Category Archives: Economics

Beware of Gurus Peddling Predictions

My Macro Obsession

I have a problem that I think a lot of investors have: I love macroeconomics.

There are few things more fascinating to me than trying to predict the economic cycle. I want to know if we’re going to have a recession or if we’re going to have a boom. I want to know if inflation and interest rates will roar back to life. I like to look back in history and analyze the twists and turns and hope that can shed light on what will happen next.

It’s a fun exercise, but it’s largely a waste of time.

The trouble with my macro-obsession is that it has led to poor investing decisions and outcomes. I failed to buy a number of stocks that were attractively priced in March because I was convinced that the United States was headed for a second Great Depression. I looked at the overvaluation of mega-cap stocks and used that as a reason to avoid other, more attractively priced, stocks that were outside of that universe.

I was completely wrong and blew it, as did many others in the market. At least I admit it.

Getting that wrong was a humbling experience for me.

I could have doubled down — I wasn’t wrong, the Fed is merely compounding their errors! I wasn’t wrong, the collapse was simply delayed! I’m not wrong; the government is lying about the unemployment and inflation statistics!

Do those responses seem like a rational explanation, or are they an example of bargaining and an attempt to rationalize an error?

Instead, my experience has led me to a different conclusion: macroeconomics is really hard and a waste of time. I want to have a portfolio that is prepared for different macroeconomic outcomes — but I’m not going to bet on a single one of them unfolding.

Some might say that macro prediction is worthwhile. I might have been a dummy about it, but they’re not dummies and they can do it!

Well, the question I ask of them: How many people can you name off the top of your head that became rich with their macroeconomic predictions?

If you go through the Forbes 400, there aren’t any macroeconomists. In other words, no one who has devoted themselves to a study of what makes the world’s economy tick have been able to get rich by predicting economic cycles, currencies, or interest rates.

Macro Gurus

The most famous macroeconomist in history is John Maynard Keynes. What is most interesting about Keynes is that he started out investing by trying to predict the economic cycle. He tried to predict recessions, currency movements, and the prices of commodities.

In the early 1930’s, he lost 80% of his money. He failed at attempting to predict macro-economics. This caused him to move on from top-down economic analysis to a focus on value investing: buying individual businesses at a discount to their intrinsic value.

If Keynes can’t do it, what makes you think that you can?

Within the Forbes 400, there are only two people who have used macro-economic predictions to consistently make money: George Soros and Ray Dalio.

For those two individuals, it’s also important to note that they don’t bet everything on a single outcome, and they are frequently wrong.

Dalio successfully predicted the financial crisis of 2007–09, but he has also been saying that we are in a situation similar to 1937 for most of the last decade. The 1937-style market decline has never materialized. He also proclaimed that “cash is trash” in early 2020 shortly before the COVID crash, when many hoped that they had more cash in their portfolio.

Dalio isn’t the only one who can get macro wrong.

There are plenty of other gurus who got things wrong.

Here is a macro prediction from Seth Klarman:

“By holding interest rates at zero, the government is basically tricking the population into going long on just about every kind of security except cash, at the price of almost certainly not getting an adequate return for the risks they are running. People can’t stand earning 0% on their money, so the government is forcing everyone in the investing public to speculate.”

This was not from April 2020. It was from May 2010. If you invested $10,000 on the day that this prediction was made, you would now have $35,000. Klarman got it wrong.

It’s also worth noting that Klarman isn’t rich because of macro predictions: he’s rich because he shrewdly buys assets when they are at a sharp discount to his estimate of intrinsic value, which he is quite skilled at calculating.

George Soros is famous for a successful bet against the British pound in 1992. He has become a billionaire by making outsized macro bets. But he’s hardly foolproof.

In 1987, he argued that the world’s reliance on the dollar would lead to: “financial turmoil, beggar-thy-neighbor policies leading to world-wide depression and perhaps even war.”

It didn’t happen.

In 1998, he made similar predictions in his book “The Crisis of Global Capitalism” and those predictions did not materialize.

If Soros frequently gets it wrong, then how is he successful as a macro trader?

The thing is: he’s a trader and he acknowledges errors and corrects positions when they’re wrong. He never bets everything on a single prediction. Soros makes many bets and never bets the ranch on a single outcome. He’s flexible and will move out of positions when he is wrong. Soros himself has said: “I’m only rich because I know when I’m wrong.”

In 2010, a who’s-who of the financial world wrote a letter in the Wall Street Journal imploring the Federal Reserve to stop their quantitative easing program. In their words, they believed that quantitative easing would risk “currency debasement and inflation.”

They were wrong! The reality is that the 2010’s witnessed some of the lowest inflation on record. The US Dollar actually strengthened after quantitative easing.

Of course, perma-bears and Fed critics will scoff at this. They’ll say that if you actually measure inflation by their metrics — inflation is actually higher than the government’s lies!

Another argument is that inflation hasn’t come through actual increases in the prices of goods — the entire stock market boom of the last 10 years has been inflationary.

Another argument would be that the only reason that the USD has strengthened is because other central banks have ramped up their “money printing” more than the rest.

Does this sound to you like sound reasoning, or does it sound like bargaining and attempt to rationalize a prediction that was wrong?

They never seem to consider the possibility that they just got it wrong. What’s more likely? That they were wrong 10 years ago, or that government statistics are lies and the debasement occurred anyway?

As for the “it didn’t affect prices of goods, just assets” — well, if all of this “money printing” was going to cause asset inflation, then why didn’t these people buy financial assets? Why weren’t they able to predict that it would cause a decade long bull market and successfully position for it?

Hindsight is 20/20. No one likes to admit that they’re wrong, so they invent excuses instead of facing the possibility that they might have just been wrong.

The reality is this: no one can predict the macro-economy. The two people on the Forbes 400 that were actually able to predict macro are error prone. When they do make errors, they own up to them and quickly correct their position. This is a sharp contrast to the macro guru’s that you’ll find on Twitter.

If there aren’t any rich macroeconomists — if there aren’t any rich financiers who did it by predicting the macro economy — if the only two people that got rich from macro make errors — then what makes you think that you can do it? What makes you think that your favorite Twitter guru can do it?

Be Wary of Gurus Bearing Predictions

There are a many gurus in the financial world. They make their proclamations on Twitter, on podcasts, or on TV. They sell books proclaiming their predictions. They exude total confidence.

My question is simple: if they can predict what’s going to happen, then why aren’t they already rich from it? What makes them better than George Soros, Ray Dalio, or John Maynard Keynes?

This is the reality that I wish I absorbed earlier. I suppose it’s something I had to learn via experience.

The reality is that nobody knows what is going to happen.

Most of the people confidently proclaiming financial predictions are selling something. Always approach their predictions through that prism. What are they selling? How do their proclamations tie into what they are selling?

They are attempting to sell books. They want higher ratings on podcasts. They want you to subscribe to their videos or sell ads.

Saying something like: “Have a balanced portfolio prepared for different outcomes” does not generate clicks and ratings. Proclaiming our imminent doom does generate ratings and clicks.

They have an agenda and it’s important that you realize that before consuming that content.

This doesn’t mean that macroeconomics is a total waste of time or should be ignored. I simply think that it is folly to imagine that any of us can predict the next turn in currencies, inflation, interest rates, or the economic cycle.

It does make sense to imagine how a portfolio would react in different situations. There should a plan for different outcomes. I think it makes sense to hold a diversified portfolio of assets that will deliver a return in different macro environments.

This is what Harry Browne tried to do with the Permanent Portfolio, which is a better template to think about these matters than trying to find the guru with the right crystal ball. The Permanent Portfolio is prepared for different macroeconomic outcomes. I have my own spin on this with the Weird Portfolio.

Whatever the mix, it doesn’t matter. The key is to acknowledge that macro prediction is really hard and likely a waste of time.

While it makes sense to have plans for different outcomes, it doesn’t make sense to think that you can actually predict the twists and turns of the macroeconomic landscape. Prediction is a fool’s errand and I’m a fool for attempting. I was a fool for trying to do this. At least I own up to it.

Will the Doomers eventually be right and will we have inflation? Well, I own some gold in case that happens. Will we have another deflationary bust? I own long term treasuries if that happens. I have some cash in an emergency fund. Will the US be replaced as a superpower? I have assets in other countries in case my country falls behind.

Will civilization collapse? Well, then it won’t matter how a portfolio is positioned, anyway. Guns and canned goods will carry more value than gold bars, puts on the S&P 500, or Bitcoin. (I have guns and canned goods, too, because I’m a bit paranoid!)

If you find yourself totally absorbed in a single macroeconomic thesis, I would caution strongly against it. The greatest names in Finance frequently fail at that game. There aren’t any rich macroeconomists.

Be careful out there and be wary of gurus peddling predictions.

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PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Ranking the Fed

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Writing about Alan Greenspan’s record made me wonder if there was a way to measure the performance of a Fed Chairman, systematically without biases.

The Misery Index

The Fed has a dual mandate: maintaining both price stability and maximum employment. Back in the ’70s, these factors of unemployment and inflation were added up into what was known at the time as “the misery index.” The job of the Federal Reserve is to keep both unemployment and inflation low (i.e., keep the misery index low). It hasn’t always succeeded:

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In the early 1960s, the US economy experienced both low inflation and low unemployment. Inflation steadily trended higher and peaked in the 1970s.

In the 1970s, the United States faced a phenomenon known as stagflation, simultaneously high unemploymentwhichand high inflation. It perplexed economists, as traditionally there was a trade-off between unemployment and inflation. The cure for inflation was unemployment, the cure for unemployment was some inflation. In the 1970s, this relationship broke down, and both soared to next heights.

This is why the misery index peaked in the late 1970s and early 1980s. Inflation has not crept back in a meaningful way since its defeat in the early 1980s. Most increases in the misery index since the beginning of the 1980s are due to increases in unemployment.

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Ranks

I decided to rank the chairmen by the net change experienced in the misery index during their tenure. By this measure, no chairman can match the record of Paul Volcker. His tough monetary medicine (double digit interest rates) caused a brutal recession in the early 1980s, but this was the medicine that the economy needed to finally break inflation.

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Regarding the average level of the misery index, the best chairman was William McChesney Martin. The data I used only covered a portion of his tenure in the 1960s. It would likely look even better if I included the 1950s. Martin presided over a period of simultaneously low unemployment and low inflation. The next best by this measure was Alan Greenspan.

By the metric of unemployment, Martin also experienced the lowest average unemployment rate. The lowest inflation rate was experienced by Janet Yellen. Inflation has been declining under her tenure, with inflation being virtually zero in 2015 due to the collapse of oil prices. The decline in inflation during this decade defied the expectations who expected the massive monetary easing of the Bernanke era to result in high levels of inflation.

Are the Rankings Fair?

Trying to empirically measure the performance of the Federal Reserve is a difficult task. My preferred measure is not the absolute level of misery, but the net change in the misery index during the tenure. By this metric, Paul Volcker is the winner.

Some might say that a chairman like Volcker is uniquely advantaged with this list because his starting point for unemployment and inflation was so staggeringly high. I would counter this and say that Volcker deserves the highest ranking for what he accomplished. In retrospect, it might seem like Volcker’s actions were obvious (tighten the money supply to restrain inflation), but this was a monumental challenge. He made the incredibly difficult decision of focusing solely on inflation. The medicine was tough for the economy: double digit unemployment and interest rates. Volcker’s policies caused an immense public backlash. Construction workers sent Volcker 2×4’s to protest his policies. The public was outraged, but Volcker’s tough medicine worked. He broke the back of inflation and unemployment soon followed.

Ronald Reagan also deserves credit for standing behind Volcker. It is quite tempting for a President to encourage the Fed to loosen monetary policy. Nixon did this in the 1970s, which helped create the stagflation problem in the first place. George H.W. Bush put similar pressure on Alan Greenspan, who didn’t give in. George H.W. Bush blamed his election loss on Greenspan. The temptation was massive for Ronald Reagan to try to twist Volcker’s arm in 1982. We remember Reagan as being popular, but at that point in the depths of the recession, Reagan had a 40% approval rating. He didn’t give in despite the public outcry, and neither did Volcker. They both deserve immense credit for that.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

“The Map and the Territory” by Alan Greenspan

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I recently finished Alan Greenspan’s 2013 book, The Map and the TerritoryThe book is Greenspan’s attempt to explain what went wrong in 2008 and why it shocked most economists.

Greenspan Hate

Since 2008, it has become quite fashionable to hate on Alan Greenspan. Right wingers in the mold of gold bugs and Ludwig von Mises acolytes look at him as someone who fine-tuned the economy into oblivion. Left wingers look at him as a libertarian ideologue who was close friends with Ayn Rand and stripped the financial sector of regulation and let banks do whatever they want, leading the economy into oblivion.

In the current environment of bipartisan vitriol, it seems crazy that back around the year 2000, Greenspan was lauded as a genius and the greatest Fed chairman of all time. The title of Bob Woodward’s 2000 book about Greenspan reflects the popular sentiment: MaestroGreenspan was the Mozart of economics, solely responsible for the economic miracle of the late 1990s.

When someone’s reputation becomes that pumped up, it’s bound to mean revert.

Mean reversion can be quite nasty. The praise heaped on Greenspan in the late ’90s and early 2000s was more than he deserved. Similarly, the hatred heaped on him lately is also not deserved. What is amusing is that the recent criticism simultaneously paints him as both an interventionist and a libertarian ideologue. Greenspan hatred is bipartisan, but the reasons for the hatred are completely contradictory.

The Record

I think that Greenspan made some mistakes, but they have to be weighed against his triumphs. His record as Fed chairman was often exemplary, even considering the mistakes he made at the end. He wasn’t an ideologue. He was a pragmatist who tried to navigate the mess of our government to achieve the best possible result. My guess is that he started out as a gold-bug Ayn Rand libertarian, but realized that purist libertarian idealism wasn’t compatible with getting jobs in government where he could actually wield influence. He wanted to actually influence public policy, not just talk about it. To be effective, he had to be open to compromise.

That Greenspan era is referred to as “The Great Moderation“. The Great Moderation was an amazing economic achievement. The Greenspan era was one of infrequent shallow recessions, low inflation, low unemployment, climbing asset prices and resiliency in the face of multiple crises.

Resiliency is a key point. During his tenure, the United States faced the following crises: the crash of 1987, the Asian financial crisis, the demise of Long Term Capital Management, the collapse of the dot com bubble, the savings and loan crisis and 9/11. While the markets experienced some wild gyrations over these events, the real economy barely noticed. Even after the collapse of the dot com bubble and 9/11, unemployment peaked at only 6.3%. To put that in historical perspective, 6.3% was the unemployment rate in 1994 and 1987 during times of expansion.

The failures are the focus right now. The failures include: believing that banks wouldn’t take excessive risks with capital (a preposterous position in retrospect), fighting the regulation of derivatives (covered in this excellent Frontline documentary). He likely took interest rates too low for too long in the wake of 9/11 and the dot com bubble (as has been theorized by the economist John Taylor). Indeed, low rates in the early 2000s might be the very reason that the recession of that period was so shallow. The Great Recession might very well have been the bill coming due for having such a relatively easy recession earlier in the decade.  None of that can be proven, of course.

Although, imagine if Greenspan did not respond to the collapse of the dot com bubble and 9/11 and didn’t let interest rates plummet. He would have been blamed for making a recession worse than it needed to be at a time when we had low inflation and could have handled lower rates because inflation was so low. It all would have been to lessen the severity of a future recession which, in this alternate universe, might never have even happened. Hindsight is 20/20, which is an advantage of being a pundit and a cost to getting your hands dirty and taking positions in the public arena, as Greenspan did.

As for regulations, Greenspan should have pursued tougher regulation of banks and regulated derivatives. Although, it is important to keep in mind that this would have put him at odds with all the banks and the entire Washington establishment. The Clinton administration and the Republicans in Congress back in the ’90s loosened restrictions on banking and didn’t want to regulate derivatives. There was a bipartisan consensus on these issues back then, as demonstrated by the passage of Gramm-Leach-Biley. The deregulation combined with public policy that actually encouraged risky lending as a form of social justice was simply toxic. A good example of this is the Community Reinvestment Act and its intensification under the Clinton adminstration.

If Democrats are on board with deregulating, then who is going to stop it? When it comes to tearing down regulations, Republicans are the gas and Democrats are the brakes. In the ’90s, there were no brakes. It was all gas, with predictable long term results. Greenspan should have sounded the alarms, but I don’t think that one man (albeit, a very influential man) could stop an out of control Mack truck barreling down a highway.

Everyone deserves blame for the financial crisis. Certainly some more than others, but most people had a hand in it. The regulators failed, Washington failed, the banks failed. More importantly and less discussed is the fact that we failed. We failed as citizens to appropriately monitor our institutions. Growing up back in the ’90s, I was always amazed at the complete and total lack of interest that most adults had in current affairs. Civic engagement fell off a cliff. The voters were asleep at the wheel while our politicians made reckless decisions. A democracy is only as strong as its participants. We weren’t paying attention when Washington was engaging in reckless actions. We gladly borrowed the money without doing the arithmetic, but then blamed the banks when the bills came due. Nearly everyone had a hand in what happened. Greenspan failed, but one man is not singularly responsible for our collective failing as a society to appropriately monitor our institutions and act with financial prudence.

The Book

This is a book review, so I suppose I should actually review the book and stop talking about Greenspan!

The book itself is a real tour-de-force of ideas. Greenspan takes the reader through a tour of his thoughts and insights into the economy, which are too numerous to list them all. The book does contain a few very big ideas, which I’ll discuss here.

Much of the book is devoted to retelling the story of the crisis and the mistakes made. Greenspan doesn’t come out and say: “I screwed up and I am sorry”, but I think it amounts to that. He discusses how we need stronger regulations. He laments the bailout and the actions of the banks. He also makes a strong argument that we need to address the risks posed by too big to fail institutions.

He even talks about better ways to deal with the environment and takes the reader through a seemingly crazy experiment of trying to determine the actual weight of GDP.

Animal Spirits

It’s clear that Alan Greenspan spent most of his career trying to reduce the economy to equations, to mathematical arrangements that can be measured. That’s why it is fascinating in the book to see him examine the importance of flesh and blood human beings to the economy. John Maynard Keynes referred to human emotions driving economic activity as animal spirits. Humans don’t always make sense. 2008 helped Greenspan wake up and realize that animal spirits are key even if they can’t be measured.

That’s why the first chapter is called “Animal Spirits”, as Greenspan catalogs all of the ways that human emotions affect our economic judgement, which isn’t a surprise to most of us, but is indeed a revelation to economics that have spent their careers trying to reduce human behavior to beautiful mathematical models.

Greenspan tries to quantify some of these emotional judgments. For instance, he observes that the yield curve (where longer maturities supply higher interest rates), has been firmly in place throughout the history of civilization.  The earnings yield of the US stock tends to stay around 5-6% over long stretches of time, implying that this is the human preference of return for the risk of owning equities. (Sidenote: This might explain why Jeremy Siegel observes that the long-term return of equities after inflation is around 6% for nearly 200 years in his book Stocks for the Long Run.)

Greenspan marvels throughout the book at the extent to which human emotions drive economic behavior. He observes that the cultural diversity of Europe is a major reason for the Euro’s struggles as a currency to unite the region. Culture plays a role in determining the savings rate of a country (does the country value consumption in the present over long term saving?) as well as the effectiveness of regulation (is the culture permissive towards corruption and cheating?).

The Entitlements-Savings Trade Off

The most interesting point that Greenspan makes in the book is that there is a trade-off between entitlement spending and savings. This makes intuitive sense because in societies with generous entitlement programs, there is less incentive for people to save money. If you know that the government will pay for your retirement, what is the point of foregoing consumption in your youth to save for retirement? Should a 30 year old pick a vacation or increased 401(k) contributions? Our tendency is definitely towards the vacation and a generous safety net only makes that choice more appealing.

In fact, Greenspan demonstrates that the sum of total savings and entitlement spending adds up to 28-32% of GDP. Over time, as entitlement programs expand and the population becomes older, increases in entitlement spending reduce the nation’s savings rate. Every dollar that we spend on entitlement programs like social security and Medicare is one less dollar that we save.

In 1965, for instance, about 5% of GDP was social benefits and 25% of GDP was saved. A total of 30%.  By 1992, about 10% of GDP was devoted to social benefits and 20% of GDP was saved. Again, a total of 30%, with the increased social spending crowding out private savings. In 2010, the amounts converged. 15% of our GDP went to social spending and 15% of our economy was devoted to savings.

Due to increased entitlement spending, national savings declined from 25% to 15%.

This is bad because savings is the raw fuel of investment. That’s less money for banks to lend, that’s less money available to issue corporate bonds, that’s less money that can be raised in the equity markets. The less capital that is available, the less investments are being made in the future productive capacity of our economy.

I think Greenspan argues pretty conclusively that there is very likely a trade off between the two. Does this mean we should tear down our entitlement programs completely to maximize our savings rate? Of course not. With that said, entitlement reform should be pursued to contain the growth of entitlement spending before it endangers the federal budget and crowds out private savings.

I think this shows a larger trade off at the core of all public policy, which we like to pretend doesn’t exist. What liberalism offers in its most extreme form is a society with maximum safety and public comfort (i.e., generous safety nets, government funded retirement, a universal basic income). What conservatism offers in its most extreme form is a society with maximum dynamism (i.e., high economic growth and creative destruction). It seems foolish to think that we can have it all: have government take care of everyone’s materials need in a dynamic and fast growing economy. This trade off is at the core of our public policy debate. We should stop pretending that the trade off doesn’t exist.

Conclusion

You should read this book! Even if you dislike Greenspan (I’m imagining Ron Swanson on the right and Lisa Simpson on the left), it doesn’t hurt to get his perspective. He was at the center of most economic policy for the last 50 years and has some useful insights. I also think it’s impressive that he took the time to write this book and take us down his own intellectual journey in the wake of 2008. Most people develop their opinions about the world around the age of 20 and barely budge after that. Greenspan is 91 years old and approaches everything with an open mind, ready to look at the data and reevaluate his opinions. The world would be a better place if we all took that approach.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.