Translate

9/28/11

Good time to sell oil futures

In May 2011, we predicted oil (WTI) price to fall to the level of $70 per barrel by the end of 2011. This is a monthly revision for September 2011. We consider the average oil price of $84 per barrel what is equivalent to the producer price index of 244 in September. (Actual estimate will be published by the Bureau of Labor Statistics in the middle of October.)


Figure 1 compares our prediction with actual oil price in 2011. In August 2011, the predicted price is a bit higher than the measured one. In any case, we expect the price to fall by approximately $5 per month to the level of ~$70 in December 2011. We also expect the price to slowly fall through 2016 and put the uncertainty bounds for the long-term trend in oil price. The level of oil price in 2016 is between $30 and $60 per barrel. These bounds are also shown in Figure 1.

A week ago, when oil price was at ~$79 per barrel, we recommended buying oil futures. The intuition behind this idea was that $79 is approximately $5 below the expected price for September. This is a disequilibrium which should be recovered in the short run. Today, oil price is at the level of ~84. This is the equilibrium level for September. A small hike in oil price is possible during the next few days. However, at a two-week horizon, oil price should fall again. Therefore, I recommend selling now and buying in approximately two weeks or when the price will be around $75. It will grow to the level of ~$82 to $85 in October or November.
Figure 1. Oil price prediction in 2011. The price is expected to fall by $5 per month between June and December 2011. The price level is ~$70 in December 2011. We also show the range of expected price evolution by 2016.

Paul Krugman on the progress of economics

I avoide re-posting any other author in this blog. However, this post (see below in red) from Paul Krugman  deserves to be reposted one-to-one becasue I agree with many of his statements on macroeconomics. At the same time, Paul needs to make a step ahead and to look at the principal problem of macroeconomics as a science  - the absence of quantitative justification and the direct rejection of empirical proof as the tool of the macroeconomics progress. When one cannot measure the progress of a science in quantitative terms - this progress cannot be seen.  Hence, economics has to open itself for a criticism from the broader scientific society before it becomes a second rate sect, which is very close to be the truth

Does Economics Still Progress?



In a few hours Sylvia Nasar and I will have an on-stage dialogue at the 92nd Street Y, centered around her new book The Grand Pursuit, which offers a set of fascinating portraits of the makers of economics. (Irving Fisher invented the Rolodex?) But as I was reading her book I have to admit that I found myself wondering whether there’s much to celebrate.



I’ve never liked the notion of talking about economic “science” — it’s much too raw and imperfect a discipline to be paired casually with things like chemistry or biology, and in general when someone talks about economics as a science I immediately suspect that I’m hearing someone who doesn’t know that models are only models. Still, when I was younger I firmly believed that economics was a field that progressed over time, that every generation knew more than the generation before.



The question now is whether that’s still true. In 1971 it was clear that economists knew a lot that they hadn’t known in 1931. Is that clear when we compare 2011 with 1971? I think you can actually make the case that in important ways the profession knew more in 1971 than it does now.



I’ve written a lot about the Dark Age of macroeconomics, of the way economists are recapitulating 80-year-old fallacies in the belief that they’re profound insights, because they’re ignorant of the hard-won insights of the past.



What I’d add to that is that at this point it seems to me that many economists aren’t even trying to get at the truth. When I look at a lot of what prominent economists have been writing in response to the ongoing economic crisis, I see no sign of intellectual discomfort, no sense that a disaster their models made no allowance for is troubling them; I see only blithe invention of stories to rationalize the disaster in a way that supports their side of the partisan divide. And no, it’s not symmetric: liberal economists by and large do seem to be genuinely wrestling with what has happened, but conservative economists don’t.



And all this makes me wonder what kind of an enterprise I’ve devoted my life to.

9/22/11

Time to buy oil futures

Several day ago I showed that oil price had fallen below expectation in August. Today oil price has been falling since the very morning  and now  is approaching $80 per barrel. We predicted $70 in December 2011.  Thus, oil price has to grow again and it's good time to buy futures.

9/18/11

Scientists, experts and lay public

Blogger Sean on Discover Magazine compares various types of experts.  Specifically, he answers the question why people trust opinion of experts in physics and do not trust economists.

This is a simple question if to separate firm scientific knowledge and scientific hypothesis.  People do trust well established physical knowledge like mechanics, and thus, they trust physicists in every day activity. For example, aircrafts, ships, satellites, buildings in seismic zones, TV, mobile telephony, etc. is the materialized scientific knowledge. It is beyond discussion of experts and lay public that numerous physical laws deserve absolute trust. (Imagine an expert discussion on the impossibility of mobile telephony as based on the absence of electro-magnetic waves. A hundred and fifty years ago such a discussion would be absolutely reasonable.)   All these physics (or scientific in a broader notation) laws are almost fully justified by laboratory experiments and other types of measurements. Because these laws are now an indispensible part of every day life people forget that this was and is the essence of scientific knowledge. 

However, there are scientific topics which have no reliable scientific solutions (yet or forever) and are characterized by a higher uncertainty in both theories and experiments. In my view, these new horizons in the hard sciences, which are formulated as hypothesis, should not be presented for the broader audience (lay public) as robust scientific knowledge. They do not have robust solutions or materializations yet. When positioned as well established scientific knowledge these hypothesis ignite severe discussion between experts and lay public. They use the uncertainty gaps in experimental justification and put forward own interpretations with various applications in real life.

I would treat “global warming” (as induced by human activity) as one of such hypothesis which should be better experimentally justified. There are so many gaps in  the estimates of major sinks and sources of greenhouse gases that the relative inputs in the final balance is not clear yet. Notice, I do not say that this hypothesis is not scientifically void. I just say that a Nobel Prize for it was a premature and political decision which has changed the terms of the scientific discussion.    

Now we come to economics and economic experts. It is well known that economics (I do not include finances, business, etc.) is a science without experimental or observational justification. When one judges by the prediction of large scale outcomes like recessions economics does not show any result at all. (Many economists are proud of that, however.) It is in drastic contrast to the predictions of the hard sciences - we foresee that our airplane will land with a very high probability in line with actions of many physical laws, staring with Bernoulli one, which creates the lifting force. Otherwise we would never use the plane.  Here the term “economic experts” comes. These are people who discuss measured macroeconomic values without any quantitative justification.  That’s why I do not like the term “expert” as applied to physicists. When I hear it I usually see a round table with several economic experts discussing a problem without any solution in scientific terms. As a rule, they can explain any process or phenomena with the same words and arguments they used to explain the opposite process and phenomena two years ago. For me its enough to decide that they are worth nothing together with their words. Economic experts use a very limited agrument base to explain everything.

In turn, the possibility to explain everything attracts the lay public. People like the illusion of understanding. In many economic blogs one can observe how readers repeat the arguments from economic experts without understanding that these experts have explained nothing. Emotionally, it is better to trust experts than scientists, who usuall do not have ready answers to all questions.

As a remark. Some physicists propose a scientific revolution in economics (Bouchaud, J.-P., (2008). Economics needs scientific revolution, Nature, v.455, 30 October 2008). I would start with a simple data analysis in line with classical mechanics (Ivan O. Kitov, 2009. “Does economics need a scientific revolution?, Quantitative Finance Papers 0904.0729, arXiv.org). Actually, economic data do not match even basic requirements of physics. They are usually incompatible over time. One needs lots of efforts to recover major time series like inflation, GDP per capita, rate of unemployment, etc. (http://mechonomic.blogspot.com/).

Therefore, a researcher in the hard sciences is hardly an expert explaining all observations and usually knows what s/he knows and what s/he does not know. The latter is the matter to investigate. When a researcher works as an expert and brings to the unprepared audience (almost any place except specialed seminars, workshops, conferences, etc.) some hypothesis with a large uncertainty it usually has a negative result. At best, nobody understands and forgets.
The worst case, politicians use one of many possibilities under the higher uncertainty for their dirty profit. As an example, I recall a long discussion in the USSR about the necessity to turn nothern rivers to the Caspian sea, which had been losing water and thus area before the 1970s. The reason is clear – money and resources, i.e. power, and this project was supported by many (specially selected) experts who forecasted the sea to disapper according to their linear models. The Soviet government was ready to start. In terms of long term observations, for an inner lake oscillations is a natural regime (as was argued by many scientists, chiefly, physicists) and the Caspian sea has been growing since the 1970s and has already inundated many small villages. The conclusion - do not give any chance to politicians to use your knowledge in their interests. In other words, do not be “experts”.

In reality, it was not the strong scientific opinion but the disintegration of the Soviet Union that stopped the project. Nobody is able to stop the greater political project “global warming”.

9/13/11

On the evolution of age dependent mean income

I published a dozen papers on personal income distribution between 2003 and 2009. One of the principal topics was the evolution of the mean (median) income and its dependence on age. Specifically,  I have shown that the age of largest mean income increases proportionally to the square root from real GDP per capita. (Actually, the mean income was used instead of GDP per capita because the Census Bureau does not include several important sources in the Current Population Surveys. See Figure 1 for differences.) Using this link I have also predicted that this peak mean income will enter the age group between 55 and 64 years after 2015.  Before 1975, the peak mean income was in the age group between 35 and 44 years. Figure 2 presents the mean incomes in various age groups as normalized to the largest mean income in a given year.  
According to Figure 1, the growth in the mean income practically stopped in 2000 and the real GDP per capita has returned to 2004. Accordingly, the growth in the age of the largest mean income also effectively stopped in 2004. Since we do not expect fast economic growth in the 2010s, the age of peak mean income may move in the 55 to 64 year group around 2020.
This observation is a crucial one for our model of personal income distribution. It is the only model which ties the age dependent income distribution with the level of real GDP per capita. Slow economic growth is equivalent to slow evolution of personal income distribution. At the same time, the age dependent personal income distribution does not depend on other factors: calendar time, education, human capital, taxes, interest rate, etc.  
Figure 1. Real GDP per capita (measured in chained 2009 $) and mean income ( in 2010 $) between 1967 and 2010. The mean income is related only to people with income (211,000,000 in 2010) and the GDP per capita is calculated for the whole population.
Figure 2. Mean incomes in various age groups (“20” corresponds to the ages between 15 and 24, and so on) normalized to the largest mean income for a given year. For example, the largest mean income in 2010 belongs to the age group between 45 and 54 years and thus the normalized mean income is 1.0 for this group.

9/11/11

Mankiw on business investment as the driver of economic growth

Greg Mankiw proposed to reduce corporate taxes in order to accelerate real economic growth, both in the short- and long-run. It is only one of many remedies proposed by macroeconomists. They do have a big problem to give not a silly recommendation based on macroeconomic analysis. But they cannot because of the inherent equilibrium state presumed by macroeconomic models. In short, this equilibrium implies that no internal force can make any change beyond the synchronized evolution of the system itself. Because these internal (economists call them endogenous) forces are well balanced they produce a very smooth growth trajectory. The only explanation of all large fluctuations around the average growth rate given by various schools of macro so far can be reduced to shocks to demand or supply, with these shocks having unknown origin. This is the feature of macroeconomics which makes it soft and worthless for quantitative forecasts. (See Krugman for the failure of the economic profession.) Economists do not really know what drives real economic growth and all their models are superficial in terms of quantities. (As a rule, economists consider the absence of empirical justification as a strong side of their theories and are proud of that. It works well before the next recession.)  
The corporate taxes are external to the nature these shocks. In other words it is not shown that the change in these taxes affects real economic growth.  If to neglect the theoretical impotence of this proposal (again, there is no proof that the tax reduction works in reality and will not be just waste of resources) one can make a thought experiment. Imagine that it works. Then, any reduction to the corporate taxes, as based on the macroeconomic grounds, would induce a positive feed-back and thus several iterations before these taxes fall to zero. This is simple induction – the reduction, supposedly (because there is no quantitative proof), helps – business needs lower taxes. What then? The government will need to make the taxes negative? 
What to do then?  According to our model, the US economy will struggle through the 2010s with the average rate of real GDP per capita growth below 2%. This implies the rate of unemployment near 9%. The slow growth will be accompanied by slight deflation. This situation has been observed in Japan since 1997 and is not too bad for the economy. The US should just be ready to redistribute the overall income in a way to support the poorest groups of population. This does not imply the corporate tax reduction any time soon.

9/10/11

Gold is the only option in the choiceless situation

The gold price phenomenon is in the centre of the current financial and economic turbulence. The role of gold is a miracle for economic and financial gurus who speculate around without any success to explain is in any useful terms. Gold stays above any economic activity and free market rules since it is not really connected to production and consumption. It also cannot play the role of value saving.  Nobody can say why it is growing and when it will start to (free) fall. There is no doubt that the latter event will happen sooner or later.   
Gold is not a normal product or asset. It plays a psychological role inherited from its “golden” past.   I would call the gold rally as the only option in the choiceless situation when everything else is worse. 
Some experts say that gold is a new bubble. In my opinion, it’s right in some sense. However, this bubble, as might be with the previous one, is a game for smart investors who can quickly withdraw money from this Panama affair (remember what happened in 1979-1980). Thus, I would recommend not joining if one cannot withdraw money momentarily when the price will start to fall.

9/9/11

Bernanke on inflation

Our prediction for the 2010s is very low and negative inflation. It has come to Ben as well.

Chairman Ben S. Bernanke  on inflation.

The Outlook for Inflation
Let me turn now from the outlook for growth to the outlook for inflation. Prices of many commodities, notably oil, increased sharply earlier this year. Higher gasoline and food prices translated directly into increased inflation for consumers, and in some cases producers of other goods and services were able to pass through their higher costs to their customers as well. In addition, the global supply disruptions associated with the disaster in Japan put upward pressure on motor vehicle prices. As a result of these influences, inflation picked up significantly; over the first half of this year, the price index for personal consumption expenditures rose at an annual rate of about 3-1/2 percent, compared with an average of less than 1-1/2 percent over the preceding two years.

However, inflation is expected to moderate in the coming quarters as these transitory influences wane. In particular, the prices of oil and many other commodities have either leveled off or have come down from their highs. Meanwhile, the step-up in automobile production should reduce pressure on car prices. Importantly, we see little indication that the higher rate of inflation experienced so far this year has become ingrained in the economy. Longer-term inflation expectations have remained stable according to the indicators we monitor, such as the measure of households' longer-term expectations from the Thompson Reuters/University of Michigan survey, the 10-year inflation projections of professional forecasters, and the five-year-forward measure of inflation compensation derived from yields of inflation-protected Treasury securities. In addition to the stability of longer-term inflation expectations, the substantial amount of resource slack that exists in U.S. labor and product markets should continue to have a moderating influence on inflationary pressures. Notably, because of ongoing weakness in labor demand over the course of the recovery, nominal wage increases have been roughly offset by productivity gains, leaving the level of unit labor costs close to where it had stood at the onset of the recession. Given the large share of labor costs in the production costs of most firms, subdued unit labor costs should be an important restraining influence on inflation.



Krugman on the profession. The reasons economists have failed

Paul Krugman wrote a relatively short article on the economic profession and crisis. The reader can find it here. There is no big difference with many other economists’ claims on the reason behind the overall failure to describe the current crisis. The profession has problems in “social dynamics” and thus should listen Paul and follow his ideas up. The profession needs consolidation around some “right” ideas and “wrong” idea must be avoided.

There is only one good sentence in this paper
“All of this would have been OK if the triumph of anti-Keynesianism was justified by superior empirical success. “

This requirement of the empirical justification must be applied to the profession as a whole. Economics as a profession needs a measurable accountability. Otherwise, there is no rule how to justify and select between various models and predictions. Unfortunately, the economic profession defends its quantitative unaccountability fiercely. As a consequence, economists will fail again, and again, and again … One can bet the failure without any risk.

9/6/11

On some methodical mistakes in the presentation of income inequality

Uwe Reinhardt onEconomix has posted on economic inequality. He presented Figure 1 illustrating the growth in income inequality in the U.S. since 1975. (All original data were taken from the Economic Report of the President to the Congress. These data sets are provided by the US Census Bureau (CB) and the Bureau of Economic Analysis (BEA).)  

Figure 1. 
So, Figure 1 has to prove that the income distribution in the US has been experiencing significant changes since 1975 and the level of economic inequality has increased dramatically.  The problem is that Figure 1, containing the change in real GDP per capita (borrowed from BEA) and the evolution of real median household income (borrowed from CB), does not prove any change in inequality. There are two mistakes. First, one should not mix household and personal incomes in one plot. The structure of households in the US is subject to severe changes. At the same time, real GDP per capita can is related to the smallest possible economic agent and is not subject to changes in structure. Secondly, the deviation between median income and real GDP per capita results not from the change in income inequality but from real economic growth. We demonstrate both effects below.
Figure 2 displays the evolution mean and median personal and household incomes and that of real GDP per capita as reported by the US Census Bureau. One can see that mean and median incomes for both persons and households do deviate since 1975. It is a crucial fact that all data sets in Figure 2, except GDP, are taken from the same source – the Current Population Surveys Annual Social and Economic Supplements conducted every March.  All variables are measured together during the same surveys from the same households. Figure 3 depicts the corresponding estimates of Gini ratio for both personal and household income distribution. It is clear that the personal Gini ratio has been decreasing since 1994 (no CB’s estimates before 1994), while the household Gini ratio has been experiencing a steady growth. Hence, the deviation between mean and median income does not necessarily proves the growth in economic inequality, at least as expressed by the Gini ratio.
Figure 2. The evolution of mean and median personal and household incomes and that of real GDP per capita, all normalized to 1975.
Figure 3. Gini ratio for personal and household income distributions. 
The difference in Gini ratios in Figure 3 also demonstrates the changes in the structure of households.  The distribution of personal incomes practically does not change over time with the Gini ratio slightly falling since 1994. The corresponding households, which consist of the same persons as used in the personal income distribution, does experience tangible changes as expressed by the growth in income inequality. Thus, one must never use real GDP per capita and real median household income in the same plot. These variables are different by nature and their comparison is intrinsically biased.
In turn, the deviation between median personal income and real GDP per capita in Figure 2 does not imply any inequality change, as least as measured by the US Census Bureau.  The mean personal income can be a good proxy to the real GDP per capita. Figure 4 shows the ratio of the GDP per capita and the mean income. This ratio also depends on the difference between the total population used for the GDP per capita estimates and the people with income used for the mean income estimates.
Figure 4. Per capita GDP divided by the mean personal income in Figure 2.  

9/5/11

Oil price in August


In May 2011, we predicted oil (WTI) price to fall to the level of $70 per barrel by the end of 2011.  This is a monthly revision for August 2011. We consider the average oil price of $86 per barrel what is equivalent to the producer price index of 240 in August.  (Actual estimate will be published by the Bureau of Labor Statistics in the middle of September.)
Figure 1 compares our prediction with actual oil price in 2011. In August 2011, the predicted price is a bit higher than the predicted one. However, we still expect the price to fall by approximately $6 per month to the level of ~$70 in December 2011. We also expect the price to slowly fall through 2016 and put the uncertainty bounds for the long-term trend in oil price. The level of oil price in 2016 is between $30 and $60 per barrel. 

Figure 1. Oil price prediction in 2011. The price is expected to fall by $6 per month between June and December 2011. The price level is ~$70 in December 2011. We also show the range of expected price evolution by 2016.

9/4/11

The war in Iraq and the period of volatility


The causality principle does not imply “after means caused” and we do not consider the war in Iraq as the cause of economic volatility in the U.S. and world wide. At the same time, the war in Iraq was the first big war for resources after the USSR disintegration. In 2003, the level of volatility in resource prices jumped and has been very high since then. We illustrate this jump in several figures below.  We present the evolution of relative producer prices, pi, of selected commodities, iPPI. In order to remove the base effect we calculate the deviation from the overall PPI, PPI, and normalize it to the PPI:

pi(t)= (PPI-iPPI)/PPI

where i corresponds to iron&steel, gold ores, crude petroleum (US domestic production). 
A higher volatility is not a surprise for the market but since 2004 is has a coherent driving force behind all commodities. It seems that this force is not an economic one but includes a strong component of new political (military) balance. Libya might be the most recent example.

Cui prodest? Might be speculators but not honest investors and general public.