By Larry Smith, Professor of Economics, University of Waterloo:
There is no doubt that the world’s financial markets play an
indispensable role in fueling economic growth and development. There is
equally no doubt that large amounts of capital are misallocated and
therefore wasted. Part of the misallocation occurs because far too many
conflicts of interest and instances of self-dealing continue to be
tolerated. That is in addition to those who with malice aforethought
create false information to mislead the unwary. However, responsibility
for the greater part of this misallocation arises from a different
source: those who claim that the future cannot be predicted usefully.
Notice how this plays out.
Those who are optimistically inclined, whether genuinely or not, and
those who are optimistic in order to promote sales, deals and
commissions are of course often contradicted by events. Are they then
held to account? Rarely. The prognosticators always invoke their great
excuse, claiming that nobody could see the anomaly coming, that they
were all wrong together. After all, the future is unknowable, they
plead. But they plead not for forgiveness, but for acquiescence in the
state of their version of reality.
Of course, they are right about one aspect of predicting the future,
the aspect they use to excuse all else. Indeed, the future cannot be
predicted in great detail, or in any detail in some circumstances. But
that does not mean it cannot be predicted usefully. The definition of
useful in this context is quite clear. Can you use the prediction to
guard yourself from danger, or in some cases to advance your economic
interests? And for economic predictions that are thoughtfully applied,
the answer is emphatically yes.
This blog has long argued that the only realistic outlook for the
global economy is slow growth, at best. The reason is entirely clear:
all of the world’s major marketplaces face serious and multiple
problems. The governments of the United States and the European Union,
for example, are near dysfunctional. And interest rates are so low only
because growth is illusive. To predict sustained growth at
historically high rates requires us to assume that all or almost all of
the world’s major problems are resolved nearly simultaneously. That is
an assumption only the heroically blind optimist could make.
Nevertheless, modest growth in the United States and no immediate
crisis like 2007-08 were enough to propel the financial markets upward,
with no allowance for anything to go wrong. Strictly speaking, it
actually meant that everything had to go right!
As this blog has pointed out, these multiple, complex and overlapping
problems inevitably produce both high uncertainty and high volatility.
So how could you be surprised that energy and commodity prices are
unstable? Or perhaps you are surprised at exactly how low energy prices
have fallen? But it is the essence of volatility in uncertain times
that the swings will be very wide, if not wild.
Notice what assumption was necessary in order for energy and
commodity prices to be even approximately stable. China would have had
to slow its massive economy from unsustainable to sustainable growth
rates and would have had to do so smoothly. China would have had to do
this even though it had never done it before and its financial and
regulatory institutions are still in development. It would have needed
timely and reliable statistics, and minimal corruption. It could not
overshoot its targets in either direction. And why we are surprised
that China has struggled with this great challenge? And as China
struggles, the energy and commodity markets weaken further.
So now that reality has emphatically asserted itself, the optimists
have bailed and the markets have tanked. Of course, once you really do
believe that the future is completely unknowable, adversity easily
causes over-reaction. So the markets are likely to fall far further
than circumstances warrant. But even that observation is uncertain. So
where does that leave the individual?
Since everyone’s circumstances are different, there is no single way
to effectively respond to today’s environment. But there are several
basic approaches that serve in times of great uncertainty. Avoid
inflexible obligations. Try to insulate part of yourself from the
external environment. One way is to seek out individual investment
opportunities that are not strongly dependent on the overall economy;
ideally, you find an investment that is strengthened by volatility and
slow growth. They do exist.
Last and not least, make sure your career strategy is aggressive. Add
to your advantage by enhancing your innovative capability. Remember the
highly innovative problem solver is always in demand.
