You have heard it a thousand times:  “Statistics show ...” – fill in the end of that sentence: that we are due for a recession, or due for an economic boom; that global climate change is occurring; that this group of people is richer than that group; that the President’s latest political program is successful; weather forecasts and hurricane forecasts – the list is endless.

What are statistics?

The answer is simple:  statistics are a historical record.  Nothing more.

Most of us are familiar with statistics in sports.  This batter had an average of .406 last year; that kicker scored 60 percent of his attempted field goals.  Such statistics are easy to understand, and most of us have no trouble calculating them.

But we also know that those statistics do not guarantee how a team or a player will do in the upcoming season.  History is full of examples where a player or a team had an outstanding year, followed by a really bad year, or vice versa.

The same is true for all statistics.

Statistics are never proof.  Never.

Statistics never prove anything.  We all know what happens in sports:  a key player is injured, retires, or is traded; a new coach or manager joins the team.  

In sports or elsewhere, actual events or actions are the causes of change.  Statistics never reveal causes, and so the fact is that statistics can never be touted as proof.

Statistics are a historical record.  If the future is exactly like the past, then statistics will look pretty persuasive.  But how often is the future just like the past?

Weather forecasting is 100 percent based on statistics.  As the saying goes, tomorrow’s weather will usually be the same as for the same date last year.  To use that as a forecast is a very simple use of statistics, and it is often accurate – but not every time.  The future is not just like the past.

But statisticians make their living by looking for ways to produce more-accurate forecasts.  The equations are terribly complex – so complex, they have an exciting-sounding name:  Chaos Theory.  People get PhD’s and tenure as college professors developing Chaos Theory equations.  Those equations attempt to identify a great many complex patterns – and yet inaccurate forecasts still result.  We still cannot predict whether it will rain on any given spot at a given time with any accuracy.  Forecasts like “There is a 60 percent chance of some amount of rain somewhere in the tri-county area” is a blatant admission that weather forecasting is fundamentally impossible – which itself is a fact proven in 1962, by the great mathematician and meteorologist, Edward Lorenz.

No matter how you cut it, using statistics to predict the future is like driving your car while looking in your rearview mirror.  It works only as long as the road ahead is just like that behind, with no Stop signs, no traffic lights, no kids on bicycles, etc.

The same thing is  true in economics and finance. 

One of the favorite books of the great investor Warren Buffett is “The Intelligent Adviser”, by Benjamin Graham, an economics professor.  The book is 2 inches thick, and while it is heavy reading, it is worth the effort for anyone who wants to increase his investing skills.

However, in surveying the history of the economy, the stock market, and investment ideas and techniques in general, Graham makes constant use of statistics.  The consequences are predictable:  Graham looks for historic investing trends since about 1890, but he virtually never identifies causes.  As a result, his investing strategies are created upon the foundation, “booms and recessions happen periodically, and your plans should include that fact.”

The causes of economic ups and downs generally fall into one of two categories, which is an important fact every investor needs to know.  

The greatest cause of economic changes is government:  wars, taxes, tariffs, regulations, and other acts (which is to say, most if not all) that have an impact on peoples’ lives (again:  economics is simply the composite, combined total efforts of each and every one of us to build, improve, and better our lives – to prosper).

The second, much more minor cause of economic change is the growth or decline of populations, businesses, or natural disasters for a given locale, or for a given type of business (e.g., the need for blacksmiths declined after the introduction of automobiles, or the decline of the use of IBM’s big “mainframe” computers after the proliferation of personal computers, iPhones, etc.).

The duration of economic declines in the second group is typically minimal and short-lived.

Economic decline due to the government is another matter.  

The best example, of course, is the Great Depression of 1929.  While the Depression was made significantly worse by the actions of the Federal Reserve, it is President Herbert Hoover’s Hawley-Smoot Act’s giant increase in tariffs, followed by President Roosevelt’s animosity towards businesses generally, his deliberate effort to pursue a Socialist agenda, and his confiscatory taxes.  Among other things, these actions confiscated the money which would have made possible an economic recovery.  

Hoover’s and Roosevelt’s actions were utterly destructive:  they brought an end to the incredible financial success and prosperity of the Roaring Twenties, and caused the Depression to last an unprecedented 25 years, until those oppressive measures were slowly removed by Presidents Truman and Eisenhower.  It was only in 1954 that prosperity returned to the level it had been in 1929.  

Similarly, it was the programs of President John F. Kennedy and Lyndon Johnson, which they labelled the “Great Society” and the “War on Poverty”, followed by the bumbling ineptitude of President Nixon and furthered by President Carter’ Socialist programs that resulted in the declines and “malaise” of the 1970s, and which only ended due to the changes championed by Ronald Reagan.

When reading Graham’s book, note that the biggest economic declines followed government actions:  the 1929 Depression, the 1970s malaise, and others.  Research the causes yourself, because Graham does not.

The short-term recessions end more quickly because people at all economic levels, given the freedom to do so, rebuild their lives as quickly as possible.  When the government stands in the way, recovery is stalled.

That is what the statistics show – if you take the time to look for the causes.

Scott Crosby
scott@scottschoice.com
www.scottschoice.com■