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Robert J. Shiller: Anxious about the Next Bubble

Professor Robert J. Shiller on secular stagnation, the rapid technological progress and why good investing is like diagnosing mental illness.

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According to Professor Shiller there is no good investing without exploring and understanding the way people's minds work: "Good investing is a little bit like diagnosing a mental illness, because you have to understand the pricing of assets to find something that is underpriced for now and will improve later. So that means understanding the origins of people's thinking. It puts you even closer to a psychiatrist than you might like to think".  

As a promoter of a movement called Behavioral Finance, he is convinced that "the human brain is wired for stories" and that narrative thinking is a strong factor behind investment decisions. Therefore, it is stories that make assets prices go up and down, and when amplified can lead to mispricing and market bubbles. Somehow that factor is often undervalued and overlooked by many.

The Age of Anxiety

When referring to current days, Professor Shiller uses the term "the age of anxiety". Indeed, the world is changing rapidly and the pace of changes can be distressing. Especially the progress in new technologies – to stay on top of it, is virtually impossible.

The amount of new devices and applications is overwhelming and, while fascinating and useful, they also make people worry about the future. What is the world going to look like in 20 years' time? In what way is the labor market going to transform? What skills will be desired and valued? Nobody can answer these questions and as prof. Shiller puts it: "It's leading to a sense of a different world that is much riskier for individuals than it used to be. And it's also an unequal world. I think the fear of inequality is amplifying now." 

Rising inequality and the rapid technological progress, topped up by secular stagnation form an unfavorable trinity responsible for the New Normal economy of today, as prof. Shiller named it. "When people are afraid they want to save more and cut back their spendings which weakens the economy, but at the same time they bid up the prices of assets." Is the anxiety of today fuelling the New Normal boom?

The Millennium and the Ownership Society Booms

When developing the subject of the past booms, Professor Shiller refers to his book "Irrational Exuberance": "One thing that I wanted to do in my book, is to think about the booms as epidemics of ideas or stories that drive certain approach to investing and causing certain kind of mispricing. I wanted to name the booms just like you want to diagnose something."

Professor sees the Millennium Boom (1982-2000) as driven by new inventions such as the internet, the omnipresent fascination with business, or geopolitical changes. People were inspired by the approaching new millennium and fell for rosy visions animated by the common expectation of great things waiting to happen as soon as the first digit of the date changed.

The second boom – the Ownership Society Boom (2003-2007) got its name from a phrase used by George W. Bush during his presidential campaign. The candidate advocated the idea that everybody was to become a capitalist and an owner, and that this was the way to prosperity. As it turned out, he was very convincing. That is the story Professor Shiller blames for inflating the Ownership Society bubble.  

The two booms previously defined by Professor Shiller were induced by uber-optimism. The New Normal, on the contrary, stems from a very different context. The world has just shaken off the financial crisis and the fear of another depression shadowing over the economy. The circumstances are not at all exciting and pessimism is widely present. For that reason it may seem paradoxical to have an economic boom now. Nonetheless, when talking about today, Professor Shiller is "concerned about overpricing and concerned about the kind of stories that are circulating now."  

Time Will Tell

Only time will tell whether Professor Shiller worries for no reason or if his concerns are justified. No expert system, no matter how advanced and scientific, is able to predict next speculative bubble. Ultimately it is human behavior and human decisions that drive markets and these two factors are far too erratic and inconsistent for any system.