Bill Emmott - International Author & Adviser

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Very well then, we are contradicting ourselves
The Times - August 8th 2010

The traditional newspaper name for this period is the silly season. For economic commentators, however, it feels more like a season of contradictions, when one week’s data or market frenzy appears to turn the previous supposed trend on its head. To sound  intellectual, let’s call it the Walt Whitman season:

Do I contradict myself?

Very well then I contradict myself,

(I am large, I contain multitudes.)

            One of the multitudes that is going to puzzle us this week is Germany’s GDP figures for the April-to-June quarter of this year. It was only in May that almost everyone said the eurozone countries were heading for disaster, that the euro was heading for the bin, and that the German economy was obviously not strong enough to rescue the others. As it happens, Germany looks set to report that its latest quarter has been its strongest since unification in 1990, and the rest of the eurozone is chugging along more happily too, helped by Teutonic trade.

            Not coincidentally, the euro has revived against the dollar—though not against sterling—and betting on sovereign-debt default has eased. Yet it is also not long since in March and April it seemed that America’s job-creation machine was making Europe’s look like a Trabant. Friday’s employment report spoiled that happy story, with government lay-offs overwhelming private-sector job creation to produce a drop in overall employment. No wonder the counterpart of the euro’s revival has been the dollar’s renewed downward drift.

            That, according to one of last year’s orthodoxies, should be leading to a new climb in the price of gold, for the frailties of paper currencies supposedly make the yellow metal the only safe asset to hold. It is true that in dollar terms the gold price is 25% higher than a year ago, so anyone who followed that advice will be feeling happy. But since the dollar began to fall again so has gold, sliding for the past two months and staging only a mild rebound in the past few days. Today’s speculative wiseacre is buying the yen or wheat futures.

            For meanwhile the other once-sure-fire bet for investors, crude oil, has been failing to follow its script. BP’s disaster in the Gulf of Mexico ought, in principle, to have either ruled out or sharply raised the cost of deepwater oil drilling, which is where most of the new non-OPEC reserves are to be found. Yet while chief executives have tumbled and compensation costs have soared, the oil price has barely moved, trading between $70 and $85 ever since the disaster began, with no discernible trend.

            And then there is China. One minute it is booming, leaving the West in the shade, shifting the balance of power firmly towards the East. The next it is confronting property bubbles and rising inflation, and we are told that we should all be worrying about defaults by Chinese local governments on their huge debts to state-owned banks. The consequent Chinese “slowdown”, as the authorities there tackle these issues, is the usual explanation for why the oil price has not budged, yet it does not seem to have stopped other commodity prices from rising in recent months.

            So what should we make of all these contradictions? One explanation, I suspect, is that commentators have become hyper-judgmental since the economic crisis began three years ago this month. So burnt are they by the accusation that they failed to forecast the crash and were complacent in the face of market lunacies that they are rushing to predict the next twist or turn.

            The tendency to over-interpret one or two months’ data has always been a problem, but it seems to have got worse recently. Despite evidence that official data is only a rough approximation of what has just been happening, and could be revised substantially in future, we still treat it as gospel, for it is all we have. The old joke needs to be rolled out again: economists have predicted nine out of the past five recessions.

            Another explanation is that although the 2007-09 crisis destroyed illusions about finance, it showed clearly the power of financial markets to make their own weather, and the role of psychology when they are doing so. Thus, the sovereign debt crisis in Europe in the spring was based as much on a prediction of how investors and traders would react as on an analysis of underlying economic forces. In the longer term, both will be important in determining the fate of Greek or Spanish debt, but it is difficult to know which will be more so.

            Finally, though, I would propose my own contradiction: that we should be both more humble and more confident. By more humble, I mean that economists should acknowledge the uncertainties in economic trends and behaviour more freely, and not rush to judgment based on a month or two’s data or market movements. That is of course a tad difficult for those paid by their investment banks to offer instant analysis to clients and trading floors, but it is worth a try.

            By more confident, I mean that we should take a longer-term view and stick to it until it has been disproved not by a month but by a year. After all, the initial, long-ish view that prevailed when recovery began in the West last year was quite logical.

            After financial crashes, deflation has been a bigger danger than inflation. In countries where consumers were highly indebted, there was likely to be a long period of adjustment, as they saved more and borrowed less: hence Americans are now saving 6% of their incomes, up from zero in 2005, and consumer spending is not going to revive until incomes do. It has more scope to do so in the eurozone, where savings were higher and consumer debts lower, but where fiscal austerity could act as a drag, thanks to historically high public debts. In emerging economies such as China, where there was no financial crash at all, inflation has long been the bigger danger. Oil? The supply of it is controlled by OPEC, and in the past two years the big Arab producers have rebuilt their surplus capacity.

            The lesson of Japan’s 1990s financial crisis was that the big danger was that companies too would cut debts and hoard cash—which is what they are beginning to do in America. The big question, therefore, and one that applies to Britain too, is how soon opportunities to export, to explore new technologies or to exploit competitors’ weaknesses will tempt businesses to resume investment and expansion. We will have to wait and see.


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