We Live in a “Black Swan” World

Bloomberg had a roundtable discussion with Nobel Laureate Robert Shiller, author of Irrational Exuberance, about keeping past economic disasters in mind. In particular, they discussed the worry that the stock market is on the verge of another 1937 and a 50% correction.

1937 was the year that the word ‘recession’ was invented. Did you know that? … It was invented because Franklin Delano Roosevelt wouldn’t call it a ‘depression’. He thought the psychology was horrible, just horrible.”

Shiller doesn’t believe harking back to the Great Depression is simply fear mongering, because we live in a “black swan” world. Economic events are unpredictable, and learning from the past is a practical way to prepare for the unknown. Investors might want to step away from the fast-paced world of speculation and take a look at the bigger picture.

Last week, we showed that stocks are currently at a peak similar to the one that occurred just before the Great Depression. To analysts like Shiller and Peter Schiff, it’s becoming increasingly apparent that the economy may be on the edge of another major recession.

Highlights from the interview:

Olivia Sterns: [Ray Dalio of Bridgewater Associates wrote:] “Tightening at the end of a super cycle? We don’t know — nor does the Fed know — exactly how much tightening will knock over the proverbial apple cart… We think it would be best for the Fed to err on the side of being later and more delicate than normal.” Professor Shiller, you and Tom were speaking earlier about how we are in uncharted territory. Ray Dalio is worried that we are once again in 1937 and that we could tip the equity markets into a 50 percent correction. Do you share his concern?

Robert Shiller: Definitely a concern. 1937 was the year that the word “recession” was invented. Did you know that? … It was invented because Franklin Delano Roosevelt wouldn’t call it a ‘depression’. He thought the psychology was horrible, just horrible.

Tom Keene: Ok, but look at this, Bob, and let’s bring it forward to the bank of Japan when, 15 years ago, they did raise rates. They had to recant. They never got over that, and they had to come back down. Why can’t we raise rates just a little bit to get off Krugman zero bound… Why can’t we [raise rates just a little?].

RS: Well, I think we don’t know whether we can do that. It depends on how the market reacts, and the psychology is kind of high-strung right now. But I suspect we can do that…

OS: I think that the big fear is what tools does the Fed have left? If they turn over the apple cart and rates are already under one percent, what do we do if we knock the recovery off its track?

RS: Well we cut back again. I suppose they could put their tails between their legs and go back. These things happen.

Brendan Greeley: Professor, how valuable is history? When we talk about the Great Depression, is that econometric analysis or is that fear mongering?

RS: Well, I hope it’s not fear mongering. You have to recognize, the Great Depression was the worst economic experience ever for this country, so it’s an outlier. I think that we live in a black swan world where we worry about these outliers, so it’s healthy to look at them.

TK: Do you agree with that, Dr. Ellis, that this is a black swan world?

Charles Ellis: Sure. You’ve got people who are really smart paying very close attention to very fast moving information trying to anticipate each other back and forth. When something starts to develop, they can go very, very fast. Very fast.

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