Noah Smith, an assistant professor of finance at Stony Brook and a very sharp blogger (Noahpinion), expressed recently an insight on his blog worth whatever additional exposure I can give it here.
This is especially so because the title Smith gives his blog entry, “KrugTron the Invincible” may be one that does Smith himself a disservice. That makes it seem as if Smith is goofing off, whereas he’s making an important point about everyone’s favorite Keynesian pundit, Paul Krugman.
Here is a quick spoiler: Smith says that yes, Krugman has had a good prediction record of late, measured against both the overly optimistic (John Paulson) and against the overly pessimistic (Niall Ferguson). And Krugman himself surely believes that his prediction success validates his Keynesian view of the world.
BAC: Back in 2010
Since this is, after all, AllAboutAlpha, let’s focus a bit on experienced alpha seeker Paulson as a Krugman foil. Back in the early summer of 2010, Hugo Londgren, of BusinessWeek, wrote a commentary contrasting Paulson’s views with Krugman’s. Paulson was saying at the time that the corner had been turned, the crisis had been overcome, and it was a great time to buy equity in U.S. based banks. Indeed, Londgren cited Paulson’s 13f that said that as of March 31, 2010, Paulson held nearly $2.995 billion of Bank of America common stock.
Oops. BAC was above $18 a share at the end of the first quarter of 2010. It was just above $15 at the end of the second quarter, when Londgren wrote his column. Five quarters later, in early October 2011, the price of BAC was below $7. Krugman, with his characteristic humility, wrote an I-told-them-so column.
Now, in late April 2013, BAC is somewhat recovered from the pits that called forth Krugman’s triumphalism. BAC [see the five-year chart above] is flat-lining between $12 and $12.50 these days.
So: is Krugman right in such instances (Smith obligingly gives others) because he is right in general, in how he sees the world? Does his streak of accurate predictions vindicate Keynesianism? That has repeatedly been Krugman’s own explanation. And, if not, is his success simply a historical fluke or is there an alternative explanation?
The Agnostic and the Blazing Sword of Analogy
Smith is not himself a Keynesian (he declares himself “agnostic” on key Keynesian matters), but his expectations have been in line with Krugman’s. So, one did not have to be a Keynesian to be less optimistic than Paulson was in early 2010. Indeed, we don’t have to take Smith’s word for his own views to know that: all the people and institutions who were selling Paulson their BAC stock so he could accumulate that $2.996 million cache of the stuff were presumably more pessimistic than Paulson was: there is no reason to believe they were all Keynesians.
Nor, as Smith rightly says, does Keynesianism necessarily have the implication that the “liquidity traps” it postulates are inescapable in the absence of a massive stimulus or money creation policy. In many Keynesian models, growth can recover on its own.
Smith’s suggestion is that many of those who have predicted successfully the course of the U.S. and European economies in recent years have done so more on an analogy than on a theory. They have presumed that the US and Europe [for whatever macroeconomic reasons] are following the course laid out for them by Japan since the early 1990s. The presumption that “We are like Japan” accounts for the right predictions nicely without a lot of theoretical baggage.
Smith’s bottom line is a good one and it might well be addressed to all of us (I emphatically include myself) who find Keynesianism doctrine in all its variants unpersuasive. “[If] you want to get into the economic prediction game, and you don’t want to be sliced and diced by KrugTron’s Blazing Sword … [t]ake a good close look at Japan.”
That is advice we have taken of late, even if not exactly as a consequence of Smith’s reasoning.