It is that time of year when people get asked to make a few predictions as to what will be happening in the coming year.
The problem with this exercise is if people were any good at forecasting the future they'd be forecasting the winning lottery numbers.
The future is both risky and uncertain. Risky in that more things can happen than are actually going to happen. Uncertain in that some things that do happen will be completely unexpected.
Going into 2012 we know that something very interesting will be happening in Europe, the United States and, of course, here in Australia. That's not to say that nothing else interesting will be happening, but we know where to start looking.
The Europeans face some challenging political economy problems. Their societal organisation structure is financially unsustainable. They work too little and spend too much while the tax burden they impose on themselves is too high. People have known this for a long time, but as Adam Smith famously said, ''There's a lot of ruin in a nation''. What has brought the problem to a head is the single currency, the Euro. Our European friends face an old-fashioned debt crisis. They have borrowed too much in what is effectively a foreign currency.
Okay — so what is going to happen in 2012? The Europeans can continue to muddle through with more of the same — even more spending and promises of fiscal responsibility and so on — the kinds of things that got them to the current impasse. Or some member states could begin to exit the Euro. This is a largely a problem involving risk. We can imagine an outcome — exiting the Euro — and then assign a probability to that outcome.
The question is how to assign that probability? You can give a guess, or follow the wisdom of the crowd and look at betting markets. Markets are pretty good at collating information and establishing prices. Betting (or prediction) markets provide pretty good guesstimates as to the probabilities of events occurring.
Looking at one of the better known prediction markets (Intrade), there is a 32.5 per cent probability that, at least, one country will exit the Euro in 2012. That figure rises to 51 per cent by the end of 2013. To my mind that suggests, on current expectations, that Europe will continue to muddle through. The market also suggests a 78.4 per cent probability that France will lose its AAA credit rating by June 30, 2012. On the other hand the probabilities of Germany or the UK losing their AAA ratings are in the low 30s. On those figures, I don't see any resolution to the European crisis in the short-run.
The Americans are having a general election in November. This is a risk problem — something must happen on the first Tuesday (after the first Monday) in November. Either Barack Obama will be re-elected or his Republican challenger will be elected. According to Intrade there is a 51 per cent probability that Obama will be re-elected. Right now, it's fairly clear who his Republican challenger will be; Mitt Romney has a 79 per cent probability of securing the nomination. All other contenders — despite all the excitement about Newt Gingrich and Ron Paul — are in single figures. The joint probability of Romney both being the Republican nominee and winning the White House is 40.6 per cent.
It is very early days in the US presidential race. The thing to watch will be the performance of the US economy. If the economy doesn't improve — dramatically — Obama will find it difficult to get re-elected. Sure he inherited a poor economy but, rightly or wrongly, American voters judge the incumbent on economic performance and I expect that the probability of Obama winning will decline over the year.
That then brings us home to Australia. Our local betting markets and the New Zealand ipredict website provide a lot of useful information. Ipredict, for example, places the probability of Kevin Rudd departing as Foreign Minister before July 1 at 43.2 per cent. The probability of Julia Gillard departing as Prime Minister before July 1 is 29.5 per cent. By contrast Centrebet has a 53 per cent chance that Gillard won't be ALP leader at the next election — that honour goes to ''Any other candidate''. Those two results can be reconciled by the expected date of the next election — according to Centrebet it is most likely to be in the second half of next year (2013). When that election does occur, there is almost a 70 per cent probability that the Coalition will win.
What's happening to interest rates? Well ipredict has slightly more than 51 per cent probability that rates will come down by at least 25 basis points in February, and again in March. The ASX Interbank cash rate futures market suggests rates will be down to 3.25 per cent by November. That isn't actually good news — if the Reserve Bank is lowering rates to that extent this year, the economy will be in serious trouble.
Keep an eye on the debate about fiscal responsibility — 2012-13 has been promised to be a budget surplus year come hell or high water — and there will be a debate about raising the Commonwealth debt ceiling.
While looking at prediction markets is very informative, and fun, it is important to remember that market prices can change very quickly, and new price-sensitive information comes along at random. So a price today is today's best guess of the future. By tomorrow that best guess could be horribly wrong.
The prediction markets, however, don't tell us the important things in life. This year many babies will be born, loved ones will die, heterosexual couples will get married (homosexual couples will have to wait), children will start school, some will start work, others will retire and, despite the challenges and excitement of a new year, people will get on with their lives.
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