Sunday , 21 April 2024

Wise Words of Advice for Today’s Economists from a Veteran Observer (+2K Views)

[Below is] a list of my favorite 25 rules for analyzing the economy. There are probably many more than this and many that have yet to bediscovered, but this list has served me well over the past quarter century and hopefully will be of use to others. Words: 1849

So says Mark Vitner, managing director and senior economist at Wells Fargo, responsible for tracking U.S. and regional economic trends in an article* which Lorimer Wilson, editor of (Your Key to Making Money!), has further edited ([ ]), abridged (…) and reformatted below for the sake of clarity and brevity to ensure a fast and easy read. The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement.

Vitner goes on to present his Twenty-Five Fundamental Rules for Analyzing the Economy, as follows:

1. Economics is just common sense made difficult

Too often economists make things more difficult than they need to be. The most important concept to grasp when analyzing the economy is what motivates individuals and businesses to buy goods and services and what motivates them to produce and provide them.Forecasting the economy then simply devolves into determining if new policies or events would cause individuals to buy more goods and services, invest in more plant and equipment, hire more workers, or work more.

2. It is important to distinguish between what you think the Fed will do and what you think they should do

As economists, we tend to follow the Federal Reserve very closely and while we may have a good understanding of how monetary policy works, our views on what the Federal Reserve should do are irrelevant. It is far more important to have an understanding of what you believe the Federal Reserve, under its current leadership, will actually do.

3.Recessions are caused by the build up of imbalances and some sort of event or policy change that causes investors, consumers, businesses and regulators to become more risk averse

Once you understand where recessions come from, you can begin to assess the risk of falling into one. The significant event leading up to the most recent recession was the housing boom, which resulted in an enormous oversupply of housing and a sharp run-up in housing prices. The event that put us on a path to recession was the unprecedented drop in home prices that began back in 2006. Falling home prices led to growing financial problems and bankruptcies at mortgage lenders and government sponsored enterprises that eventually brought down huge investment banks and financial institutions.

4. Imbalances can build up far longer than seems logical

During a boom, all sorts of justifications for the elevated level of economic activity will seem logical. We saw this at the height of the tech bubble and height of the housing bubble, which is one reason we ended up with such a tremendous oversupply of fiber optic cable and single-family homes.

5. Persistent inflation is always a monetary phenomenon

Measured price increases can sometimes pop up because of supply disruptions, spikes in key commodity prices, or bad weather. A persistent rise in inflation, however, will only take hold if the money supply has increased dramatically for a sustained period of time.

6. Rising food and energy prices by themselves are deflationary if they are not accommodated by a loose monetary policy

If consumers are spending more of their income for necessities, they have less to spend on everything else.

7. Conditions do not have to be perfect in order for the economy to grow

That is a good thing because conditions seldom are perfect. The economy almost always faces a seemingly endless string of challenges: the budget deficit is too big, taxes are too high, regulation is too burdensome, and consumers have too much debt yet the economy… [has grown] solidly throughout most of this period.

8. There is a tendency for forecasters to focus more attention on what is wrong with the economy than what is right

Bad news almost always gets more attention than good news, and this is no different with economics. A danger, however, is that focusing too much attention on the negatives might cause you to miss out on valuable opportunities.

9. The natural tendency for the U.S. economy is to grow

Each year the United States adds close to three million new residents, which means we add the equivalent of France to our population every 20 years. In addition, trend productivity growth is somewhere around 2 percent. When you add in Americans’ strong desire to live better than each preceding generation, there is an enormous natural tendency for the U.S. economy to grow.

10. The greatest forecasting mistake economists have made is to underestimate economic growth

Paying too much attention to all the negatives in the economy tends to make economic forecasts too pessimistic. Forecasters tended to overestimate the drag from federal budgets deficits during the late 1980s, the banking crisis in the early 1990s, and most of the subsequent crises that we faced during the past two decades. Many forecasters were also slow in recognizing that the potential growth rate of the economy had increased in the late 1990s with the advent of new information technologies.

11. A trend will continue until is stops

This famous line attributed to Herb Stein [1998] really cuts through the clutter on a number of fronts. Anything that grows faster than the underlying fundamentals can support will ultimately stop. If homebuilders build houses at a faster rate than the growth in the number of households that can afford to buy them, then ultimately building activity will stop. Likewise, if the federal government spending rises faster than the Treasury’s ability to raise taxes or borrow money then spending growth will eventually stop.

12. You can learn an awful lot by simply observing

Some of the best economic indicators I have seen in recent years have been things that I have observed with my own eyes and then verified with the data. If the airports seem more crowded take a hard look at the airline revenue passenger miles, whose growth tends to coincide with real GDP growth. A pickup or deceleration in airline revenue passenger miles may tip you off to a shift in the economy’s underlying momentum. While it may seem trivial, the same holds true with retail sales and business at your favorite restaurant.

13. Never be overly eager to change your forecast

Obviously you have to change it when the facts change but always remember that economic data are revised frequently and often by substantial margins. Some of the worst mistakes I have made have been to give up on a forecast too soon.

14. Do not be afraid of making mistakes

You will make them. It is part of the job. I learned when I was a goalkeeper on our high school soccer team not to get so upset about the other team scoring a goal [because] you [cannot] second guess every move. You can do the same thing in economics. The critical questions you need to ask are: is your forecast well thought out? Have you researched and tested you conclusions? What are the holes in your argument and what are the risks associated with them? Are you making conservative or aggressive assumptions? If you have done all your homework, stated your position clearly and identified the risks, then you are likely to be wrong far less than you are right. Most important of all, have you informed your clients and prepared them for contingencies?

15. Rapid growth nearly always sows the seeds of its own destruction

Booms generally lead to busts because they lead to overproduction or overinvestment in the sector that is booming.

16. Booms generally lead to unforeseen problems

When activity is booming sloppy credit underwriting, inefficient operations, and outright fraud are hard to see. This is the basis behind one of Warren Buffet’s [2002] favorite sayings “You never know who is swimming naked until the tide goes out.” Just think of the Bernie Madoff scandal, which did not become evident until the fall 2008 financial market collapse.

17. Capital will always flow to the highest available risk-adjusted rate of return

Every investment and business endeavor involves evaluating the risks involved in investing in that business and the return on that investment. The greater the risks, the higher the return has to be in order to attract any given amount of capital. Anything that heightens risks in the economy tends to restrain investment and business activity in general.

18. The economy does not simply grow and contract, it is constantly evolving

This is a concept made famous by Joseph Schumpeter [1975] and has become known as creative destruction. The basic concept is that there are always new industries and growth sectors evolving in the economy and there are always industries and sectors that are declining. Unfortunately, the declining sectors are typically easier to see than those that are growing.

19. Soft landings are extremely hard to pull off

The relatively long business cycles of the past few decades have witnessed several attempts by the Federal Reserve to bring the economy in for a soft landing. The Federal Reserve’s objective is to slow the economy just enough to head off inflationary pressures without causing the unemployment rate to increase. The Federal Reserve’s record is spotty to say the least. The problem with soft landings is that slower economic growth leaves the economy vulnerable to external shocks. The Federal Reserve nearly engineered a soft landing back in 1990 but then Saddam Hussein invaded Kuwait and oil prices skyrocketed, sending the economy into recession later that month. We were also headed for a soft landing back in 2001 but 9/11 put an end to that.

20. Changes in political leadership matter

[Why?] Because the forces behind these changes have an immense amount of resources invested in their efforts.

21. Try toview the economy through the eyes of a business owner, consumer, and policymaker

Think about how each would view the current environment and what each would view as risks and opportunities.

22. Always look for consistencies and inconsistencies

Inconsistencies in the economic data and your forecast demand considerable attention and may provide a hint about possible mistakes and vulnerabilities in your forecast.

23. Write your reports and give presentations as if you were explaining economic concepts to your mother.” This will help ensure you respect your audience and do not talk over their heads.

24. Listen to those who have opposing views

At a minimum they will provide a good stress test to your own view and they might be right. I have found that I learn much more from reading reports and books written by folks that I disagree with than those I agree with.

25. Do not outrun your headlights

Know you limitations. The economy is like a giant puzzle that you will never finish piecing together. Do not try to do everything. Accept help when it is offered and concentrate on the things you know and do best.