Russ Randall on the Economy

Last night I heard an interesting presentation by Russ Randall on the economy. I haven’t investigated his claims sufficiently to judge whether they’re remotely on track, but he tells a fascinating and initially-plausible story.

Randall started a web page with the peculiar name, Austrian Enginomics, which he describes as “Austrian Economic Theory blended with engineering logic.” I’m not quite sure what that means. In Randall’s favor, he was predicting economic trouble back in 2005:

Many economists believe the current (May 2005) cycle of interest rate tightening will be the cause of the economy eventually “breaking” and sinking into a recession or worse. Enginomics (and Austrian economic theory) recognizes the root cause of any upcoming economic downturn was the financial bubble creation in the first place; NOT the series of interest rate increases. The current series of post-root-cause central bank interest rate increases are belated attempts to correct a problem they created in the first place by the extended artificial suppression of interest rates and administration of easy monetary policy operations. (emphasis omitted)

Randall tries to estimate the real value of economic production based on inflation, population, and productivity measures. He places actual “total equity valuation” in 2007 at around 8 trillion dollars, whereas the nominal value showed closer to 18 billion. By this account, stocks have not reached their downward correction, and real estate is about half way there. The bond market has not yet started to fall but is soon to follow.

Randall further argues that the serious problems started around 1994, when easy money policy started to generate “the most extraordinary equity bubble in the history of the republic.” This bubble began to correct from about 1999 till about 2002, when the feds again started cranking out easy credit.

So the bad news, by Randall’s account, is that the economy is going to get seriously worse before it recovers. The good news is that our economy does produce vast real value, so, while production will dip below normal for a period as firms and individuals make the necessary transitions, the economy will recover. If, that is, the federal government does not totally destroy the economy through attempts at massive central planning.

There is an obvious potential problem with Randall’s account, though: his base-line estimate of productivity may be way off. This goes back to debates about the Great Depression. I am persuaded that most of the stock gains through the ’20s represented real economic improvements; the era showed profound advances in technology and manufacturing. While federal policy did create a bubble, the deep problem was caused by Hoover’s tariffs and wage and price controls. I have no idea whether productivity today tracks Randall’s estimates. But I would want to look carefully at the tremendous advances in computer technology, the internet, cell communication, and medical technology before concluding that his estimates are accurate. Obviously, if real productivity is higher than what Randall estimates, then the bubble is smaller, as are the necessary economic adjustments.

Generally, I am not going to get in the game of trying to predict the economy. It’s a very hard thing to do, which is why very smart people routinely lose tons of investment money. A friend of mine once related a story that illustrates the problems. He was part of an investment club that spent considerable time tracking stocks and creating just the right portfolio. After many years of this, the portfolio showed practically the same gains as the S&P 500. We’ve all heard that chimpanzees throwing darts at a board could over time do about as well in creating a diversified portfolio as the highest-paid experts in the field.

That is not to say that the market is fundamentally irrational or totally unpredictable. Rather, because people tend to capture obvious gains immediately, and because of the inherent uncertainty of the future, “get rich quick” investment typically doesn’t work. A major source of uncertainty is the large-scale, capricious economic intervention of politicians.

Yet, at a broader scale, economic trends are predictable. In an economy with fair and stable rules that protect property and voluntary association, the economy will tend to continually grow more productive and prosperous. In a completely capricious society, whether run by local thugs or national dictators, the economy will tend to stagnate and shrink. We are in a middle stage, and general economic trends are difficult to predict precisely because it’s hard to measure and anticipate the conflicting movements of productivity gains and political losses.

Obviously, people looking to invest or protect existing investments do their best to anticipate short-term economic trends. But, for the general long-term health of the economy, what are important are the principles. We’re in the mess we’re in precisely because politicians and their appointees have strayed from sound economic principles and turned to range-of-the-moment tinkering. On this point, Randall and I agree.