Extrapolating the Future 

by

Ross M. Miller
Miller Risk Advisors
www.millerrisk.com
May 14, 2012

Forecasting the future is a tough business, which is why, despite my spot-on forecasts back in the early days of these commentaries, I avoid making public forecasts anymore. This month's commentary looks at how coming shortcomings in economic and financial forecasts carry over into our everyday lives.

The consistent thing about economic forecasts is how wrong they are. Computer-based economic forecasting models hit the mainstream with the much-publicized Club of Rome model that was described in the 1972 bestseller, The Limits to Growth. The book disavowed that their hideously primitive computer models were trying to predict the future, but the press conveniently ignored this disavowal. The best thing that came out of this exercise was a healthy skepticism about long-term economic modeling.

Today's hideous models come from places like the Federal Reserve, the Council of Economic Advisors, and the Congressional Budget Office. The typical model forecast a world that reverts to above the mean and stays there forever (which is just ten years for the Congressional Budget Office since their models assume that is when the world ends, a bit like the Mayan calendar, but without a fixed endpoint). The Fed's current projections only provide detail to the end of 2014, but things still look uniformly rosy. The absolute worst-case scenario for real GDP growth in 2014 is 2.9% and the best-case is a whopping 4.3%. Beyond that, it's green grass and blue skies forever with "longer run" real GDP growing between 2.2% and 3.0%. The Council of Economic Advisors Annual Report on page 74 has us zipping up to 4.2% real GDP growth in 2015, followed by a slow glide back to 2.5% growth in 2020 that continues through 2022, when we reached the federally mandated end of the world. With long-term GDP growth in the U.S. is very close to 2%, these forecasts are very optimistic and provide no defensible reason that growth should settle into a level above the long-term average. Moreover, there is no recession on the horizon; indeed, like most long-term forecasts, it would seem that recessions are no more.

Of course, these forecasts can be seen as just a central tendency for the economy, albeit a grossly optimistic one. The problem is that it is very different to plan for an economy that has always had its ups and downs in the past (and will always have them into the indefinite future) than it is to plan for one with all the bumps smoothed over. Indeed, it is a basic mathematical property of volatility that all things equal, higher volatility translates to lower growth.

Economic forecasters are not the only ones who view the future as an unending sea of tranquility. The small subset of people who actually plan for their futures mainly view the world the same way. (Apparently, based on numerous behavioral studies, most people lack the cognitive apparatus to plan for the future.) Those rare perspicacious planners among us also tend to learn from the rocky past, anticipating smooth sailing in the future. It is one thing to say "expect the unexpected," it is an entirely different thing to plan for the unexpected in all but the most superficial of ways.

Planning directly for every conceivable adverse future event is not only impractical; it is the fast track to the loony bin. Still, we are not helpless in facing the future. Extra food and water is always a good thing, especially in rugged climes where disasters come with the territory, but a militia-grade arsenal is, with rare exceptions, going a bit overboard. Bad things are guaranteed to happen, but knowing just how they will happen is the problem. I write this as someone who lived through the fallout shelter boom of the early 1960s and saw the scary shelter signs go up on every public building. Duck and cover my ass.

The best way to plan for an unknowable future is not to plan for specific eventualities, but to develop general capacities that could come in handy regardless of how the future plays out. For people, that can translate into activities that promote both physical and mental health. Being healthy is a winner in any economy, and especially those in which the healthcare delivery mechanism breaks down as seems likely sooner or later. Developing social capital is always a good idea. Making friends and participating in society are good for you and the world around you no matter what transpires. And by friends I do not mean those of the social media variety, but real interpersonal human contact. The best friends are those who do not even know what social media is.

The public sector seems incapable of planning for the future in a rational manner. Little of the vast federal bailout money has gone for meaningful investment projects that will pay social dividends in the future. When I was in graduate school, they taught something called cost-benefit analysis. It was a primitive and technically incorrect version of finance that was used to determine which public projects to fund. The only cost-benefit analysis that is done these days is motivated by politics and campaign contributions. Old-fashioned cost-benefit analysis was driven purely by the dollar amounts of social benefits relative to social costs (both admittedly nebulous concepts). Cost benefit analysis was supposed to be blind. A project that greatly benefits a political enemy should always be preferred to one that provides lesser benefits to a political friend. Inequities resulting from the mix of projects selected could always (in theory) be papered over after the fact with "transfer payments." Naïve rather, I would say.

Right now I'm planning for summer, fully aware that it is a rare summer that goes according to plan. Once again, my summer commentaries will have a popular culture theme. This summer I am doing three commentaries on record albums that were released around 1970. I'm starting with the popular album, Crosby, Stills & Nash (May 1969) by the group of the same name. That album was monumental at the time it was released and has remained popular throughout its 43 years of existence. The other two albums are more obscure, but more interesting.