Don’t Worry Be Happy

With all the discussion in the news about shutting down the government and refusing to lift the debt ceiling ordinary citizens may feel they do not know enough about economics to judge the effect these situations may have. Thus those of us who do understand economics have a patriotic obligation to share our knowledge with others.

 Because many of you have heard for years the canard that economics is the “dismal science” we must dispose of that first. While it may be dismal, economics is certainly not a science. Five economists examining the same figures can provide four descriptions of the economy, six explanations for how it got there and three reasons why what has happened is not possible. Economics is also in the eye of the beholder. There are however some important ideas about which all can agree.

 Supply and demand is a basic concept that is quite easy to understand. Unless you have or can borrow $40,000 or more you can’t have a new fully loaded Mercedes. If you could supply and demand would become unbalanced and too many of the wrong sort of people would have Mercedes. Fortunately shifts in supply and demand tend to be self-regulating. Greater demand tends to raise prices and in time increase supply and falling demand tends to reduce supply by lowering prices and forcing high cost and/or low quality suppliers out of business. Unless the supplier makes a lot of cars in which case the government may temporarily repeal the law of supply and demand in that particular segment of the economy. This is known as a free market.

The devalued Mercedes market can soon be set right as original owners quickly switch to higher-priced models or brands thus rebalancing the market. It is a basic principle of economics that people of means will pay whatever price is necessary to keep desirable products out of the hands of the wrong sort. This is known as inflation. The major function of government is to help the right people bid up prices. Despite minor aberrations our government has been singularly successful in fulfilling this mission.

Forecasting the direction of the economy is an important activity of the economist.  Econometric models are used for this purpose.  While there are many models they all share the basic idea of predicting where we are going by examining where we have been.  This is an extremely accurate method unless something changes.

Today’s econometric models run on very large computers at major universities and other well-capitalized organizations. They can process large numbers of questionable statistics and assumptions.  The amount of data examined and the number of assumptions tested by current sophisticated mathematical models greatly exceeds our ability to understand the results. 

Once a businessman has decided what the economy is likely to do he can generally find a forecast from an econometric model to support his view. Of course this is not possible in all cases. If the businessman foresees a major change in the economy, the forecast he needs will not be available until several months after the change begins. Some businessmen find this inconvenient.

The economy is well known to move in cycles commonly known as boom and bust.  It is theoretically possible for an economy to avoid growing too rapidly and breaking down but there has been no practical experience. There is some evidence that boom and bust is of divine origin; the first cycle having been established when Adam and Eve left Paradise. Perhaps for this reason few politicians have attempted to experiment with anything else for any significant period of time.

 There are many different opinions about what economics can and should do. These differing opinions are referred to as “schools of economics”, an appellation which manages to insult both institutions. It seems more reasonable to assign anyone who believes economics can forecast future events to a church of economics. Church members appear to believe theirs is the true religion and the only way to economic salvation. Those who follow false prophets are doomed to ever deepening recession, depression and the collapse of the world economic system.

The Bible suggests faith can move mountains. Experience has shown faith can build, and lack of faith can destroy, giant financial institutions. In fact our economic structure depends fundamentally on twin pillars: faith and ignorance. People must believe in the system and to do that they must be unable to comprehend it. This is embodied in Polcyn’s First (and only) Law of Economics:

                       When enough people understand an economic system it will collapse.

Fortunately we seem to be in no immediate danger in spite of the severe trauma we have endured and are enduring. So long as one in a row constitutes a successful track record for an economist there is still hope. I trust this brief explanation will enable you to feel more comfortable about your future financial security.