Short-term Economic Speculation is Pointless

People know that weather forecasters rarely get it right, yet continue to tune in to see what these fallible seers have to say about the meteorological outlook. People know, or should, that economic forecasters were invented to make weather forecasters look good, yet they continue to pore over the prognostications of those who have gotten it wrong as if past performance tells us nothing about the difficulty of predicting the course of an advanced industrial economy.

The reason seems to be that people prefer some clue—any clue—to the future, over uncertainty. That authoritative-sounding person promising sunshine tomorrow may be wrong, but believing him or her replaces uncertainty with a feeling that maybe this time we know what is in store for us. So, too, with economists: people seem to prefer going into the new year knowing that a consensus of experts expects the growth rate to be this or that number, rather than to admit that they face the unknown or, worse still, the unknowable.

This year the news they are getting is grim indeed. Consider the following headlines from the Wall Street Journal’s year-end review. “Investors Fear Stocks in U.S. May Not Revive”; “U.S. Property Set to Return to Earth”; “Venture Capitalists Don’t Expect Healthy Returns Anytime Soon.”

There’s worse. The Financial Times tells us, “Dollar set for another tough year on markets.” Indeed, the greenback “stands on a precipice.” Holiday sales are widely reported to have been disappointing (although the trend towards post-Christmas buying at bargain prices may make comparisons with earlier years suspect). The latest surveys show that consumers, who have kept the American economy moving forward in the face of a collapse in business investment, are increasingly nervous about their job prospects, and are suffering from a decline in confidence. Besides, we are warned that they are so deeply in debt as to be forced to rein in their spending in 2003.

Meanwhile, in November, a period described by Federal Reserve Board chairman Alan Greenspan as “a soft spot” in the economy, capital goods orders fell, as did the orders backlog. About the only thing rising was the price of oil, which siphoned billions out of the American economy to pay for imports. How much of the rise was due to the cut in flows of crude from strike-torn Venezuela, and how much to the perceived impact of a war to change the Iraqi regime, no one can tell. But we do know that when prices pierce the $30 level, oil is a drag on the economy.

So why not abandon the forecasting-is-a-mug’s-game position, and simply pronounce that all is not well as we enter 2003? Because much is going well, indeed. The housing market remains strong, and interest rates low—negative, in real (inflation-adjusted) terms, in the case of short-term rates. Greenspan reckons that the backlog of refinancing applications will be worked down during the first quarter, and should sustain consumer spending well into the year. Hourly compensation continues to rise, making workers richer, while rising productivity more than offsets that increase, and keeps labor costs in check.

Even gloomy businessmen are beginning to cheer up, perhaps in response to government data that show that third quarter profits were 12 percent above those in the same quarter of 2001 and free cash flow is now twice as high relative to sales as it was in early 2001. The Institute of Supply Management reports that 70 percent of manufacturers and service companies responding to its semiannual survey say that that they expect sales in 2003 to top 2002.

They may well be anticipating that obsolescence will force a rise in long-deferred investment in new equipment, and that the resolution of the corporate governance issues that occupied the front pages and corporate board meetings will allow executives to focus on growing their businesses.

That, of course, will be a bit easier for American businessmen now that the dollar has declined some 10 percent against a trade-weighted basked of currencies. Europe’s politicians may be delighted that their brainchild, the euro, is rising against the dollar, but the businessmen who must step up exports if the double-digit employment rate in Germany, and the almost-as-high, and rising rate in France, is to be brought down are not quite so ecstatic. Europe’s stagnant economies now find themselves facing interest rates too high to stimulate a recovery, a need to cut spending and raise taxes in order to meet the budgetary restrictions of the euro’s creators, and an appreciating currency that will reduce the attractiveness of the area’s exports. This is not a trifecta on which most economists would like to bet.

None of this is to say that precipitous drop in the dollar might not cause problems for the U.S. economy. But such a fall off a precipice seems unlikely. Japan persists in buying dollars to prevent the yen from threatening its export-led strategy by getting dearer, and driving the nation’s economy further into the doldrums; and Europe, Latin America, and other areas are not expected to grow as rapidly as is the United States. In short, after fleeing to gold, the investment of choice late last year, there are few havens as safe as the dollar to which investors can turn.

All of which is a rather long-winded way of saying that it is difficult to guess which way the economy will go in 2003, especially when we do not know whether there will a war in the Middle East, how long it will take for America to achieve its objectives there, and what the impact on oil supplies and prices will be. Nor can we predict whether some other shock to the system, such as a possible credit downgrading of Ford or General Motors, will drive businessmen and consumers to take fright. Or whether the president will succeed in pushing through another stimulus package.

It is somewhat easier to develop a reasonable picture of the long-term prospects of the American economy, a chore to which I will turn next week, barring intervening “hot,” breaking news that requires comment.

This article appeared in London’s Sunday Times on January 5, 2002, and is reprinted with permission.