Friday, October 2, 2009

Has Stefan Karlsson Become a Pack Dog?

Sweden's Stefan Karlsson could be a pretty solid economist. From what I have read of his work, he understands the business cycle. But unfortunately, he is afraid to pull the trigger when theory tells him he should. Instead, he has become a pack dog trend follower, which means that at best he will be in the early part of the pack in forecasting, but still part of the pack, nothing more.

He knows the money supply is contracting and that it has for months, see his September 4 comments. That should be enough for him to pull the trigger on forecasting a double dip, IF he really believes in the Austrian economics that he identifies with. Afterall, the theory states that an economy is distorted when central bank money is printed. The money distorts the economy in favor of wherever the Fed directs the money. If the money printing stops, the distortions begin to reverse and thus the downturn--which is really an adjustment process to a non-central bank distorted economy. That's really all you need to forecast the business cycle.

Economic data from there only tells us which sectors are likely to be in greatest reversal, and a bit about the timing of the reversal. But to just look at data without tying it to a theory, will never get you out in front of the pack, and certainly does nothing to enlighten as to why the cycle occurs in the first place. Or when it will end, if say, the Fed starts printing again.

Thus, it is quite surprising that Karlsson has twice recently looked to data to determine if a double dip is about to occur, without any reference to theory. If you read his posts he has simply become a member in good standing of the always late trend followers.

For example on September 28, he wrote:

How sustainable is the U.S economic recovery? Before I make a more definite statement on the subject, I'll have to look at the data released later this week. But given what we know now, it appears to be very weak and vulnerable.

First of all, the durable goods order report indicated weakening investment demand, considering both the negative monthly change and the downward revision of previous numbers.

Secondly, the Chicago Fed National Activity Index showed continued contraction in August.

And both the existing and new home sales reports were disappointing.

The one positive report was the retail sales number which showed strong growth. Because of that, it is highely likely that notwithstanding the above numbers, GDP growth was positive in Q3 2009-at least compared to the previous quarter and not adjusting for terms of trade effects.

However, that gain was largely built on people taking advantage of the "cash for clunkers"-scheme. But since that is a temporary scheme, there will likely be a hangover in the form of lower sales later.

In short, current data suggests that the risk of a "double dip" recession is very high.
What happened to the business cycle theory he claims to understand? Why is he just looking at economic data, without reference to money supply?

He did this again, yesterday:

Probability Of A Double Dip Increases

A few days ago I listed a few reasons to believe that at least in America, we will see a so-called "double-dip recession".

Most data since then have supported that case.

Data from the housing sector have been relatively bullish, with house prices, pending home sales and residential construction all increasing after years of decline. Given the fact that the housing sector is particularly cyclical, this is an argument for the bullish case.

However, housing has not always been very useful as a leading indicator, and particularly not during the latest decade. During the 2001 recession, it didn't contract at all, and while housing did contract before the 2007-09 recession started, it started to contract as early as late 2005 and early 2006, almost two years before the overall economy started to contract. This means that even if housing has bottomed, it could take a long time before the overall economy recovers in a significant and sustainable way.

Just about all other news about the economy have at the same time been negative:

-The ISM Manufacturing index fell back.
-Non-residential construction continued to drop.
-Car sales fell dramatically.
-Real disposable income, both excluding and including the effects of transfer payments and taxes, continues to decline.
-Jobless claims increased.
-The ADP survey showed continued private sector job losses.
-After having increased in the previous weeks after previous big declines, money supply dropped again.

Clearly, the numbers suggests a renewed downturn in all sectors except housing, something which in turn most likely means a renewed overall downturn.

Tomorrow's employment report may perhaps settle the case, or if it is unexpectedly strong increase uncertainty. Remember however, that contrary to what most financial journalists suggests, the most important number from a macroeconomic perspective is neither the unemployment rate nor the change in payrolls. The most important number will instead be something which is not formally presented, but which can be easily calculated using other numbers. The most important number is aggregate labor income. That is a function of two other numbers presented: namely the number of payrolls and average weekly earnings. The latter is in turn a function of two factors: average work week and average hourly earnings.

There isn't a bad economist alive, including some of the worst like Krugman and Mankiw, that don't look at this same data to forecast the economy. But they have an excuse, they don't understand business cycle theory, Karlsson does. Economic data only tells us what is going on at the moment, not where the economy is headed. Karlsson should know this. When I look at data, it is to see if it confirms what I have already forecast, not the other way around.

Karlsson should know this. I think he just doesn't have the balls to follow through on what he knows. He has thus become simply another member of the data dog pack.


  1. Wow! While I am an admirer of Martin Zeig, a successful investor who's most enduring advice was "don't fight the FED", I am stunned by your single-minded tenacity to predict a double-dip recession. You have reduced the world economy to a single variable (money manipulation) by a single institution (U.S. Federal Reserve)and are convinced that this and this alone is enough to confidently predict a double dip. Even the great Von Mises acknowledged that the Austrian Business Cycle theory could not be used for specific predictions but only a general understanding of cause and effect. After all there are millions of decisions by tens of millions of people in a feedback loop called the economy generating action and reaction ad infinitum. And only a fraction of this action is ever reflected in empirical data. So what makes you so sure??

  2. Sorry about the typo, that was supposed to be Martin Zweig, who is the author of "Winning on Wall Steet."

  3. You have reduced the world economy to a single variable (money manipulation) by a single institution (U.S. Federal Reserve)and are convinced that this and this alone is enough to confidently predict a double dip.

    I haven't reduced the entire economy to one variable, simply the business cycle, granted the bussiness cycle may be intensified and diluted by other factors, but the business cycle itself is simply the result of central bank money manipulations. What other factor(s) do you suggest, causes the business cyclw?