You get a lot of attention if you shout out things like “The stock market
is about to collapse”, or “The US dollar crash is just around the corner”, or
“The housing market slump is about to unfold”. But from the viewpoint of
sound economics, making these kinds of predictions is quite impossible.
Putting probabilities to certain outcomes – such as "I assign a
probability of 30 per cent that the stock market collapses in 2018" –
might be fashionable among forecasters, but it certainly does not do the
trick or make things any better.
Some Can
To be sure: One cannot, and should not, dismiss the idea that there might
be people out there who have the ability to forecast events happening in the
future correctly on a sustained basis. For instance, a successful
entrepreneur belongs to this very group. He or she comes up with products
people want to buy going forward, and they sell these products at prices
which exceed production costs. They are also in a position to forecast
changes in consumer demand and adjust their output accordingly.
Also, there are successful stock market investors, who stand out with many
years of outperformance compared to their competitors. To be consistently
better than the market, they must see and know something others do not see or
know, and take action accordingly. For instance, they must detect undervalued
stocks, and reap a decent profit when the market pushes stock prices towards
their intrinsic value. They successfully invest at the right time in the
"right" shares, which deliver outperformance over time.
Successful entrepreneurs and investors must have what it takes – the
vision, courage, business acumen, or whatever it might be – to get the future
right. That does not mean that they will not make forecast errors. But for
some reason, their forecast errors turn out to be less devastating than those
of the majority of the people. One thing is certain, though: Successful
entrepreneurs and investors do not base their forecasts on the idea
that economics would put you in a position to make correct predictions. Why
is this so?
Most Cannot
Economics is not a science that provides you with the means for
forecasting the future. As Ludwig von Mises puts it: “This is not to say
that future human actions are utterly unpredictable. They can, in a certain
way, be anticipated to some extent. But the methods applied in such
anticipations, and their scope, are logically and epistemologically entirely
different from those applied in anticipating natural events, and from their
scope.
Mises' statement might require some further explanation.
Rightly understood, economics is the science of human action, or, to be
more precise, economics is about the logic of human action. Its “Archimedean
Point” is the irrefutably true statement that “humans act”. The latter cannot
be denied without causing a logical contradiction. If you argue “humans
cannot act”, you act, and you would thus contradict your own statement. From
the self-evidently true statement “humans act” we can deduce, or unfold,
further true statements.
To give some examples: Human action, which is always the action of an
individual, is purposeful; action requires means to attain goals; means are
scarce; human action presupposes the category of means and ends, that is
causality; time is an indispensable means for action; human action implies
time preference and thus the originary interest rate (and both are positive,
they cannot be zero, let alone be negative); the law of marginal utility is
also logically implied in the statement “humans act”.
These (and other) statements are logically implied in the proposition that
"humans act". Any economic theory that contradicts the implications
of the concept of human action must raise serious doubts as to its truth
value. For instance, an economic theory in which human action does not take
time, or in which human action is not constrained by definite time preference
and a positive originary interest rate, can be dismissed as being logically
false (as unrealistic, as unworldly madness).
The Role of Ideas
The irrefutably true knowledge that humans act implies that ideas (or
theories) make humans act. And ideas are the ultimate given in the
explanation of human action; they cannot be traced further back to other
explanatory factors. This we cannot deny. Denying it would assume the existence of
external (physiological, biological, chemical) factors which systematically
explain human actions. However, science has so far failed to come up with a
definite relation between external factors and human action.
In fact, there is a logical reason why such a relation cannot be
discovered: Man undeniably has learning ability, meaning he can
learn. Arguing “Man cannot learn” presupposes that
man can learn; otherwise one wouldn’t say anything to someone else; assuming
the contrary would amount to a performative contradiction. And arguing that
“Man can learn not to learn” runs into an outright logical contradiction. As
we cannot reject the notion that humans have learning ability, we can
understand why we cannot know the future of our actions.
For if we assume that we know today how humans will act in the future, we
would say that we have not only sufficient knowledge about natural phenomena
but also know humans’ future choices, preferences and value scales in the
future. The latter, however, would imply the denial of learning ability:
Knowing today how humans act in the future would contradict the logically
true statement that humans have learning ability – for we would know today
all things happening in the future – but this is a logical contradiction and
thus false.
Forecasting Impossible
It is now easy to also understand why there cannot be any constant
relation between external factors and human action – in the sense that
if the factor X occurs, humans will take certain action, and the
result will always be Y. From experience, we know that different
people, in response to given stimuli, often act differently at different
points in time. But experience does not prove anything. Luckily, we do not
have to take recourse to experience to know that there are no quantitative
regularities in human action.
The reason why there are no such behavior constants is a logical one: If
the external factor X causes certain action (in the sense of “if X,
then Y”, or “if X goes up by 10 per cent, then Y
will decline by 5 per cent”), we would be in a position to forecast today
human action in the future (in quantitative terms) – and again, we would
thereby contradict the logical conclusion that humans have learning ability:
If we know today how we will act in the future, we have to assume that we
cannot, and do not, learn along the way.
Now we have come full circle. Economics – if and when rightfully
understood as the logic of human action – does not, and cannot, provide you
with insights predicting future human action. Any attempt to use economics
for making predictions runs counter to logic and is thus bound to fail. This
by no means suggests that economics is a trivial undertaking. On the
contrary! What economics can do is outline (with absolute certainty) the qualitative
results of human action taking place under certain conditions and
circumstances.
For instance, economics tells you with apodictic certainty that if people
engage in voluntary exchange, all parties will benefit; or if the central
bank increases the quantity of money, the purchasing power of the money unit
declines (compared with a scenario in which the quantity of money had
remained unchanged); or that a rise in the quantity of money in the economy
will never be “neutral” as far as peoples’ income and wealth positions are
concerned, it will always benefit some at the expense of others.
Entrepreneurial Competence
The vast majority of economists these days is, however, heavily engaged in
the business of forecasting. They try to forecast where, say, interest rates,
stock prices, exchange rates will stand in 3, 6, 12 months, or even farther
out. And there is demand for such forecasts: A great number of investors is
eager to listen what these forecasting economists have to say about the
future, and quite a few investors take the economists’ forecasts seriously,
namely as input for their investment decisions.
From what we have outlined earlier, however, we can know for sure that
“mainstream” economists will fail in the effort to forecast the future and
that a significant number of investors will get disappointed: Economics as a
science cannot predict how humans will act, it cannot quantitatively forecast
how economic magnitudes will develop. Such predictions are, and for logical
reasons, beyond the reach of economics. One should not be misled about this
fact by elaborated mathematical models and highly sophisticated econometric
techniques.
The truth is that any economist who thinks that the science of economics
is about forecasting is disoriented. His or her advice will not help
you make wise investment decisions. So what should you do if you are
concerned about a looming stock market crash? The answer is pretty
straightforward. If you think you cannot be better than rest of the
pack, invest in a broadly defined stock market index (or certificate) and
stick to it. Because if you cannot outperform, there is simply no point in
engaging in any crash forecasting.
Alternatively, you could turn to consistently successful entrepreneurs and
investors for seeking advice. Perhaps they would tell you not to waste any
time on forecasting a stock market crash – for no one knows how people will
react in the future. Successful businesspeople and investors might come up
with a rather different recommendation: namely, put your money in great businesses,
purchased at a decent price, and stick to it, whatever may come. Over time,
you will be doing better than those thinking they could forecast the crash.
Be that as it may, economics teaches us about the laws of human action,
but it does not provide insights about how people will behave in the future,
how human beings will quantitatively respond to certain factors. Economics is
not a forecasting science, it is a reconstructing science: It allows
us to understand, from the starting point of the irrefutably true statement
that humans act, the qualitative consequences if humans act under certain
conditions which, however, are often uncertain from the present point of
view.
Murray N. Rothbard credits this solid, logically grounded and, as far as
practical matters are concerned, most crucial insight to Ludwig von Mises:
“It is above all Ludwig von Mises who recognizes the freedom, of mind and
choice, at the irreducible heart of the human condition, and who realizes
therefore that the scientific urge to determinism and complete predictability
is a search for the impossible—and is therefore profoundly unscientific.”
