More On Economists In Silicon Valley

This article entitled “Economists Adding Up At Amazon.com, Microsoft, Google” appeared on the website Investors Business Daily.

Why Is Macro So Hard? Repeating the Bad News but Not the Good

Humans are weird. We like to hear bad news, particularly if it’s about others, or if we can use it to gain sympathy for ourselves without actually getting hurt.

In macroeconomics, this means that you will be exposed to less news stories about the economy when it is doing well, and more when it is doing poorly.

We are currently towards the end of a weak expansion, maybe around a peak. This is prime time for bad news plus the same bad news.

Three months back, the news was that forecasting models were indicating that the economy was that the economy might be peaking soon (we discussed this here and here). Now the news is that real GDP growth for the first quarter of 2016 is going to come in around zero (the linked article is required reading). If you think about it, they mean the same thing.

The closely watched Atlanta Fed GDPNow model now shows first-quarter growth tracking at 0.1 percent, compared to a 0.4 percent estimate earlier in the week.

Do note that I’m not saying that both of these items are not news. Instead, what I am saying is that “evidence that we’re peaking and evidence that we peaked” is covered more than “evidence that we’re not peaking and evidence that we did not peak”. But, given the fact that the economy tends to be in expansion about three times as much as it’s in contraction, we should actually hear more about the latter.

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One problem with cyclical industries is that they overproduce and then have to pull back production and draw down their inventories. Some are of the view that the first quarter was a pull back, and that this is a good sign for the second quarter:

The JPMorgan economists, however, say there may be light at the end of the tunnel.

"While 1Q is adding up to be a clear disappointment relative to expectations from a few weeks ago, it now looks like the inventory correction was largely completed by the start of the second quarter, which is a favorable development for growth in that period. We now think that real inventories increased $54bn saar in 1Q, a rate that is likely to be sustainable moving forward," wrote JPMorgan economist Daniel Silver, in a note.

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.