Beyond the Bubble: An Interview With Robert Shiller
Yale University economist Robert Shiller is very much in demand these days -- no small achievement for a bearish practitioner of the dismal science in these exuberant times.
Earlier this week he pontificated with the best and the brightest at the White House Conference on the New Economy. Last month he testified before Congress on margin lending. And his new book, Irrational Exuberance (Princeton University Press), is getting deservedly good reviews, despite the fact that Shiller blames the media for helping to inflate the "biggest [stock market] bubble ever in this country." I pinned the professor down between engagements and classes this week to chat about that and other money matters. Here's some of what he had to say.
Tell us about "the biggest bubble ever."
In percentage terms, it's close to the market in the '20s. From 1995 to 2000 the market tripled in real terms, and from 1924 to 1929 the market slightly more than tripled. But I still like to call this a bigger bubble because we're in a bigger economy. Also price-earnings ratios are higher now. They're 45 now [calculated on a 10-year moving average]. They never got above 33 in 1929.I guess all this "New Economy" talk is what's inflating the bubble. It's actually the other way around. If you read accounts of new eras you see that they come in reaction to stock market increases. The market booms, then we're in a new era. People see the stock market go up, they're puzzled and they want to know why. That's when public speakers begin to mention the 'grand new era we're coming into.' So what gets the stock market going? There are a number of factors that make up the 'skin' of this bubble, including the revolution in information technology, demographics of the baby boom and increased media coverage of business and investing. It's like an avalanche -- something disturbs the snow, one drift hits another, then another. But what skier dislodged the snow and started the avalanche may not be that important. At the White House Conference on the New Economy there was a lot of talk about the Internet and how it's going to transform the economy. I found myself captivated by it too. But the Internet itself is not that significant an invention -- computers are the fundamental invention, and they've been around for 50 years. And it's not clear that the Internet should push valuations higher. As an economist, I could pose an equally plausible theory that the Internet will make us all fabulously rich in the future so I don't need to save. Therefore I'll sell all my stocks and the market will fall. That sounds crazy. What about all the productivity improvements brought about by the Net? Is the actual invention of the Internet more important than vending machines? They're everywhere! Think of all the labor they save! That's a pretty good invention, but I don't hear anyone saying that the stock market should triple because of vending machines. C'mon, they're not really comparable are they? The thing about the Internet is that it's so visible and user-friendly. Visibility is what matters for valuations. I guess that's where the media come in. The media is very important, starting with the invention of the printing press in the 1500s. By the early 1600s there were regular newspapers. Holland was the first country with a free press and there were lots of pamphlets and newspapers. Tulip mania -- the first speculative bubble -- coincides with the advent of the press. This isn't the first "new era" either, is it? In 1901 there were expansive stories about the new century and futuristic optimism about technology in particular. New corporate giants like U.S. Steel and Standard Oil looked very powerful. It could be imagined that we would all be very well off because of them. That turned out to be an exaggeration. The '20s was a period of a lot of very visible technology We first got radio stations. People could tune in to "Amos & Andy" or hear the president speak. It was also a time when the automobile and good roads expanded a lot. Airplanes too. Very visible inventions, like the Internet today. How do new eras and speculative bubbles end? One-day events play a role, but less of a role than people think. The new era in 1901 wasn't followed by a sudden crash. The market just didn't go up anymore and for the next 20 years it did badly. The 1929 crash reversed almost completely by 1930. Nonetheless, it's the one-day events that change the way people think. They become the symbol of something wrong. After the 1929 crash the market just spiraled down over a period of years, as negative factors became prominent. Public opinion can change quite sharply in a few years. Right now we're at a record high in consumer confidence. I don't expect that will continue forever. We're in an experimental period were we've got a lot of start-up companies with no profits, built on hope. One kind of event that could trigger a market decline would be the failure of a lot of these. Or it doesn't have to be that severe. It might just be some change in public thinking about the economy. It's very hard to predict what the focal point will be -- there are so many things that might attract attention. If there is a downturn, writers will come up with new slogans and create a new view of the world. Then there will be a whole new way of public thinking: "I used to think that the market always comes back from a dip. But now we're in an 'X economy.' I don't know what 'X' is, something that some writer invents. Down how far, and for how long? I react against these guys on CNBC who say with great precision what's going to happen. The market is way overpriced now -- it could easily fall by half. But I don't know. What should investors do? Some people are putting high percent of pension funds in the stock market. These people will have a tough time. People should diversify -- real estate, bonds and international. There are still some stocks that look pretty cheap. Ford Motor (F) has a P/E [price-to-earnings ratio] of 7. Certainly, Social Security funds should not be put in the stock market. Where's your money now? I have a lot of inflation-indexed bonds, money markets and real estate. I'm a big fan of TIPs (Treasury Inflation Protection bonds). They're yielding 4% -- quite a bit more than the 1% dividend yield on stocks.
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