Safety in numbers

The MB nemesis, Gittins!, offered a piece over the weekend in which he gave the economics fraternity a caning for failing to foresee the current global slowdown. Using the now famous Carmen Reinhart and Kenneth Rogoff text, This time it’s different, Gittins! concludes:

In their landmark study of hundreds of financial crises in 66 countries over 800 years, Reinhart and Rogoff find oft-repeated patterns that ought to alert economists when trouble is on the way. One thing stops them waking up in time: their perpetual belief that ”this time is different”.

But, as we’re witnessing at present, even when economists and financial market players have been hit over the head by reality, their ignorance of history stops them understanding what happens next. Wall Street and Europe fondly imagined the Great Recession was behind them, only to discover it’s still rolling on.

Reinhart and Rogoff could have told them – did tell them – financial crises of this nature aren’t so easily escaped. The Great Recession was so called to signify that another depression had been averted.

The authors say a more accurate name would be the Second Great Contraction. ”The aftermath of systemic banking crises involves a protracted and pronounced contraction in economic activity and puts significant strains on government resources,” they say.

They show that, in the run-up to America’s subprime crisis, standard indicators such as asset price inflation, rising leverage (debt relative to the value of assets), large sustained current account deficits on the balance of payments and a slowing trajectory of economic growth exhibited virtually all the signs of a country on the verge of a severe financial crisis.

So why did so few economists recognise the signs? Everyone thought this time was different.

I don’t recall Gittins! forecasting the current slowdown, do you? Indeed, I only recall a string of boosterish pieces about an endless China boom. But let that pass. My point today is more broad than that. I want to juxtapose Gittins! critique with something written on Friday by investment blogger, John Hempton at Bronte Capital. For those of you who don’t know, Hempton is a former fund manager at Platinum and whip smart investor. He was a key source for me in c0-writing of The Great Crash of 2008 with Ross Garnaut. On Friday he wrote a post examining why so many doubted the now infamous Sino Forest fraud:

In early June Carson Block and his firm Muddy Waters research published a report which made outrageous sounding allegations against Sino Forest – then a highly respected Canadian listed Chinese forestry company that had borrowed well over $2 billion to develop and expand forestry operations in China.

The base allegation in the report was that most the forests did not exist and by implication the (more than) $2 billion borrowed was stolen. Presumably many more shares have been sold too taking the total theft well above $2 billion.

It was an outrageous jaw-dropping allegation and Carson made no attempt to soften the blow. His language was inflammatory because his message was inflammatory. When $2 billion is stolen by reputable people I can’t see how you can say that without appearing inflammatory. Some people, understandably, refused to believe it.

…The analysis of these people was staggeringly weak and self-referential (I can’t speak for Chandler because I never saw his analysis). They judged Sino Forest against data provided by Sino Forest or people associated with Sino Forest. This is an elementary mistake in assessing fraud. To find fraud you need to be able to judge against things you are fairly sure are not fraudulent.

Everything the Carson Block doubters said sounded reasonable. Certainly more reasonable than Carson Block sounded because Carson Block held the radical position. Sounding reasonable however was wrong.

I think what is going on here is a general problem. When someone says something – anything – that is so far from the consensus as to sound outrageous then they will be considered mad, and sometimes they will be considered mad even after they are proven right.

To me, Hempton’s analysis is exactly right. Adopting important and throughly researched contrary positions is a thankless task. Most will write you off as mad. And when you’re right, hate you for it.

But the role is nonetheless vitally important. Is it only through this process of resisting the consensus that dialectical history advances. To put it simply, it’s how we improve ourselves. Which brings me back to Gittins!

To me, there is a deep irony in an economics commentator adopting a holier-than-thou position against short-sighted economists unless that commentator has a record of stepping out on a limb themselves. It is the role of the economic commentator to be “mad”. Only that way can s/he bring the glare of sanity to the economists that are bunched like penguins finding warmth in self-referential thought.

I admit, Gittins! is better than some at canvassing the new and seemingly unlikely, which is perhaps why he is so frustrating. But this weekend’s article was not a case in point. Looking back at the GFC and current slowdown through a self-congratulatory lens without bringing its lessons to current Australian circumstances is to commit the very fallacy that the article seeks to castigate. Indeed, it is worse. It is to add obfuscation to fallacy.

What hope is there that Australian economists and economic policy will be held to account and improve in such a context?

Houses and Holes
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  1. Sandgroper Sceptic

    There is no hope. At least not in the short term. They will defend themselves until they become irrelevant. Economics orthodoxy is like a religion.

    Steve Keen is doing some great work, yet he gets a lot of flak and in the past was certainly seen as “fringe”, which to his credit he wore as a badge of economic rebellion.

  2. Yes I read Gittins! on the weekend as well and thought my God what a hypocrite, where were you during 2007-08?

    standard indicators such as asset price inflation, rising leverage (debt relative to the value of assets), large sustained current account deficits on the balance of payments and a slowing trajectory of economic growth exhibited virtually all the signs of a country on the verge of a severe financial crisis.

    I believe Australia gets a tick for all of the above. Credit growth may have stalled, but asset prices are falling.

    The bubble fueling Australia (China) gets a tick for everything except the CAD. There is no better example of the “this time is different” syndrome than China. The belief in Chinese infallibility is almost universal these days.

    I do my best to hold economic commentators to account. For example, Peter Martin spent the early part of the year talking up the benefits of the strong Australian dollar and rapid employment growth. When employment growth appeared to stall, he claimed the numbers were “dodgy”. I hang around his blog like a bad smell reminding him of these posts.

    Most econ journos can write whatever the hell they like knowing it will be completely forgotten a few months later and no-one will remind them. I’m sure Gittins! believes he was warning everyone about at looming crisis in 2007. No-one has told him otherwise, and comments are rarely allowed on Gittins! pieces.

    • Its a work in progress, but:

      “Forecast tracker hopes to highlight those that tend to miss their targets or projections and the others that should be acknowledged for having a good track record with forecasts, predictions or promises.”

      Please feel free to submit forecasts of any nature, the long or the short way.

    • I feel like he only wrote the first third of the article. Where’s the analysis of Australia’s current position and what’s likely to happen over the next five-ten years?

      A very lazy effort.

      (Currently posting from Ireland and I can tell you that everyone here thought Ireland was different and no-one loved their houses as much as they did. Let’s just say that things have changed…)

  3. No, I don’t recall Gittins predicting the GFC, although he was more bearish in the Howard years. He seemed to shed his bear skin when the Labor government was elected in 2007. If he’s now putting his bear suit back on, that could mark an interesting point in the cycle. But Adam Carr’s capitulation will be the ultimate bottom marker.

  4. Guys, just an FYI; the “Spehre” link is not linked/broken… Kudos for improving your Social Strategy though.

    You MB Blokes might even like to try ‘Flatter’ which ‘our’ collective mate Mr Steve Keen has been using and is quietly ‘monetising’ his blog – and fair enough too!



  5. The power of human denial is epic, and I think well documented. Humans almost necessarily need to tell white lies in order to function, or we would do nothing.

    For example with the housing bubble, baby boomers would be more than happy to see the value of their assets quadruple. They don’t need/want available evidence to tell them that their investment strategy is pure speculation, because of all the other difficult questions it raises. You might then have to realise that you will have nothing for retirement, that you have made houses unaffordable for your children, and that for some you have affected an enormous transfer of wealth from poorer young couples to your older generation.

    In other words, to accept the available evidence would require the acceptance of the other unpalatable consequences of your actions. It is much easier to deny anything is happening or that you are to blame for anything.

    As you are saying H&H, keen observers of reality have been derided throughout history because it is easier for human nature to deny anything that doesn’t fit with our particular self serving narrative.

    • Dave,

      Would you include in that “denial of reality”, the following people, along with the dreaded Baby Boomers:

      The politicians who, for decades through their taxation policies and giveaways, made investment in real estate cheap, attractive, and rewarding. And who have, since the introduction of the compulsory superannuation, gone out of their way to ram home the message that individuals will be more responsible for their own retirement income.

      The Banksters who only too happily made barrels of cheap money available, defying all sensible and economically sound lending criteria.

      The real estate industry, that with every breath, and not some little help from their mates in the media, firmly implanted the concept of the “ever-upward real estate curve”.

      The abovementioned media.

      The spruikers, flying planeloads of people to the Gold Coast and other “hot” destinations, and closing deals with befuddled “investors” before they got off the plane.

      I could go on, but I think you get the drift.

      The Baby Boomers and their investment properties are the symptom, not the disease.

      As a matter of interest, how many Baby Boomers did you see on “The Block”, working their bums off for nothing for the Network, in the vain belief that they were going to make a killing from a few slap-up renos?

  6. Brilliant post HnH…

    I have been working on a project where I hold everyone to account…the politicans, journos, central bankers, data providers, industry associations.

    It will be a website all about accountability for wrong calls and failed analysis. A tool to be used by the people to see how many people stuffed up from 2007-2012 with their analysis and projections.

    The aim is to ruin them and their reputations until they go away and think about why they go things so wrong and how.

    All the fools in the media that made so many bad calls and wrong prediciction, but whom carry on as if they are all oracles in their own way.

    The internet will set us free from this trap. All we need is to invest the effort, be brave and be willing to be ‘inflamatory’

  7. Well said, Dave BD.

    My own hobby horse on the subject of economic crises, is that almost NOBODY has worked out that a bubble in urban land is far more damaging to an economy, that the old ho-hum boom and bust of share markets and “paper economies”. Monetary easing seems to fix “paper economy” cyclical volatility – but it is powerless to fix cyclical volatility in the “dirt economy”.

    Reinhart and Rogoff have done an OK job in identifying the “this time it’s different” mentality, but they don’t get it about the difference between paper economy busts and dirt economy busts. It IS “different” this time – way different – and it is MUCH WORSE for the fact that it is the “dirt economy” that went “bubble and bust” this time.

    The crucial symptom that economists SHOULD be watching, to note a “dirt economy” bubble, is the amount of “planning gain” that is occurring; i.e. the difference between the price of farmland and the price that actual developed urban land sells for (taking into account costs of development). When this figure gets out of hand, run for cover.

    Look at China right now. Nuts. Insane. Why is anyone anywhere, making their plans around China anchoring the world economy for the next little while?

    The only stable part of the world economy now, is the part where “planning gain” in urban land, is nigh on non-existent. Southern and heartland USA. There is nowhere else worth investing in, emigrating to, or locating a business in.

    There might be other national enclaves of urban land price sanity – Germany, for example.

    I won’t go into “why” the “planning gain” and the presence or absence of urban land price volatility – follow the Unconventional Economist for a while, if you want to know. Leith Van O is simply the world’s best blogger on this topic.

  8. Since Gittins clearly holds Rogoff in high esteem, perhaps he should consider this:

    “With China, you have the ultimate ‘this time is different’ syndrome. Economists say they have huge reserves, they have savings, they’re hard-working people. It’s naive. You can’t beat the odds forever.” (Rogoff in July this year)

    • As I said above, the belief in Chinese infallibility is almost universal these days. Rusted-on supporters of free markets and economic liberalism, fall over themselves to proclaim that China will grow forever, and the CCP will prevent any major crashes.

    • Sweeper, I doubt anyone is saying China will ‘beat the odds forever’. Just for a period of time, length unknown!

      • They’ve been well and truly beating the odds for at least 10 years now.

        What’s striking though, is the way US economists (eg. Roubini & Rogoff) see obvious flaws in the Chinese model, yet the econ elite in this country (up to and including Stevens) see a never ending industrial expansion. They point out the positives; growing living standards, manufacturing powerhouse but not the obvious negatives; overcapacity, social tensions and a harsh inventory cycle.

    • Which is ironic isn’t it?

      I mean, the center of “successful” communism is now the center of capitalism and lauded as such, whilst the center of “successful” liberal market capitalism is now lost adrift in a sea of socialism unsure if they should tighten the sails…or build more leaky boats.

      Sorry, I stretched that analogy a little too far…

      • Well, a major element of capitalism is the centerally planned enterprise. Free markets are really just a competition to see which enterprise has the best planners or plan.

      • Well said DD – it amuses me when I hear the debate re: government vs corporate planning, i.e that the former has no idea and we should leave everything to the corporate market….which uses bureaucracy and central planning.

        There’s more to it of course (its more about incentives), but those of us who have studied corporate Australia know there is as much dead wood and bureaucratic malaise as in any public department.

        Which brings me to the word: competition.

        Why don’t we have competing governments? i.e at the canton…err…State/council level? The incentive to compete has been completely removed, instead the incentive is to not make as many mistakes as the other department.

        3d1K = more of an even keel…I used to be a missile tip right winger years ago. In fact I think I’ve gone anti-Churchillian on my philosophical path.

        Although I’m still a thief according to Mr Bob Dylan…..not a Prince keeping the view…..

  9. All this talk of the failure of capitalism, misses the vital point. As I just said:

    “…..The only stable part of the world economy now, is the part where “planning gain” in urban land, is nigh on non-existent. Southern and heartland USA. There is nowhere else worth investing in, emigrating to, or locating a business in…..”

    The only stable part of the world economy, happens to be the bit that is still the “MOST FREE MARKET”. Not just the absence of urban land “supply” distortions, but low taxes, low regulations, small government, and non-punitive workplace law. When are people going to “get it”?

    China is the model? You wait. Smart industry is already picking Southern USA INSTEAD OF CHINA for new factories etc. China’s inevitable meltdown will NOT be “tidier” than the western world’s (unless you call mass murder of protesters etc, “tidy”).

    I agree that venal bankers have played a pernicious role in undermining “capitalism” – they are just some of the best people at “gaming” distortions to the free market. There are no problems with the banking sector devouring the economy in Texas.

    Lenin called certain people “useful idiots”. Ayn Rand said that businessmen who collude with “big government” to rip the rest of the population off, should be hung. All this is not so much about “capitalism”, as it is about “capitalists behaving parasitically within an increasingly statist economic framework”.

  10. Yes, I too have grown very tired of Gittins! and his I-know-them-cos-I’m-one-of-them-but-not-really-one-of-them smugness (them being economists). Just days before his w’end piece he was on about the China Boom lasting for DECADES and how we all need to become knowledge workers and telecommute and blah blah blah…

    He did have a good patch about a decade ago when he discovered Kahneman and the behavouralists… but it’s been back to the tired old views of yore for a long time now.