Be careful when reading headlines of economic or financial news that use superlatives. The news often it isn’t as earthshaking as the headline suggests.
Consider the following two headlines “Euro breaks all-time high against dollar” and “Euro/dollar exchange rate same value as 4 years ago.” Both headlines are factually correct.
Last Tuesday, the euro reached a record high in terms of its cost in dollars. It broke the old record, set in January 1999, by mere fraction of a penny.
If the value of the dollar relative to the euro was not a big deal four years ago — and it was not — is a return to that same value important in 2003? Maybe, but anyone saying so should explain why.
The mere fact that an exchange rate “breaks all-time high” means little. The same is true for headlines proclaiming “all-time high” tax cuts, trade or budget deficits, or even movie ticket sales.
Here are some tips for the intelligent citizen who wants to be informed, but not misled, by economic and financial news:
Absolute numbers need to be put into context. In recent weeks, I saw headlines describing a “biggest tax cut in history” and “biggest trade deficit in history” and a “biggest first weekend for a movie” in history. The word “biggest” makes for a good headline, but the absolute dollar size of some tax cut or other economic event relative to earlier ones doesn’t say much.
For one thing, there’s inflation. When comparing a tax cut in 2003 to one in the early Reagan administration, one must account for the fact that the average price level is about 84 percent higher than it was 20 years ago. Adjusted for inflation, a $350 billion tax cut or budget deficit in 2003 equals $190 billion in 1983. And ticket sales of $95 million claimed for a recent movie would be the same as $7 million in 1939, the year “Gone with the Wind” came out.
Most economic indicators mean little without some comparison. A debt of $10,000 may appear huge to a college student with a work-study job but be almost negligible to a 45-year-old doctor with a six-figure income. In the same way, a $300 billion trade deficit would equal 50 percent of GDP for Mexico, but it’s only 3 percent of U.S. GDP.
The U.S. economy grows nearly every year. A $250 billion budget deficit in the third year of George H.W. Bush’s administration represented nearly 4 percent of 1991 GDP. A deficit of that size under his son’s administration is just over 2.5 percent of GDP.
Population matters. Last fall, an article proclaimed that record numbers of students were enrolled in U.S. colleges and universities. One would expect that, since the U.S. population grows every year.
The population is 42 percent greater now than when I graduated from high school and a 25 percent higher than when I started teaching economics in 1980. There are 30 million more Americans than in 1990.
So of course more people are enrolling in college than before. We are also using more toilet paper and buying more shoes. There are well more than twice as many potential viewers for “The Matrix Reloaded” than there were for “Casablanca” in 1940.
Percentage changes also need context. It is not uncommon for percentage changes to carry an air of drama, i.e. “XYZ Inc. profits are up 80 percent!” But such percentage change announcements mean little unless we are told something about the base on which the calculated change took place.
If the XYZ Inc.’s business is in the toilet, and earnings are only 1 percent of equity then an 80 percent increase would mean that earnings now equaled 1.8 percent of equity. That is still nothing to get excited about. But if the change takes place when XYZ already had been cranking out earnings of 20 percent of equity, then the same announcement may represent spectacular success.
In general, percentage changes usually are larger when a product or practice is new and the base for change is quite small. I am old enough to remember a headline that 100,000 people in the U.S. used Bitnet, a predecessor to the Internet. A 50 percent increase on 100,000 users is only 50,000 people. On 30 million users it would be 15 million new participants.
The message here? Read the news, including the headlines. But keep your common sense.
The news is seldom as dramatic as first presented.
© 2003 Edward Lotterman
Chanarambie Consulting, Inc.