2008 saw a great Financial Crisis. Not to mention all the commotion, on the future of world economy. How did it happen and why wasn't it anticipated? For last few months, I have been talking on the tools to analyse, about the analytics and its power to understand the variables and the systems.
So, why did such a successful financial instrument failed to understand and predict the impending crisis. It must have been very clear from the numbers. :-)
May be it didn't. May be it was just ignored.
Let me choose one basic variables to explain how numbers speak in the world of economics.
The above graph shows the relationship between the CPI of durables and non-durables goods. Ohh, what is CPI? It is simply a Consumer Price Index- in simple terms it denotes the price of the goods that consumers pay for and is a good indicator for the inflation. So more price means more inflation.
Starting from the early 80s, there is a close call between the price of Durable goods (electronic gadgets etc) and Non-Durable (cosmetics, foods etc) goods. The prices seem to be slowly rising. But in 1990, we see the divergence in the price. At around 1997, it seems the price on Durable goods are starting to fall very slowly, while the price on Non-Durable goods are shooting high.
Now, the analysis is not always about the rise and fall in the numbers. It is about saying why it is happening and how it can be controlled. But before that, let me pose a question. What do you want? Do you want a constant CPI or a rising CPI or a falling CPI. Which one is better?
Constant CPI would obviously denote a stagnant market, with no selling or buying at all. Inevitably, due to dynamic market , there is always going to be fluctuation. So there is a range in price over which this fluctuation happens. We are looking at a range not at the discrete particular point. But this range also increases and decreases according to civilisation's ability to purchase and sell. It like saying what to call expensive and what to call cheap.
So much talk over one graph! Yes, because, one graph is able to give so many information, because it is affected by many variables which reveals itself on the process of analysis.
Now the change in the CPI value of durable goods and non-durables goods can have many reasons. One such reason can be, the demand of non-durable goods might have increased. Its a basic economics. Also let me add another graph showing the production cost of the Non-durable and Durable goods.
We can see that the producer's price index for the Durable Goods have not changed since 1997 but the production cost for the Non-Durable goods have increased at a very high rate. This may have been reflected on the Consumer's Price Index. But there is a conflict between the correlation of CPI and PPI, which I better not address now.
So, on a simple note changing the production cost changes the consumer's cost. It is not enough, just stating the fact, we still don't know why the production cost suddenly rose in 1997. Does the Great Asian Crisis on 1997 has to do anything with it.
Think about it and let me know what you all think. I may post further articles investigating this phenomenon.