Economists aren’t very popular. Dismal scientists, after all, are the kind of experts who don’t know what they’re talking about but make you feel as if that’s your fault. Such bamboozling is often deliberate, especially when it comes to forecasting. Projections and prejudices take on the air of unchallengeable truths when expressed in faux-scientific language and garnished with mathematical hocus-pocus.
As an economist myself, I’d say that one of the few positives from this ghastly sub-prime crisis is that the profession is becoming more humble. Since the credit crunch, the use by economists of ever more complex models, and the increasingly inane assumptions that go with them, has partly reversed. Good.
Presenting economics as a science was always self-serving nonsense – with the arcane jargon often used to obfuscate and ram through policies backed by powerful vested interests that would otherwise be exposed as a stitch-up. The vast majority of economists failed to see the sub-prime collapse coming. It’s also true that, for years before the Lehman collapse in late-2008, many particularly well-paid dismal scientists promoted arguments against effective financial regulation, disdaining those who were for it. That smoothed the emergence of the too-big-to-fail banks that have cost us all so dearly and may well do so again.
Economics is a study of human behavior – above all, the allocation of scare means between competing ends – or it is nothing. As such, the subject requires deep analysis of commercial and financial life in all its institutional richness. For that, you need a very solid grounding in theory and numeracy, yes, but also a broad dash of history, politics and, not least when forecasting, instinct and guile. During 2013, I’ve seen encouraging evidence that some of the world’s leading university economics departments are taking such lessons on board. As this column looks ahead to a new year, I’ll make my small contribution to “keeping economics real” by presenting some bracing but honest predictions, warts and all, in language as clear as I can muster.
Many have written that 2014 will be the first “normal” year since the financial pyrotechnics of 2009. Certainly, the International Monetary Fund is predicting relatively buoyant global growth of 3.6pc, up from 2.9pc in 2013. My fear is that those hoping for some calm after five stormy years could be disappointed.
The US economy remains almost twice as big in dollar terms as that of China. America’s economic policymakers are still by far the most powerful on earth – never more so than today. Since 2008, the Federal Reserve has tripled the size of its balance sheet under quantitative easing, with other big central banks – in the UK, the Eurozone and Japan – following in its wake.
American QE will be “tapered” from January, we learnt earlier this month, with the Fed slowing its money-printing habit from $85bn to $75bn monthly. How the Fed manages this QE unwind is, by a long way, the most important single factor that will influence global financial markets during 2014 and, in turn, the broader world economy.
The mainstream view is that the unwind will be relatively uneventful, with the inevitable fall in the price of US Treasuries, as the Fed buys fewer of them, being contained – so preventing an interest rate spike that could debilitate the US housing market and kill-off America’s recovery. Yet for every respectable economist who says this publicly, I know two who privately disagree.
The Western world is in uncharted monetary territory. There is acute concern at the world’s leading central banks the QE unwind could go wrong. On Friday, the
10-year US Treasury rate moved above the psychologically important 3pc threshold to its highest level since July 2011, in part due to the prospect of lower Fed purchases. This yield, up sharply from 1.8pc in January, is the benchmark for interest rates across America and much of the global economy.
That’s alarming given that Western governments and households are generally far more indebted now than when QE began. If the gradual withdrawal of extraordinary monetary measures backfires, debt markets rebel and government yields spiral upward, the economic fall-out would be horrific. I’m not saying that will happen in 2014. But I believe such scenarios will come very much into focus – and that spells, at best, a great deal of bond market volatility.
Just before Christmas, Bank of England Governor Mark Carney reasserted his “forward guidance” that the UK base rate would remain at 0.5pc until unemployment falls to 7pc – which the Bank predicts will happen in 2016. In the real world, though, the rates applying to mortgages and credit card debt are determined not by the Monetary Policy Committee but by the market. If market rates rise significantly, the MPC – lest it risk irrelevance – will be forced to follow suit. It strikes me that 2014 could be the year when that truism, also, comes to the fore.
Western equity markets, too, look precarious – although, again, you wouldn’t think so if you relied on mainstream opinion. US share prices have, on average, risen 20-30pc during 2013, after strong gains the year before. Double-digit rises are widely predicted this year too. But, once more, it all depends on QE, given that so much of the central-bank liquidity tsunami has been channeled into financial assets.
If money-printing and corporate cost-cutting are spent, what will keep stock markets buoyant? Even if the Western world is now staging a meaningful recovery – a big if – that will take a while to work its way into sales and company profits. In the meantime, the Dow Jones index of leading US stocks just hit another all-time high – for the fiftieth time in 2013. Shares now seem to rise on good news – growth is coming – and on bad news – maybe the Fed will reverse the taper or keep the funny-money withdrawal ultra-slow.
As a result, stocks across the Western world look not only over-priced compared to earnings, but utterly detached from economic reality. If the Fed taper does happen, I think the Dow will end up lower at the end of 2014 than at the start. Even if the taper proceeds on the basis of strong growth and employment data, the economic gains won’t be enough, in terms of equity prices, to offset the QE withdrawal.
The same applies to the FTSE-100 – perhaps even more so, given the UK’s Eurozone exposure. While monetary union looked less shaky during 2013, as the European Central Bank hosed-down the region’s moribund banking sector with printed money, the euro remains an incoherent construct. That truth will eventually out. The ECB’s stress test of 130 banks, due in October, could well be a flashpoint.
I’m not a gloomy person by disposition. But I’d rather be called pessimistic than be proved wrong. Last week I predicted 2014 will be the fourth successive year in which Brent crude averages over $100 a barrel. This week I’m saying bond markets will be far more volatile than expected and US/UK stock markets will fall.
If the QE unwind can be contained, the still-too-big-to-fail banks don’t blow-up and there isn’t another Minsky moment on global markets, than the UK should grow by around 2.5pc in 2014, with the emerging nations of the East averaging 5.0pc or so. If there is a repeat “spectacular”, though, all bets are off.
The chances of that happening are far higher than most economists are prepared publicly to admit. After all, given how unpopular they are, they’re desperate to be liked.