"You're free to build, but ..."

 

The National-led Coalition boasts that it will "fix housing" by bringing in rules requiring councils to zone enough land* on which land-owners are free to build sufficient housing to allow for the next thirty years of demand.**

Doesn't that sound great, you think. "Free to build," you say! 

The National-led coalition's housing honchos are either stupid, naive, or they think that we are.

As should have been obvious from Auckland council's passive-aggressive resistance to government diktats on the Medium-Density Residential Standards (MDRS), telling councils to "free up land" only works if councils are so inclined. If they are already so inclined, ministers wouldn't need to tell them. And if they aren't so inclined then, well, as Bryan Caplan points out in his new "graphic novel" Build, Baby, Build: The Science and Ethics of Housing Regulation, councils can hinder construction in dozens of other ways ... if it's so inclined. (And it is.)

For starters it could ...

Go tell Minister Bishop. (Or send him a copy of Bryan's book.)

* * * * 

* Zoning is a restriction on land telling owners that the planners know better than the owner (and would-be buyers) what should go there. How is it a restriction, you ask? If the planners' zone allows what the owner would do anyway, it's not needed. If it disallows it, it's not wanted.

** This presumes that the grey ones would even know, to any standard of meaningful proof, what demand would look like over the next thirty years. I mean, it's not like there's any thirty-year stretch in recent history they could point to and say "look, we got it right."

The Governor who printed $50 billion of inflation ...

"Yesterday the Reserve Bank ... released a statement saying, 'The NZ economy continues to evolve as anticipated by the Monetary Policy Committee.' What a line coming from a Governor who told 'Bloomberg News' in the US in 2021, whilst he was busy printing $50 billion in cash, which is the primary cause of our current high inflation, that "The fear of the 70s, the 80s, stagflation, it is such a different world [now]." How amusing, given that stagnation, recession & inflation is exactly what we are now experiencing. How amusing that the RBNZ says our economy continues to evolve as anticipated when its forecasts could not have been proved more wrong.
    "It gets worse. ..."

~ Robert MacCulloch, from his post 'When will the Reserve Bank of NZ Stop Spinning and Stop Misleading Parliament and the Nation?'

Says Law explains why we don't need a recession to kill price inflation

Image Source: Unsplash

We need to engineer a good recession, say central bankers, to kill the inflation engineered by those same central bankers. But as Alasdair Macleod explains in this guest post, policy makers who believe a recession will kill price inflation, and therefore allow central banks to reduce interest rates, are simply wrong. This is simply mad macroeconomic dogma.

Updating Say’s Law For Modern Times

by Alasdair Macleod

It was Keynes’ offhand dismissal of Say’s law, or the Law of the Markets, in 1936 which is leading us into an economic and monetary crisis.

It was dismissed by him to invent a role for the state.

That is why Keynes is so popular in the mainstream establishment. By dismissing market reality, he invented a whole new branch of economics. Macroeconomics exchanged statistics and mathematics for human action, the prospect of centralised management substituted for ambiguity.

In this article I look at the flaws in macroeconomics, the state theory of money (an old recurring theme from John Law onwards), misleading statistics measured in unhinged fiat currencies, and why Keynesian fears of a general glut are misplaced — all of which stem from the error of dismissing Say’s law.

Importantly, Say’s law ties the volume of production to demand, so policy makers who believe a recession will kill price inflation, and therefore allow central banks to reduce interest rates, are simply wrong.

The state-educated mainstream is so sold on macroeconomic theories and the state management of economic outcomes that reasoned debate gets no traction. The only solution is for a final economic and monetary crisis to bring an end to all macroeconomic dogmas.

The origin of macroeconomics

Jean-Baptiste Say wrote his ground-breaking book on economics in 1803, revising subsequent editions. His Traité D’économie Politique, as it is known in French in short form, described the division of labour and the role of money as the agent for turning specialised production into general consumption. It became known as Say’s law or the law of the markets, and was the first commandment of classical economics, until Keynes persuaded us otherwise in his General Theory published in 1936.

Keynes denial of Say’s law was in the spirit of Humpty Dumpty — ″’When I use a word, it means just what I choose it to mean – neither more nor less.” He rewrote economic definitions to suit his thesis. Humpty Keynes redefined economics to exclude the inconvenient reality of Say’s law, along with many others that logically followed from it. It was necessary for Keynes to deny it in order to ease in a role for the state, allowing governments to intervene in the relationship between production and consumption. 

The invention of macroeconomics, which played down the unpredictable human element expressed in markets, in favour of statistics and mathematical analysis, can be traced to Chapter 3 in his General Theory, where he wrote:

“If, however, this is not the true law relating the aggregate demand and supply functions, there is a vitally important chapter of economic theory which remains to be written and without which all discussions concerning the volume of aggregate employment are futile.”

Say’s law was summarily dismissed, hardly mentioned again in his seminal work. The whole basis of Keynes’s new macroeconomics, that vitally important chapter of economic theory which remains to be written, boils down to that one little word, “If” heading the quote above. “If” is a supposition and certainly not evidence leading to the discovery of an entirely new branch of economic science. It was a simple trick, dismissing the inconvenient truth early in his thesis so that he could proceed to construct a fantasy. 

Keynes should have been dismissed as a quack, like John Law who propounded similar theories and ruined France in 1720. And like Georg Knapp, a German economist of the Historical school, who published his state theory of money in 1905, arguably encouraging the Kaiser’s government to build up armaments before the First World War at no visible cost to the people, and to continue to finance itself by inflationary means after Germany’s defeat.

Yet with Keynes’s little “if”, here we are nearly ninety years later still travelling along his intellectual rails full tilt into the buffers of economic destruction. The reasons why Law, Knapp, and now Keynes and their theories rose from obscurity to fame are that their theories appeal to governments, seemingly conferring on them an economic role, enhancing their control over their citizens, and therefore the justification for increased power and revenues. The last thing they will consider is that these theories are flawed, until the evidence of a final crisis forces them to face up to their fallacies.

Despite Keynes’s intellectual fraud, the division of labour and the role of money cannot be denied. But the world has moved on from the simpler world of J.B. Say. At the time of the French Revolution when he was observing the economic activities of people, tradesmen probably refused to take credit for payment, accepting only gold and silver coin because paper assignats followed by mandats territoriaux were successively descending into worthlessness.

The more things change...

Plus ça change, plus c’est le même chose! Today, under neo-Keynesian policies directed by the state, it is only forms of credit that intermediate between our production and consumption, and coins are only tokens. Over two centuries ago in rural France, consumption for most was more a question of survival than access to the luxuries we are familiar with today and reckon to be our right. Production was basically local, whereas today it is global. And we now have factories, when few existed in the predominantly agricultural economies of Say’s time because the industrial revolution in France had barely started.

Yet, despite all these differences Say’s central proposition still holds -- Say's Law, the Law of Markets, still links production to consumption; and it still rules out a general glut of goods due to a collapse in consumption. It still holds -- and as long as reality is what it is, it always will. No employment: no demand. No demand: no employment.

However, rehabilitating Say’s Law into modern economics must take account of today’s economic and monetary conditions. Neo-Keynesians ignore the consequences of credit’s loss of purchasing power in their static models. This may confuse the issue for them, but Say’s law still holds whether transactions are in money or credit. (Here, we are defining legal money as a medium of exchange without counterparty risk — gold and gold coin.) Now that we have only fiat currencies whose values in terms of goods are continually deteriorating, statistical evidence is worthless — despite macroeconomists treating long runs of price and related data as if the purchasing power of a fiat currency is constant over time. I have more to say on this below.

In the days of sound money and the credit which took its value from it, we could see the consequences of economic progress and regression on both individual prices and also their general level. Today, we labour under the delusion that what we knew to be true under sound money still applies to unsound fiat currencies and their dependent credit. In all our statistical comparisons we therefore believe that all price changes still come from the values of goods and services. And by dismissing Say’s law, we dismiss the certainty that the purchasing power of unanchored credit will continue to decline even in a recession. So, what are the true consequences of a deteriorating economic condition for prices in a modern economy?

It is far from a simple matter, but as a starting point we can sensibly argue three points. 

• First, just as Keynes dismissed Say’s Law in order to create an economic role for the state, its rehabilitation must reject his supposition entirely and everything that flowed from this error. 
• Second, that with the dismissal of the state from economic functions, macroeconomic statistics-gathering can only have restricted validity, and economic modelling must be dismissed entirely. 
• And third, in economic conditions leading to unemployment not only does consumption decline but production will as well because the unemployed are no longer producing. In other words, there is no such thing as a Malthusian glut, and the hope in some quarters that price inflation will diminish in a recession as demand contracts will be disappointed.

The rest of this article looks at the major issues arising from the Keynesian dismissal of Say’s Law — the law of the markets.

The errors in modern socialism

Perhaps the starkest example of the difference today between a state-controlled economy and a relatively free capitalist one is found in the contrast between the two Koreas. In the North, they are starving. In the south, people of the same ethnicity are prospering. This is not just a fluke. In the late 1940s, China was descending into communism and abject poverty while Hong Kong rose from the ashes of Japanese occupation and the collapse of the military yen into capitalist prosperity with no natural resources of its own. Concurrently with China and Hong Kong, East and West Germany exhibited the same phenomenon until freedom of movement between the two returned.

The empirical evidence of these failures and success are put down to communist extremism by historians and today’s politicians in the western alliance, and they say are different from democratic socialism. But apologists for state intervention and control can argue as much as they like that communism is different from democratic socialism, but they cannot explain away the fact that communism is simply socialism in extremis sharing the same basic flaws as socialising democracy.

Understanding why this is the case is hampered by the superficial attraction of organisational planning applied to spontaneous markets. The former appeals to a surface form of logic, while the latter lacks a ready explanation. This riddle was laid bare by the great economist of the Austrian school, Ludwig von Mises in his 1922 book Socialism: An economic and sociological analysis. The essence of the argument was contained in a further essay, Economic Calculation in the Socialist Commonwealth, written in 1920 and a hot topic for decades thereafter. 

In that essay, Mises laid down the reasons why economic management and intervention by the state would always fail. As the Russian economist, Yuri Maltsev put it, “Mises exposed socialism as a utopian scheme that is illogical, uneconomic, and unworkable at its core.” Maltsev confirmed this from his personal experience as an economist in the Soviet Union.

The difference between communism and democratic socialism can be likened to the fate of a lobster plunged into boiling water compared with that of a frog, who in the modern cliché is cooked from cold. The relative level of authoritarianism is different from the outset but ends up being similar in its final outcome. The demonstrable failures of democratic socialism have led to ever-increasing restrictions on markets, inching it ever closer to communism. The common denial of capitalism and the profit motive as being somehow immoral is part of the pro-state and anti-market propaganda.

The reason the state always fails in its attempt to manage the economy is partly due to its objectives being political in nature rather than economic, and partly due to the impossibility of it entering into economic calculation. It was the latter point which Mises explained so well in his 1920 essay. Irrespective of the politics, it is impossible for a state which owns the means of production in its central planning to know in advance whether its output will be demanded by consumers. Some of it might well be, but assessing the level of demand in the planning of production is impossible. And the state cannot assess the evolution in a product to ensure it will be freely demanded in future. The state therefore resorts to monopolistic behaviour to enforce consumption.

By way of contrast, the capitalist in a free market will use his specialist knowledge to assess demand and seek to respond by supplying his product to consumers profitably. For him, the customer is king. If he fails, he either cuts his losses, or adapts the product to satisfy consumer demands. Production methods and output evolve to satisfy demand, which together define progress. While the state is unable to evolve its production satisfactorily and therefore lacks the fundamental ability to foster economic progress, capitalists seeking profits in free markets improve economic conditions and standards of living wholly in accordance with Say’s Law. In other words, through specialisation the entire cohort of independent manufacturers and service providers together satisfy the general and evolving demands of the markets.

As a matter of reluctant practicality, social democracy permits capitalism to exist. In common with the early fascist policies of Mussolini, capitalism is tolerated so long as it can be controlled by the state. This control is achieved through extensive product regulation, by partial nationalisation of the economy, and by virtue of the fact that state spending is the largest single element in a social democratic economy. This spending is not funded out of production, but by taxes imposed on producers and consumers. A socialising state is promoted as a benefit for society as a whole, but the reality is that is an economic burden in proportion to its size.

Under the aegis of social democracy, the economy becomes increasingly directed away from market freedoms, and it performs progressively less than its potential to improve the living conditions of the population. The economy’s underperformance is invariably blamed upon the private sector by the state when it is the consequence of the state’s own interventionalist policies.

How statistics mislead us all

The social division of labour means that it is always the individual who deploys his or her skills in order to consume — consumption which is personal to the needs and desires of the individual. While there are needs common to each individual, the consumption of which goods and services an individual actually desires cannot be forecast by any observer. Much of tomorrow’s demand is spontaneous and is not even known in advance to individual consumers. 

Even if they are accurate, the gathering of statistics measuring this demand can only be of its past history. It is a gross error to think that demand statistics valid in the past can be projected into the future and retain any true relevance. We see this in the continual failure of economic modelling and econometric forecasts. It is one thing for an economist to further his understanding of a branch of human science, as a branch of psychology, and another to assume it is a natural science, such as physics or biology. The former cannot be averaged and predicted, while the latter can be statistically quantified. No wonder Keynes, whose primary discipline was mathematics, preferred to dismiss Say’s law in favour of mathematical and statistical analysis.

Mention has already been made above of the mistake in comparing prices of goods and services over time valued in fiat currencies. The chart below of WTI oil, a basic unit of energy upon which almost the entire global population depends, illustrates the enormity of this mistake.

The two prices are in legal money, which is gold, and in fiat dollars, which is currency. Since 1950, when the price of WTI oil was $2.57 per barrel and in gold grammes it was 2.28, in dollar terms the price has soared to around $70 today, a multiple of over 27 times. Yet in gold, it is 1.14 grammes, having exactly halved. In legal money the price has been considerably less volatile than in dollars. The riddle posed to us by this chart is which price should be used for valuing oil — a depreciating and volatile dollar, or a relatively stable legal and sound money?

Clearly, it is long-term dollar price comparisons which are badly flawed. Yet market traders, proud to call themselves macroeconomists without understanding the implications of the term, maintain their long-term charts of oil and other commodities in dollars wholly unaware of their falsity. Furthermore, everything which can be traded is valued in fiat dollars and other currencies, from financial assets to housing. The next chart is of residential property in London, priced in pounds and gold.

Anyone who observes the residential property market in the UK will tell you what an excellent 'investment' it has been, nowhere more so than in London. But this statement only holds for a fiat pound, which since 1968 has lost over 99% of its purchasing power measured in real legal money, which is still the gold sovereign coin. Today, the value of London residential property in gold has risen by a paltry 14% since 1968, compared with 116 times in depreciating pounds. Yet, the plain facts are met with widespread disbelief.

Under the fiat currency regime, values of everything are a flawed concept, reflecting not changes in subjective values so much as that of declining fiat currencies. But this statistical legerdemain which fools everyone extends to other areas of the statistical universe. Labour productivity analysis is a nonsense because of the underlying assumptions, and the lack of consideration of the costs to an employer of employment and other labour taxes. The approach is always from the statist viewpoint, whereby politicians wish to see higher output per worker promoting higher tax returns. It is never that of an employing businessman who is the only true assessor of the costs and benefits of employing the various forms of labour in his enterprise profitably.

GDP and government spending

To confuse gross domestic product with economic growth, itself a meaningless term when economic progress is implied, is a further error. Governments are fixated on GDP, which must always grow. GDP is not economic growth, but growth in the total currency value of transactions, usually over the course of a year or annualised.

If the currency is debased by its inflationary issuance, nominal GDP increases to the extent that debasement feeds into the GDP statistic. Inflation of the currency is particularly associated with increased government spending, so virtually all the increase in it fuels GDP. In the past, governments have regularly outperformed market expectations of GDP growth by the simple expedient of increasing government spending. Investors failing to understand this trick see it as positive, and stock markets rise on the news. GDP is only good for allowing a government to estimate prospective tax income. Otherwise, it is a useless and misleading statistic.

As stated above, GDP is routinely and unconsciously confused with economic progress. But a moment’s reflection will show that progress cannot be statistically measured. Progress is a concept which at its fundamental level is an improvement in a person’s living standard. There is no doubt that entertainment technology, in the form of televisions, gaming computers, and other electronic equipment all of which have fallen in price have improved many people’s enjoyment immensely. GDP incorporating declining prices for these products is bound to undervalue these benefits, and by classifying their prices as deflationary might even claim they detract from economic growth. Yet, government spending which is funded by removing purchasing power from producers and consumers and is therefore a brake on progress is classified as positive due to its inclusion in GDP.

During the covid crisis, when much of the productive economy shut down UK government spending rose to about 50% of GDP, though since then it has declined to an estimated 43% in the last fiscal year (to April 5th, 2023). Similar increases occurred in other nations. In Europe, French government spending peaked at 61.3% of its economy in 2020, declining to 58.1% last year. In Italy it was 57% and 56.7% respectively, and in Spain, 52% and 47.8%. With these levels of state spending, when analysing GDP it is extremely important to decide how to treat it.

Government economists are bound to argue that government spending is important in economic terms, and that GDP growth must include it. Furthermore, on a consumption basis it is argued that spending by government employees must be included, as well as government demand for goods and services. While this might appear to be a valid point, it misses the bigger picture.

While it is true that state employees’ and departmental spending are part of the total economy, the state’s taxes which fund them reduces income available for consumption for those not employed by the state. Government spending as a whole replaces it with the provision of services not freely demanded, which is fundamental to the benefits which flow from Say’s law — the law of the markets.

You don’t have to look far for examples of how state spending is a burden on overall economic activity, and that the successful economic approach is to free up the private sector, eliminating government and its intervention as much as possible. It is this approach which led to the remarkable success of Hong Kong in the post-war decades, compared with the poverty inflicted on the same ethnic people on the mainland under Mao Zedong where government was 100% of the economy.

Convincing the establishment that inflating GDP ends up suppressing economic progress is an uphill struggle. Instead of accepting the empirical evidence, governments routinely use their tax-raising powers to increase economic intervention, spending as a proportion of the whole, and debasing the currency by deliberately running budget deficits.

This leads to a conflict between politicians seeking to represent the electorate’s interests and the state itself. Politicians on the right vying for office are usually free marketeers with ambitions to reduce the state’s presence as a proportion of the total economy. They are appointed with a zeal to take an axe on spending and bureaucracy, but there are good reasons why they never achieve it. When they gain ministerial responsibility, their priority changes to protecting their budgets from being reduced, because cuts in departmental spending amount to a loss of power. Therefore, to the extent that any savings on spending are achieved, ministers always want to come up with other plans to maintain or increase funding levels. The negative economic consequences simply rack up, and the government’s share of GDP inexorably tends to increase.

This is the true legacy of confusing GDP with economic progress. While the transactions that together make up a GDP total can be measured, their true value in terms of the satisfaction and the progress in the quality of life they provide cannot. The only way in which they can be measured is by each individual in a community and nation, and not by those who claim to represent them.
Why there cannot be a general glut

The Keynesian error of believing that a recession leads to a general glut, and therefore a fall in the general level of prices, has its origin in the 1930s depression. But it is obvious that under the conditions of the division of labour, whereby people are employed to produce so that they can consume, this cannot be true in a general sense, because production must decline as well as consumption when unemployment rises. In other words, a general glut of unsold produce cannot arise, because the unemployed are no longer producing.

Nevertheless, Keynesian fears of a glut when a recession occurs and unemployment rises leads modern governments to create demand in a recession by increasing welfare benefits. According to the Keynesian playbook, this funding is stimulative by means of inflationary deficits, intended to help stabilise prices as demand weakens. But without a general glut and a stable currency the overall level of prices is unlikely to change significantly in real terms when there is no government intervention because of Say’s law.

Modern governments intervene by deficit spending without contributing to production. Instead of a recession leading to surplus production, government spending leads to surplus demand. This explains how the inflationary effects of Keynesian stimulation can lead to significantly higher prices, even in a slump, as was seen in Britain’s inflationary crisis in the mid-1970s. It is also entirely consistent with the factors driving an economy into a slump during a currency’s collapse, such as witnessed in the European inflations in the early 1920s.

So, what happened in the 1930s, disproving Say’s law in the minds of the neo-Keynesians?

The first error in their analysis was not understanding the consequences of the inflationary 1920s. They were fuelled by the Fed’s expansionary monetary policies under the leadership of Benjamin Strong, and President Hoover’s anti-capitalist, interventionist policies at the peak of the credit cycle. The inevitable consequences were a speculative bubble followed by a financial crisis between late-1929 and 1932 which wiped out thousands of banks and their credit, which were the backbone to maintaining economic activity. And this was followed by Hoover’s heavy handed interventionism.

Hoover also raised income taxes significantly to fund his interventions. Despite these increases, during Hoover’s tenure the Federal Government’s deficit to GDP soared from a 0.7% surplus to a 6.4% deficit and these deficits continued under Roosevelt, though they lessened as the banking crisis passed.

Not only did banks go bust in their thousands, but there were other factors. The Smoot-Hawley Tariff Act, which built in higher tariffs on top of those of the Ford McCumber tariffs of 1922, was signed into law by President Hoover in 1930. So, not only was bank credit in the economy imploding, but including tariffs the prices of imported goods and therefore the production costs of most American manufactured products were raised to uneconomic levels. It was a fatal combination, because little could be produced profitably at a time when there was little or no bank credit available. Consequently, US GDP contracted from $103.6bn in 1929 to $56.3bn in 1933. This was not the same thing as a general glut, because demonstrably both production and consumption contracted. Primarily, it reflected a collapse in bank credit.

While credit had become freely available in the previous decade, the introduction of tractors and other farm machinery had led to a massive expansion of agricultural output. Prices of agricultural produce, which were already declining due to oversupply, were bound to fall even more when credit was withdrawn by failing local banks in America. The farming community was forced to sell its output at anything they could get for it, because of the lack of credit.

This was a specific market adjustment at a time when worldwide cereal and other agricultural output prices were falling due to overproduction. The slump in prices attributable to the banking crisis hit farmers particularly hard, not just in America but worldwide through values reflected on the commodity exchanges.

Because American farmers were forced sellers of their agricultural output, it was later assumed by Keynes and other economists that there was a glut and that Say’s law was therefore flawed. But the mistake was to miss the links between the collapse in bank credit from bank failures, the pressure on farmers to dump their product at any price, and the coincidence of global overproduction due to the rapid advances made in mechanisation in the previous decade.

The causes of the 1930s depression and its longevity were clear — you need look no further than empirical evidence. Long before Keynes traduced Say’s law, both Hoover and Roosevelt with his New Deal made the depression considerably worse than it would otherwise have been, acting as proto-Keynesians. It was the first time that the Federal Government had intervened in what would otherwise have been two or three years of economic and credit hiatus, which had been the experience of previous episodes. The previous depression in 1920—1921 lasted only eighteen months without statist intervention. Before President Hoover’s tenure, it was generally acknowledged that intervention only made things worse, and that left alone, a slump in business activity would correct itself.

Economists subsequently formulating statist policies badly misread the causes of a slump. They still fail to appreciate that there is a cycle of bank credit, identified by economists of the Austrian school as a business cycle. It is caused by bankers acting as a cohort increasing the quantity of credit to a point when their balance sheet exposure becomes excessive relative to the bankers’ own capital, and they then try to reign in their balance sheets. This is not a conspiracy between bankers, but reflects their human behaviour, and is cyclical in nature. It can be traced for so far as reasonable records exist, in the UK as far back as the end of the Napoleonic wars. And it is a cycle of credit expansion and contraction averaging roughly ten years.

Even for economists, it is always easier to observe the evidence of an economic downturn than its underlying cause. In all the voluminous analysis of the great depression, the cycle of bank credit is hardly mentioned. Only economists of the Austrian school have pointed out that the depression was the natural consequence of excessive credit expansion in the previous decade. And Keynes’s followers with their mathematical and statistical macroeconomics are still blind to the role of bank credit underlying booms and slumps. They think they can model the economy, steering it from one objective to another by supressing free markets. But they cannot model human bankers’ balance of greed for profit and fear of losses.

Economic and monetary policies ignore Say’s law — the law of the markets — persisting in their failed interventions. The response to failure is usually to claim that the error was to not intervene enough. A feature of these failures is for policy makers to seek solace with their international counterparts, doubling down in a group-thinking effort to achieve statist objectives.
The errors in currency management

This week, the persistence of consumer price inflation in the UK has even led a member of the Monetary Policy Committee to say that interest rates will have to be raised to the extent that the UK economy enters a recession. But with broad money supply, no longer expanding, we can see that there’s something wrong with his analysis. At the same time, all commentary on stubborn price inflation is about too much demand for too few goods. Changes in the purchasing power of the currency are never mentioned. While individual prices fluctuate, when the general level of prices increases it can only be because of changes in a currency’s purchasing power.

There is only one reason why the purchasing power of a fiat currency changes, and that is in the behaviour of its users. By adjusting the relationship of their immediate liquidity to their spending, collectively they can have a profound impact on its purchasing power. This is why the state theory of money fails, and the monetary authorities always fail to control the purchasing power of their fiat currency. A currency must be anchored to real money, which is gold coin.

When banknotes were fully exchangeable for gold coin, their purchasing power remained constant irrespective of the quantity in circulation. But banknotes are typically less than a tenth of the circulating medium, the balance being bank credit. The relationship between bank credit and banknotes is almost parity. Therefore, so long as counterparty risk between a bank’s depositors and the bank is not an issue, bank credit will always take its value from the currency. It is the currency which must be credible.

In the first of the two charts above of WTI oil priced in dollars and gold, we can see that the price of oil in dollars was stable between 1950 and 1970, when the dollar price increased from $2.57 per barrel to an average of $3.35. At that time, the dollar was loosely tied to gold through the Bretton Woods agreement, with only national central banks and organisations such as the IMF able to exchange dollars for gold. During that time, M3 money supply increased from $172bn to $750bn, an increase of 336%.

This was not the only example. Between 1844 (the time of the Bank Charter Act) and 1900, the wholesale price index was unchanged, and it was also remarkably stable over that time fluctuating little. But between 1844 and 1900, the sum of Bank of England banknotes in circulation and commercial bank deposit obligations increased eleven times —almost entirely bank credit with the Bank of England’s note issue being little changed — and there was a material increase in the quantity of short-term, commercial bills funding foreign trade as well. Monetarist theory would suggest that the expansion of credit on such a scale would undermine the purchasing power of the currency, but plainly it did not.

The reason the expansion of bank credit need not undermine a currency’s purchasing power is that so long as the level of credit is genuinely demanded by economic activity instead of financing excess consumption, its expansion does not drive up prices. The source of excess consumption is to be found in government deficit spending because individuals always have to settle their debts while a government does not. As mentioned above, governments can always resort to deficit spending.

From this we know that government fiscal and monetary policies coupled with its fiat currency are the sole reasons behind a deteriorating purchasing power for its currency. Indeed, the Keynesians deliberately target a continual rate of debasement reflected in a CPI inflation rate of 2% by using monetary policy in an attempt to regulate credit demand.

The solution: leave markets alone and bring back sound money

If monetary stability is to return, all attempts by governments to manage private sector outcomes which have always failed and will continue to do so must be abandoned. And sound money, that is to say a gold coin standard freely available to ordinary people at their choice must be re-established. Interest rates would then stabilise at risk-free annual rates of just a few per cent set by markets in the context of demand for investment capital and the availability of savings. Market stability will automatically follow. The diversion of human activity into speculation will diminish, benefiting the economy from its redeployment into more productive pursuits. No longer would we have governments attempting to chase monetary objectives which bankrupt homeowners with mortgages as a result of misguided Keynesian policies.

A return to sound money clips the wings of high spending politicians, but other specific changes must also be introduced, reversing Keynesian macroeconomic policies entirely:

• Government spending must be reduced substantially, with an initial target for it to be no more than 20% of the economy. This will reduce the tax burden on productive businesses and workers for the benefit of non-inflationary progress. It will require extensive legislation to be passed eliminating mandated spending commitments.
• The policy of regulating goods and services must be abandoned, and responsibility for judging product suitability handed back to individuals.
• All taxation must be removed from savings, interest earned, and capital gained: savings will have already been taxed when earned. Savings are the necessary source of investment funding for economic progress. And citizens must be encouraged to save for their future, because the state must withdraw from providing widespread welfare, restricting it to a bare minimum for genuine need.
• Inheritance taxes and death duties must be rescinded. Families should be allowed to accumulate and pass on wealth which is otherwise destroyed the moment it is acquired by government. 
• Protectionist trade policies must be abandoned in favour of free trade. The benefit to an economy from the comparative advantage of buying the best suited products from anywhere are enormous, as the evidence from entrepôt economies, such as Hong Kong, confirms.
• Government ministers must not be permitted to accept lobbying by pressure groups and businesses, because their democratic responsibility is to the entire electorate.
• All central bank activities must cease and replaced by a note issuing authority regulating the relationship between gold coin held in reserve and the face value of notes in circulation. The relationship should be laid down by law, funded by government, and for the gold coin to note relationship to be maintained at a 40% minimum at all times. It must be coin and not bullion in order to be available to the entire population. A bullion standard risks foreign arbitrage in potentially destabilising quantities.
• Foreign policy must be amended to not interfere in other nation’s politics, except where national interests are demonstrably affected.
• Government spending must be fully accountable. All revenue received by the Treasury must be hypothecated — no more robbing Peter to pay Paul.

Clearly, these reforms will not happen before an existential crisis serious enough to force a complete policy overhaul. Even then, it depends on government ministers and bureaucrats correctly diagnosing the reasons for the crisis, which with all of them in thrall to neo-Keynesian macroeconomics and the realisation and admission of their own roles in creating a final crisis is extremely unlikely to happen in a Damascene fashion. Instead, a period of policy vacillation is likely, leading to a danger of political instability and a retreat into yet more socialism.

The final crisis brought upon us by Keynesian policies will almost certainly not mark the end of all our troubles.

* * * * 

Alasdair Macleod is Head of Research for Goldmoney. He has been a celebrated stockbroker and member of the London Stock Exchange for over four decades. His experience encompasses equity and bond markets, fund management, corporate finance and investment strategy.

Follow him on Twitter.

His article previously appeared at the Cobden Centre, UK.

INFLATION: "We are] still at risk of really bad macro forecasting errors, and central banks unable to live up to their rhetoric."

"[F]inance minister Grant] Robertson has been both an active and passive party in the serious decline in the quality of our central bank over recent years, and ... only the Minister of Finance – current or future – can make a start on fixing the institution. Institutional decline – and it isn’t just the Reserve Bank – has been a growing problem in New Zealand, and the current government’s indifference has only seen the situation worsen...
    "But, for better or worse, when most people think of a 'monetary mess' at present they probably primarily have in mind inflation.... [and] there simply isn’t any compelling evidence ... that any or all of the many things one can criticise Robertson for really go anywhere towards explaining how badly things have gone with inflation ...
    "[T]o me the evidence very strongly suggests that what happened over the last two to three years was that (a) central banks badly misunderstood what was going on around the macroeconomics of Covid, (b) so did almost all other forecasters, here and abroad, and (c) there isn’t much sign that central banks with better qualified more focused people or more open and contested policy processes did even slightly discernibly better than the others. I wish it wasn’t so.... 

The Survey of Professional Forecasters , published by the Philadelphia Fed, shows a clear 'hedgehog' – one that systematically overestimates the Fed’s willingness to hike interest rates, up until the time of the first hike in 2015, at which point SPFs estimations have underestimated the speed of hikes.

    "[I]t is remarkable how the [central banks'] forecasting errors are so uniformly wrong in one direction at a time. But they make for pretty hedgehogs.... If hedgehogging is unintentional, as Jonathan Newman observed on Mises.org a few years ago, 'their models are junk.' If the tendency is intentional, they are just trying to project unwarranted optimism – which is indeed the suggested explanation among those who’ve studied the Fed’s forecasting failures.
    "[W]e – and other countries – [are] still ... at risk of really bad macro forecasting errors, and central banks unable to live up to their rhetoric."

~ composite quote from Michael Reddell, from his post 'New Zealand’s monetary policy mess,' and Jokaim Book, from his post 'Central Banks' Forecasts Are Basically Garbage'

There really is a "climate emergency" ...

"It is now almost a third of a century since 1990, when the UN's Intergovernmental Panel on Climate Change (IPCC) made its first predictions about the weather," Christopher Monckton reminds us.

So, since they're meeting again in what they call COP27, and gain making apocalyptic predictions about the decades ahead, let's see how their first third-century of crystal-ball gazing has gone.

What did they say in 1990?

Under the IPCC Business-as-Usual (Scenario A) emissions of greenhouse gases ... [t]his will result in a likely increase in global mean temperature of about 1 C° above the present value... [and 1.8 C° warming from preindustrial times to 2030."

=> This translates to 0.3-0.34 C°/decade medium-term warming. However, since 1990 only 0.14 C°/decade has occurred.

That's not what you'd call highly competent weather forecasting: while oft proclaiming that warming is far worse than they've been predicting, instead it's been less than half as much!

And their predictive power is even worse than it looks:

IPCC’s business-as-usual scenario was founded on the assumption that on business as usual CO2 emissions would increase by 10-20% by 2025. The truth, however, is that it is only 2022 and yet global CO2 emissions are not 20% above their 1990 level but 60% above it ...

Does this sort of error matter?

This matters. For global climate policy is based not on the unexciting observed reality, which is that in the real world global warming is slow, small, harmless and net-beneficial, but on IPCC’s and the models’ wildly exaggerated predictions, which have not been cut back to bring them into some sort of conformity with mere reality.

Based solely on these failing predictions, for example, we keep hearing that we are in a "crisis," that this is an "emergency," that (though not so much anymore) this is our "nuclear-free moment."

And yet, even on this allegedly. overheating planet, one is ten times as likely to die from cold weather rather than hot, that in general extreme weather is if anything decreasing rather than increasing, and that over the last century climate disaster deaths have decreased by 98%.

Even "the most plausible danger of rising CO2 levels and temps, rapid sea level rises that would destroy coastal investments," are only predicted by the bad predictors "to reach 3 feet in 100 years" -- and that's the most extreme of their predictions. Future, wealthier, generations can master that.

But there really is an emergency. The fake climate emergency has created a very real energy emergency.

The false idea that fossil fuels' climate impacts are an "emergency" that requires us to rapidly eliminate fossil fuels has caused an energy emergency ... [in which] skyrocketing energy prices are driving price inflation in every area of life.... the worst-affected are poor nations—who are getting outbid for today’s scarce energy supplies.

As Alex Epstein reminds us.

Today’s high fossil fuel prices are not primarily a “Putin price hike.”
They are caused by global anti-fossil-fuel “climate emergency” policies—which made fossil fuel prices artificially high before Putin’s war and prevented the free world from quickly increasing production in response.

Yes, it is galling seeing the same climate warriors who created this very real energy emergency winging their way to a resort in Egypt in order to berate all the rest of us to wear an energy hairshirt. Just remember when their carefully crafted headline predictions emerge how bad they've already been, yet how disastrous the emergency they've created.

Modelling

 

"A recent article in Stuff does a good job of explaining the science behind mathematical modelling. But the article suffers from two glaring fallacies.
    "First, the article fails to recognise that these S.I.R. models [in which the population is assigned to compartments with the labels S, I, or R (Susceptible, Infectious, or Recovered)] are certainly a way of looking at disease propagation, but they are certainly not the only way; in fact, they are not even a very good way since they are highly stylised and based on restrictive assumptions....

    They may be useful in understanding the path of disease propagation in the early stages of a new disease. But beyond a point, the usefulness of such models is limited.... In the age of big data and rapid advances in data science, excessive reliance on 'toy' mathematical models is misguided.
    "The second problem plaguing this type of analysis in New Zealand is lack of peer review and quality assurance. This is something that NZ journalists just do not understand; the need to have research results validated by objective referees to have any faith in the conclusions. This lack of review is partly why, using the same modelling techniques, researchers at Auckland come up with numbers that are seriously at odds with those reported by people at the University of Otago....
    "You need objective assessors around the table to play devil’s advocate.
    "Unless we insist on better, evidence-based policy and quality assured research, our policy responses will continue to fall short."

          ~ Ananish Chaudhuri (Professor, Author, Commentator & Purveyor of Common Sense)

Further

"S.I.R. models in Covid are actually 1.5 years behind the current understanding of the consequences of Covid-19 policies, and half-century behind the macroeconomic understanding of human behaviour (the Lucas critique on ignoring human behaviour in macro). They are entirely obsolete for policymaking because they ignore human and government responses. 

    "This is daftly comical exactly because a) the governments impose restrictions and b) people do adjust behaviour (distancing, masks, work from home,... think the US or Sweden)... This is the nuance that is informing policymakers abroad! 

    "Here in SIR Hendyland, we [instead] lay sacrifices at the altar of a debunked model of zero behavioural responses, and the heretics are promptly stoned. There is an active suppression of informed discourse. In large part, this happened due to zero openness, zero scrutiny, hence zero accountability. And the media are to blame, I'm sorry to say."

          ~ Martin Berka (Professor of Macroeconomics at Massey University)

"There is a paradox of computer models. If you understand why a computer model gets the results that it does, then you do not need a computer model. And if you do not understand why it gets the results that it does, then you cannot trust the results." #QotD

"The bottom line for me is that there is a paradox of computer models. If you understand why a computer model gets the results that it does, then you do not need a computer model. And if you do not understand why it gets the results that it does, then you cannot trust the results. If you are using a computer to try to figure out causal structure, you are using it wrong."
        ~ Arnold Kling from his post 'Epistemology'
.

"Only the superstitious think that profitable forecasts about human action are easily obtainable. Economics itself says that forecasts, like many other desirable things, are scarce.." #QotD

"Economics is the science of the postmagical age. Far from being unscientific hoobla-hoo, economics is deeply antimagical. It keeps telling us that we cannot do it, that magic will not help. Only the superstitious think that profitable forecasts about human action are easily obtainable…. Economics itself says that forecasts, like many other desirable things, are scarce. It cannot be easy to know which great empire will fall or when the market will turn…. Some economists allow themselves to be paid cash money to answer such questions, but they know they cannot. Their very science says so."

~ Deirdre McCloskey, from her article 'The Art of Forecasting: From Ancient to Modern Times'

[Hat tip Cafe Hayek]

.

The continuing blindness of economic forecasters

I always enjoy reading Rodney Dickens eviscerating the foolishness of economic forecasters,¹ and by extension of the fools who buy them and lap them up – both in business and in the media.

His latest report on the forecasters is as entertaining as always. He calls it an Economic Literacy Report. My favourite two sections are the first two, which:

• Expose the consistent failure of the economic forecasters to provide reliable advance warnings of
  upturns and downturns in economic growth, residential building, interest rates and the NZD.
• Review the track record of the mainstream economic forecasters.

Let’s start with a one-word evaluation of their track record: appalling. When it comes to forecasts, these folk – and you hear them all the time in the media, talking their book – couldn’t hit a barn door with a bowling ball.

Rodney looks at the record of ten forecasters, all of whom sell their shit for big money, on their forecasts for exchange rates, interest rates, GDP growth, consumer spending and residential building activity, all of which clients paying good money for their forecasts would hope would be somewhere in the ballpark, but all of which they persistently get wrong.

Not just wrong, but dramatically wrong. The black lines in these charts show the actual outcomes; the coloured lines flying in directions unrelated the black lines indicate the “predictions” of the forecasters. I pick out some of the more delightful…

Rodney then rates them on their ability to spot the sort of major event that those buying these forecasts might need to know, such as the 2008 recession, and (what he calls) the 2010 mini-recession. How many of them spotted that? Can you hear the crickets?

Even the most pessimistic of the forecasters surveyed by NZIER in December 2007 predicted 1.4% GDP growth for 2008/09 (red line, right chart). None predicted a recession…

The [2010 mini-recession] recession started before the first major Canterbury earthquake in September…  In June 2010, just before the recession was about to start the Reserve Bank predicted that annual GDP growth would remain at over 3% (the blue line, below), which was only slightly lower than what it had predicted in March (the green line)…

    The Reserve Bank was one of the 10 forecasters NZIER surveyed in June 2010 as part of a regular
quarterly survey… The blue line in the left chart below shows the March 2010 average or consensus GDP
growth predictions for the 2010/11 and 2011/12 March years. In March 2010 the economic forecasters
were on average predicting that annual average growth would remain a bit above 3%, which they were also predicting in June 2010 (the green line). Even by September 2010, after the mini-recession had started,
the economic forecasters were on average predicting around 3% growth (the orange line, which includes
the predictions for the 2012/13 March year).

Sure, there are times when the economic crystal ball gazers get it right by chance. But you could do that too, and by the same methodology:

By consistently predicting that economic growth will head to around 2.5-3% the economic forecasters will
get it right from time-to-time by chance. For example, prior to the slowdown in economic growth in 2005 the economic forecasters persisted in predicting that growth would slow and eventually they were roughly right. Similarly, by consistently predicting that economic growth would rebound to around 3% after the crisis the economic forecasters eventually got it roughly right.

But this is hardly worth boasting about, and reveals more about the models than their ability: it reveals that, as with global warming models, the expected outcomes are essentially baked into their models.

Now, you might object about now that using the 'average' of the forecasters’ prediction hides those few forecasters who've been successful.  But that hypothesis is tested as well, the chart series showing both averages and (as some above do) maxima and minima.

So that hypothesis can be abandoned too.

Now, these charts are hardly a compelling argument for the efficacy of economic forecasting.  Of course, Rodney is himself a forecaster --  he has his own methodology radically to that sold by the munters he measures  -- but he's at least aware that the public, that is, you, need to be aware not to take forecasters' predictions as gospel.

Why are they so wrong so often?

Because the future is inherently uncertain, and econometric analysis can’t change that one whit. All it does is provide mathematical justification for going wrong with confidence.

Now, it’s true as economist Ludwig Von Mises say that “historians and statisticians content themselves with prices of the past,” while “practical man looks at the prices of the future”--and that econometricians pretend to use the prices of the past to predict the prices and conditions of the future.  But the fact they can’t, and never can, just reinforces the crucial role of entrepreneurs in driving economic activity: in taking risks on the future with their own money based on their own individual estimations of the future.

It’s not blind crystal-ball readers who move the world, it’s entrepreneurs. And most econometricians wouldn’t even know how to spell the word.

Unlike politicians and central planners, who do take these forecasts as gospel (and central bankers, who think they write the gospel), entrepreneurs who actually act on the basis of forward projections rely in the main not on forecasts like these, but largely on their own independent judgement of what the future holds-- and it's them after all who actually move the economy and drive production. 

Entrepreneurs will certainly listen to forecasters, and they definitely don't mind forecasts being taken seriously by the easily led, since it sets up opportunities to take advantage of their poor estimates.  ( What entrepreneurs are often looking for is, as Israel Kirzner explains, "unexploited opportunities for reallocating resources from [low-valued] use to another of higher value [which] offers the opportunity of pure entrepreneurial gain.  A misallocation of resources occurs because, so far, market participants have not noticed the price discrepancy involved.  This price discrepancy presents itself as an opportunity to be exploited by its discoverer.  The most impressive aspect of the market system is the tendency for such opportunities to be discovered.")

Entrepreneurs themselves generally recognise the truth stated by Ludwig von Mises, "that the main task of action is to provide for the events of an uncertain future."  If, for example, the date of booms and busts and the like could be predicted "with apodictic certainty" according to some formula or other, then everyone would act at the same time to make it so.

   In fact, reasonable businessmen are fully aware of the uncertainty of the future. They realize that the economists do not dispense any reliable information about things to come and that all they provide is interpretation of statistical data from the past...   
    If it were possible to calculate the future state of the market, the future would not be uncertain.  There would be neither entrepreneurial loss nor profit.  What people expect from the economists is beyond the power of any mortal man.

The greatest danger of 'the forecasting delusion' is the illusion that "the future is predictable, that some formula could be substituted for the specific understanding which is the essence of entrepreneurial activity, and that familiarity with these formulas could make it possible for [bureaucratic management] to take over the conduct of business."

    The fact that the term 'speculator' is today used only with an opprobrious connotation clearly shows that our contemporaries do not even suspect in what the fundamental problem of action consists.
    Entrepreneurial judgment cannot be bought on the market. The entrepreneurial idea that carries on and brings profit is precisely that idea which did not occur to the majority. It is not correct foresight as such that yields profits, but foresight better than that of the rest.

If you’re relying only on foresight better than that of those who rely on forecasts, that leaves anyone with only half a brain ample opportunity.

---

1. I hasten to point out that this is my own estimation. Rodney  himself has his own forecasting methodology.

Government Economists: About as Useful as a Fork in a Sugar Bowl

Guest post by Dan Steinhart, introducing John Mauldin

Humans tend to believe what they're told by authority figures. Even in the face of contradictory evidence.

The Milgram Experiment taught us this in 1963. Posing as scientists, researchers instructed volunteers to inflict painful electric shocks on what they thought were other innocent volunteers, as a penalty for answering questions incorrectly. The shockers couldn't see the people they were shocking, but could hear their reactions: terrible cries of pain, pounding on the wall, pleas to stop, and eventually, ominous silence.

Of course, it was all a ruse, but the shockers didn't know that. They thought they were effectively torturing the victims. Yet most shockers ignored the victims' agonized pleas to stop, opting instead to obey the "scientist's" commands to continue.

Why? Because the "scientist" was an expert. He was wearing a white lab coat, so he must know best.

We treat economists similarly today, deferring to their expertise in economic matters, even when common sense suggests they are wrong. Paul Krugman says an alien invasion would cure our economic ills by forcing us to spend money to defend against their attack. If a stranger on the bus said that, you might direct him to the nearest mental facility.

But Krugman? He has a framed MIT doctorate gracing his office wall, so he must know what he's talking about.

Here's a dirty little secret: Economists—particularly government and other mainstream ones—stink at their jobs. They're awful at forecasting the future. History shows that not only are economists incapable of forecasting recessions, they usually can't even recognize that we're in a recession once it's already started. If you were as bad at your job as the average economist is at his, you wouldn't have a job. Management would fire you, assuming they could do so before your horrendous decisions brought down the entire company.

With that background, I'm excited to share with you an excerpt from John Mauldin's fantastic new book, Code Red. As you might've guessed, the premise of the passage you'll read below is that mainstream economists have a horrific track record, a claim the book backs up with impressive stats. For investors, relying on mainstream economists' forecasts is a sure path to subpar returns.

But Code Red is about so much more. I plowed through it this over the weekend, and if I had to describe it in one word, it would be "satisfying." John Mauldin and his co-author Jonathan Tepper beautifully explain how seemingly unrelated pieces of the global economy fit together, how we've arrived at our near zero-interest rate world, and which countries are closest to crisis. What seems absurdly complex before reading the book becomes crystal clear afterward.

Here are a couple of the chapter titles, to give you an idea of the topics Code Red covers:

• 20^th Century Currency Wars—The Barbarous Relic and Bretton Woods
• A World of Financial Repression
• Easy Money Will Lead to Bubbles, and How to Profit From Them
• How to Protect Yourself Against Inflation
• A Look at Commodities, Gold, and Other Real Assets

With that, I'll leave you to explore the excerpt for yourself. If you like what you read, you can purchase a copy of Code Red for 28% off the regular price by clicking here.

Enjoy.
Dan Steinhart
Managing Editor of The Casey Report 

An Excerpt from Code Red:
Chapter 6 - Economists Are Clueless

By John Mauldin & Jonathan Tepper

In November of 2008, as stock markets crashed around the world, the Queen of England visited the London School of Economics to open the New Academic Building. While she was there, she listened in on academic lectures. The Queen, who studiously avoids controversy and almost never lets people know what she's thinking, finally asked a simple question about the financial crisis, "How come nobody could foresee it?" No one could answer her.

If you suspected that mainstream economists are useless at the job of seeing a crisis in advance, you would be right. Dozens of studies show that economists are completely incapable of forecasting recessions. But forget forecasting. What's worse is that they fail miserably even at understanding where the economy is today. In one of the broadest studies of whether economists could predict recessions and financial crises, Prakash Loungani of the International Monetary Fund wrote very starkly, "The record of failure to predict recessions is virtually unblemished." This was true not only for official organizations like the IMF, the World Bank, or government agencies but for private forecasters as well. They're all terrible. Loungani concluded that the "inability to predict recessions is a ubiquitous feature of growth forecasts." Most economists were not even able to recognize recessions once they had already started.

In plain English, economists don't have a clue about the future.

If you think the Fed or government agencies know what is going on with the economy, you're mistaken. Government economists are about as useful as a fork in a sugar bowl. Their mistakes and failures are so spectacular you couldn't make them up if you tried. Yet now, in a Code Red world, we trust the same bankers to know where the economy is, where it is going, and how to manage monetary policy.

Central banks say that they will know when the time is right to end Code Red policies and when to shrink the bloated monetary base. But how will they know, given their record at forecasting? The Federal Reserve not only failed to predict the recessions of 1990, 2001, and 2007, it didn't even recognize them after they had already begun. Financial crises frequently happen because central banks cut interest rates too late and hike rates too soon.

Trusting central bankers now is a big bet that (1) they'll know what to do and (2) they'll know the right time to do it. Sadly, they generally don't have a clue about what is going on.

Unfortunately, the problem is not that economists are simply mediocre at what they do. The problem is that they're really, really bad. And they're so bad that their ineptitude cannot even be a matter of chance. As the statistician Nate Silver pointed out in his book The Signal and the Noise:

Indeed, economists have for a long time been much too confident in their ability to predict the direction of the economy. If economists' forecasts were as accurate as they claimed, we'd expect the actual value for GDP to fall within their prediction interval nine times out of ten, or all but about twice in eighteen years.
    In fact, the actual value for GDP fell outside the economists' prediction interval six times in eighteen years, or fully one-third of the time. Another study, which ran these numbers back to the beginning of the Survey of Professional Forecasters in 1968, found even worse results: the actual figure for GDP fell outside the prediction interval almost half the time. There is almost no chance that economists have simply been unlucky; they fundamentally overstate the reliability of their predictions.

So it gets worse. Economists are not only generally wrong, they're extremely confident in their bad forecasts.

If economists were merely wrong at betting on horse races, their failure would be harmlessly amusing. But central bankers have the power to create money, change interest rates, and affect our lives in every way—and they don't have a clue.

Despite their cluelessness, there's no overestimating the hubris of central bankers. On 60 Minutes in December 2010, Scott Pelley interviewed Chairman Ben Bernanke and asked him whether he would be able to do the right thing at the right time. The exchange was startling:

Pelley: Can you act quickly enough to prevent inflation from getting out of control?
Bernanke: We could raise interest rates in 15 minutes if we have to. So, there really is no problem with raising rates, tightening monetary policy, slowing the economy, reducing inflation, at the appropriate time. Now, that time is not now.
Pelley: You have what degree of confidence in your ability to control this?
Bernanke: One hundred percent.

There you have it. Bernanke was not 95% confident, he was not 99% confident—no, he had zero doubts about his ability to know what is going on in the economy and what to do about it. We would love to have that kind of certainty about anything in life.

We're not picking just on Bernanke; we're picking on all central bankers who think they're infallible. The Bank of England has had by far the largest QE program relative to the size of its economy (though the Bank of Japan is about to show it a thing or two). It has also had the worst forecasting track record of any bank, and the worst record on inflation. Sir Mervyn King, the head of the Bank of England, was asked if it would be difficult to withdraw QE. He very confidently replied,

I have absolutely no doubt that when the time comes for us to reduce the size of our balance sheet that we'll find that a whole lot easier than we did when expanding it…

(Are central bankers just naturally more arrogant than regular human beings, or are they smoking some powerful stuff at their meetings?)

Let's see whether this sort of absolute certainty is at all warranted.

In his book Future Babble, Dan Gardner wrote that economists are treated with the reverence the ancient Greeks accorded the Oracle of Delphi. But unlike the vague pronouncements from Delphi, economists' predictions can be checked against the future, and as Gardner says,

Anyone who does that will quickly conclude that economists make lousy soothsayers.

(As an aside, we suspect that economists may be the modern-day functional equivalent of tribal shamans. Instead of peering at the intestines of sheep to forecast the future, we look at data through the lenses of models we create, built with all our inherent biases, and then confidently predict the future or try to guide government policy in one direction or another, generally along paths that fit the favor depending on whether we are telling our fellow tribe members and leaders and potential leaders what they want to hear. It may be that economics is more like religion and less like science than most of us want to admit.)

The nearsightedness of economists is nothing new. In 1994 Paul Ormerod wrote a book called The Death of Economics. He pointed to economists' failure to forecast the Japanese recession after their bubble burst in 1989 or to foresee the collapse of the European Exchange Rate Mechanism in 1992. Ormerod was scathing in his assessment of economists:

The ability of orthodox economics to understand the workings of the economy at the overall level is manifestly weak (some would say it was entirely non-existent).

When people think of economic forecasts, they almost always think of recessions, while economists think of forecasting growth rates or interest rates. But the average person in the street only wants to know, "Will we be in a recession soon?"—and if the economy is already in a recession, he or she wants to know, "When will it end?" The reason most working Americans care is that they know recessions mean job cuts and firings.

Figure 6.1 Recessions lead to falls in GDP and spikes in the unemployment rate
Source: Variant Perception, Bloomberg

Unfortunately, economists are of no use to the man or woman in the street. If you look at the history of the last three recessions in the United States, you will see that the inability of economists and central bankers to understand the state of the economy was so bad that you might be tempted to say they couldn't find their derrieres with both hands.

Figure 6.2 Economists have never predicted a recession correctly

Source: Societe Generale Equity Research

Let's remind ourselves what a recession is and how economists decide that one has started. A recession is a downturn in economic activity. Normally, a recession means unemployment goes up, GDP contracts, stock prices fall, and the economy weakens. The lofty body that decides when a recession has started or ended is the Business Cycle Dating Committee of the National Bureau of Economic Research. It is packed with eminent economists and other extremely smart people. Unfortunately, their pronouncements are completely unusable in real time. Their dating of recessions is authoritative and more or less accurate, but this exercise in hindsight comes together long after a recession has started or ended.

To give you an idea just how late recessions are officially called, let's look at the past three. The NBER dated the 1990-91 recession as beginning in August 1990 and ending in March 1991. It announced these facts in April 1991, by which time the recession was already over and the economy was growing again. The NBER was no faster catching up with the recession that followed the dotcom bust. It wasn't until June 2003 that the NBER pinpointed the 2001 recession—a full 28 months after the recession ended. The NBER didn't date the recession that started in December 2007 until exactly one year later. By that time, Lehman had gone bust, and the world was engulfed in the biggest financial cataclysm since the Great Depression.

The Federal Reserve and private economists also missed the onset of the last three recessions—even after they had started. Let's look quickly at each one.

Starting with the 1990-91 recession, let's see what the head of the Federal Reserve—the man who is charged with running American monetary policy—was saying at the time. That recession started in August 1990, but one month before it began Alan Greenspan said, "In the very near term there's little evidence that I can see to suggest the economy is tilting over [into recession]." The following month—the month the recession actually started—he continued on the same theme: "... those who argue that we are already in a recession I think are reasonably certain to be wrong." He was just as clueless two months later in October 1990, when he persisted, "... the economy has not yet slipped into recession." It was only near the end of the recession that Greenspan came around to accepting and acknowledging that it had begun.

The Federal Reserve did no better in the dotcom bust. Let's look at the facts. The recession started in March 2001. The tech heavy NASDAQ Index had already fallen 50% in a full-scale bust. Even so, Chairman Greenspan declared before the Economic Club of New York on May 24, 2001,

Moreover, with all our concerns about the next several quarters, there is still, in my judgment, ample evidence that we are experiencing only a pause in the investment in a broad set of innovations that has elevated the underlying growth rate in productivity to a level significantly above that of the two decades preceding 1995.

Charles Morris, a retired banker and financial writer, looked at a decade's worth of forecasts by the geniuses at the White House's Council of Economic Advisors. In 2000, the council raised their growth estimates just in time for the dot-com bust and the recession of 2001-02. In a survey conducted in March 2001, 95% of American economists said there would not be a recession. The recession had already started that March, and the signs of contraction were evident. Industrial production had already been contracting for five months.

You would have thought that their failure to forecast two recessions in a row might have sharpened the wits of the Federal Reserve, the Council of Economic Advisers, and private economists. Maybe they would have tried to improve their methods or figured out why they had failed so miserably. You would be wrong. Because along came the Great Recession, and—once again—they completely missed the boat.

Let's look at what the Fed was doing as the world was about to go up in flames in 2008. Recently, complete minutes of the Fed's October 2007 meeting were released. Keep in mind that the recession started two months later, in December 2007. The minutes make for depressing reading. The word recession does not appear once in the entire transcript.

It gets worse. The month the recession started, the Federal Reserve was all optimistic laughter. Dr. David Stockton, the Federal Reserve chief economist, presented his view to Chairman Bernanke and the meeting of the Federal Open Market Committee on December 11, 2007.

When you read the following quote and choke on your breakfast or lunch, remember that at the time the Fed was already providing ample liquidity to the shadow banking system after dozens of subprime lenders had gone bust in the spring, the British bank Northern Rock had been nationalised and spooked the European banking system, dozens of money market funds had been shut due to toxic assets, credit spreads were widening, stock prices had started to fall, and almost all the classic signs of a recession were evident. These included an inverted yield curve, which had received the casual attention of New York Fed economists even as it screamed recession.

Read these words of the Fed's chief economist and weep. You can't make this stuff up.

Overall, our forecast could admittedly be read as still painting a pretty benign picture: Despite all the financial turmoil, the economy avoids recession and, even with steeply higher prices for food and energy and a lower exchange value of the dollar, we achieve some modest edging-off of inflation. So I tried not to take it personally when I received a notice the other day that the Board had approved more frequent drug-testing for certain members of the senior staff, myself included. [Laughter] I can assure you, however, that the staff is not going to fall back on the increasingly popular celebrity excuse that we were under the influence of mind-altering chemicals and thus should not be held responsible for this forecast. No, we came up with this projection unimpaired and on nothing stronger than many late nights of diet Pepsi and vending-machine Twinkies.

We do not want to pick on Dr. Stockton unnecessarily, as all other government economists were equally awful. The President's Council of Economic Advisers' 2008 forecast saw positive growth for the first half of the year and foresaw a strong recovery in the second half.

Unfortunately, private-sector economists didn't do much better. With very few exceptions, they failed to foresee the financial and economic meltdown of 2008. Economists polled in the Survey of Professional Forecasters also failed to see a recession developing. They forecasted a slightly below-average rate of 2.4 percent for 2008, and they thought there was almost no chance of a recession as severe as the one that actually unfolded. In December 2007, a Businessweek survey showed that every single one of 54 economists predicted the U.S. economy would avoid a recession in 2008. The experts were unanimous that unemployment wouldn't be a problem, leading to the consensus conclusion that 2008 would be a good year.

As Nate Silver has pointed out, the worst thing about the bad predictions isn't that they were awful; it's that the economists in question were so confident in them:

This was a very bad forecast: GDP actually shrank by 3.3% once the financial crisis hit. What may be worse is that the economists were extremely confident in their bad prediction. They assigned only a 3% chance to the economy's shrinking by any margin over the whole of 2008. And they gave it only about a 1-in-500 chance of shrinking by 2 percent, as it did.

It is one thing to be wrong. It is quite another to be consistently and confidently and egregiously wrong.

As the global financial meltdown unfolded, Chairman Bernanke, too, continued to believe that the United States would avoid a recession. Mind you, the recession had started in December 2007, yet in January 2008 Bernanke told the press, "The Federal Reserve is not currently forecasting a recession." Even after banks like Bear Stearns needed to be rescued, Bernanke continued seeing rainbows and candy-coloured elves ahead for the U.S. economy. He declared on June 9, 2008, "The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so." At that stage, the economy had already been in a recession for the past six months!

Why do people listen to economists anymore? Scott Armstrong, an expert on forecasting at the Wharton School of the University of Pennsylvania, has developed a "seer-sucker" theory: "No matter how much evidence exists that seers do not exist, suckers will pay for the existence of seers." Even if experts fail repeatedly in their predictions, most people prefer to have seers, prophets, and gurus with titles after their names tell them something—anything at all—about the future.

So, we have catalogued the incredible failures of economists to predict the future or even to understand the present. Now, with their record in mind, think of the vast powers Fed economists have to print money and move interest rates. When you contemplate the consummate skill that would actually be required to manage Code Red policies, you realize they're really just flying blind. If that doesn't scare the living daylights out of you, you haven't understood this chapter so far.

John Mauldin (left) is the President of Millennium Wave Advisors; author of several books including “The Little Book of Bull's Eye Investing,” “Endgame: The End of the Debt Supercycle and How It Changes Everything,” and “Code Red: How to Protect Your Savings From the Coming Crisis.” He was previously chief executive officer of the American Bureau of Economic Research.
His website is MauldinEconomics.Com.

Dan Steinhart (right) is a CPA and Big 4 accounting firm alumni, reformed Wall Street trader, and the Managing Editor of The Casey Report .

This post first appeared in the Casey Daily Dispatch.