Do You Understand Ceteris Paribus?

Since no one seems to take Latin any more, you probably cannot translate “ceteris paribus.”

Real economists frequently cite the need to explicitly state the assumption that “all other things are equal.”

In the blogging world, the biggest voices on economics are not economists. This should not surprise us. The pop economists are playing to our vision of reality:

  1. State what the reader already believes;
  2. Provide data that appears to support the belief; and
  3. Add some bogus conclusion.

It happens every day.

Background

I am going to reveal something personal and unprofessorial. I like Jack Reacher – the character, the strength, the simplicity of needs, the moral compass, and of course, the ability to “connect.”

Like many others, I was interested in the upcoming movie. How could Tom Cruise portray this giant? In reading about the story I discovered something interesting about investments. Lee Child is a pseudonym and the Brit who is actually writing is a guy named “Jim Grant.” No, not that one!

In a great story by Brian Curtis at Grantland the author reveals why his work is so persuasive and sells so well:

Although he’d never lived in the U.S., Grant had visited frequently, had lapped up American TV, and had even married an American woman. “It was really a question of mimicking,” he says. “If you’re familiar with the rhythms and the word choices of the country and you can put them down on paper, it actuallybecomes their nationality.” British drollery metamorphosed into a kind of hypnotic, Eastwoodian growl. Killing Floor, the first Reacher book, opens like this:

I was arrested in Eno’s diner. At twelve o’clock. I was eating eggs and drinking coffee. A late breakfast, not lunch. I was wet and tired after a long walk in heavy rain. All the way from the highway to the edge of town.

Grant’s wife, Jane, read his drafts and clipped out Britishisms. She called herself the Committee on Un-American Activities.

The Americanness of Lee Child’s novels did not come from granular detail, from a novelistic sense of place. “You know you’re in Nebraska because he says, ‘We’re in Nebraska,'” notes Otto Penzler, the owner of New York’s Mysterious Bookshop. “You don’t smell the cornfields.”

No, Child aims to deliver a different American vision. When Reacher goes to Nebraska, as he did in Worth Dying For, Child borrows images from movies and TV shows — it’s a “Nebraska” of our collective imagination. As Child puts it, “If you stick to that mental image, everybody says, ‘That’s a well-researched book.’ If you actually supply the reality, people say, ‘The guy’s never been there.'” It’s as if Child is feeding back to us the images America once beamed to England.

Investment Implications

Bringing this back to the world of investments there is a clear conclusion:

The great novelist of thrillers reveals the technique of the great fiction writers of economics!

They are telling you what you think you already know – not trying to inform.

Spotting These Imposters

The biggest tipoff to the pop economist is when he/she does not say, “ceteris paribus.” This means that the author is trying to change only a single variable in a multivariate world – an amateur approach.

Here are two current examples:

  1. Profit margins. We have all heard ad nauseam that profit margins are mean-reverting. The blunder of this one-variable approach is a failure to consider why profit margins are so high. Corporations have squeezed employment and costs. Think lean and mean. Those taking this viewpoint have been wrong and the multivariate approach which I endorsed two years ago and again last year has been correct. Profit margins will decline if and only if there is a massive increase in revenue and gross earnings. There is still time for investors to grasp this concept, since the wrong-headed bearish viewpoint prevails.
  2. Interest rates. Suppose interest rates were to move higher, forcing greater government expenditures and offering a more attractive alternative to stocks. The Fed might go broke! I need to write more on this theme, but the concept is the same. The Fed is actively trying to increase inflation expectations. They want to encourage investment. That is the plan, little understood by traders. So there is no “ceteris paribus.” When interest rates rise, the move will be accompanied by a vigorous economic rebound, including business and consumer investment.

Only the pop economists isolate on one variable and project the worst case.

This piece is cross-posted from A Dash of Insight with permission.

3 Responses to "Do You Understand Ceteris Paribus?"

  1. Bill Connors   January 29, 2013 at 11:02 am

    Yes, amateur economists get way too much credence. But as a 28 year asset mamager I am more frustrated with the smugness of 'real' economists. Over and over they describe the detail of the trees and predict this and that. And when the forest catches fire they blame it all on somebody else who simply didn't follow their advice. Colleges teach them they can control complex economies like NASA can land rovers on Mars. It is this over-confidence, I believe, that is at the heart of the ongoing debacle called the fractional-reserve, fiat-currency World Economy. I'd vote that Central Banks be headed by time-tested investors, not Ivy League Economists.

  2. Allan Dias   January 30, 2013 at 9:35 pm

    About your examples
    1. Profit margins will also fall if there is a decline in sales and revenues: there is a point below which you cannot cut employment in a business!

    2. As regards inflation expectations, investments etc. the question is who are going to buy the products of this investment given the real (not govt. mangled figures) unemployment situation. You say "when interest rates rise they will be accompanied by…" what you mean is they SHOULD be… and the fact that this is what your theory specifies does not mean it will happen. As Bill Connors stated, Ivy League 'economists' get too much credence as well. All your theories come with a bucket list of assumptions (discretely) attached, most of which are not true in the real world and hence very suspect. Unfortunately, many of them 'work' till they stop working, at which point the damage is done.

    Allan

  3. Michael   January 31, 2013 at 8:33 pm

    “ceteris paribus” This would apply not only to amateurs, but also to purported professionals such as Paul Krugman. His columns and blogs are one-dimensional rants. The sad part is that too many "amateurs" follow his writings and accept his beliefs. But this is what the New York Times wants – columns written for the high school senior with an interest in business and economics. It is pablum disguised as serious thought. But, hey, it seems to be working.