Rudi Dornbusch - How to think about the world of economics

 

Rudi Dornbusch -  “In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.”

There will be a lot research reports and thought pieces about what will happen in 2021. Some will discuss impending doom and others will focus on optimism, but most will not employ the key thinking from Dornbusch. For many of the big macro issues, we can see them coming, but the impact from any problem will take time. 

• Inflation
• Credit blow-ups
• Government dislocations 
• Stock market revaluations

These events are not black swans. These are grey or white swans representing known risks that will have to be faced, but with unknown timing. 

Policy-makers will do everything in their power to slow the inevitable; macro-prudential policies for the longer-run and liquidity injections in the short-run. We have seen a strong taste of this behavior in 2020. Monetary liquidity in many forms, aggressive fiscal policy, financial repression, and price manipulation were all employed. Why should we expect anything different in 2021? 

All policies will attempt to stop any economic pain and forego any destruction, albeit it is still happening though not immediately obvious. The impact from excessive policies will create new distortion that will have to be addressed through a new set of policies to solve the new problems. Think of the driver who overcompensates when starting to skid. There is no value judgment here other than issues will be pushed into the future until there is a catalyst that cannot stop swift repricing and adjustments. 

So, what can investors do? When reviewing forecasts, answer a simple set of questions: 

• What issues or problems are being expected?
• Why do we expect these issues to arise?
• When will they occur?
• What will be the catalysts to create these changes?
• What will be the policy and market response to these shocks?

You will quickly learn that all of these questions cannot be answered, yet much can be learned though working through the questions and possible scenarios. For some this may all seem obvious, but year-end makes for many proclamations with little support. 

Rudi Dornbusch was the great macro international finance MIT professor who influenced generations of economist. It is worth remembering his macro wisdom.