Mitchell J. Held is a Managing Director within Salomon Smith Barney’s Economic & Market Analysis Department. In this capacity he contributes to the formulation of the firm’s U.S. economic and interest rate outlook. Mr. Held joined Smith Barney in 1981, was Smith Barney’s chief economist in 1996 and 1997 and the firm’s chief financial economist from 1987-1996. He began his career in Citibank’s Economics Department in 1976.
In February of 2001, Mr. Held came to the Pepperdine campus to speak to students in the Residential MBA program at Malibu on the topic of economic forecasting and Salomon Smith Barney’s outlook for the economy in 2001. Shortly thereafter Professor David Smith, himself an economist, had an opportunity to talk with Mr. Held about his view of the California economy in light of the state’s electricity crisis, about economic forecasting as a profession, and about President Bush’s proposed tax cut.
GBR: In California our attention is focused right now on the electricity crisis. Do you see the potential impact of the electricity crisis as a serious concern? Is it something that could impact the national economy, or is it more likely regional?
Held: I think right at the moment it’s probably a regional problem and, with all due respect to the wonderful citizens of California, when prices go up from a supplier you generally have to pay more. The way the deregulation program was set up, it seems as though the price to consumers was locked in and didn’t allow for any further rise in energy prices. The producers of electricity had an increase in the cost of their basic material, so it did create a significant squeeze, and as a result the crisis occurred. Now, can it spread? Sure it can spread, especially given some of the problems in the northwest, and given some of the contracts that are in place there. This problem could spread a little bit to the Pacific Northwest over the next six months. In the east, electricity supplies at the moment at least appear to be ample. Since the economy has slowed the way it has, even if it turns out to be an extremely hot summer this year, my guess is that we can satisfy the demand relatively easily outside of the west coast. California itself is an eighth of the US economy. Add in Washington and Oregon and you’re probably talking about over 15 per cent of the economy, which is not an insignificant portion, but my guess is that the effect of this crisis is not going to spread too widely, at least not right now.
GBR: When our economy was more manufacturing based, we knew that a steady and reliable source of energy was important. Is energy still important in the macro economy? Could a price shock in natural gas or oil prices still cause or contribute to a recession?
Held: We’ve had much more effective use of labor over the last ten years. We’ve also had a much more effective use of energy over the last ten years. So the importance of energy is not as great as it was before. That said, if I were planning a business, and I knew that California had an electricity supply problem, I would think twice before re-locating there. So I think over the longer run it could affect migration patterns of individuals in search of jobs, or companies in search of places to locate.
GBR: Having just gotten my latest natural gas bill yesterday at home, it seems to me we already have had a major shock in terms of the cost of natural gas. Is that part of what’s happening to the slow-down of the economy at this point? Or is that still to be felt?
Held: It will be felt in California. The cost of energy in general has gone up. And when energy prices go up, it works the same way that a tax works. If you have to pay out more for energy, that gives you less money to pay for discretionary items such as automobiles and vacations and other fun stuff like that. I think in my house we’ve let the temperature get down to forty degrees, and that’s about as low as we’re going to go. So it does act as a tax. And I think it’s been one of the contributing factors that has essentially slowed the pace of consumer spending.
Now what is interesting is that, at least as of today, in spite of all the talk of slow-downs in the economy or slow-downs or weakness in consumer confidence, consumers are still buying. They’re buying cars; they’re buying houses and things of that nature. I’m not sure what that really means. It could bear out the old expression, “When the going gets tough, the tough go shopping.” But that cannot last forever. So we’ll have to see if indeed the consumer starts to pull back given the negative psychology that’s out there, the higher energy prices which act as a tax, and announcements of layoffs and job reductions.
GBR: You have been in the forecasting business for some time now. How has your approach to forecasting changed over the last 25 years? Is the job dramatically different than when you originally started?
Held: The first week I was at Citibank in 1976 there was a release on business inventories, actually it was business sales and inventories. I had to write up a piece on that data for a publication which I think was called “Economic Week.” This morning there was some data that came out on business inventories. I had to write a release for publication in something that we call “Mitch’s Monday Morning Money Market Memo, Wednesday Edition.” That’s literally true. The first piece was on business inventories; the last piece I’ve done today was on business inventories. So in that broad sense, the job itself hasn’t changed.
But, the way the economy behaves is different. If Wal-Mart sells one less scooter today, everybody along the supply change will know about it immediately, and everybody along that supply chain will adjust for it. Back in the mid-seventies if Wal-Mart sold one less scooter, it would take a while for the scooter manufacturer to know. Then it would take a while before the guy who supplied the scooter manufacturer with metal or with rubber for tires would know, and the whole economic cycle was kind of stretched out. Now we all have all of this information, and we get it very quickly. As we get that information quickly, the response from the economy is much quicker as well. So that’s a big change from the way business is done today to the way business was done 25 years ago.
GBR: So you’re saying that makes for a more volatile economy?
Held: Yes, exactly.
GBR: If I can follow-up again with a question on data, you mentioned that you started with inventories and you’re still doing inventories. Has the quality and the amount of data that you have to work with changed significantly?
Held: The amount of data has gone up, and the quality has gone down. The amount has gone up because there are a lot more private sources of data that are now published — for a fee, I might add.. At the same time, the government’s budget for the collection of data has gone down, and gone down significantly. So the quality of the data collection has fallen, as has the quickness with which the government data picks up trends. Because of that, you tend to rely more on anecdotal evidence and on discussions with, in my case, our equity analysts, and so on. You figure that they have recently spoken with financial officers or the chief information officers or the chairmen about what’s going on in their business. The micro-anecdotal evidence, in my opinion, becomes more important in a way. You’re not so much forecasting what’s going to happen, nor even forecasting trends. You are trying to forecast changes in trends. You want to forecast turning points. And the anecdotal events become a lot more important when forecasting turning points than they were in the past.
GBR: You just indicated that you’ve had to rely on more anecdotal information. Is that also because the economy is much more complex than it used to be? And although forecasting has become more sophisticated over time, is it possible that the complexity of the economy is outpacing that?
Held: We have a record in economic forecasting of basically doing just a little bit better than a Hall of Fame batter. Ted Williams’ average was about .400. That means he got it right four out of ten times. Unfortunately, economists get it right probably five out of ten times. It’s one of the reasons why, in general, economics is taught in the schools of arts and science rather than in business schools, at least in the undergraduate level. It is an art, or an art form. A weird art form, but it is an art form. And it’s important not so much to get it exactly right as to get signposts to focus on to see where you might go right and where you might go wrong. I think too many economists are trying to forecast what the Fed should do, where economists should probably forecast what the Fed will do. It’s subtle, but there’s a big difference there. You want to get into Greenspan’s shoes, and you want to know what’s going to make him press the button or not press the button. You don’t want to be saying, “Hey, Greenspan, you should have lowered rates more quickly.” That doesn’t help you any.
GBR: How should we judge economic forecasts? How much importance should we place on them?
Held: If you take a top-down approach to investment, which is the approach that we take, economics is important because it gives you a sense of whether or not the Fed must provide liquidity to the system or the Fed should take away liquidity from the system The overall market is generally determined — not on a day-by-day basis, but over time — by the provision of liquidity. The Fed puts liquidity into the system, and some people grab that liquidity and buy with it. Some other people take that liquidity and invest with it. If the Fed provides more liquidity to the system, it’s more likely that people are going to invest. What economics does best, I think — or what we try to do — is to see whether the conditions warrant additional liquidity or less liquidity. So we’ve got to figure out how fast the economy can grow, how close we are to various signposts that could indicate an inflation concern. We have to try to figure out where the Fed stands, and then figure out whether or not they will increase or decrease liquidity. And I think we do a pretty good job at that. When you start talking about forecasting individual quarters, or individual statistics . . . I don’t want to say a dartboard is better, but, you know, keep it by your side.
GBR: Is your job potentially more important now that we’re seeing some downturns in the economy? I mean, with the nine years of good times that we’ve experienced, maybe there’s been some concern among economists that they aren’t needed quite as much…
Held: Actually what’s interesting is that economists were probably less important in the dot.com explosion because then you could basically close your eyes, pick a stock, and it went up. And even if it went up less than the market, you didn’t care because the market went up so much. I think when you go into this kind of environment, the economists are probably more important in terms of hand holding. There’s a fear among many that the economy will plunge and you could have a Japanese-type economy. In Japan, I think it’s one-third of the quarters since 1990 have shown declining GDP. They’ve had a deflationary environment. Probably the biggest concern of an equity holder is that the economy doesn’t replicate that. So he or she wants to make sure that the economists can see signs of life or signs of stimulus coming on or whatever, that can appease his or her concerns. So I think with an economist, hand holding is probably more important today than it was when every stock was going up no matter what stock you chose.
GBR: Do you have any thoughts that you would like to weigh in with regarding the proposed tax cut and what you think it would do or not do?
Held: The tax cut is kind of interesting. One of the highlights of the 1990’s was that fiscal policy was restrictive and government was busy raising taxes and lowering spending — or allowing spending to grow at a much slower rate, and I don’t think there’s anything wrong with that. I think from fiscal year of 1991 to 1999, discretionary spending rose an average of one and a half percent per year. In fiscal years 2000 and 2001, it rose four times that amount, about six percent. Significant change. If you look at Mr. Bush’s proposal for tax cuts, he assumes that spending is then going to fall to four percent, and that’s without a Medicare prescription change or anything like that while, in fact, the chairman of the House Ways and Means Committee has already said that is not going to happen. It looks like spending will have to start at six percent. So now, not only are you cutting taxes and creating stimulus, but you’re increasing spending and creating stimulus. Not that there’s anything wrong with creating stimulus today, but there may be something with creating stimulus tomorrow because of the fact that the economy could respond to that and grow quickly and put us in the same kind of pickle we were in earlier last year, in the year 1999. And then you’re going to have to rely on monetary policy to tighten up more aggressively. And that’s the problem. Then you’ve reduced liquidity, and then markets fall, and that’s bad.
So, the stimulus that’s coming on is nice if you will. I don’t think there’s anybody there who’s going to refuse a tax cut, but you may find yourself with a deficit a couple of years down the line as well. That would compound the problem or remove all of the improvement that we’ve seen. In the near term it may not be a bad deal, but over the long run, you get some significant tax cuts and spending increases, It’s not the way I would conduct fiscal policy.
GBR: You’re not a supply-sider, I take it?
Held: Supply-siders always said, “Cut taxes and the expansion of the economy will bring enough additional tax income by virtue of a growing economy to pay for everything else.” The 1980’s didn’t support that. Remember? We didn’t grow enough to produce the promised tax bonanza.
GBR: Tax cut or not, this time let’s hope the economy continues to grow for the US and for California. In this regard, your insights have been very valuable. Thank you for taking the time to share your perspective with our readers.
