There you go Sun, TSC article.
JACKSON HOLE, Wyo. -- Here's the forecast Merrill Lynch chief
economist Bruce Steinberg was spinning back in October.
The winds of deflation are blowing through the world
economy. ... Under these circumstances, the two Fed
easings to date are just the prelude of more easings to
come. ... We are again lowering our estimates of future
economic growth and earnings. We expect U.S. gross
domestic product to grow only about 1.5% during 1999,
perhaps even less. As we explained last month, the
Treasury yield curve may be the best predictor of
recessions. Calculations based on current spread
relationships indicate that the probability of a recession,
negligible at the beginning of the year, is now 30% and
rising.
The interaction of a profit squeeze and an incipient credit
crunch is beginning to stifle growth and raise the risk of
recession. An earnings slowdown usually leads to
cutbacks in capital spending, and that process is already
under way. A profit squeeze also eventually slows job
growth and, therefore, consumer spending. Because the
U.S. economy is now the most equity-linked economy ever,
an earnings slowdown -- which also depresses the equity
market and its wealth effect -- can now have deeper effects
than in the past. At a minimum, the huge boost that
consumer spending has gained from the market's wealth
effect will dissipate.
The latest Fed survey shows that banks have tightened
credit standards and are likely to tighten them further.
Credit availability is being curtailed. ... We believe the Fed
will be up to the task. We expect it and other Western
central banks, even the European Central Bank, to
aggressively ease policy, which will be critical. When
lenders start running from risk, interest rates must fall
sharply to stabilize growth. ... The fact that the yield curve
flattened after the Fed lowered rates shows that a lot more
easing is needed. ... By mid-1999, if not before, we expect
the federal funds rate to be down to 4%. If that is not
enough to put the economy on an even keel, the Fed will
keep on easing.
Here are highlights of the forecast the folks at the University of Michigan
were spinning back in November. (Note that Michigan puts out the
consumer sentiment index, one of three main consumer confidence
indices.)
Economic growth falls to 1.5% in 1999 from 3.9% in 1998.
The unemployment rate rises to 4.9% in 1999 from 4.5% in 1998.
The Fed forces down the funds rate a full percentage point, to
3.75%, by December.
In short, said the Michigan forecast chief, "This long expansion is
heading into its slowdown mode."
The point here is not to hunt down poor forecasts and crucify the people
who produce them. As fun (and lucrative, if you can believe it) as that is,
it's hardly challenging; game is ridiculously plentiful in these woods (so
much so that shooting fish in a barrel seems downright sporting in
comparison). More important, it's just not fair. Every economic forecaster
under the sun makes bad calls all the time.
It is entirely right, however, to question closely the thought processes that
produced such forecasts. That's the point here: to dissect such thinking
and to use the resultant entrails to figure out whether or not you ought to
listen to these people anymore -- even if they tell you that the 1963
split-window Corvette was the best one ever made.
The Michigan forecast came -- and not at all coincidentally -- in the wake
of a material and months-long decrease in the Michigan confidence
index; it had fallen to 97.4 in October (its lowest level since December
1996) from 110.4 in February (its highest level ever). The thinking here
was that shaky shares lead to nervous consumers lead to increased
saving and sorrier spending numbers in no time flat.
The pedestrian nature of such thinking perhaps explains its popularity;
even (supposedly) bright forecasters bought into the confidence thing
hook, line and sucker.
The positively fetching thing about the confidence indices is that, over
time, they correlate nicely with consumer spending -- and hence GDP
(spending accounts for roughly 68.2% of GDP). Both Michigan and the
Conference Board are constantly publishing neat charts to prove it.
Yet the ugly little secret here is that, over time, every variable in
economics pretty much correlates with every other variable in economics.
It's always unwise to use confidence indices to predict spending --
especially in a short-term sense. They're just too volatile (note that the
Michigan index has bounced as high as 108.1 since its all-time low in
October). And even if they weren't, such an exercise boils down to first
counting on (usually disinterested?) respondents to tell the whole truth,
and then counting on them to act in a fashion precisely consistent with
their responses. In short, it boils down to assuming that people actually
go ahead and do everything they say they will do.
If the absurdity of that premise doesn't slam you in the face, then perhaps
you can take comfort in an appeal to authority: No good forecasting model
includes confidence as an explanatory variable anywhere. Not one.
Leaving aside a violent violation of the Paperwork Reduction Act of 1995,
Steinberg ought to have been indicted on two counts. More forecasters
than you suspect are guilty of Count One: Public Display of Gross
Ignorance Concerning the Wealth Effect. Bright forecasters know that the
wealth portion of the consumer's spending decision takes into account
not what shares did last month, but rather what they have done on a
cumulative basis over a number of years. (Does no one remember Milton
Friedman?) Bright forecasters also know that it will take an
unambiguously big drop in share prices (30%) that persists for a long
period of time (six months) in order to get consumers to change their
spending habits materially.
Dimmy-dim forecasters know neither.
Count Two: Jumping on an Unforecastable and Major Economic Event
Because It Supports a Lousy Years-Old Forecast is the economics
equivalent of abducting a child. That's how disgusting it is.
Steinberg had been forecasting slowdowns in all forms -- inventory
slowdowns, housing slowdowns, employment slowdowns, consumption
slowdowns and gross domestic product slowdowns -- since at least
August 1997. Then came a four-sigma event whereby Russia devalued
and defaulted, which led directly to a big hedge fund blowing up, which
led directly to Fed easing.
As far as slowdown reasoning goes, this event proved exponentially
more useful than the same stale Unsustainability Argument that had for
years served as the hallmark of this crowd. (Why's growth going to slow?
Just because. It's unsustainable.) And, especially in light of that hangdog
yield curve, it was a no-brainer that the recession forecasts would flow
like red from a split head.
And oh, they did, my brothers. Steinberg, along with wing-nut New Era
types everywhere, rolled out the recession artillery. They told you that the
chance of recession stood at 30% and provided updates every 2
percentage points; they warned that if the Fed didn't get just plain
Japanese with the funds rate, we were all gonna die.
And most disingenuous of all, they said this:
See that? We were right about the slowdown all along.
Epilogue
Michigan has backed off on the slowdown thing. But look for a renewed
effort once its sentiment index dips below 100.
Most wing nuts still cling to their slowdown forecasts; as has been the
case for the better part of three years, they simply push them back yet
another quarter when they fail to come to pass. They ignored facts last
autumn -- money growth always slows before the onset of a recession;
money growth was accelerating at the time, and the actions the Fed took
were intended to accelerate it even more -- and they're still ignoring them
now. Not one of them will grant, even now, that the last of the Fed's
easings probably wasn't necessary. And they would still prefer that the
Fed lower the funds rate. By a lot. And the sooner the better.
Sickest of all, the Steinberg growth forecast recently turned a 180. It's now
one of the highest on the Street.
Our man found faith at some point during the past few months. Maybe he
started looking at the numbers; it seems more likely that he saw Jesus in
his tortilla.
But whatever the case, a reversal like that ought to worry us all.
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