. But there’s nothing for China, which arguably fared worse. And nothing for the Eurozone which definitely did worse. And how to explain Japan, which actually showed more private credit at this time, even though they were in recession  too?

However, there’s clearly a false positive for the U.S. in 2000-1. No sign of a recession at all there.

I also think we should be suspicious of the data. Why is the data for Japan and the Eurozone so choppy, while the data for the U.S. and China is smooth? Something smells fishy about that. Going further, wouldn’t the ups and downs of Japan and the Eurozone be making an awful lot of false signals?

All in all, you should be very careful about reading too much into a chart like that purports to answer macroeconomic questions.

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