Wednesday, October 13, 2010

Economics: The Dismal Science

Alan Greenspan, former chairman of the Board o...Image via WikipediaI Want to Make Money: Shoud I Study Business or Economics?
Scientists estimate that within 14 years there will be a solar eclipse. Not only that but they predict that it will occur at 10:25 am; that it will last 8 minutes and that will be seen only in the Western Hemisphere.
Economists predict that next week's inflation will be 2%, and most likely they will be wrong.
It isn't that scientists do their job well and economists badly-not at all. The problem lies in the nature of the data that each specialist works with. The data economists use are always doubtful and filled with subjective opinions. By now the public is used to the dismal corrections and adjustments that take place the following quarter.

That economics is a 'dismal science,' we are sure, yet the sobriquet does more ill than good, for. Economics isn't a science at all but a pseudo-science.

Economists are asked to give a vision of what will be, for example, the economic dynamism of the next quarter. Very difficult task if one takes into account that by the time the information is gathered and processed it already lags; it never approximates reality.

To simplify this argument, think about your business. Can you, today, predict exactly the level of sales for this quarter? That is an impossible. Especially if we assume that sales in addition to factors related to the type of product, brand, advertising, etc, will be influenced by inflation, overall economic growth, investment, etc. Despite all this, a shrewd business person makes money.
But if a business person cannot predict sales with some degree of accuracy, how can the economist give realistic projection of what will happen in the country?

To further complicate things, economists must deal with the self-fulfilling prophecy of the economy. If someone says that the shares of a company will go up in value by 25% within a month, it is likely that the increase will happen in a day rather than in 30 days because everyone will want to buy shares and benefit. The same phenomenon occurs with the inflation data, the exchange rate, GDP, etc. If we say that there will be inflation within a month, people will rush to stock up now in order to avoid the high prices, and that triggers inflation. If we say that the specter of another financial crisis is imminent, people stop investing and the economy will fall even more. And that is what is happening in the current recessionary environment-a vicious cycle fueled by fear.

How do we extricate ourselves from this quagmire? It can be done with solid understanding of economic theory and economic and models that instill confidence, with good statistical tools, with toughness. The starting point out of the malaise is credible data, data that is free of political manipulation. While Alan Greenspan -for many years- sailed the seas of economic uncertainty with great panache, Bernanke's grip at the wheel seems weak and erratic.

Summary: Who makes money consistently?
While the unemployed suffer, the hedge fund managers thrive and get richer by the minute. Why is this so? Simply because they have terrific crystal balls -business models as opposed to econometric models- and quick decision making that the Federal government lacks. The only way to make money on a sure basis is by investing in a good hedge fund, a fund that is protected with indexed options, futures contracts, and the like.

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