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Having left U.S. service under four presidents mid-1975 and having spent another couple of years as an advisor to the U.S. Senate, I found myself in demand for private, exclusive advisory roles to the CEOs of several of the world’s biggest banks, asset managers, industrial corporations, insurers and sovereign wealth funds. Some of the tasks involved rethinking business strategies and global deployment of management and production resources, but eventually I was asked to devote greater focus to financial interactions across global markets.
Because of my background in economics and econometrics learned under the tutelage of some of the world’s most prominent economists, including eight Nobel Laureates, it was natural that clients asked me privately to give my personal thoughts on many business, government and academic forecasts. Gradually, a number of central banks, finance ministries and even government leaders around the world asked me to compare notes and help look for what might be blindsiding events in their own outlooks.
From this extraordinary experience, I learned that there were wide variations in how economic activity was measured in practice. Data used not only varied in availability, but -- more importantly – it varied in quality. The highest level decision makers rarely questioned the details in reports they were provided. Forecasts invariably focused on national economies with minimal attention to the interaction of economies through world trade, investment and financial flows.
It also became evident that everyone’s evaluation of the world economy was reliant on data typically available from the IMF, World Bank, OECD, WTO and other multilateral organization sources. Few decision makers were aware that such sources lag reality by many months, as each member government collects and polishes national data to present the best possible image of its own economy. When objective IMF national review teams suggested criticisms of policies and data provided by officials representing the big industrial economies, IMF directors who held a majority of votes in that institution quietly sidelined them.
By looking at how national economic data is typically collected over many years, it became increasingly clear that information technology was providing data faster and faster, allowing better insight on real-time performance, but forecasting remained mired in methodologies devised decades earlier. A bifurcation was slowly developing between private decisions based on near real-time, sector-specific information and public policy decisions based on observations that were months, sometimes years, old.
Central banks found themselves driving fast-moving machines through winding roadways with eyes glued to their rearview mirrors. Worse, government deliberations involving legislatures spent months and even years considering policy responses to business or labor complaints. Often, legislation was approved that no longer applied to the circumstances that had originally given rise to business complaints. This became particularly evident in the U.S. congressional debate about how to respond to foreign-government exchange rate and purchasing policies, barriers to U.S. exports and perceived foreign incentives for outsourcing American business activities. The U.S. executive branch and congressional responses to claims of foreign unfair treatment of American corporations, financial institutions and labor unions took months, sometimes years, to devise. The actions ultimately taken were no longer relevant as challenges took new forms or emerged in new geographic locations.
During the 1960s, 70s and 80s, forecasts and broad economic outlooks were increasingly disconnected with the pace of world events. Moreover, they failed to build in an understanding of continuously changing political and security priorities in other countries. Traditionally crafted forecasts became increasingly disconnected with reality.
Market technology has also been undergoing accelerating changes. Most notable was the emergence of high-frequency trading (HFT), which accelerated transactions from days, hours and minutes to milliseconds and microseconds. HFT transactions in stock trading soon migrated across borders as well, enabling trading in many different time zones in each 24-hour cycle. HFT also migrated across asset classes, beyond equity markets to trading in commodities, bonds and ultimately to the most liquid market of all, foreign exchange trading (where HFT now dominates daily trading). Global financial transactions have become possible 24 hours a day every day, from any computer in any location. Of course, this has enabled an ever-growing means of regulatory arbitrage as well as accelerating innovations in financial engineering. Much-touted macroprudential reforms are often little more than cosmetic adjustments that aim to hide blemishes that no longer prevail.
Central banks as well as governments are always behind the curve of real-time events with inadequate computer capacity and unqualified analysts to monitor market manipulation by market participants. Familiar with what many central banks and governments are now doing, I can confirm that little effort can be found among them, or even among most businesses, to try to catch up with real-time markets. Needed management monitoring changes are often brought about by regulatory interventions and findings of misbehavior rather than by carefully planned information technology reforms.
Central bankers publicly declare that they are data-driven, but this has little meaning because their methodologies of data collection and analysis are increasingly obsolete. Nonetheless, economic forecasters continue looking to central bank data and public speeches about that data for guidance on where markets are likely to go. In the event of economic, political and security turning points, central bank models based on past experience break down. Worse, they cannot cope with unanticipated natural events like pandemics, wars and Carrington events like solar storms. When big turning points are encountered, decision makers should anticipate that political and big institutional responses will be very slow, with long periods of severe disruption. Institutional inertia is one of the most powerful forces at work in today’s markets.
With higher speed and global-scale volume prevailing in world economic activity, traditional forecasting is simply not adapting fast enough. Moreover, most forecasting still is compiled looking at one national economy at a time, assembling global outcomes with one national assessment added to another like children’s building blocks. In the U.S., many forecasters remain obsessed with the U.S. economic outlook on the assumption that the world has only marginal effect on the American economic juggernaut.
I spent much of these last four decades walking through global interactions, connecting dots that others overlooked, in my chats and written assessments for a relatively small number of the world’s biggest movers and shakers. It has been an exhilarating experience, but the downside was that my views were sought in confidence. Busy with personal appearances in dispersed geographic locations, I spent less time speaking and writing about what I was learning. When at Oxford, from 1957-1961, I was deep into basic economic theory, and published much while still a graduate student. Some of that has, in recent decades, reemerged in various reprinted collections of notable works of the last century. My public observations in the last decade or two have been limited to national security, defense related questions and to occasional thoughts on the inadequacy of public and private responses to the great financial crisis (which has yet to work itself through fully).
In conclusion, traditional, timeworn economic forecasting methodologies on which we rely -- whether prepared by governments, central banks or private economists -- are gradually becoming less relevant and reliable. We cannot give them up because we need to understand changes in economic trajectories over time, but I see a growing need for healthy skepticism in using the data on which we have long been reliant.
In particular, governments need to admit and reveal flaws in the data they are using. There is great need for the press and media to apply healthy skepticism to continuous waves of good news spun by governments to feed an irrepressible social addiction to hopium that everything is awesome – or will soon be. Markets have become unanchored, buffeted by political spin, nonobjective industrial and financial news and algorithms designed to pursue or front-run momentum or create an illusion of momentum where there is none. This ongoing degradation of market economics and inability of governments to comprehend and cope needs to be taken into account when trying to envisage where we are, where we should be going and how to get there.
Dr. Harald Bernard Malmgren is a scholar and has been an ambassador, international negotiator and senior aide to U.S. Presidents John F. Kennedy, Lyndon B. Johnson, Richard Nixon and Gerald Ford[1] and to U.S. Senators Abraham A. Ribicoff and Russell B. Long, United States Senate Committee on Finance, advisor to many foreign leaders and CEOs of financial institutions and corporate businesses, and frequent author of articles and papers on global economic, political and security affairs.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
