What is the “problem”? Imagine three massive objects in space … stars, planets, something like that. They’re in the same system, meaning that they can’t entirely escape each other’s gravitational pull. You know the position, mass, speed, and direction of travel for each of the objects. You know how gravity works, so you know precisely how each object is acting on the other two objects. Now predict for me, using a formula, where the objects will be at some point in the future.
Answer: You can’t. In 1887, Henri Poincaré proved that the motion of the three objects, with the exception of a few special starting cases, is non-repeating. This is a chaotic system, meaning that the historical pattern of object positions has ZERO predictive power in figuring out where these objects will be in the future. There is no algorithm that a human can possibly discover to solve this problem. It does not exist.
And that of course is the basic problem we have in economics and investing. When we say that past performance is not indicative of future results, that aphorism is more than just legalese.
I’ve written before about chaos theory and complexity economics. Such ideas can easily discourage us from even thinking about the future. Ben Hunt explains why that’s not the right response. The real answer is to think about the future differently.
With that prelude, let’s move on.
Gavekal Trifecta
If I had to rank economic forecasting groups (as opposed to individuals) for consistent quality, Gavekal would be high on the list. They publish a staggering amount of good research on wide-ranging topics. I especially like that they don’t have a “company line”: The Gavekal partners and analysts frequently disagree with each other, often with considerable vigor. Watching their arguments from the outside is a bit voyeuristic but enjoyable.
Here are just a few Gavekal snippets from the opening week of 2018. We’ll start with Anatole Kaletsky, who zooms in on inflation as this year’s key unknown factor.
Will inflation accelerate in the U.S., but not in other major economies? I think the answer is “Yes”, for the same reasons as above. However, I also expected inflation to accelerate and bond yields to increase last year. Instead, both inflation and growth ended the year exactly where they were.
The simple answer is that U.S. unemployment is now 4.1 percent instead of 4.8 percent. I was wrong about 5 percent unemployment being a non-inflationary growth limit, and maybe 4 percent isn’t either. But whatever the exact number may be, the U.S. is certainly closer to its non-inflationary growth limit now than it was a year ago. In addition, the Trump tax cuts, if they actually stimulate higher U.S. consumption and/or investment (which they may not do by any meaningful amount) will add to U.S. inflationary pressures, since new production capacity will take several years to boost non-inflationary trend growth.