July 27, 2010
You mentioned that the long-term average multiple was 15 times ten-year earnings. Currently it's about 22 which you said is a bit on the high side, but not egregiously high. What kind of returns, based on your experience, could investors expect over a ten-year period in environments where you are starting with the kind of similar multiple of what you have today, in the low 20s?
Based on our forecast using regressions, it's a tough call whether stocks or bonds will pay more over the next 10 years. It's not an inspired time. Our forecasting regression would suggest positive returns, but not terrific. So what do you do?
Let’s turn to the economic environment and how it might help answer that question. You recently had an opinion piece in the New York Times. You argued that investor and consumer sentiment in and of themselves could lead to a double-dip recession. What do you think about that?
Consumer confidence has always been a difficult topic for economists, because it is really more psychology than economics, and it is hard for us to be systematic about it. Now there are confidence indexes, although they are not usually generated by economists. They are by business groups or psychologists.
We have some evidence now that confidence has taken big swings, and it has gone through long-term swings. In the 1990s, for example, there were periods of rapidly rising confidence as measured by those indices and then sharp drops afterward.
In order to forecast the economy it would be nice if we could think about forecasting confidence.
This is where I get worried. I don't need to tell you that right now in the US it looks like the economy is improving, but we still have high unemployment, and it is weighing on people's psyches. It is leading people to wonder whether we are going to have a normal recovery. If they reach negative conclusions it can be a self-fulfilling prophecy.
Could you define a double-dip recession?
I have my own definition, which is a recession, which is a pair of recessions between which the economy never fully recovered. If you look at the unemployment rate for the United States going back to 1948, recessions were quite clear and sharp. Between every pair of recessions there was a normal period where the unemployment rate got down to 4% or 5%, or when the long-term unemployment rate got down below 1%. That measures people who have been unemployed for 27 weeks or more.
This time I suspect unemployment won't reach those levels.
Have we had a double-dip recession without that intervening recovery?
The last double-dip recession was 1980 and then 1981-1982. That was a pair of double-dip recessions. Before that, you've got to go back to the 1929-1933 recession and the 1937-1938 recession. Those were four years apart, but I still count them as a double-dip because we never got out of the high unemployment between them.
As you look back at those double-dip recessions, to what extent were they fueled by consumers’ apprehensions and worries about their jobs or about the economy recovering?
That is the fuel. In my book, Animal Spirits, with George Akerlof, we argue that that is the defining characteristic of economies. Economists don't recognize this, and they should. Recognizing this should lead to a change in economic theory.
It is not just consumers; it is also investors and investor confidence. When you reach a situation when people think that we are going to be in a depression, or that we might be in a depression, everything stops. Consumers don't buy that new car. But it is also the school district that doesn't hire the new teacher. In fact, they lay off.
Businesses decide they are not going to launch a new product now and wait until better times. Or they run down inventory. As an entrepreneur you could say, I have a great idea, but I can't do it now. Even if you thought you wanted to do it now, a lender might conclude, “Great idea, but come back in five years.” That's what slows everything down and that is obviously what is happening.
Going back to the 1930s, one of the things that President Roosevelt is most known for was reigniting a sense of confidence among Americans, for example through his radio addresses and the famous quote, “We have nothing to fear but fear itself.”
To what extent do you see reigniting that sense of confidence going forward as a key role for our political leadership, both the United States and elsewhere?
It is very important. Offsetting that is that we live in a world economy, and one leader in one country can't cure the world. But I think that we had a boost from President Obama in the United States. He is a charismatic figure despite all the people who dislike him. Maybe they dislike him because he is charismatic. I don't know. But his popularity has suffered. He sounded like a smart guy, in charge, enlightened, and with a plan. He did the stress tests on the banks, and it worked. Those stress tests boosted confidence a lot, because the testers said our banks were basically all right.
That same stress test process just happened in Europe.
Those results are about to be announced, and it is a question of whether it will have the same effect. It is actually a powerful technique when it works. But if the testers are really objective, it might not work in some circumstances.Display article as PDF for printing.
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