WWI warns us about markets’ ability to see the future

Summary: Confidence rules America, with US markets at or near record high valuations and Team Trump expanding our wars. Time for a reminder that our ability to predict events is small, which means these moments of great confidence are periods of high risk. This is a revised post from 2014.

“We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping. …I admit to not understanding it. …Nothing seems to spook the market.”
— Richard Thaler, new Nobel laureate in economics, interviewed on Bloomberg TV on 10 October 2017.

Expect the unexpected: fish


US equity and bond valuations are at record high levels by most metrics. Understandably, with the previous long deep bear market 33 years in the past, the last big war (in its economic effects) 64 years in the past, American reigning as the sole superpower, inflation low, following five years of stable growth with no obvious imbalances of the sort that cause recessions.

Many people take comfort in such high asset prices. That “markets” — the collective action of investors — can predict the future is a core part of the Neoliberal and Libertarian articles of faith. Believers tell us stories of markets’ fantastic predictive ability, supposedly an emergent phenomenon from millions of investors. It is a “wisdom of crowds” thing.

Count me among the skeptics when it comes to forecasting. Even stocks’ performance as a leading economic indicator is controversial among economists.

Sometimes investors are wrong; the October 1987 crash predicted nothing. Sometimes investors see events a little late: the Great Depression began in August 1929, the stock market crashed on October 29 (timeline here). Sometimes investors are right: the US stock market peaked on 9 October 2007, the recession began in December, the economy crashed in Fall 2008 (timeline here).

The 2008 crash is a useful case study in our inability to see ahead. Here’s a survey of risks by Nial Ferguson (Prof History, Harvard), typical of those before the 2008 crash. He doesn’t even mention the structural weakness of banks, the factor converting a real estate downturn into a global crash. I have investigated many claims of predicting the crash and found none to be valid. See several claims of predictions, including Jonathan Kirshner’s. Also see Steve Keen’s claims (here and here).

“Wall Street indexes predicted nine out of the last five recessions.”
— Economist and Nobel Laureate Paul Samuelson in his Newsweek column, 19 September 1966.

4 March 1999: The Economist predicts $5 oil!
4 March 1999: at the trough The Economist predicted $5 oil!

Predicting bigger and broader risks

Geopolitics also have an immense effect on markets — an even less predictable effect than economic cycles. On this 100th anniversary of WWI let’s see how well investors anticipated that horrific event (timeline here).

In hindsight, WWI looks almost inevitable. Historians see its origins in the two decades of rising geopolitical tensions among the major western powers, as William Lind explains. Yet investors either did not feel rising tension, or failed to act on them. For a scholarly yet readable account I recommend Nial Ferguson’s “Earning from History? Financial Markets and the Approach of World Wars” (Brookings, Spring 2008; source of the quotes below). An assassin killed the Archduke Franz Ferdinand of Austria on 28 June 1914. In the following month stock prices declined throughout the western world. Prices of US railroad and industrial shares dropped 15%. The Vienna stock market crashed on July 13.

Although selling of stocks and intensified, investors in most assets in Europe’s so-far unaffected nations remained calm (especially in the bond markets, which dwarf stocks in size). Similar crisis had been resolved through diplomacy during the past few generations. Europe had not experienced widespread war for a century. Compelling analysis by experts such as Jan Gotlib Bloch (aka Ivan Stanislavovich Bloch) in his famous 1899 book, Is War Now Impossible? The Future of War in Its Technical, Economic, and Political Relations. Even more popular was Norman Angell’s 1909 book The Great Illusion A Study of the Relation of Military Power to National Advantage. These used fact and logic to prove that modern war was irrational and hence unlikely. They were right. Unfortunately, that did not make it impossible or even unlikely.

While eventually proven false, these predictions and Europe’s long peace and prosperity immunized investors against fear.


“Apart from an upward movement in Austrian bond yields, there were no significant shifts on either the bond market, the money market, or the foreign exchange markets until the final week before war broke out.”

On Friday, July 28, Austria declared war on Serbia and Russia mobilized its army.

“The Vienna market was the first to close, on July 27. By July 30 all the Continental European exchanges had shut their doors. The next day London and New York felt compelled to do the same. Although a belated settlement day went ahead smoothly on November 18, the London Stock Exchange did not reopen until January 4, 1915. Nothing like this had happened since its founding in 1773. The New York market reopened for limited trading (bonds for cash only) on November 28, and something like normal service resumed the following month, but wholly unrestricted trading did not resume until April 1, 1915.

“Nor were stock exchanges the only markets to close in the crisis. Most U.S. commodity markets had to suspend trading, as did most European foreign exchange markets. The London Royal Exchange, for example, remained closed until September 17. It seems likely that had the markets not closed, the collapse in prices would have been as extreme as in 1929, if not worse.”

No market mechanisms can withstand a flood of sellers overwhelming buyers. Since 1987 the US stock exchanges have relied on trading capacity (ready to handle enough trades to liquidate the nation overnight) and circuit breakers to withstand the next big one. Both will fail, eventually. I suspect they have not given ten minutes thought as to that scenario. As for the rest of us, I believe this describes us today…

“The stakes for investors had thus been very high in the summer of 1914, although few of them seem to have known it before the storm broke. The impact of the war was very far from uniform on the various asset classes open to a typical capitalist of the prewar years. John Maynard Keynes’s archetypal prewar rentier, sipping his tea and playing the global markets from the comfort of his London boudoir, had little suspected what havoc would be wrought by “the projects and politics of militarism and imperialism, of racial and cultural rivalries, of monopolies, restrictions, and exclusion.” {From Keynes great 1919 book, The Economic Consequences of the Peace.}

“These forces were indeed the serpent in the paradise of pre-1914 globalization.”

Forecasting with models


“Unless you expect the unexpected you will never find truth, for it is difficult to discover.”
— Heraclitus, the pre-Socratic “Weeping Philosopher” of Ionia

The vast majority of research, geopolitical or economic — especially for a general audience — consists of forecasting that the past will repeat. That’s the easy message. That’s what people worry about and hence what sells. People fear the immediate past — a war in Europe (for generations we feared the Soviet armies would storm across the Rhine, something they had little capacity to do), another crash of stock or real estate prices, the great depression or great inflation (e.g., 1965-1983). Or the reappearance of dragons from our past (overpopulation creating famines).

Forecasting new things is more difficult and has a smaller audience. It doesn’t pay well, and smart people tend to avoid it. Unfortunately, our rapidly changing world, with unprecedented innovations arriving like trolleys, means that we should expect new problems.

Rather than the futile guessing about shockwaves (low probability, high impact events), let’s instead focus on resilience. We can prepare for historically rare but certain to repeat events. For example, you can make your investment portfolio an “all weather” one. Before worrying about what the weather might be in 2050 or 2100, have we prepared to withstand the great storms of the past two centuries?

August 1914 has another lesson for us: don’t listen to people who advocate starting wars. No matter that they say it will be short and cheap. They’re often wrong. Sometimes disastrously wrong.

About US markets

Brad Delong (Prof Economics, Berkeley) reminds us that the outbreak of war on 31 July triggered “the longest circuit breaker” in NYSE history. Bonds resumed trading on November 28; uncontrolled stock trading resumed on 1 April 1915.  His post, as usual, gives an interesting account of that episode. Who closed the NYSE, and why? There is another lesson from this history, one of importance to us today.

Key to bright future

Do I spend a lot of time making forecasts?

Yes, it’s my business. I’m quite good at it. On the top menu bar are buttons to pages listing my hits and my misses. That’s because I’m careful, making forecasts only when the information and logic make a strong case. Even with a modestly high batting average, the demand is low.

As most analysts will tell you (e.g., the CIA analysts writing about Saddam’s nukes and links with al Qaeda), people want to be told what they already believe. Preferably in an exaggerated and exciting fashion.

For More Information

See Nial Ferguson’s other about this: “Political risk and the international bond market between the 1848 revolution and the outbreak of the First World War“, Economic History Review, February 2006

If you liked this post, like us on Facebook and follow us on Twitter. See all posts about Nial Ferguson, about markets, about forecasts, and especially these…

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6 thoughts on “WWI warns us about markets’ ability to see the future”

  1. Just heard that tech employment in SF is down (slightly) for the first time in years. Can’t find a confirmation on the web, but a popping of the Bay Area bubble could certainly be a Black Swan. Larry, do you have any information in that regard?

    1. Larry Kummer, Editor


      (1) Here is the news: “Bay Area hammered by loss of 4,700 jobs“. Plus 2,700 in August.

      (2) Those kind of local economic stats tend to have large error bars. So tiny fluctuations should be ignored. Watch trends.

      (3) The SF Bay area’s chief industry is producing stock certificates. It’s a volatile industry. For details see “Who will get hurt from the next stock market crash? Not just investors…

      (4) Crashes in a small area like the SF Bay (I live there) usually have only small national effects. Note that the national economy appears to be accelerating.

      (5) The SF Bay area and California have governments that would be considered inadequate for a colony of cherrystone clams. As Texas in he late 1980s oil, people tend to consider lucky favorable circumstances reflect their region’s inherent genius.

    2. I had heard that a proper popping of the tech bubble would in fact mostly be bad for Silicon Valley rather than the national/global problem we had in ’07, because most of the money is from private citizens rather than institutional funds and so on. Is that valid? (Just asking since you’re in both the area and the field. I bet the weather’s nice, at least.)

      1. Larry Kummer, Editor


        There are two major factors at work in popping of a bubble: its size (by several metrics — such as capital, employment) and its leverage. The second acts as a bubble magnifier on the way up and the way down. The creditors get hurt in the crash, vs. the relatively small amount (interest paid to them) they made on the way up.

        The most important creditors, economically speaking, are banks. They are central players in the economy, and highly leveraged. US banks have collapsed every decade since the 1970s — in the NY crash, in the Reagan-era Latin America crash, during the 1990s real estate crash, and the 2008 home mortgage bubble. These crashes can devastate an economy. That’s why banks are so tightly regulated, and so often bailed out (in America, by us all).

        Silicon Valley is just one part of the San Francisco Bay Area, comprised of 9 counties. Its Combined Statistical Area (CSA), 12 counties, is the fifth largest in the USA. Tech is a large part of this CSA, but not the only large economic activity. And as the 5th largest CSA, a bust in it would depress but probably not serious hurt the nation.

        The 1980s oil bust is a relevant example.

        By liberating resources locked up in a region, a regional bust can stimulate the rest of the nation — a partial offset to the depressing effect of the regional decline.

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