Thursday, December 30, 2010

Long Term Forecasts: Often Wrong, Never in Doubt

Think back to the middle years of the "Japanese Economic Miracle." American consumers were buying Japanese-made cars by the millions, first made in Japan, then made in Fremont and Marysville. Japanese banks were getting into equity research and investment banking. Japanese companies were buying trophy American real estate, like Rockefeller Center. We were all going to work for Japan, Inc. That forecast was outrun by reality.

The Japanese auto industry made its mark, and it made some smart moves by taking minority stakes in future manufacturing leaders like Hyundai. Eventually, however, companies like Toyota got too big and lost their way. They are entering the inevitable adjustment period. Japanese investment banks lost hundreds of millions of dollars, and they never took their places at the table of the Wall Street elite. Much of the real estate was bought at the absolute top of the market, and the buyers got whipsawed into selling near the bottom. Global economics and currencies forced adjustments that destroyed any myths about Japan, Inc. Political, social and demographic issues, forgotten by most quantitative forecasters, led to a Lost Decade.

Fast forward to the current forecasts about the Chinese economic juggernaut. The capitalist enterprise in China is growing up in a Wild West atmosphere, unfettered by economic, financial, legal or environmental regulation. Our western gold rush eventually turned into fools gold. We see occasional reports about homeless Chinese construction workers building Olympic venues, major health and pollution problems in the countryside, a forgotten prison population, and a central government that blithely believes it will forever keep the genie of political and social change in the lamp.

Martin Feldstein, not usually optimistic about economic trends, writes about self-corrective, economic mechanisms at work in adjusting the global savings-investment imbalance. He believes that we will see an increase in both U.S. private and government savings, the latter being driven by increased fiscal responsibility in future budgets. Feldstein also sees rising Chinese consumption, both public and private, driven by both income effects and by a real appreciation of the renminbi, which he estimates is already rising at a nine percent annual rate.

He estimates that a potential rise in the US savings rate to 7 percent of GDP, which after absorbing some of this to increasing fixed investment, would leave enough to reduce the current account deficit to about 1 percent of GDP without any large government regulatory changes. He could very well be overly optimistic, but it doesn't seem unreasonable.

If we as a nation were to to invest in rebuilding our manufacturing base into an efficient machine by global standards, and improve the productivity and training of our work force, then we could reap significant benefit from these medium to long-term adjustments. Forget those long-term forecasts, and Happy New Year!

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