Musings 27 7/10/11
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Forecasting Is Not Humanity's Strength
Two things continually amaze me: the typical financial forecaster's confidence in their own analysis/forecast for the future, and the general lack of faith in humanity'a ability to adapt.
Looking at human systems in terms of natural selection is nothing new, of course--sociobiology was a buzzword in the 1980s. What puzzles me about the blogosphere's "doom and gloom" consensus is how readily they extrapolate end-game trends to complete social breakdown, as if humans will inevitably respond to instability with an orgy of self-destruction.
That is certainly possible, and there is evidence to support this conclusion, but it is not "inevitable" in the sense that gravity is inevitable. Indeed, as Jared Diamond noted in his book "Collapse", some societies choose to live within their ecosystem's means.
There is nothing inevitable in history, and it seems rather myopic to grant that humanity's single greatest strength as a species is fast cultural adaptation (as opposed to adaptation of the genome, which takes thousands of years or even tens of thousands of years), yet discount any future adaptation to negative trends. I addressed this in Adaptation, Habituation, Consumption and $9/Gallon Gasoline (April 2010).
Some observers look to "cognitive biases" such as the recency bias to explain our inability to look beyond a trend we see unfolding in the present, and this certainly has something to do with it.
But I suspect there is a deeper reason for our desire to cling to forecasts based on current trends or history: uncertainty makes us uncomfortable. We will make a hasty decision or fasten onto a position just to end uncertainty. I think this desire for the equilibrium of certainty drives much of our irrational attachment to ideologies and other "this explains everything" world views.
It seems self-evident to me that we are entering an era of rising instability and unpredictability, as the infrastructure of the Status Quo (the Savior State, globalization, cheap fossil fuels, etc.) is experiencing depletion or margin return.
This further suggests that those who are comfortable with ambiguity, contingency and uncertainty will be happier and less anxious regardless of what transpires than those who dogmatically cling to one forecast or another or a fixed ideological spyglass.
The almost comical failure of even the best informed forecasts was illustrated by a seminal Department of Defense study released to the public last year: Joint Operating Environment 2010. The study encapsulates the strategic consensus at the end of every decade from 1900 to the present, and it is painfully obvious that a mere decade later, the entire picture was utterly different from that forecasted a decade before.
Thus I am skeptical of all "written in stone" forecasts, be they blogosphere-based forecasts of gold going to $10,000 per ounce or Status Quo forecasts of low interest rates essentially forever. Both forecasts are possibilities, but to cling to these possibilities as if they were near-certainties is to make a deep and possibly catclysmic error in an era in which the only certainty is uncertainty.
The DoD study made a good point about the fragility of history:
"Adolf Hitler enlisted in the 16th Bavarian Reserve Regiment (the “List” Regiment) in early August 1914; two months later he and 35,000 ill-trained recruits were thrown against the veteran soldiers of the British Expeditionary Force. In one day of fighting the List Regiment lost one third of its men. When the Battle of Langemark was over, the Germans had suffered approximately 80% casualties. Hitler was unscratched.
Seventeen years later, when Winston Churchill was visiting New York, he stepped off the curb without looking in the right direction and was seriously injured.
Two years later in February 1933, Franklin Roosevelt was the target of an assassination attempt, but the bullet aimed for him hit and killed the mayor of Chicago.
Can any one doubt that, had any one of these three individuals been killed, the history of the twentieth century would have followed a fundamentally different course?"
The study also made key points about the rise of globalized capital and Peak Oil:
"In 1983 the daily transfer of capital among international markets was approximately $20 billion. Today, it is $1.6 trillion."
"By 2012, surplus oil production capacity could entirely disappear, and as early as 2015, the shortfall in output could reach nearly 10 MBD."
These points suggest that the global economy is highly vulnerable to disruptions at critical "choke points," both physical choke points such as the Strait of Hormuz but also in financial "choke points" such as capital flows, currency valuations, and derivatives, which remain largely opaque to government oversight.
As you know, I have been arguing that the consensus that the U.S. dollar is doomed to continue its slide to oblivion is questionable, partly because the dollar Bears are so numerous and confident in their forecasts. History rarely rewards a crowded trade where 97% of the punters are on one side of the trade.
Along these lines, here is a profound observation from frequent contributor B.C.:
"Keep in mind that the US dollar has already fallen 50% in CPI-adjusted terms since '00-'02 and 75% since the all-time US dollar high in 1985. Adjusted for the CPI- and US$-adj. price of gold over the same periods, currencies throughout history have rarely lost more effective purchasing power without disappearing. In this context, as bizarre as this might sound, cash in US$ terms is perhaps among the most unloved and undervalued assets one will find today."
History should keep us humble about the reliability of our forecasts and trend extrapolations. Indeed, other studies have found that the well-informed "expert" forecasters are more likely to be flat-out wrong that less "expert" observers because the "amateurs" have a more realistic grasp of their abilities to predict the future and of history's contingencies.
I remain deeply skeptical of these consensus views:
1. The Status Quo will endure without major disruption or change
2. China will continue growing rapidly and will soon dominate the world economy and political structure
3. The US dollar will continue heading to zero.
4. There is no hope of positive adaptation or a positive response to the demise of the Status Quo.
Many things remain possibilities, but that doesn't mean they are probable. We will just have to embrace uncertainty, ambiguity and contingency and keep our eyes open and our analyses flexible.
From Left Field
Historical footnote of interest (note to self--remember to forward this to the Federal Reserve):
After the South Seas Company stock bubble burst in 1720, wiping out thousands of investors, a resolution was proposed in Parliament that bankers be tied up in sacks filled with snakes and tipped into the murky Thames.
Thanks for reading--
charles
