Fanciful Guesswork

Regular readers of Gone to the Dogs will be familiar with my scepticism regarding forecasting ability or skill. The short version of my argument is that we display little or no ability to forecast with any degree of reliability. Despite this, many investment decisions - ranging from tactical asset allocation through to stock selection - rest on a foundation of economic, market and company forecasts. These forecasts often are wideranging, and can embrace topics as diverse as prospects for the oil price, an exchange rate and the ability of a company's management to retire debt quickly to reduce interest costs and so bolster an earnings forecast.

It is also not uncommon for forecasting to extend to the socio-political environment - recall the doomsday forecasts of the Club of Rome from the 1970s?

The article below by Philip Stevens of the Financial Times deals with the above theme, arguing that whilst we have come to the time of year when anlaysts apply their mind to forecasting events for 2009, we only need to compare their forecasts for 2008 to the events that unravelled, to remind ourselves of the futility of the exercise. Still, forecasting is fun and, what is more, it is widely followed.

ADVICE FOR SEASONAL SEERS: THE FUTURE IS NOT IN THE STARS

The season of seers is upon us: the time for commentators to reinvent themselves as clairvoyants. Confounded by the present, they (or do I mean “we”?) seek solace in the certainties of the future. The imminence of Barack Obama’s presidency makes the temptation this year doubly irresistible.

True, anyone who takes the trouble to look back at some of the punditry of December 2007 could be forgiven for treating all this with a certain scepticism. One of the things we might have learned from the tumult of 2008 is just how quickly the unthinkable can become the unremarkable.

Never mind. Perhaps there is indeed a sage somewhere out there who foresaw that during 2008 the oil price would first soar to $150 a barrel and then crash just as quickly towards $40. The same prophet no doubt predicted the demise of the global investment banks – the collapse of Bear Stearns and Lehman and the flight of those masters of the universe at Goldman Sachs into the humbling embrace of the US Federal Reserve.

From there, it was but a small step to predict that plucky little Iceland would go bust and that governments everywhere would return front and centre stage to nationalise the global financial system. Interest rates at close to zero, banks taken under state control, hedge funds vilified? It was all there in the tea leaves.

Surely the commentariat anticipated the death of the do-as-you-please liberal capitalism that had reigned supreme for more than a decade? Didn’t we? As for Bernard Madoff’s alleged £50bn fraud, it was obvious all along that his investment fund was a vast Ponzi scheme? Wasn’t it?

The same perspicacity led the pundits to predict that Mr Obama would emerge the winner from a contest with John McCain. You know, I was sure that Hillary Clinton and Mitt Romney were tipped as racing certainties for the Democratic and Republican nominations. I must have missed something.

Anyone with the slightest feel for British politics would have known too that Gordon Brown’s stock as prime minister would soar even as the economy slid into an economic bust he had promised could never happen. And just about everyone knew that the determinedly dour Mr Brown and France’s well, rather more gregarious, Nicolas Sarkozy would end the year the very best of chums.

To be fair, the soothsayers got some things right. George W. Bush has not disappointed the prevailing view that his presidency would come to a wretched end – even if this week’s shoe-throwing incident in Baghdad elicited a sympathetic wince even from some of his harshest critics.

To borrow a sporting cliché, 2008 has been a year played in two halves. The first saw the rehabilitation of Thomas Malthus as governments joined a desperate contest for dwindling global resources.

Commodity prices headed for the stratosphere; central banks saw the spectre of inflation. As for the economic slowdown in the world’s most advanced economies, this was no more than a necessary adjustment. The rising powers of Asia would pick up the slack. Remember all those confident theories about “decoupling”?

In the geopolitical sphere, the narrative was about energy riches fuelling the rise of authoritarianism: the world would belong to Vladimir Putin’s Russia, Hugo Chavez’s Venezuela and to the sovereign wealth funds of the Gulf. Democracy would retreat before an authoritarian axis running from Moscow to Beijing.

The second half 2008 has turned the first on its head. Malthus has been returned to the history books and John Maynard Keynes has been disinterred in his place. The state, politicians have decided, has a role beyond standing back to let the market weave its magic.

Mr Putin has been humbled by a collapsing stock market; China has not escaped the economic misery of the west; Dubai no longer seems quite the Eldorado of earlier imagination.

Investment bankers have fallen lower even than journalists in rankings of public esteem. Central banks have discovered that the problem is not inflation, but deflation. Just as we thought that $150 oil would be with us forever, so now the economic slump seems to stretch into an indefinite future.

If there is anything that has united the two halves of the year, it has been the extent to which conventional wisdom has provided a wholly inadequate explanation of events. Official responses to the successive crises that would once have seemed eccentric are now mainstream.

The bigger lesson has been about how hard we find it to peer into the present. Economic interdependence and the shift in relative power to the rising nations of the east have been a commonplace in our discourse for some time. It is only this year that we have begun to see what the changes mean.

On the financial front, the message has been about the failure of political governance to keep pace with the integration of global markets; governments, central banks and regulators have simply failed to keep up with the ever-tighter interconnections between markets.

The result? A contagion whose virulence has surprised even those who had the prescience to foresee the threats inherent in the financial alchemy that turned subprime mortgages into seemingly triple-A-rated financial instruments.

The geopolitical story has been one of more tables turned. Until this year financial crises were things that happened to “them” – to Latin America, Asia, Russia and Africa. The credit crunch was made in the west – a story not of the irresponsibility of the emerging world but of the profligacy and regulatory failures of the most advanced nations. This time the rising states were the creditors, the west the debtors.

There lies the wider context for the truly extraordinary events of 2008 – a world in which the established order has cracked in response to the changing pattern of power. Everyone sees the rise of China and India, America’s relative decline and the inadequacies of the international system. Now we know something of what this passing of the post-cold war world means in practice.

The chaos speaks to a world in which the west is surrendering centuries of economic and political hegemony; to a globalisation that has at once weakened nation states and demanded more of them; and to an emerging multipolar system that has broken the multilateral boundaries of the old order. We talk about it, but have not properly understood it. There is no harm in looking for the future in the stars – but we are more likely to find it in the present.