James Grant: The pioneers of market prediction taught us just how unpredictable the economy can be.

Book Review: ‘Fortune Tellers’ by Walter Friedman

The pioneers of market prediction taught us just how unpredictable the economy can be.

JAMES GRANT

Jan. 3, 2014 4:43 p.m. ET

The pioneers of the impossible business of predicting the financial future are the subject of Walter Friedman’s carefully wrought “Fortune Tellers.” Luckily, the book arrives in time for the New Year’s forecasting season.Do you itch to know whether stock prices and interest rates will rise or fall? Whether the U.S. economy will sink or swim? So did your forebears. To scratch the itch of the early 20th-century investor, Roger W. Babson (1875-1967), Irving Fisher (1867-1947) and John Moody (1868-1958), among others, hung out their shingles as business prophets. This is their story.

Fortune Tellers

By Walter A. Friedman
Princeton, 273 pages, $29.95

 

James H. Brookmire pioneered the use of ‘leading indicators’ to predict economic shifts.

To skip right down to the bottom line, they weren’t very good at their jobs. They had their flashes of insight, all right—Fisher, a renowned scholar, had more than flashes—but not one of them could consistently crack the code of the future. Neither can their professional descendants (I myself being as fallible as the rest of the 21st-century strivers).

The stature of current economic forecasters can be easily gleaned from a sample of Wall Street witticisms. Thus, “What do you call an economist with a forecast?” Answer: “Wrong.” Or, “He who lives by the crystal ball eats ground glass.”

So it’s agreed: The financial and economic future has been, is now and forever will be a mystery. Yet the power and dominion of the forecasting profession only seem to grow, especially in the monetary realm. Governmentally licensed scholars on the Federal Open Market Committee fix interest rates and manipulate the stock market according to their reading of the entrails of some not especially reliable econometric models. Once we had the gold standard. Today we have the Ph.D. standard.

The Great Depression figures prominently in Mr. Friedman’s history. It was a disaster that nobody—at least nobody prominently featured in “Fortune Tellers”—foresaw. Babson, bearish since 1926, did predict the 1929 crash, only to announce that a bottom in share prices had been reached in 1931, at least 12 months early. Fisher dismissed Babson’s 1929 forecast with the immortal line: “Stock prices have reached what looks like a permanently high plateau.” Of an earlier predictive failure, Moody, founder of the bond-ratings service that bears his name, admitted: “I had thought all along that I was a great builder; but now, for the first time, I discovered that I was only a great optimist.”

Babson and Fisher were odd ducks. Each was a tuberculosis survivor, a health nut and irrepressible entrepreneur. After contracting TB, Babson would work with the windows wide open in the dead of a Massachusetts winter. He outfitted himself and his staff with full-length parkas and enormous mittens to ward off the cold.

As for life chez Fisher in New Haven, Conn., Mr. Friedman records the impressions of Lucy Sprague, wife of the business-cycle theorist Wesley C. Mitchell. “His versatile mind,” she remembered of Fisher, “had many projects going on . . . simultaneously, from health projects and circular files [Fisher’s invention, a kind of Rolodex] to economic investigations.” At dinner: “While I ate right through my succession of delicious courses, he dined on a vegetable and a raw egg.”

At least in comparison to Babson and Fisher, Moody was a paragon of ordinary human behavior. He traveled widely, distancing himself from his business for months on end. After the Panic of 1907, which he did not predict, he contemplated suicide. Later in life, he embraced the Catholic Church. “This great Mother Church of the Christian Faith has brought me the inestimable blessing of perfect peace,” Moody attested. “Where all was doubt before, she gives me certainty.”

Their predictive lapses notwithstanding, Babson, Fisher and Moody each contributed his mite to the cause of financial understanding. Babson posited that, in one form or another, the physical laws of action and reaction apply to financial markets; in effect, what goes up, must come down. Moody, a crusader for financial transparency, filled his popular and profitable Moody’s Manuals with heretofore undisseminated corporate data. Fisher, among the world’s pre-eminent economists (albeit one who died broke), worked to infuse the discipline then known as “political economy” with mathematical rigor.

Mr. Friedman, a historian at Harvard Business School, does not fail to acknowledge Oskar Morgenstern, a progenitor of game theory and a lifelong skeptic of the pretensions of econometrics. Consistently successful forecasting is impossible, Morgenstern reasoned. An unerring forecaster would soon attract a following large enough to change the course of events. “A crash is coming in six months,” the genius would proclaim. Taking sensible precautions before the clairvoyant’s deadline, the public would instantly sell or, at least, not buy—and its anticipatory actions would invalidate the forecast.

Joseph Schumpeter is another member of Mr. Friedman’s all-star supporting cast. In 1936, the Austrian-born economist registered his doubts about the possibility of forecasting. In Mr. Friedman’s summary: “While doctors might be able to advise patients about their general health, they could not determine whether a healthy patient would be struck by a brick upon leaving the hospital.”

And what was the falling brick of 1929-33? Enter, here, Herbert Hoover. As Warren G. Harding’s secretary of commerce, the famed humanitarian had champed at the bit to intervene in the depression of 1920-21; the slump cured itself before the government could get around to fixing it. Secretary of commerce, as well, under Calvin Coolidge, Hoover ordered the publication of troves of economic data. Informed business leaders, he believed, would keep the economy on the straight and narrow. Government would not coerce the executives into constructive counter-cyclical action but, when the time came, could prompt them to do the right thing. Business and government together would nip depressions in the bud.

So when stocks crashed in 1929, Hoover, as president, summoned the captains of industry to the White House. Profits should bear the brunt of the initial adjustment to the downturn, he said. Capital-spending plans should go forward, if not be accelerated. Wages must not be cut, as they had been in the bad old days of 1920-21. The executives shook hands on it.

In the wake of this unprecedented display of federal economic activism, Wesley Mitchell, the economist, said: “While a business cycle is passing over from a phase of expansion to the phase of contraction, the president of the United States is organizing the economic forces of the country to check the threatened decline at the start, if possible. A more significant experiment in the technique of balance could not be devised than the one which is being performed before our very eyes.”

The experiment in balance ended in monumental imbalance. (For chapter and verse, see Murray Rothbard’s “America’s Great Depression” or “Banking and the Business Cycle” by C.A. Phillips et al.) The laissez-faire depression of 1920-21 was over and done within 18 months. The federally doctored depression of 1929-33 spanned 43 months. Hoover failed for the same reason that Babson, Moody and Fisher fell short: America’s economy is too complex to predict, much less to direct from on high.

Henry Singleton (1916-99), longtime chief executive officer of the technology conglomerate Teledyne Inc., is not one of Mr. Friedman’s subjects, but the corporate visionary understood the limits of forecasting. Once a Business Week reporter asked him if he had a long-range plan. No, Singleton replied, “we’re subject to a tremendous number of outside influences and the vast majority of them cannot be predicted. So my idea is to stay flexible.” His plan was to bring an open mind to work every morning.

The inspiring part of Mr. Friedman’s study is the story of how the failed prophets picked themselves up and dusted themselves off. Benjamin Graham was an investor rather than a prophet. His hedge fund suffered a 70% cumulative loss between 1929 and 1932. While enduring that torment, Graham began work, with David L. Dodd, on what would prove to be the bible of value investing, the book titled “Security Analysis.” (Details can be found in Graham’s superb autobiography, “Benjamin Graham: The Memoirs of the Dean of Wall Street.”)

Irving Fisher didn’t turn his face to the wall either, though he had reason to if anyone did. His “permanent high plateau” remark made him a laughingstock. His margined, undiversified equity portfolio vaporized. (Shares in his main holding, Remington Rand, dropped to $1 from $58.) He was heavily in debt to his sister-in-law. He turned his mansion over to Yale University, his employer, in exchange for a nominal monthly rent—which he presently was unable to pay.

Though sorely beset, Fisher produced one of his best known works in 1933, the essay called “The Debt-Deflation Theory of Great Depressions,” in which he observed that plunging prices made debts unsupportable. The way out? Price stabilization, the very policy that Hoover had championed. The economist, however brilliant in mind and resilient in spirit, seemed to draw no useful comparison between the self-curing depression of 10 years earlier and the over-medicated one through which the country was still slogging.

Like the other figures profiled in “Fortune Tellers”—and like today’s prognosticators and social engineers—Fisher never seemed to understand either the power of Adam Smith’s invisible hand or the complexity of the social organism we call “the economy.” Mr. Friedman instructively quotes one of his biographers, Robert L. Allen : “With Fisher everything was cut and dried, practical and pragmatic, the variables all well specified. . . . He ignored or dismissed, or assumed away, all the great imponderables.”

It’s a shame that the professor from Yale never had the opportunity to imbibe the wisdom of the CEO from Teledyne.

—Mr. Grant is the editor of Grant’s Interest Rate Observer, now beginning its 31st year.