Friday, September 29, 2006

Every Move You Make

I've been an economist (or student of economics, depending on how you define "economist") for about five years now and one constant are people asking me about the economy based on the latest changes. Don't get me wrong, I like questions. But sometimes these questions are based on the latest news in some minor adjustment of a commonly reported number. The DOW dropped twenty points. Oil prices slipped. The Fed is rasing interest rates. They don't really matter.

The same thing happens on news shows, especially financial ones. Part of this is neccessary because investors want to know about every tick (which you can't know about but they still want it) and part of this is wanting to fill up airtime. But the conversation is always the same and almost daily: is the economy a bear [doing poorly] or a bull [doing well]?. The latest tick of the market is always at the front of the debate as critical evidence.

Let me tell you a little secret. You cannot determine the quality of the economy by merely looking at the latest adjustment. Rarely does a one time gain or loss matter (it only makes a difference if it is very, very large). The market has error, it has trends, it has noise and it has risk. Each change is an attempt to determine what the price should be; each indicator is subject to the messiness of that discovery process.

Let me close with an example. Copper is probably my favorite economic indicator. When the price rises, it signals people want more copper and because copper is used for many things but people rarely store it these people probably want it for production purposes. But copper just jumped because, in part, of the possibility of a strike. Does that mean the economy is doing even better because the price rose? Not at all. Does that mean the economy will enter a recession because of the strike? Again, no. What matters the trend and what's going on beneath the numbers, not every single adjustment in the value. Prices are like people: you should learn why they are as they are if you want to understand what's going on. Stalking won't help.

3 comments:

Jenny said...
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Jenny said...

“You cannot determine the quality of the economy by merely looking at the latest adjustment.” Well said. After all, some people did very well financially between 1929 and 1935.

Chris Rasmussen said...

David.

One "economic indicator" that I think does have a great deal of importance for what the state of the economy now is housing prices.

After all, the rapid rise in housing prices over the past 5-7 years has been a result of the flood of liquidity created by the Fed. Of course, this is a natural line of arguement posed by Austrian economists such as yourself.

Chris