Recently a Japanese economist visited Washington to explain his government’s “five year economic outlook.” A five month outlook might have been more credible. Yet with surprising hubris, the economist forecast inflation and GDP five years out.
For decades, hubris has been the common currency of the economic policy world. It is killing the economics profession. In the 1960s and 1970s, for example, liberal economists believed they could eliminate all poverty. In the 1980s, conservatives thought tax policy could permanently raise the savings rate. It turns out other factors also influence a person’s decision to save.
In the first decade of this century, some central bank economists thought they could engineer monetary policy (with the help of global capital inflows) to eliminate the U.S. business cycle. What happened? The underpricing of financial risk helped lead to the global financial crisis.
The experts also blundered in Europe. At first, the economists assumed tiny Greece’s debt problems could be contained. Italian policymakers were engulfed in hubris as their government bond interest rates remained unaffected by the Greek crisis. Bank of Italy governor Mario Draghi (now head of the European Central Bank) was in the midst of a victory lap when, to his embarrassment, Italy’s long-term rates skyrocketed.
Hanging by a thread, the euro project today looks like a case of hubris on steroids.
Now the world is being flooded with money and debt. The relational matrix of debt, interest rates, and growth has become the great conundrum of our time, a Rubik’s Cube of difficult choices with unintended consequences. Yet as the financial system has grown more stunningly complex, hubris strangely has shifted into high gear.
Keynesians demand massive new government spending, insisting that with the economy having so much excess capacity, debt doesn’t matter. Many conservatives demand fiscal austerity, believing the announcement of which will somehow attract global capital. Yet the austerity talk produces precisely the kind of market uncertainty that scares away investors.
But the big granddaddy of them all is the hubris surrounding quantitative easing (QE), a policy tantamount to propping up a bicycle with a set of monetary training wheels. In the United States and Japan, central bank economists are thrilled because QE rallied stock markets. The hope is that affluent stock owners will increase consumption, creating a trickle-down monetary effect to the rest of the economy.
Seldom mentioned is that central bankers have a terrible track record at identifying and controlling financial bubbles, including stock market bubbles. The economists say trust us anyway, because this time is different. But look at the rosy economic forecasts of the FOMC, the Federal Reserve’s policymaking committee, over the last several years. Each January, the FOMC has predicted annual growth of roughly 3.5 percent. The outcome was always closer to 2 percent, despite a grab bag of ever-increasing monetary stimulus.
Economists fare the worst in understanding politics. Under QE, the gap between American families that own equities and mere wage-earning families has widened dramatically. Government, as economist Robert Johnson put it, has become “an insurance agency for the rich and powerful with premiums paid by the middle class.”
The economics profession has ample reason to feel defeatist. For decades, despite a variety of fiscal and monetary stimuli under both parties, middle-class wages and salaries in real terms have stagnated. The saving grace was the availability of cheap loans, only now the loans are becoming tougher to obtain.
Most Americans can sense something is fundamentally wrong. The traditional fiscal and monetary tools aren’t working the way the experts predicted. Public and private leverage has become an unsatisfactory substitute for innovative breakthroughs that enhance productivity, dramatically increase GDP growth, create jobs, and lead to increases in real wages and salaries.
Stocks rally, correct, then rally some more. The economists cheer their own success. Meanwhile, six in ten Americans still sense the country is moving in the wrong direction. And the crux of the problem may well be this simple observation: Sensing the system is broken, Americans no longer “salivate for the future,” as columnist David Brooks aptly put it.
So at worst, the field of economics is dying. It is becoming less a science and more an art. At best, it needs a giant rethink in light of today’s challenges.
Some questions to ponder: How could the experts be so wrong? Over the last five years, after fiscal and monetary stimulus, global public and private debt increased by a stunning $48 trillion (global GDP is $85 trillion). Stock market capitalization jumped by an astounding $26 trillion. Yet the world economy is actually slowing.
What are the factors (exchange rates, macroeconomic conditions, level of real interest rates, direction and level of capital flows) that might provide clues as to whether a nation’s debt has reached the danger zone? Or is the only choice before reducing debt simply to wait until a crisis sets in?
How do we understand the almost metaphysical nature of entrepreneurial risk-taking, the source of most new jobs? Is such risk-taking facing death by a thousand legal and regulatory cuts from Washington?
How do we survive a global capital system with ever expanding oceans of money and seemingly few rules of the road? Are central bankers irrelevant? Is eye-popping financial volatility, therefore, the “new normal”?
And, in the process, is the little guy in America the permanent fall guy?
How do we assure that the emerging U.S. energy revolution transforms the competitiveness of American industry and raises real wages and salaries across the board?
An economic policy rethink won’t be easy. But the first step is to deep-six the hubris. This year should mark the death of all government five-year economic forecasts.
David M. Smick, a macroeconomic adviser to a number of global investors, is founder and editor of the International Economy magazine and author of The World Is Curved: Hidden Dangers to the Global Economy.