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Long Term Projections

March 7, 2012

Long term projections are so difficult, they might as well be impossible. The idea that anyone can reliably predict 10 or more years into the future, beyond broad generalizations, is totally absurd.

Can’t implies won’t
If something can’t happen, it won’t. Mexicans won’t be 137% of the population in two decades, because the maximum is 100%. Medical spending/college tuition won’t grow at 10% forever, because evenually it runs into the cap of “all the spending there is”. NGDP only grows at about 5% per year, so eventually, they have to slow down to that rate (or lower).

Even if it is mathematically possible to grow at a certain rate, there are feedback mechanisms. In the graph above, interest costs are around 50% of GDP, which is absurd. Basically all that graph tells you is that the person who wrote it is wrong. Taxes only amount to about 20% of GDP, and the Laffer curve does eventualy slope down. Once the government hits around 30% of GDP in taxes, there will be serious pressure to default. By the time interest costs alone are even 10% of GDP, default will be inevitable. Things don’t continue in a straight line forever, because if they get bad enough, people take action to fix them.

If you’re so smart, why aren’t you rich?
The Efficient Market Hypothesis states that market prices reflect all publicly available information. If anyone were able to predict the future better than the market, they would a.) make tons of money and b.) correct the market prices. The market price would then reflect this new information as well. Financial markets are information aggregators.

Let’s say you knew that a price was too low on some stock. You could buy it up, and sell it later when the price was high enough. But because you buy it, the price starts to go up, and eventually it will reflect the correct price. The same works for prices which are too high, and shorting instead of buying.

Conditional Forcasts and Pattern Predictions
There are exceptions to the unpredictability of the future. First, you can make conditional forcasts. If A happens, it will cause B to happen as well. Secondly, pattern predictions, which don’t try to get exact numbers right, but simply describe the overall pattern of things. We can’t tell exactly what the weather will be in 10 years, but we know that summer will be hotter than winter and “Farmer’s Alminac” type stylized facts. Likewise, economists can’t predict exact prices, but they can tell you that if there is a binding price cap, there will be a shortage.

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