View from New York: Forecasting by aberration and particularism

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There was a partial eclipse of the sun, literally, over Wall Street yesterday, albeit a brief one, but sure enough, one market theorist out there found a way to interpret even this phenomenon as a leading indicator of the direction of interest rates, the near-term strength of the American recovery and the future of the Clinton administration.

'Bearish,' the Star Theories Dow Letter decided; the last such occurrence, 6 June 1982, coincided with the worst bank collapse (to date) in American history.

Just what is going on with American economics? Is the recovery, so promising in January, floundering - as all the numbers were suggesting two weeks ago - and threatening to plunge the economy underwater for a third time? Or do last week's surging prices signal the opposite, an outbreak of damaging inflation? Or does the sudden buoyancy of gold this week mean that America is in for the worst of both worlds, the frustrating 'stagflation' of the Carter years of the late 1970s?

By Friday, the verdict of the markets was 'none of the above'. After succumbing to a general panic that drove long-term bond yields up over 7.06 per cent and gold up to almost dollars 384 an ounce, a wave of reverse psychology suddenly took hold late on Wednesday afternoon. By the closing bell, economic fears of all sorts evaporated, 30-year yields plummeted back below 6.98 per cent and the Dow Jones Industrial Index pulled out of a 30-point dive and went crashing through another historic threshold, 3,500 points.

The consensus on why this mood swing occurred? 'Because nothing happened,' one respected trader explained, referring to inaction on the part of the US Federal Reserve, which - Wall Street had convinced itself - was going to raise interest rates on Wednesday.

'We woke up from a nightmare of our making,' Richard Hoey, a veteran mutual-fund economist, confessed later.

But in a broader sense, nothing has happened; the fundamentals of the American economy remain unchanged through the roller-coaster ride of the past two weeks. The economy never was growing at an annual rate of 4.7 per cent, as some would have you believe of George Bush's last quarter in office. But some people took that number seriously, and now America has to put over-sized inventories to work before the GDP figures reflect a real picture of the recovery.

Excess capacity

Inflation has indeed bottomed out, but for the time being at least there appears to be enough excess capacity and labour about to diffuse any build-up in demand pressure. And as for stagflation, it seems the only people mentioning it as a serious possibility are Republican newspaper editorialists and, for some reason, British business columnists.

Which raises the question of what America's economists have been doing. As a whole, the forecasts of these 'dismal scientists' - which tend to cancel one another out at the best of times - seemed particularly contradictory this week. On the question of the gold rally alone, 'they agree that it is either an aberration or an augury or both', points out James Grant, himself both a goldbug and a cynic. 'Accordingly they would be long or short or perhaps uncommitted pending clarification of monetary policy by the Federal Reserve Board.'

The truth, Mr Grant argues, is that economists 'are going to read whatever macro-economic message they want to project into the rise in gold prices'. Others who could not find an honest economic explanation for the run-up in gold and said so 'simply looked foolish', confesses Brian Fabbri, economist with Midland Montagu Securities in New York.

The apparent incoherence of economic forecasting is hardly news. But the profession's reputation for equivocation has not been helped by the fact that in recent weeks its members have had to resort to an unusually broad range of exceptional circumstances, aberrations and particularisms to explain why the statistics are not matching up with their predictions, or, more correctly, why their forecasts failed to predict what the statistics are revealing.

The weather, for example, has been enlisted to explain first weak growth and then unexpected inflation, both slow housing starts and later a jump in first-time home purchases. (Matters have not been helped by the admission by Washington's Bureau of Labour Statistics that it had miscounted the growth in US employment in the 1980s by some 2 million jobs, and consequently exaggerated the contraction of payrolls during the recession by about the same number).

Such 'particularisms',however, are exactly how more dangerous bouts of inflation tend to first reveal themselves, notes Roger Kubarych, an economist who works with Henry Kaufman, one of Wall Street's legendary pessimists. What is distressing, he argues, was the unanimity of Wall Street and Washington economists last month - each for their own reasons - in refusing to accept even the possibility that inflation might be reappearing.

Uncomfortable time

'If it is an uncomfortable time to be an economist, it's even rougher being one who is trying to manage a bond portfolio,' Mr Kubarych complains. For his part, he believes some mild form of stagflation is a danger, although it is not the most likely scenario for the American economy, which is slow growth and modest inflation. On the other hand, the least likely, he says, is robust growth and modest inflation.

Where there is some clarity and useful consensus among US economists is in the policy implications of all this chaos, and in the impact of Clintonomics on the economy. The Federal Reserve will do nothing in the short term about interest rates; even if the Fed governors wanted to react to the kind of selective inflation the statistics are suggesting, 'slowing consumer spending by raising rates is not the right prescription', explains Dan Seto, an economist with Nikko Securities in New York. 'The Fed doesn't have the right instruments to deal with this sort of problem.'

And President Bill Clinton's budget strategies, which looked either very clever or very lucky when interest rates bottomed a month ago, can now have only a depressing near-term effect on the economy, everyone seems to agree - what management gurus would call a 'lose-lose' scenario, at least politically.

If he manages to get his tax plan adopted, it will 'be the worst thing that could happen to the economy in the short run', Midland's Mr Fabbri says, delaying healthy economic recovery until next year. If he fails, the bond market, now in effect focused on deficit reduction, and then the stock market will abandon any pretence that his election was ever bullish for business.