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VIEWPOINTS : Next Time I'll Be More Circumspect

September 06, 1987|LESTER C. THUROW | LESTER C. THURLOW is Gordon Y. Billard Professor of Management and Economics and dean of the Sloan School of Management at Massachusetts Institute of Technology in Cambridge

Will a great depression come in 1990? The only honest answer is that no one knows for sure, but I don't think so. Should one sell "all stocks and stock-related assets and real estate after the middle of 1989, but keep U.S. Treasury bonds and AAA corporate bonds?" I don't know, but I am not planning to.

Given my beliefs, you might ask why I wrote the foreword to the book by Southern Methodist University economist Ravi Batra, "The Great Depression of 1990," which has been on the New York Times' best-seller list for two months. The simple answer is that I wrote the foreword to a version of the book that had a less inflammatory title ("Regular Cycles of Money, Inflation, Regulation and Depressions") and that did not contain such specific financial advice. I wrote that foreword because there were arguments in the book worth considering. Maldistributions of income and wealth, such as those that are now appearing in the United States, can lead to economic difficulties.

The more complicated explanation is that, as much as I disagree with some of the specific conclusions of Batra's book, I believe even less in having legal brawls of the type that would have been necessary to remove my foreword from the book and my name off the cover. The author and publisher would not take the foreword out voluntarily, and I was not willing to go to court to force them to do so.

History Teaches Lesson

If anyone bothers to read the foreword, which is unlikely, he or she will realize that I carefully distanced myself from the specific conclusions. But given the circumstances, let me clearly set out what I believe about the probability of an economic crash.

Only twice in history have stock price to earnings ratios been as high as they are now--1929 and 1965. Historical evidence would seem to indicate that the American economy cannot for long sustain this. Perhaps something will be different this time and allow stocks to remain stable or even go higher, but it is hard to identify what that something might be.

But to say that the stock market is perhaps overvalued is not to say that the economy will collapse. After 1929 it did; after 1965 it did not. While real stock prices fell 50% in the 17 years after 1965, the real gross national product grew 56%. A declining stock market did not lead to a declining economy.

The stock market also did not bring the economy down with it in 1929. What brought the economy down then was the collapse of the banking system in 1930. As long as the government stands behind the banking system, even a sharp break in stock prices is not going to start a Great Depression.

Few Hold Wealth in Stocks

The reasons are simple. The great majority of Americans hold essentially none of their wealth in stocks. As a consequence, a falling stock market means nothing to them personally. Government expenditures also now account for more than one-third of the GNP. The economy cannot collapse unless middle-class and government expenditures collapse, and they are not going to collapse simply because of a decline in stock prices.

If you like to generate financial nightmares, I would suggest focusing attention not on the stock market but on the very small probability that the government won't, for some reason, protect all of the depositors in the weak banks and savings and loans that dot the American landscape. But one should remember that nightmares are hardly ever true.

Great Depression scenarios usually begin with stock market crashes, as is the case in Batra's book. But predicting the stock market in a modern society is what witchcraft is in a primitive society. Where there is a demand to explain what is essentially mysterious, someone will don the robes of a soothsayer.

Stocks are unpredictable. But it will always look like someone has a good forecasting record. Suppose that I flip a coin 50 times and 100,000 people are trying to guess the sequence of heads and tails. Some will probably come close to getting it right. They will be able to claim that they are smart, perhaps justifiably, but more likely they are simply lucky.

Higher stock prices lead people to feel wealthier and to spend more, but the economy affects the stock market more than the stock market affects the economy. If you have a healthy economy, the stock market will take care of itself. If the economy isn't healthy, there is, alas, very little that you can do as an individual to avoid its consequences. Who is to say, for example, that in an unhealthy economy the price of gold (Batra's preferred investment) would rise? It might fall, as it often has in the past.

Being aware of the pitfalls of financial forecasting, in the past I have tried conscientiously not to do it. Having stumbled into a situation where I seem indirectly to be endorsing some very particular financial forecast, I guess I better be a lot more careful in the future when I write forewords to books.

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