Sunday, April 3, 2016

Journalists Are Often Lousy Economists

Most of what people learn about the economy comes from journalists. Fair enough. But things get stickier when it’s about economics rather than the economy.

For students moving on to careers in FIRE, reading what journalists write is essential, but parsing whether or not the journalists theories make sense is even more so.

Tim Worstall spotted this one in one of Britain’s largest newspapers (not required, but fairly easy reading). It starts out with a discussion of the poor decision of newly rich investors from India getting burned buying worn out old companies from their former colonial parent.

But, towards the end, it turns into a clueless analysis of the trilemma (you know, the thing that China is having so much trouble with this past year):

In contrast to my early years as a financial journalist, when sterling crises were two a penny [note: sterling is a pet name the British have for their currency], nobody much cares about the current account deficit these days. Yet news last week that it reached a jaw-dropping 7pc in the final quarter of last year was enough to make even the most sanguine of observers sit up and take notice.

I’m going to continue with the quote, but here’s an aside about the paragraph coming next. I have touched on this in class: this sort of claim is like saying you’re amazing because you set a new world record just this morning for the number of breakfasts you’ve eaten in your lifetime.

It’s a profoundly alarming spectacle, but both the UK budget and the current account deficits seem get markedly worse with each passing, post war, economic cycle. These latest ones are by far the deepest yet.

That they are in any way tolerable is I suppose down to the much more sophisticated nature of global capital markets, which makes funding them a lot easier than it was. But this in turn may make the country even more vulnerable to a sudden stop, or to any loss of international confidence in the economy’s underlying solvency. Eventually there will be a shock, triggered possibly by Brexit, which will manifest itself in a deep devaluation and possibly a consequent, precipitous rise in interest rates.

A current account deficit of such magnitude would normally be an indicator of an economy which is seriously overheating, sucking in imports for lack of available domestic capacity. Yet inflation is at virtually zero …

Worstall correctly points out that the reason the U.K. used to have sterling crises all the time was from bad management of the trilemma.

[It’s] because we don’t have either fixed currency rates nor dirty floats. You can manage two of three, just about: currency rates, interest rates and trade balances. You cannot manage three of three. For the third is the tool that must be used to manage the other two.

But if you’re not trying to manage currency rates then you can leave the trade balance alone.

In class, and in this blog, with respect to China I described the trilemma as comprising exchange rates, monetary policy, and capital flows. These are just different aspects of the “currency rates, interest rates and trade balances” listed above.

The U.K. learned the hard way that you can’t control all three. The Chinese are still learning.

And do not forget that new government officials tend to forget lessons like this, and have to relearn them periodically.

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