SPECIAL REPORT: DIVERSITY FIRST PERSON Beware of forecasters
Anthony Hilton FCSI(Hon)
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WORRIES ABOUT RECESSION MAY BE OVERDONE, ESPECIALLY IF DOUBLE-DIGIT INFLATION PROVES TO BE TRANSIENT
In 1966 the great economist Paul Samuelson famously quipped that the market has forecast nine of the past five recessions. Fifty years on, society remains fixated by forecasts. Thus in 2022 most forecasters said much of the Western
world was heading for inflation and recession – mainly due to the hangover from the Covid-19 shock on supply and demand, and the energy shock from the war in Ukraine. Politicians, central bankers, the markets all agreed. So the US Federal Reserve (Fed) began to push interest
rates up and was followed by several other countries. According to economic theory, pushing up real interest
rates dampens the economy partly because it lowers the level of investment by firms. It also hammers heavily indebted companies, who then struggle to pay the extra interest. And it hits consumers, partly through higher mortgage payments, and because they are less likely to spend on discretionary items, like going out. Hence pubs, restaurants, and travel companies also struggle. The authorities think they need more unemployment so
workers don’t strike for more money – though they tend not to say this publicly. Most economists seem to agree – particularly those who work in the City and are tuned in to markets. But there are dissenting voices.
For example, Professor Louis Brennan of Trinity Business School in Dublin, in a letter published in the Financial Times (FT) (9 November 2022), says profit not wages is the inflation problem. The growth of mega-corporations means these big companies are oligopolies and can push up prices with no qualms, whereas small companies are constrained by their markets and competitive pressures. Even more telling is Andrew Smithers, founder of an
A book written 25 years ago, The fortune sellers: The big
business of buying and selling predictions, by forecaster William Sherden, makes a different point. Economists, stock market analysts, scientists, trend spotters were all at it, writes Sherden, but “their forecasts are about as reliable as the fifty-fifty odds of flipping a coin … most consist of conjecture, unproved theory, or the extrapolation of past trends, which anyone could do.” A decade later, John Ioannidis, a Stanford, California
professor, published a paper called ‘Why most published research findings are false’. He said, in some ways echoing Smithers, this was largely because the assumptions which underpin a theory don’t stand up in the real world. So, putting up interest rates to curb inflation causes more
Some measures of inflation do seem to
be mitigating
problems than it solves. But some measures of inflation do seem to be mitigating. In August 2022 virtually everything was going up. But in November 2022, according to an opinion piece by FT columnist Ruchir Sharma, cargo shipping prices were plummeting, delays at ports were shortening, and supply chain shortages turned into gluts. The change in supply is nowhere more visible than in gas. It surged to over €300 per megawatt hour at its August 2022 peak. But in late autumn it was about 80% lower. Russia used to supply 30–40% of Europe’s gas. Now it is barely a trickle. European demand has been cut by 10%, and supplies from the US, the Middle East, and Norway have made up the difference,
though gas prices are still well above pre-pandemic levels. Arguably, the real cause of worldwide inflation is the
economics consultancy, who says in an opinion piece for the FT (30 March 2022) that conventional macroeconomics is simply wrong. Conventional macroeconomic theory works on untried assumptions, he says, whereas he has formed his own conclusions based on available data. He finds that in the real world, short-term interest rates (and share prices) have little long-term effect on the real cost of capital and investment. “We must stop using consensus theory both because it is wrong and because policies based on it regularly generate financial crises,” he writes. “Many will wish to ignore this because it is incompatible with consensus theory. But it is vital for our future.”
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strength of the dollar, which surged in 2022. This adds to inflation in the developed economies, other than the US. It adds even more to inflation in the emerging economies, largely because they import a lot and their currencies are at the wrong end of the dollar surge. The Fed raising interest rates makes the dollar even stronger, and inflation even worse. As former US Treasury Secretary John Connally once observed to European finance ministers in 1971: “The dollar is our currency but it is your problem.” So, if the world wants lower inflation, it should in fact sell
dollars and urge the US authorities to do the same – as happened at the Louvre Accord in 1987. Or the Fed could reverse itself and lower interest rates.
But, at the risk of making a forecast, neither is likely to happen soon.
THE REVIEW MARCH 2023
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ILLUSTRATION: PADDY MILLS/SYNERGY
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