The human mind loves linear extrapolation over time. We build 5-year plans. Graphically, five-year plans look like hockey sticks: first, slow and minuscule income, revenue growth in the first year, and then spectacular growth by the fifth year. I have sat through a dizzying number of presentations for start up businesses which rarely, if ever, achieve their predicted spectacular growth. For every Apple or Google there is a Pets.com and bankruptcy. However, hope springs eternal.
Rosy Scenario and Her Evil Twin
Investment analysts, CEOs and government officials constantly project questionable positivity. Prosperity is always around the corner, green shoots of recovery are everywhere, and a chicken will appear in every pot. We pillory realistic if negative analysts as pessimistic naysayers, prophets of doom or worse. But we ignore reality at our peril. More often than not Rosy Scenario often clashes with her evil twin Dashed Expectation. The results are often calamitous.
Ignoring Reality
The last decade has brought ignoring reality to a high art form. Linear extrapolation has brought the following prophesies:
- Dow 36,000
- Internet businesses with no customers and unrealistic business plans worth several times the value of established companies (IBM, DuPont)
- Ever-rising housing prices
- The FIRE economy (Financial, Insurance, Real Estate) supporting the entire American economy
- Sustained non-problematic leverage ratios of 30 and 40:1
- Debt growth several standard deviations greater than GDP
- Counterparties to derivative contracts always making good
- Never defaulting on sovereign debt
- Pension fund assets always earning between 7-9%
- Federal debt growing faster than tax receipts
- Public sector wages growing faster than GDP and tax receipts
- Aggressive accounting (Enron, Lehman) considered good financial engineering
- Zero interest rates restoring economic prosperity.
Past is Not Always Prologue
We are prisoners of our past experiences. We expect the Federal Reserve to cut interest rates and the economy to magically recover. We are surprised when the nominal unemployment rate is at 9.7% and the actual is 17%. We are surprised when Wall Street bonuses soar and Main Street suffers. We are surprised when Moody’s threatens to downgrade US debt from AAA rating. See Moody’s Says U.S. Debt Could Test Triple-A Rating
Rarely do we say that this time is different. As a society, we have incurred debt far exceeding our capacity to repay. Balance sheet recessions/depressions are far worse than previous inventory recessions. Just as the Vietnamese fooled our World War II trained generals, the Federal Reserve and Administration are intent on fighting an outdated economic war.
It is time for some nonlinear thinking. Instead of posturing, Congress should be asking Ben Bernanke for a Plan B. Averting financial Armageddon is not enough. JP Morgan CEO, Jamie Dimon, projected a banking crisis every five to seven years. See Elizabeth Warren Exposes Jamie Dimon. As a society we can ill afford another year like 2008. Reality is gaining on us.
How well did the five-year plans work out for the brittle Soviet system? Is it time to ditch Rosy Scenario and deal with reality?
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