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As a newly anointed Fed chairman, I was watching

the markets very closely. What new piece of information surfaced

between the market's close at the end of the previous trading day and its

close on October 19? I am aware of none. As prices careened downward

all that day, human nature, in the form of unreasoning fear, took hold, and

investors sought relief from pain by unloading their positions regardless

of whether it made financial sense. No financial information was driving

those prices. The fear of continued loss of wealth had simply become

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THE AGE OF TURBULENCE

unbearable.* And while the economy and corporate profits subsequently

advanced, it took nearly two years for the Dow to recover fully.

When markets are behaving rationally, as they do almost all the time,

they appear to engage in a "random walk": the past gives no better indication

than a coin flip of the future direction of the price of a stock. But sometimes

that walk is interrupted by a stampede. When gripped by fear, people rush to

disengage from commitments, and stocks will plunge. And when people are

driven by euphoria, they will drive up prices to nonsensical levels.

So the key question remains, as I summarized it in a 1996 reflection I

shall never live down, "How do we know when irrational exuberance has

unduly escalated asset values, which then become subject to unexpected

and prolonged contractions?" It is often suggested that the richest investors

are those best at gauging shifts in human psychology rather than at forecasting

earnings per share of ExxonMobil. A whole school of stock-market

psychologists has arisen around this thesis. They call themselves Contrarians.

They trade on the view that irrational exuberance eventually ends up

in falling stock prices, as shares get bid up for no plausible reason, and then,

when that becomes evident, fear grips the market and prices unravel. Contrarians

pride themselves on trading against crowd psychology. Since stock

prices are cyclical, some do succeed by trading contrary to the crowd. But

you rarely hear about those who try this approach and lose their shirts. I

also never hear much from coin tossers who lose.

Perhaps someday investors will be able to gauge when markets veer from

the rational and turn irrational. But I doubt it. Inbred human propensities to

swing from euphoria to fear and back again seem permanent: generations of

experience do not appear to have tempered those propensities. I would think

that we learn from experience, and, in one sense, we do. I, for example, when

asked what worrisome imbalances and problems lie over the forecast horizon,

invariably respond that financial crises that are foreseeable by market

participants rarely happen. If a stock-market bulge is perceived to be the

precursor of a crash, speculators and investors will try to sell out earlier. That

defuses the nascent bubble and a crash is avoided. The sudden eruptions of

*I find the oft-quoted explanation that it was program trading unconvincing. As prices tumbled,

sellers could have turned off the program-trading switch.

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fear or euphoria are phenomena that nobody anticipates. The horrendous

decline in stocks on "Black Monday" came out of the dark.

Successful investing is difficult. Some of history's most successful investors,

such as my friend Warren Buffett, were early to understand the

now well-documented anomaly that the rate of return on stocks, even adjusted

for risk, exceeds that on less-risky bonds and other debt instruments,

provided one is willing to buy and hold equities for the very long run. "My

favorite holding period is forever," said Buffett in an interview. The market

pays a premium to those willing to endure the angst of watching their net

worth fluctuate beyond what Wall Streeters call the "sleeping point."

The lessons of stock-market investing apply to the forecasting of whole

economies. Because markets tend to steady themselves, a market economy

turns out to be more stable and forecastable over the long run than in the

short run鈥攁ssuming, of course, that the society and institutions upon which

it rests remain stable. Long-term economic forecasting is grounded in two

sets of historically stable data: (1) population, which is the most forecastable

statistic with which economists deal, and (2) productivity growth, the consequence

of the incremental buildup of knowledge and the source of sustainable

growth. Since knowledge is never lost, productivity will always rise.*

What, then, can we reasonably project for the U.S. economy for, say,

the year 2030?