Forecaster Gary Shilling

They used to say that this maverick economist was wrong about his warnings of disinflation and depression. Now, they say he was just a bit early.

 

You've probably heard of Salomon Brothers' Henry Kaufman and First Boston's Albert Wojnilower, the Dr. Doom and Dr. Gloom of economic forecasting. During the late 1970s, their warnings about high inflation could send the markets into a tailspin. But the economy has now passed them by. We are in the Age of Disinflation, and the economist who predicted it first -- and perhaps understands it best -- is an iconoclastic free-lancer named A. Gary Shilling.

Call him Dr. Loom, for the recession that he always sees looming in the future -- including 1987. Dangerously high levels of debt, high real-interest rates, and a whopping trade deficit all combine to provide the basis for a painful and prolonged downturn, he says. A drop in consumer spending will start it off. And a couple of major bank failures could turn it into an old-fashioned depression.

Even if you don't agree with Shilling's prognosis, you have to admire the skepticism and common sense he brings to economic forecasting -- all of it in refreshingly plain English. His role as the bear among the bulls is a familiar one for him: back in 1973, when he was the 36-year-old chief economist at the investment firm of White, Weld & Co., he alone predicted the 1973 recession after seeing an ominous buildup in inventories. A decade later, his book, is Inflation Ending? Are You Ready?, was a bit early for economic-forecasting purposes, perhaps, but well timed for him to take his own advice and make a small fortune in the bond market.

Shilling and his staff provide economic advice to about 100 corporate clients from their offices in New York City. He was interviewed by senior writers Bruce Posner and Paul B. Brown.

INC.: Why should anybody who knows his own business, his own industry, bother with forecasts from big-shot economists who all tend to say the same things and, as often as not, are wrong?

SHILLING: There's no doubt there is a love-hate kind of relationship between businesspeople and forecasters. With the economy now so volatile, the larger economic forces press in on many more business decisions than they used to, which makes the forecasts more important. Yet the volatility has another result: because of it, much of the forecasting has become pretty lousy.

INC.: That's a pretty serious indictment of your profession.

SHILLING: You have to look at it in a historical context. Forecasting really came into its own during the '50s and '60s, a time of almost uninterrupted growth in the U.S. economy. In those days, it was easy to forecast -- all you had to do was take the recent past and put a ruler on it. People were navigating by looking in the rearview mirror -- and it worked, because the road was straight. But the result was that there was a vast overselling of forecasters' abilities, so that when the economy returned to what were probably more normal circumstances -- when the road got crooked all of a sudden in the '70s -- looking in the rearview mirror didn't work any longer. And business people began feeling as if they had been bagged.

I blame that on the economists mostly, because it was their responsibility to give some perspective on what they were doing. They had forgotten the first rule of economics, which is that there is no free lunch.

INC.: Free lunch?

SHILLING: If you can make a forecast with absolute certainty, then nobody is going to pay you for it because everybody else can do it, too. It becomes a free lunch, which is worth what you pay for it. The only forecasts that are really worth anything are those that have some risk to them -- the ones that give you some insight on when the consensus is wrong, that tell you where the glitches are, the deviations, the turns in the road. What an economist gets paid to do is to spot the significant, but as yet undiscounted, deviations from the trend.

INC.: So your criticism is that economists, just like journalists, travel in herds?

SHILLING: The fact is that economists are just like other people: they'd rather go wrong in the good company of their colleagues than be out on a limb, where they risk being a laughingstock. Obviously, you're going to make mistakes if you diverge from the consensus. But to me, no guts means no glory.

INC.: That argument has a certain emotional appeal. But it doesn't exactly square with the common understanding of what forecasters do. Don't you simply plug lots of hard, objective data into your computer models and wait for the magic numbers to come out the other end? What does that have to do with guts or glory?

SHILLING: Perhaps I can explain it this way. Years ago, I used to go to a forecasting conference at the University of Michigan. A guy named Daniel Suits was running that model then. He used to get up every year and say, "Here is our forecast of a year ago. But since then, we found that our model was really off in the auto area, so we went back, and we reworked our auto equations, then plugged in the numbers again, and -- what do you know? -- it comes out right on the money. Isn't that wonderful? Now here's our projection for next year."

What Dan Suits didn't say is that next year it isn't going to be autos that are going to go haywire -- it will be housing or capital spending or whatever. And so forecasters spend so much time correcting the model for last year that they don't spend the time asking themselves what is to be really important next year -- figuing out what are the one or two factors that are going to deviate from the trend, from past experience. That is the only question that is really worth asking. Otherwise, computer modeling is just a glorified trend-forecasting technique -- it's very complicated, and it's very sophisticated, but it's not very good at predicting the turning points.

INC.: So there is a fair amount of guesswork, as you see it, in any forecast that looks beyond trends.

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