Today I had the pleasant experience of catching up with a fellow economist, with whom I had worked for five years up until late last year. We had great fun chatting about recent developments, what each of us had been up to, and prognosticating about what might be in the realms of economics, politics and economic policy.
During the conversation, my friend happened to relate a story from a quarter-century ago, when he worked as a chief economist for a large banking group which had a branch here in Australia. At the time – the late ’80s – the economy was booming along, with both entrepreneurs and established companies surfing a wave of plentiful and relatively cheap credit.
Being an economist, and thus being both accustomed and paid to find the clouds behind any silver lining, my friend looked out across to the horizon and concluded that over the coming year to two years, interest rates would have to rise and rise significantly, and that this would cause an almighty crunch of activity in the real economy. However, when he read the economic reports from his fellow private-sector economists, and the reports from the ‘official family’ of Treasury and Reserve Bank economists, all he could find were references to the expectation that interest rates would fall, and not rise.
After scratching his head, and going over his analysis a number of times with his economic team, he concluded that there was no way that interest rates could fall. They could only rise, they would only rise, and the dynamics of the market reaction to those rises could only be to cause them to rise further to a level of 17%.
He further realised that this wasn’t simply an academic exercise in proving oneself to be the smartest smarty-pants in the room. His analysis necessarily implied a positioning of the bank’s investment portfolio which would be contrary to that held by many other market participants, and which would lose money if the Treasury and the Bank implemented policies which were in line with their forecasts (which would only be rational). He would have to take his analysis, and his recommendations, to his colleagues in other departments through the bank and seek their approval for implementing a strategy followed by none of their competitors. If my friend was wrong in his analysis, the strategy would be a dud, and the bank would lose a lot of money, alone and quite spectacularly. His career would be ruined.
My friend and his colleagues in the economics team stuck to their guns. He was able to persuade his colleagues in the bank’s other teams of the wisdom and correctness of his analysis. The bank positioned its portfolio accordingly. Sure enough, the economic and financial environment evolved as he had predicted, interest rates rose to unprecedented levels, all the other institutions had to rush to recover their positions and cover their losses – one of the major local banks, Westpac, had to be bailed out by Kerry Packer at $3 per share. My friend’s bank cleaned up. His correct analysis, and willingness to take a position contrary to the multitude of other ‘experts’ in his field, had made him and his employer quite a deal of money, and had secured his position at the bank.
The lessons that I want you to draw from this anecdote are:
- it is possible for a whole bunch of experts to be wrong;
- it is possible for your analysis to be right, even when it puts you in disagreement with a whole bunch of experts;
- if you find yourself in this position, check your analysis and weigh it against the analysis and arguments of the people who disagree with you, so that you are aware of all arguments and can be sure that you aren’t missing something.
One last lesson that I was going to recommend was ‘once you’ve done this, and are sure that you are right, stick to your guns’. But I must add a caveat to this, which I will introduce via a second anecdote.
I joined the Commonwealth Treasury as a graduate economist in February 1998, and found myself placed in the Balance of Payments Section of the Economic Conditions Branch of Economic Division. The great event at that time was the Asian Financial Crisis, which (from memory) had begun in mid-1997 with a balance-of-payments crisis in Thailand and which had then rolled on to affect Malaysia, Korea and Indonesia. The crisis had poleaxed growth in Australia’s exports and caused the Australian dollar to fall heavily against the US dollar.
Consensus thinking was that it was only a matter of time until the local economy fell into recession as a result of the regional economic slowdown. I remember one private-sector economist, I think he was at AMP, really sticking his neck out and predicting severe recession. This gloomy view was also the consensus view among the Assistant Secretaries of Economic Division, except for one man: the head of Economic Conditions Branch and my manager-one-removed. A good, experienced macroeconomist with years of experience, including having hung out a shingle and worked as a consultant, the AS-ECB had done his own analysis and had concluded that the local economy would be buffeted but not swamped by the crisis, and that the fall in the local currency, plus capital inflows from troubled regional financial centres into Australian financial centres, would cause the Australian economy to keep growing at a healthy rate.
The reaction was as you might expect. The AS-ECB was derided as a nitwit who didn’t know what he was talking about. Office politics and rivalries, never far below the surface in a milieu as full of ambition, self-confidence and ruthlessness as Treasury’s, meant that his overly-optimistic forecast was presented with ridicule to the Deputy Secretaries and Secretary. Life became difficult for him, and he was soon moved on from ECB.
His deputy, the Chief Advisor to ECB, became the next AS-ECB and immediately forced all of us low-level functionaries into revising our forecasts so as to achieve an overall forecast for annual real GDP growth in the 1998-99 fiscal year of 2%. The only forecaster to retain their independence of mind was the macro model, TRYM, which produced an initial forecast of a growth rate of 5%. TRYM’s calculations were tweaked until it conformed to the prevailing worldview and produced a forecast of 2%.
What happened next?
- Later that year, the Chief Advisor ‘leveraged’ his new title of AS-ECB into a more lucrative position with a private sector economic consultancy full of other ex-Treasury economists (a rumour has it that, when the Chief Advisor went to tell the Secretary of his planned resignation and his desire to get ‘private sector experience’, the Secretary, known for his deadpan demeanour, fixed Chief Advisor with a puzzled look and said ‘But [X], you’re going to [advisory full of Treasury people].’)
- On beginning at the advisory, the Chief Advisor told his new colleagues about how, when the macro modellers had put the latest data into TRYM, the model had produced a 5% forecast for GDP growth. Everybody laughed. This anecdote was thought so entertaining that it was leaked to The Australian Financial Review (which is where I read it).
- After being sacked from his role and taking a sabbatical, AS-ECB came back to Treasury’s revenue area for a short while, and then soon after took up a position as chief revenue forecaster for the Australian Tax Office. He has never returned to Treasury.
- The Australian economy recorded a real GDP growth rate for the 1998-99 fiscal year of 5%. AS-ECB and TRYM had been correct, and Chief Advisor and all the other Assistant Secretaries in Economic Division had been way, way out. I don’t remember anyone saying that they had been wrong or apologising to AS-ECB. If the injustice of it all affected TRYM, the computer model never showed it.
- Ten years later, Chief Advisor went on to a quite healthily remunerated job in investment advisory.
- In 15 years of following the local financial and economic landscape, I have never, ever again heard anything from the man from AMP who said we were heading for severe recession. He has disappeared from the economic community.
So, the further lessons that we can draw from this second anecdote are:
- it doesn’t matter if you are right, or have the best argument – if you can’t bring people with you, and the matter is contentious, then you face career risk; and when you are proven right, it may be too late to correct the situation (especially if everyone else wants to forget an episode that shows them up as being dills and you as having been right);
- it doesn’t matter if you are wrong, if you are with the consensus and you won’t be shown to be wrong until it no longer matters; the economic advisory didn’t care whether the Chief Advisor was right or wrong, all that counted for them was that he had been both Chief Advisor and AS-ECB, and that he could tell a good story;
- if you are going to go out on a limb and buck the consensus, then you had better make sure you are right, because if you are wrong, you are standing out naked like a shag on a rock and professionally you are GAWN.
This all relates to professional and social considerations. In the world of finance, where you are investing your own money, it is different: if you think you’re right, you don’t need to go up against the consensus in a fight to the death. Invest accordingly, and if you’re right, you may not need to work ever again.
But if you’re investing other people’s money, and you go against the consensus … well, let Jeremy Grantham tell you about his experience.