23. The Plight of Business Forecasting

People by and large know today that a boom brought forth by a policy of credit expansion and “easy money” cannot last forever and must sooner or later lead to a slump. They do not want to be taken by surprise and ruined. They are anxious to learn in time when the turning point will come because they plan to arrange their affairs early enough so as not to be hurt by, or even to profit from, the crash. As they believe that economics is the art of predicting tomorrow’s business conditions, they consult the economists.

“How will business be in the coming months?” asks the newspaperman when interviewing the economist. No convention of businessmen is held without the solicited presence of a professor of economics, or the head of a bank’s research department, who in guarded language produces a cautiously qualified prediction about the nation’s, or the world’s business. Whenever and wherever a businessman catches sight of an economist, he tries to sound him out about the future state of the market.

What Brings About the Slump

Economics explains the phenomenon of the trade cycle (i.e., the repeated emergence of periods of unusually good business that are invariably followed after some time by a reversal into unusually bad business) as the necessary effect of the attempts to manipulate the rate of interest. Governments and political parties are committed to the idea that it is good policy to lower the rate of interest below the height it would attain on a free market. And they believe that the expansion of bank credit is the right means to produce this desired effect. They do not realize that the boom which they artificially create by such credit expansion must finally result in the catastrophe of the depression.

Spokesmen of governments tried to disparage the economists’ explanation of the recurrence of economic depressions. They tried in vain. This economic doctrine, the so-called monetary or circulation-credit theory of the business cycle, is irrefutable. The fanatical supporters of inflationism, unbalanced budgets, and reckless government spending have, it is true, succeeded in banning sound theory from universities and textbooks. And they have founded special research institutions whose main purpose it is to put the monetary theory into oblivion. But their triumph is always short-lived. Today people are fully aware of the fact that credit expansion is the ultimate cause of the slump. All public declarations on the state of business, even those uttered by bureaucrats, are based upon a full acknowledgment of the monetary doctrine of the trade cycle. It is precisely the cognition of this theory’s correctness that in the present boom period alarms businessmen and prompts them to inquire nervously about the date of the turning point.

Economics: Not Quantitative

Economics predicts the outcome of definite modes of conduct, in our case, of a policy of credit expansion. But this prediction is qualitative only. Economic prediction can never disclose anything about the quantitative relations concerned. There is not, and there cannot be such a thing as quantitative economics.

In the field of the natural sciences there prevail constant relations between definite magnitudes. By means of laboratory experiments the scientists are in a position to determine these constants and to make practical use of them in predictions and in technological design. But in human action there are no such constant relations between magnitudes. There, all quantities are variables or, as a more appropriate term describes them, historical data. It is, therefore, not due to alleged backwardness, or to the much-talked-about “youth” of economic science, that it is not quantitative but, as people say, “merely” qualitative. No constant, fixed quantitative economic relationships exist, on which quantitative economic predictions would have to be based. And what does not exist cannot become a matter of scientific inquiry.

Economics can only tell us that a boom engendered by credit expansion will not last. It cannot tell us after what amount of credit expansion the slump will start or when this event will occur. All that economists and other people say about these quantitative and calendar problems partakes of neither economics nor any other science. What they say in the attempt to anticipate future events makes use of specific “understanding,” the same method which is practiced by everybody in all dealings with his fellow man. Specific “understanding” has the same logical character as that which characterizes all anticipation’s of future events in human affairs?anticipation’s concerning the course of Russia’s foreign policy, religious and racial conditions in India or Algeria, ladies’ fashions in 1960, the political divisions in the U.S. Senate in 1970; and even such anticipation’s as the future marital relations between Mr. X and his wife, or the success in life of a boy who has just celebrated his tenth birthday. There are people who assert that psychology may provide some help in such prognostications. However that may be, it is not our task to examine this problem. We have merely to establish the fact that forecasts about the course of economic affairs cannot be considered scientific.

Statistics: Necessarily Retrospective

The usual method employed in business forecasts is statistical and, thereby, retrospective.

The statistician recites a mass of statistical information, which necessarily refers to the past only, and he works it into charts and curves. He is so preoccupied with arranging and rearranging the data available that he entirely fails to realize that they do not have any relevance to the problems in question. They refer to the past, not to the future. They depict trends that prevailed in the past and are, by and large, familiar to everybody. They in no way answer the questions that all people, and especially businessmen, are asking. People know that trends can change; they are afraid that they will change; and they would like to know when the change will occur. But the statistician knows only what everybody knows, namely, that they have not yet changed.

In the sphere of human action statistics are a special method of historical research. They record historical facts in quantitative terms. But history deals always with the past, never with the future. If the future were merely a continuation of the trends that prevailed in the past, it would not be uncertain and we would not then be in need of any forecasting. But as this is not the case, what is called economic forecasting is merely guesswork.

Professional forecasters blame their much talked about failures on the fact that the figures available are insufficient and reach them too late. This apology misses the point. However complete and recent statistical information may be, it always remains information about the past and does not assert anything about the future.

The Self-Contradiction of Forecasting

People’s ideas about the possibility of business forecasting, and its practical value for the conduct of one’s own affairs, are self-contradictory and unrealizable.

The businessman thinks: If I know the date of the boom’s collapse some time in advance, I will be in a position to sell my stocks and reduce my inventories of both raw materials and products at boom prices. Then, at the critical moment, I will have cash and no debts. The man who entertains such ideas overlooks the fact that this knowledge could be helpful to him only if he alone has it, while all other people are still bullish. But how could this occur if, as popular opinion assumes, economic doctrine enables the economists to predict the day of the crisis? If economists really could predict when the crisis would occur, then all people would learn simultaneously the date of the impending crash. Consequently, they would all immediately try to adjust their transactions to this expectation. They would all stop buying forthwith and start selling. But then, as a consequence of this attitude, the catastrophic drop in prices, the slump, would appear at once; it would not wait for the distant day the economists had predicted. Nobody would derive any advantage from the economists’ forecast; at the very instant this forecast was uttered and accepted as correct, the crisis would already be consummated.

From time immemorial people have known that the very act of predicting may change the actions of men and thus eliminate the forces that are required to bring about the predicted outcome. Obstinate fatalists have acquiesced in the illusion that all attempts to avoid a prognosticated evil are futile; and that frequently, in some mysterious way, against the intention of the actor, they even bring the prophecy about. No such subterfuge is permissible in our case. The very fact that people are putting faith in the forecast of a crash results in the annulment of the prediction: it instantly produces the crash. Thus, what the businessman wants to attain by asking the economist for information about the future of the market could not be realized, even if the economist were in a position to answer.

Reprinted from National Review, April 4, 1956.