Economics is not science

The conclusion of the 77th Annual Report of the Bank for International Settlements begins with the sentence "Economics is not science, at least not in the sense that repeated experiments always produce the same results."

They got that right.

Among the many other things that they got right in a 244 page report on the state of the world economy is, if there is a crisis looming, no one sees it coming.

The Great Inflation in the 1970s took most commentators and policymakers completely by surprise, as did the pace of disinflation and the subsequent economic recovery after the problem was effectively confronted. Similarly, virtually no one foresaw the Great Depression of the 1930s, or the crises which affected Japan and Southeast Asia in the early and late 1990s, respectively. In fact, each downturn was preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a “new era” had arrived.

Well, a "new era" has arrived.

Some might characterize the "new era" as one where asset prices increase at some multiple of the rate of credit growth and everyone crosses their fingers that this can go on indefinitely.

It can't - never has, never will.

You'd think that the history of asset bubbles would serve the same purpose as experimentation so that economics could be a little more like science, but you'd be wrong.

Some interesting charts

The charts below from the BIS report tell the story of four economies around the world and how household assets and debt are related. After more than 15 years, Japan is still recovering from their late 80s bubble, the U.S. and U.K. are both giddy with asset inflation while not seeming to mind the debt too much (yet).

Old Europe, with their measly four percent debt service ratio (lower right chart) just doesn't seem to get it. You can't have a booming economy if you don't have booming debt!


It all seems so obvious to some. Rampant money and credit creation leading to soaring asset prices at a time when consumer prices appear to be stable may be a sort of "economic nirvana" to bankers and Wall Street types, but, at some point, asset prices stop rising.

From someone who read the whole thing

Apparently Ambrose Evans-Pritchard read the entire BIS report and then filed this story with the Telegraph U.K. - the headline gets right to the point.

BIS warns of Great Depression dangers from credit spree
The Bank for International Settlements, the world's most prestigious financial body, has warned that years of loose monetary policy has fuelled a dangerous credit bubble, leaving the global economy more vulnerable to another 1930s-style slump than generally understood.
...
In a thinly-veiled rebuke to the US Federal Reserve, the BIS said central banks were starting to doubt the wisdom of letting asset bubbles build up on the assumption that they could safely be "cleaned up" afterwards - which was more or less the strategy pursued by former Fed chief Alan Greenspan after the dotcom bust.

It said this approach had failed in the US in 1930 and in Japan in 1991 because excess debt and investment built up in the boom years had suffocating effects.

While cutting interest rates in such a crisis may help, it has the effect of transferring wealth from creditors to debtors and "sowing the seeds for more serious problems further ahead."

The world waits to see what Ben Bernanke will do to "clean up" after Alan Greenspan.