• The sky is falling

    Ben D. Kritz

    Ben D. Kritz

    While the Philippines has spent the entire week focused on the critical, time-dependent implications to national policy of love triangles gone bad, a new hot topic has emerged in the international business media that might just warrant some of our attention.

    In an op-ed piece in his eponymous magazine last Sunday, media mogul, former Republican US presidential aspirant, and all-around conservative icon Steve Forbes wrote about the “brewing troubles in emerging markets,” and described the root cause of those troubles as “. . . the result of economic ignorance: too many central bankers don’t know how to defend their currencies, which are under attack. If they don’t get their act together, we could have another big financial crisis like that which hit in Asia in 1997-98. The danger is that the Fed [US Federal Reserve], the IMF [International Monetary Fund], the European Central Bank, the Bank of England and the Bank of Japan are just as clueless as their developing country counterparts on how to quickly put a stop to a potentially devastating currency crisis that will hit banks hard everywhere.” Bloomberg columnist William Pesek added his views on the same day: “From Thailand to Indonesia to Malaysia—even as far as India—Asian nations are displaying an extremely worrying set of shared vulnerabilities.”

    The theme has since been picked up and spread faster than anyone can possibly keep up with, but the message is the same no matter who is sharing it: The emerging and developing markets are on the verge of some sort of meltdown, the evidence for which is rapidly declining currencies, equity markets that are, if not already in a tailspin, extremely sensitive and inclined to drop at the slightest hint of bad news, the growth of various kinds of debt and asset bubbles, and rapidly expanding income gaps. Add to that growing political instability in a number of countries, and the prognosis for the world economy is not encouraging.

    In the clearest signal yet that the news is being taken seriously, emerging market exchange-traded funds (ETFs) in the major markets (these funds are a key source of “hot money” inflows into local markets) are in what appears to be a full-scale collapse: the New York Stock Exchange-traded iShares MSCI Emerging Markets ETF has dumped close to 11 percent of its value this month, while London’s Vanguard FTSE Emerging Markets ETF is down nearly 9 percent; altogether, emerging market ETFs have lost more than $7 billion in January alone.

    The obvious question of the moment is, “Is the economy headed for another crisis?” But I am not going to attempt to answer it, because on further reflection it seems very likely the only logical response would be, “It depends.” Allow me to elaborate:
    Economics is an entirely zero-sum phenomenon; someone wins, someone else loses.

    Classic and very simple examples of this are the inverse relationship between stocks and bonds (bond yields tend to drop when stock prices increase, and vice versa), and the inverse relationship between exchange rates and imports/exports (higher currency value is better for importers and worse for exporters, while exporters benefit and importers suffer when the exchange value of the currency declines). Because of that, economists have internalized the equilibrium theory, which allows predictions to be made.

    The problem with that (and the reason why so many economists repeatedly get it wrong) is economics is not an empirical science, but a social one. First, it lacks any sort of unifying set of axioms or constants that are valid for any approach. Second, and more importantly, almost all the variables used in any kind of economic modeling are unpredictable, because they are people, and people do not act predictably. When economic models and predictions get it wrong, they do so either because they failed to account for enough factors, or they assume (as mathematics forces them to do so) that the variables will behave within a rationally predictable range. Worse still, the biggest variable in any economic analysis may be the analyst himself. It is the nature of most social sciences that they are both interpretive and to some degree participative, and economics is no exception—that’s how economists end up wearing labels like “Keynesian” or “Austrian,” find their way into career disciplines where those orientations are an advantage, and then view economics from the perspective that is most relevant to their beliefs (and in most cases, their own income).

    So if you are an analyst for whom the work of Adam Smith may as well be an extra protein in your DNA, and for whom success is defined by how much profit you and your clients earn from short- to medium-term investing in equity markets, you’re going to perceive the markets as an avatar of the entire economy. If you are an analyst whose actual business is political image management, you’re going to work for the government and consider statistical macro-indicators the standard of judgment. And if you are an analyst in the media trade, you’re going to base your conclusions on broad phenomena that help you deliver the greatest amount of your product in the most marketable way. And whichever one of these analysts you are, you will almost certainly mistake agreement with your thesis for confirmation of it, whether you’re actually right or not.

    The only solution to all of this from the point of view of the average reader just trying to get a sense of where the economy is going for the purpose of managing the micro-economy of his own home or business is to take it all with a grain of salt; be open-minded about information from a variety of sources, and consider the context in which those bits of information are delivered. From the analyst’s point of view, the beneficiaries of our efforts would be better served by placing those efforts in a more relevant context in the first place—if we spend more time convincing our readers why what we have to say really means something to them (instead of trying to convince ourselves of our own cleverness), we might soon find ourselves making that happy ascent from merely being “interesting” to being indispensable.



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