If Economists Are So Smart, Why Are They Always Wrong?
When I took Econ 101 and 102 as a young college student back in antediluvian times the textbook we were assigned was Paul Samuelson’s Economics: An Introductory Analysis. This book is the all-time best selling economics textbook and is still around today (19th ed.).
I had the 1961 edition. In it, Samuelson, a prominent Keynesian economist who won the Nobel prize in economics, predicted that the economy of the Soviet Union would overtake the U. S. economy in 23 years (by 1984). Even as late as the 11th edition (1980), Samuelson stood by his prediction.
As anybody who knows anything about the Soviet Union, their top-down centrally planned economy was a disaster that left its citizens in poverty. It was inefficient, wasteful, driven by coercion, politics, corruption, and cronyism. Consumer wishes were ignored. Goods were under-produced or overproduced. There were shortages of everything, except vodka and hydrogen bombs.
There was a joke floating around Moscow at the time about shortages: Yuri Gagarin’s daughter (he was the first man in space and hero of the Soviet Union) answers the phone: “No, mummy and daddy are out,” she says. “Daddy’s orbiting the earth, and he’ll be back tonight at 7 o’clock. But mummy’s gone shopping for groceries, so who knows when she’ll be home.”
They were far, far behind us.
So how is it possible that Samuelson and his fellow Keynesians could even consider that a planned economy could work better than a free economy? For 11 editions he persisted in believing that failed theory. And a generation of students left school with the idea that a centrally planned economy could work.
Mainstream economists today aren’t much better.
For example, one would think that you could rely on those economic wizards at the Federal Reserve, those guardians tasked with the dual mandate of creating full employment and stable prices, but they got it wrong too. In the run-up to the Crash of ’08 and the Great Recession, Ben Bernanke, the then chairman of the Fed, not only didn’t see it coming but he failed to grasp the magnitude of the problem when it hit.
The truth is that almost no mainstream economist predicted the Crash of ’08 or the ensuing Great Recession. Most economists, Bernanke included, were forecasting that the economy would recover soon and any downturn would be mild, and certainly there was no recession on the horizon.
If these are the brightest guys in the room, why didn’t they understand what was happening? It makes you wonder if these guys really understand how economies work. The obvious answer is that they don’t.
Therein lies the problem: contemporary economics is not able to explain what happens in the real world. The lack of valid theory, the improper use of mathematics (econometrics) and raw empirical research as a substitute for good theory has led contemporary economics to a dead-end. Even worse, they recommend economic policies that often achieve the opposite of what they intended and make problems worse. And, we end up paying for their mistakes.
Oh, dismal science, you have failed us.
So here we are trying to figure out what to do. Do we buy a house? Do we change jobs? Do we start a new business? Do we move to another town or state? Do we invest in the stock market? Do we invest in Bitcoins? Do we take on (more) debt? Do we buy a new car? Should we save or spend? Should we retire?
It would have been nice to know back in 2006, for example, that everything would eventually blow up (as it did in 2008). But the conventional wisdom then was that things were fine, don’t worry; it was the worst possible advice.
Business cycles occur on a regular basis. And boom-bust cycles are now the norm. At any given time, we are somewhere in the business cycle. The Fed, the generator of these cycles through its monetary policy, is always fighting the last war by attempting to bail out the last bust, and by doing so creates the next boom. If you don’t know where we are in the cycle, you can get crushed.
But, who can you trust?
It’s obvious that you can’t rely on conventional economic wisdom.
If you dig a little deeper you will find that some economists did see the 2008 bust coming, but they were ignored or laughed at. Most of these economists were free market types who understood the causes of the boom-bust business cycle. Also, some contrarian investors were aware of the problems and when the bust came, they made billions for their clients.
Let me impart a basic truth: no one can accurately predict the future. But, if you hear the train coming down the track, it’s best to get off the rails.
I am not an economist, merely a student of the science. I have shed my Keynesian upbringing as well as what the mainstream likes to think is economic “science”. On the other hand, free market economics has only helped my understanding of the economy and its cycles. I try to do what essayist Richard Epstein said, “True freedom comes only to a lucid mind unbound by conventional wisdom and suspicious of received opinions.” It’s not easy. But being a contrarian helps.
Which gets back to the question of “who can you trust?” Based on my 40+ years of observing and studying the economy and investments, I have formed some guidelines which have worked for me. Perhaps they may help you:
Free market economists tend to be contrarians and you should listen to them—but if they are selling you something, run for the door.
Contrarian investors are worth listening to—but if they are selling you something, run for the door.
Because someone was right before doesn’t mean they’ll be right again.
There are permabears and permabulls. Simple Internet searches will reveal who is who. Avoid both.
If you increasingly hear experts say we are not in a bubble, we probably are.