The Art of Forecasting: Great Expectations, Small Triumphs

0:00I'm sure that by now you in the audience know a little bit more about bubbles and business cycles than I do. I regard it as a special privilege to be participating in this conference. That was, you just heard the official biography of my career. The unofficial story is that I owe a great deal to the Austrians. I was working on my PhD in economics at the New School, teaching economics in college, and then I quit. I didn't see much of an intellectual point to it all. I went to Wall Street, started working in commodities, and then I began to read the Austrians, in particular the work of Murray Rothbard, and then I began to see that there was such a thing as economics, Such a thing as probing intellectual truth about the economy.

1:02My own talk is a little icing on the cake for you. It's just reflections on the forecasting game. I, in my position as a columnist, see a lot of forecasters. Thankfully, I don't have to do too much of it myself. What I'm going to do is comment on some of the efforts that have been made at forecasting and some of the small triumphs that have been made, and I emphasize small. Well, hopefully you have my exhibits. They would have been displays on the screen, and I would like you to take a look.

1:48Before we do anything else, I noticed that there was a mistake. You'll notice that the exhibits are numbered in the right-hand corner. Before you would even take a look at the first exhibit, take exhibit five, that's exhibit five, and put it between exhibit two and three, and then with a pen in the lower right-hand June 8, 1998 June 8, 1996 For approximately 45 minutes, I might not be able to go through all my displays, but I'll be able to go through most of them.

2:51I will leave 15 minutes for questions, and then, as was noted, I do answer my email, and I would be happy to get into a correspondence with any of you. Well, Forecasting Prosperity, take a look at my second slide, is my first topic. And the good news, bad news joke is relevant to the issue, and it goes this way. God gets so angry about the way crony capitalism is messed up in Asia that he decides to end the world in three days. So he calls Yeltsin, Clinton, and Kim Dayoung up to his office in the sky and gives them the news.

3:38Clinton goes back to his Oval Office, calls Gorin, and tells him there's good news and there's bad news. The good news is that God exists. The bad news is that he's going to end the world in three days, so let's party. Yeltsin appears before the Russian Parliament and he tells them there is bad news and there is bad news. The first bad news is that contrary to what we believed, God exists. The other bad news is that the tyrant will end the world in three days. Kim Dae-young appears on national TV and declares, people of Korea, there is good news and there is good news. The first good news is that God called me, among all the other leaders of the world, with Yeltsin and Clinton, to share his thoughts with us.

4:33The other good news is that in three days, the Asian crisis will be over. Well, I appreciate that laughter. It did come through. Thank you. Well, there has been good news in the U.S. economy over the past two years and a lot of it has been missed. I first want to take a look at what the consensus has been saying about these prosperous times since early 1996 and then get to a forecast that's actually been pretty accurate. Take a look at that slide five and page five I should call it. That's the summary from the Wall Street Journal.

5:24The Journal does a poll of 50 to 70 economists, mostly street economists, the first of the year and the middle of each year. and actually that should be called, I'm sorry, June 8th, 1998, it should say January 8th, 1996. So what was the consensus saying in January 8th, 1996? Well, economists forecast slower economic growth. The economy's expansion will move into its sixth year this spring, but the pace of growth will be slower than in 1995. That's the consensus of 64 economists participating in the Wall Street Journal's semi-annual survey.

6:09Annualized growth after inflation in gross domestic product savings economists will range between 1.8% and 2% for each of the four quarters. I mention the consensus because the consensus, I cite the consensus because the consensus is supposed to be more accurate than any individual forecast. Well, the consensus was wrong, but in early 1997, now take a look at page three, slide three, the U.S. economy is heading into its seventh straight year of expansion, but it will be coasting at a slower growth rate than at the previous 12 months. Slower growth rate because the growth rate in the previous 12 months had been pretty rapid.

6:55That is the consensus of 57 economists participating in the Wall Street Journal's semi-annual survey. For 1997, the economists were looking for only a modest slowdown in GDP growth to an annualized rate of 2% in both the first and second halves of this year. Once again, the consensus was calling for modest growth, and once again the consensus was wrong. Early January 1998, now take a look at page 4, the consensus was saying the same thing. The U.S. economy will continue to expand for the new year, although the pace of growth will be slower than in 1997. Same refrain. As the Asian financial turmoil, rising wages and leaner corporate profits put a check on growth. The economy will grow at a 2.4% clip in the first half and 2.1% in the second half, the economists say. Well, at that point, the consensus was indeed worried about the Asian financial turmoil, and they sort of split June 8, 1998. Page 6. Same thing. Just when it looked as if the U.S. economy may have

8:11escaped serious harm from the one-year-old Asian financial crisis, economists see trouble ahead. They say the brunt of the crisis will hit the U.S. during the next six to nine months. The consensus estimate of the economists put gross domestic product growing at an annual and a rate of 2.29% during the second half of 1998. Once again, moderate growth and we'll be done with this in a moment. January 4th, 1998, even though growth had again been way above trend, the consensus was saying the same thing. The economy is expected to continue growing this year, but at a slower pace than in 1998, according to a majority of 54 economists who participated in the Wall Street Journal's latest semi-annual forecasting survey.

9:02I won't read the rest. Notice 2.1%, 1.8%, 2.2% and 2.4%. All moderate rates of growth. Well now take a look at page eight. That's what growth in gross domestic product actually did. This has been a time of prosperity. 1996, the economy grew at 3.9%, 3.8% in 1997, 3.7% in 1998, and there was a bit of a slowdown in 1999, but it was still quite healthy, the growth ran 3.1%, has run 3.1% in the first half of 1999. Well, after all this better than expected news, now take a look at page 9, the consensus finally changed its tune, and who knows, maybe this should be taken in a contrarian way.

10:08Perhaps the boom is finally coming to an end. What was the consensus saying? Economists see blue skies ahead for the U.S. economy for the remainder of this year. I'm bowing to reality, says Maureen Allen, Chief Economist at Scudder Kemper Investments, Inc. Ms. Allen revised her growth forecast for the second year to 4.3% from 1% six months ago. It appears that economists have decided it's time to stop betting against the economy. Indeed, of the 54 Economist Survey, all but three believe that the economy will grow at a moderate or strong pace for the remainder of this year. There's nothing that can break this economy's back, says Diane Swank, Senior Economist at Bank One in Chicago.

10:57Well, my problem with the consensus forecast and with most of these economists is not just that they're wrong, But they're wrong for the wrong reasons. By that I mean I have had difficulty discerning anything systematic in their forecast, anything beyond the simple idea that either that the economy is going to sort of revert to moderate growth, which is a constant refrain over the past few years, I'll find a reason or two for it. But really, the core idea is that trend growth of 2% is about right, and then after having been battered by all that better expected news, they suddenly change their tune.

11:46However, there is one forecaster who actually doesn't even participate in the Wall Street Journal survey. His name is Jason Benderly. He has his own consulting business based in Vail, Colorado, called Benderly Economics. He is an economist. Everything he does is based upon the data. And over the past few years, beginning in 1996, he's been right. And I think he's been right for almost the right reason. And what I want to do after that once-over lightly about the consensus forecast is to walk you through some detail about the nature of his forecast.

12:43Some of this might look a little bit intimidating, but we'll go slow. Hello. Now take a look at page 10. That's a scattered diagram. And what you see in the vertical axis is wages and salaries as measured by the employment cost index. And on the horizontal The married male unemployment rate is a fairly easy one to talk about. I would really call it the core unemployment rate, not because I'm a sexist, but only because there probably is such a thing as a core unemployment rate for which the married male unemployment rate is a priority.

13:40Proxy. Now, what's true about married males? Married males tend, more than most groups, to be stable in their work habits. When they lose a job, they actually do make a great deal of effort to find another one. Some of us don't, even though we might be listed is Unemployed. Because of this, they've accumulated a large inventory of job skills, so that they're sought after, they tend to be sought after. Now obviously, over time, the labor market has changed, and there are many more women in the labor market. For instance, there in In fact, there's also been men have dropped out of the labor market. Unmarried men have done so, and for that reason, the headline unemployment rate might be a little bit misleading about what's going on.

14:51But the married male unemployment rate, which is, again, a proxy for the core rate, might be telling us something. I say a proxy because I'm sure that there are a lot of other people who are core workers in that sense. In particular, a lot of women who are core workers, who seek a job energetically if they lose one, who have developed a huge inventory of job skills and who are for that reason sought after. It's just that we don't have any figures for that particular group and for that reason we use the married male unemployment rate. Now, the thesis is that the married male unemployment rate tends to determine the course of wage rates decisively.

15:43I'm gonna change my terminology and just call it the core unemployment rate tends to determine the course of wage rates decisively. In other words, if the unemployment rate for core workers is quite low, that means that they are sought after. And for that reason, wage rates are going to explode. I shouldn't say, perhaps I shouldn't say explode, I should use the milder term accelerate. Now, all I've been doing so far is talking about the horizontal axis, I haven't talked about the vertical axis. The vertical axis is the change in the wage rate.

16:31What do I mean by change? Turn for a moment to page 11, and there we're looking at the year-over-year increase in wages. In 1999, so far this year, the increase has been 3.7%. In 1998, it was 4.0%. In 1997, the increase was 3.5%. Now, underneath that, on page 11, we're looking at wage acceleration and deceleration. Now, in other words, from 1998... I'm sorry, that's drawn wrong as well. And that 1999 to 1998 should mean, of course, 1998 to 1999, and that shows a 0.3% decline in the increase, in other words, a 0.3% deceleration.

17:23And you get that, of course, from subtracting 4.0% from 3.7% in 1999, 1998. In fact, that 0.3% may not be true. It may well be that the official wage rates are a bit inaccurate. I could go into that, but let's just take those numbers literally and We can now look back on page 10. On page 10, we're looking at the acceleration and deceleration of the wage rate.

18:11And what does it show? It shows that when the married male unemployment rate cuts below about 3.2%, wage rates generally start to accelerate. They started to accelerate in 1996. In 1999, we're looking at a deceleration. However, as I say, that may not be true. The acceleration is probably continued. I could go into reasons why the acceleration happens. In other words, it's not just, generally speaking, that wage rates grow at a rapid clip when the married male unemployment rate, that is the core unemployment rate, cuts below 3.2%, it's that they accelerate and this might remind you of what's called the narrow, the non-accelerating inflation rate of unemployment.

19:09The non-accelerating inflation rate of unemployment, in this case, looks like a 3.2 percent. At 3.2 percent, it neither accelerates or decelerates, but below 3.2 percent wage rates accelerate. Now, this is something that Banderley has uniquely understood with his econometrics. And what he realized in early 1996 is that the married male unemployment rate had gotten low enough to bring about a consumer-led expansion, a rapid consumer-led expansion that would push GDP growth to the three and a half to four percent level.

20:04Now take a look at page 12. There we're looking at the married male and the plumb rate. I said 3.2% was neutral, it's actually 3.6%. All this it tries to show is that the rate tends to move in fairly stable cycles. It takes a long time for it to move up or down. It took a long time for it to move down, but once it did move down in 1995, there was a tendency for it to stay there. And it's possible to track it by looking at other indicators to help want to index the number of unemployment insurance claims, the survey of jobs hard to get.

20:58And so it was possible to, first of all, have confidence that the married male unemployment rate, once it had hit this zone, where it was going to cause wage rates to accelerate, it was likely to stay there, and then it was possible for Vandalik to chart it, to track it, by looking at those variables which are advanced indicators of where the unemployment rate is going to be, and he then was able to put together a forecast that this economy had gotten to a point where it was going to be difficult to stop prosperity in its tracks. Finally, take a look at page 13. That has

21:51a few lines. Let me walk you through those. All it shows, what it shows first of all is is the increase in real average hourly earnings, which is the broken line, and then it shows real consumer spending, and the bottom line takes the growth of real consumer spending minus the real increase, minus the increase in real average hourly earnings. and what it shows is that spending always increases faster than real average hourly earnings with the exception of recession and those recession periods, for instance, the early 90s, the early 80s, when spending increases at the same rate as real average hourly earnings.

22:47What is this caption? It really says that average hourly earnings, which are paid to the bottom 80% of the population, tend to understate the increase in spending. They understate the increase in spending, and there's sort of a floor, because they're a proxy for the spending of people who do not save a great deal. People who don't have a whole lot of money to invest, people who live from hand to mouth. In the earlier graphs, we showed that once the Maryland unemployment rate had hit below a certain level, Earnings were going to explode. Now we have another approximate law of the way markets behave, that when earnings explode, real consumer spending tends to increase at an even faster rate, and we begin to have the makings of a forecast that worked.

23:56A Forecast that called for growth in gross domestic product between 3.5% to 4%. Now, there are some other factors, obviously, at work. Real average hourly earnings aren't the only factors. The three other factors are, of course, the number of hours worked, and the total number of hours worked multiplied, of course, by real average hourly earnings in order to get you an idea of how much money is going into the hands of those people who tend to consume a very high percentage of their income. And hours worked, again, could be tracked through help wanted, through unemployment insurance claims, through the number of people who said that jobs were hard to get.

24:48In addition, a second factor is home purchases. When people buy homes, and that's a factor that could be tracked through the mortgage bankers index, when people buy a lot of homes, they buy a lot of consumer durable. They tend to save less out of their income because they think of buying a rug or buying an appliance as an investment. So consumption rises that way. Survey, and thirdly, there's expectations. Expectations are tracked by the Michigan University Index Survey of Consumer Sentiment and also by the Conference Board Survey. When expectations are high, people will spend a lot. Well, Benderly was right about the prosperity of the past few years, and the consensus was wrong, and as I've suggested, the consensus was wrong for the wrong reason, and Benderly was right for something approaching the right reason. What is he saying now? Well, he now agrees with the consensus, the consensus now He now agrees with him. He believes that the factors that could bring this economy down are still not strong enough to stop the consumer-led expansion because, again, the core rate of unemployment is so low that wages are going to continue to rise rapidly,

26:34in fact continues to accelerate, at some point the process will be stopped, certainly something is going to happen around the turn of the year with Y2K problems, but he I guess has tunnel vision because he recognizes, well he recognizes that there are factors that could stop the expansion the weakness of the dollar and other factors that I'm sure you've learned about over the course of yesterday and this morning but still this this is a powerful influence that for which he had a small triumph in isolating well enough of that for the moment take a look at page 14 in which Einstein dies and goes to heaven, God calls him into his office and says, Al, it's a pleasure We're here to have the smartest man who ever lived with us at last.

27:56We're opening up a new wing for the next year, but for the time being, you're going to have to share a suite with three other guys. Einstein says, well, I'm very particular about the company I keep, and God says, Al, speak to these guys. If there's any problem, talk to me. So, Einstein goes up to the first gentleman and says, I'm Albert Einstein, the smartest man who ever lived, who are you? The guy says, I'm, in my life, I was an astrophysicist and I have 180 IQ, and Einstein says, well, terrific, we'll talk black holes, we'll talk big bang, we'll have a great time. He goes up to the second gentleman and says, I'm Albert Einstein, the smartest man who ever lived, who are you?

28:45Well, I was a concert pianist in my time, I have a 160 IQ, but Einstein says, terrific, we'll talk Brahms, we'll talk Beethoven, we'll enjoy ourselves. Goes up to the third gentleman, says, I'm Albert Einstein, the smartest man who ever lived, who are you? Well, the gentleman says, well, Dr. Einstein, the first thing I have to say is that I have only a 60 IQ. Einstein says, terrific, tell me what interest rates are going to do next year. Well, that really does relate to forecasting interest rates. Take a look at page 15, and that shows where the 30-year T-bond rate and where the Moody BAAA rate stood at the end of each year.

29:40For 1999, it's as of last week. First, rates rose, and then through the prosperity, rates fell from 96 through 97 through 98, and they've only begun to come back in 1999. Now, what What was the consensus saying? The consensus looking for moderate economic growth in each year since late 1995. It said that interest rates were going to be unchanged consistently, that the long-term interest rate, I should say, the long-term interest rate, they were saying other things about short-term rates, but that the long-term interest rate was going to be unchanged.

30:31and of course they said this because a moderate rate of growth generally would call for unchanged interest rates. That going into why rates actually increased in 96, they actually, they increased in 96 primarily because growth was rapid but in 1997 and 1998 the reverse happened and of Of course it happened because of all kinds of unexpected factors, oil prices falling, food prices falling, general recession around the rest of the world so that commodity prices were weak and then of course going into 1997 and 1998, the Asian crisis hitting causing and even further disinflationary and deflationary factors which tended to weigh on interest rates.

31:31None of it was expected, and for that reason the consensus simply got it all wrong. And into 1999, the consensus was expecting moderate interest rates because even though they were looking at a high rate of growth, They began to look at a high rate of growth in mid-99, they simply extrapolated the same trend, they were looking for unchanged interest rates. I'm sorry, I made a mistake here, I'm being unfair, the consensus actually is looking for higher interest rates and they were only looking for unchanged interest rates in early 1999 because they were looking at a moderate, they were forecasting moderate rate of growth, so strike that.

32:18They were consistently wrong and consistently looked at unchanged interest rates because they were consistent in thinking that the rate of growth would be moderate. But the Benderly forecast was also wrong. Benderly was looking at, was forecasting prosperous times, and of course he said, well, if that's going to happen, then interest rates are bound to rise. and he also got it wrong, so no small triumphs there, I think I have only a few minutes to just discuss forecasting recession and then I'm going to stop, once again no triumphs, page 16, forecasting recession, let's start with the economist, I enjoy this quote because perhaps I have a personal vendetta against the economist.

33:14I think it's a very overrated paper, overrated weekly. What were they writing on April 15, 1989 about the Japanese stock market? What Japanese investors have become aware of is the dramatic way Japan's blue chip companies have changed the sources of their earnings through restructuring. This has made their profits too erratic to give any meaning to rigid measures such as the P-E ratio. Instead, investors have started to assess the company's future stream of earnings by looking at the total value of a firm's assets. The implication is that shares may be underpriced. Well, that was written, of course, about eight months before the NICA hit a high of $39,000 and then crashed, and even today, last I checked, and this day was trading under $18,000.

34:11I don't know what it's done over the last couple of days, but it didn't work out. Now take a look at the consensus forecast in early 1990. That was six months before the official start of the 1991 recession. They were seeing danger signs, but of course it was difficult to forecast that a recession was actually going to happen. Despite recent danger signs, the U.S. economy will continue expanding for its eighth consecutive year, helped by lower interest rates, according to a survey of 40 economists by the Wall Street Journal. By far the gloomiest of the 40 economists surveyed is A. Gary Schilling.

34:58He now has predicted three of the last recessions that never happened. Now Schilling was right at that point, but unfortunately Schilling is indeed a stopped clock. He's always forecasting recession. He never saw an expansion he didn't dislike, and for that reason he does indeed have weak credibility. Now cut to July 5, 1990, that's page 19, and there again, even though the recession actually began that month, actually officially began in June of 1990, just the month before, the consensus was mentioning recession, but they thought that Chairman Greenspan would does save the day. Falling interest rates will bolster the sagging U.S. economy, helping to avert a recession for at least another year, according to a survey of 40 economists by the Wall Street Journal. Then in January of 1991, six months into the recession, the economists finally got it right. They were closing the barn door after the horse had The party is over. Now comes the painful cleanup. That's page 20. This grim New Year's forecast is the consensus view of 40 economists and the Wall Street

36:29Journal's semi-annual survey. Most predict the U.S. economy will shrink for at least the next six months, driving the jobless rate sharply higher by mid-year. We're in a very severe recession, contends Philip Braverman, chief economist of DKB Securities Corp. In terms of bankruptcies and financial pain, this This recession could well be the most severe since the 1930s. Well, I cite Phil Braverman, who was actually recently retired, only because he was another Cassandra, another stopped clock, always calling for slowdown and for recession, totally blind and the prospects of prosperity and the forecast that the recession could be as bad as the 1930s was certainly misplaced.

37:22The worst recession since the 1930s still remains the one in the early 80s and this recession was comparatively mild. I mentioned that the consensus was looking for Alan Greenspan to save the day in 1990 and 1991 and he was unable to do so. Page 21, here's a depressing quote from Chairman Greenspan about his inability to forecast bubbles. History tells us that sharp reversals in confidence happen abruptly, most often with little advance notice. What is so intriguing is that this type of behavior has characterized human interaction with little appreciable difference over the generations.

38:13Whether tulip bulb or Russian equities, the market price patterns remain much the same. We can readily describe this process, but to date economists have been unable to anticipate sharp reversals in confidence. That's too bad that Chairman Greenspan is as befuddled as the rest of us in timing the breaking of market bubble. I have a few minutes. I want to end on an upbeat note. I'm going to skip the Harry Cone joke and get to the substance. That's page 22, Forecasting Markets. Here's something. That's page 23, shifting ground altogether and getting back to my commodities background.

39:03This is the trading record of a company called Wizard Trading. They manage something like 70 to 80 million dollars and they trade commodities. It's purely computerized. The system was developed, as a matter of fact, by somebody who used to work for me in commodities years ago, who at that point didn't believe in technical analysis, but then had a conversion. And amazingly enough, what he did was he programmed his computer to recognize various chart formations. And since 1991, if you notice this track record, he's managed to eke out a profit.

39:51It's not a very impressive profit. Those profits would unfortunately be taxed at ordinary income rates. But to my mind, it's a real pebble in my shoe. As somebody who can only believe in fundamental forecasting, who doesn't believe in the power and the power of charge formations, here in what is essentially a zero-sum game, trading futures contracts, after commissions and after fees, he's made an average of 14%, one down year in 1997, that was 11% loss, and his gross, using about 35% leverage, has been 18%. When I ask him why do chart formations make sense, he tells me that it's something like a seaman checking signs about what the weather is going to be.

40:48If there are certain patterns, then if the wind's blowing, he determines it's going to rain. It's possible to look at a chart according to him and have a better than even chance and that you're going to be right about the direction of prices and what I find a little bit intimidating is that he has managed to make a profit in the use of these chart formations.

41:19As I say, this is a completely computerized system. The computer recognizes various chart patterns, trends and counter trends and makes its decisions accordingly. The last trading Trading Markets, page 24. I just wanted you to know that Chairman Greenspan, who can't forecast, is at least on record as saying that the bull market is coming to an end, the bull market in stocks is over. In his Humphrey Hawkins testimony, he lets the following statement, consumption growth should slow some if it seems most likely outside gains in share values are not repeated.

42:06And actually I think that he hopes to bring about a trading range market. He dearly prays that he's not going to be responsible for a market crash. I'm going to end there, because I have taken a fair amount of time. We have a few minutes for questions, so let me open it up to you. Thank you. I'm going to have to repeat your questions, so bear with me and keep them relatively short, Can you say something about the methodology that long-term capital management used?

42:58Well, I can't say anything very good about their methodology. I asked those guys in the show, and I forget the other guy's name, to give back their Nobel Prize. Clearly the mistake they were making was really very similar to the fundamental mistake that has been made in understanding rational options pricing. The options model gives you an edge, and a lot of arbitrageurs have been very happy about that edge, but it should have been recognized a long time ago that, for instance, when it When it comes to stocks, that model has certain assumptions in it that are not quantified.

43:52Number one, it assumes it knows what's going to happen to dividends, what's going to happen to interest rates, and more importantly, it assumes it knows the shape of the curve of market volatility. So all these guys did was calculate a few things and then say, hey, well, look, let's make assumptions for the rest. And they put on their war paint and they had a model. And this same mistake was carried through to arbitraging in world markets. They wished that there were One of the assumptions built in to these models, one of the assumptions being, for instance, that the Russians wouldn't shut down their bond market unexpectedly.

44:43So, clearly, it should have been understood that these models give you an edge, but you have to be very careful to understand what's going on in the real world, lest you become He asks, if you were to look at the minutes of the Fed, how does their record compare to those of the forty Wall Street Journal economists? Oh, yes, well, thanks, I should have mentioned that the Fed has been tracking the consensus almost exactly. The Fed was anticipating moderate growth since 1996. It's been consistently wrong, and that's the reason why Mr. Greenspan did not tighten, because he thought that he's always been behind the curve.

45:53He's only beginning to respond in the same way that the consensus is responding, by assuming that he might once again be surprised on the upside by an economy that expands at a faster rate than he imagined it could. And what he's done, of course, is helped the expansion along by holding the line on interest rates. And, of course, last year, because of the fact that markets seized up, as he put it, he even eased interest rates. But had he agreed with Benderly that the economy was going to grow at 3.5 to 4 percent, had he understood that the unemployment rate had gotten so low that wage rates were going to accelerate, then he probably would have tightened far more than he ever thought he should, and I believe he's still behind the curve.

47:08Gene, shouldn't we be skeptical, this gentleman asks, of the whole idea of predicting national recessions, since some parts of the economy can be doing very well while others do badly? Oh sure, that's absolutely so. I guess the reason, well, all right, now I see, I think I see what you're saying. Excuse me. I was about to say another point. I do believe that there's a reality to recession because a lot of the economy is not doing I think that there's a reality to the unemployment rate. When the unemployment rate rises toward 10 percent, it does mean that there's a lot of pain out there.

48:08But I think that simply because some of the economy is always doing well, even in the recession, isn't necessarily the reason why we don't seem to be able to forecast recession. I think that the term recession does describe something about reality, high unemployment rate, a number of industries doing poorly, laying off their workers, not investing. I think those things do happen, but unfortunately, what seems to trigger a recession, which as Mr. Greenspan correctly notes, is a break in confidence.

48:56That break in confidence is very difficult, if not impossible, to forecast. Very hot. Jean, comment please on your second prediction, exactly why you think the Federal Government is going to do this, and also how will they proceed to do it? Oh, thank you. Oh, actually, you looked ahead in my last chart where I actually made a couple of predictions. Sorry I published that, but I think the government will do it for a couple of reasons. First, they will do it because there is a bipartisan consensus about this issue.

49:43Clinton has already said that, as I'm sure you know, that he thinks it's a good idea to invest some money in the stock market. Clearly, the Republicans aren't averse to the idea. In particular, they aren't averse to bailing out the stock market. And for that reason, if there is a bear market, it's going to make perfect sense. First of all, some smart guy, maybe Larry Summers if he's still around, is going to say hey look, people at Barron's were pointing out that we in the government are so stupid that we only know to buy at the highs, we only know to buy when the market has been soaring 25-30 percent.

50:30What we're going to do is take advantage of this big market dip, because we're investing for the long term. So that circumstance will be very propitious. Secondly, Washington likes the stock market. They recognize that there's an enormous constituency that also likes the stock market. And thirdly, they will probably keep the faith. and the faith that stock prices yield a better return than bonds do. Now, as for exactly how it's going to be implemented and when, I'm not sure. I don't know whether it's going to take a 30 percent bear market or a 25 percent.

51:22I'm sure that a number of philosopher kings will be appointed to manage this portfolio. It's probably a perfect job for Alan Greenspan to do once he retires. No doubt he will enlist the services of Robert Rubin to help him out. I don't know if that answers your question. It's the best I can do, but if you want to press me, that's fine. Do you agree with Alan Greenspan, as quoted on page 21, that the market bubble is driven by animal spirits, as Cain said, or is it simply a rational response to government intervention and regulation of the economy?

52:10No, I don't agree with that statement that the market bubble is solely driven by animal I tend to associate myself with the Austrian theory of the business cycle, and strangely if you look at some of Alan Greenspan's statements, he's got a lot of ambivalence about that himself. He, as some of you may know, he once taught human action at the Nathaniel Brandon Institute prior to going into politics.

52:56So he is very aware of Austrian theory and every once in a while he makes an allusion to it. A couple years ago, he spoke about inflationary imbalances, and that's not a literal Austrian statement, but it's certainly an Austrian concept that the inflation of the money supply brings about imbalances. I also noticed, by the way, that in a recent speech, Greenspan spoke about time preference, which is right out of human action. That's by Ludwig von Mises, as I imagine most of you know, who is, to my mind, the father of the Austrian School.

53:46So, no, of course, I don't agree that it's purely animal spirits. I tend to agree that the breakdown in confidence is what seems to precipitate the bursting of the bubble. But as I say, it's not just that I don't agree with it. I'm not sure that Alan Greenspan agrees with it either. I think if you read his speeches, by the way, you'll see that he's often very confused and very ambivalent about what's been going on in the economy. He has spoken humbly about all the on-the-job training he has received over the last few years.

54:36And as I say, I think that he's a bit behind the curve even now about what's likely to Jean, back to your prediction number two. Since in the next fair market and recession, government revenues are going to collapse. What are they going to use to buy the stocks? Well, government can always find something. They will sell treasury bonds and that's what they invariably do. That's what's often called fiscal stabilizers. The government sells treasury bonds by printing money and then with that money it's going to buy stock which of course is roughly similar to buying stock on margin.

55:42and not, I shouldn't say roughly similar, it's identical to that. So they, as a matter of fact, you know, if we have the same smart guys in government running the economy as we have, like Summers and like Rubin, they might be fairly explicit about this. It's a leveraged play. They're taking in money at, you know, 5% and they're buying stocks with it Will Greenspan retire or be reappointed?

56:36I'm talking about small triumphs, about forecasting. That isn't going to be one of my small triumphs predicting whether he's going to retire or not. I will go out on a limb only in this regard. I just imagine that a man in his early seventies who's fairly vigorous and who has a relatively I have a young wife. He's married to Andrea Mitchell, who was in her early 50s and quite vigorous. He can get some other jobs, but it's probably more appropriate in terms of his relationship with Andrea to keep at his really important day job.

57:22And so my prediction, even though this forecast is worth very little, is that he will indeed want to be re-nominated and that he will be re-nominated. Certainly he will be because he's got enough clout to be re-nominated. The question of whether he wants it, and as I say, a man with a young wife really will I just discovered a couple of days ago that Alan Greenspan's father-in-law lives in my building.

58:07Somebody in the building told my wife that he saw Alan Greenspan walk into the lobby and we later found out that he was visiting his father-in-law with Andrea, of course. Given the Fed's record of forecasting, what's your explanation for why Wall Street and the public have such tremendous confidence in Greenspan and the institution? I have to think a moment. I guess I guess you can, you do have to agree that this is now becoming one of the longest expansions on record. It's been a relatively stable expansion and for that reason Alan Greenspan is getting There is a tendency on Wall Street for people to believe that simply because relatively good things have happened, they should credit it to the only man who's seen it.

59:38The blinders that they wear about his poor forecasting record may be determined by the fact that his poor forecasting record has been identical to their poor forecasting record. So for that reason it may well be that smart fed watches are going to overlook his obvious problems in this regard. The investing public listens of course to the economists. The public at large always likes to look up to a father figure. He speaks with a great deal of humility and calm. That helps also. And so as I say, it's probably only that things have been good and when things are good, we will credit it to whoever seems to be running the show.

1:00:44What's your view of the effect that the perhaps hundreds of billions of dollars that's come in from Russia into the market has had on the market and what might happen if those flows cease because of the money laundering investigations and all? I mean, in general, of course, the trade imbalance is the hot money that could potentially destabilize this economy. If it does turn out to be hot money, hot money not just from Russia, from all sources, Then, the one thing we can be relatively sure about, which is that abrupt changes are very difficult to deal with.

1:01:44If there is a rapid exit from our markets by foreign money, then that rapid exit could set off a decline in confidence that Mr. Greenspanning won't be able to stop by rapidly cutting interest The Capital Markets could once again, as he puts it, seize up and even the powerful force that Bentley has isolated could be wrecked and we could be in a recession. But I always pray for the expansion to continue. I would like to see a trading range market in stocks.

1:02:34I'd like to see them just, you know, a market that ranges from 8,000 to let's say 10,000 the next few years, so that earnings can be given a chance to grow and catch up with those high prices. And I hope that if and when there is an exit from the U.S. markets by foreign money, that it happens slowly enough for the economy to adjust to that process. But I think certainly that when you look at the dangers to the U.S. economy, sooner or later, one or more of those factors are going to do us in. Floyd? When he asked us what to comment on Greenspan, February before last, saying that if the entire international financial structure was not entirely Y2K compliant, it would come down.

1:03:26Comment please on Greenspan's statement of February last, that if the entire international financial and banking system wasn't Y2K compliant, that it could all come down. Did he say that? Well, gee. I admit I've been impressed by others who have said that, and unfortunately I can't say too much about it. I wrote at one point about the Y2K problem. Certainly you can paint some pretty dire scenarios about what could happen There are all kinds of obvious interdependencies, not just in banking, but in manufacturing and embedded systems.

1:04:19I have to admit that I just reverted to prayer about Y2K nine months ago because it's such an impossible topic to cover. It would be more than a full-time job for two or three journalists. I only wish that some of the dailies had put two or three reporters on the Y2K problem to actually find out what's been happening among the industries and in banking. But I guess I could hazard a couple of guesses. It does appear that our own financial system, the U.S. domestic financial system, is probably Y2K compliant.

1:05:12I don't know about all of the rest of the economy, but assuming the rest of the economy is more or less going to muddle through, Then what I'm skeptical about is what's going on, and worried about I should say, is what's going on in particular in Asia, Japan, and maybe a little even a bit in Europe. On the other hand, just like the Asian crisis did the U.S. economy a lot of good by bringing about cheap oil prices, cheap commodity prices, cheap imports.

1:05:59It's very possible that the way the Y2K will play out is that there will be a flight to the U.S. because we seem to be more Y2K ready than other economies. But as I say, that's been very daunting. It's been very daunting to try to predict what Y2K will do. And so those statements are made with all due modesty. Prediction number two comes true, whether it's through the Fed or the Treasury or the Social Security system. Is it ever going to be possible to put that socialist genie back in the bottle?

1:06:57and then if we're also lucky and if the market does well, then we might be encouraged to allow

1:07:56I think we offer people a great deal of flexibility about when they want to retire, when they want to retire early, or whether they never want to retire and simply leave that money to their kids. But I think that's only an outside chance. The way I read the political situation, most likely we will have perhaps an even more pernicious form of socialism in the sense that government will begin to invest in the stock market. And my fear is that at some point down the road, that process will become politicized. At some point it's very possible that, you know, a Democratic Senator might say why are we investing in cigarette stocks when we have a policy towards cigarette stocks.

1:08:51I think that's a real risk. On the other hand, it is also possible to imagine a bunch of high priests who are given the power to invest and who don't have to tell Congress where that money is invested. I'm just a little skeptical that that will happen. As I say, I think the individual retirement accounts are an outside chance. I think, unfortunately, the greater likelihood is that the government will invest directly in the stock market with some of the perils that that involves. Jean, thank you very much.