Cautionary Tales with Tim Harford - Buried by the Wall Street Crash

Episode Date: December 6, 2019

Both of the world’s greatest economists, Irving Fisher and John Maynard Keynes, thought they could see into the future and make a killing on the stock market - and then both were wiped out by the Wall Street Crash. One died a pauper, the other millionaire. What does it take to bounce back from ruin? Oh... and UFOs.Read more about Tim's work at http://timharford.com/ Learn more about your ad-choices at https://www.iheartpodcastnetwork.comSee omnystudio.com/listener for privacy information.

Pushkin As the night draws in and the fire blazes on the hearth, we warm the children by telling them stories. Cinderella teaches them that if you want to leave the party early, leave your phone number rather than a piece of design of footwear. But my stories are for the education of the grownups, and my stories are all true. I'm Tim Halford, gather close, and listen to my cautionary tales. Late one evening on the 20th of December 1954, a small group of people sat together in a living room in Oak Park, a suburb of Chicago, waiting for the end of the world. They were led by a woman named Dorothy Martin, who was a conduit for messages from aliens, or God, or both.

The messages were alarming. At midnight, the aliens would land a flying saucer in the backyard and convey the true believers to the safety of a planet named Clarion. Then, at dawn, a cataclysmic flood would destroy much of the world. Now, at five minutes to midnight, the believers were waiting. Some were disheveled, since the aliens had demanded they remove all metal from their clothing. Braklips, buttons, even trousers, Ips, have been hastily slashed away by fumbling hands wielding scissors or razors. Some of the group were there out of mere curiosity. Others had sacrificed almost everything for this moment. They'd quit their jobs, given away their possessions, and

said farewell to their families. But what distinguishes this particular apocalyptic cult from all the others is that a small team of social scientists, led by the world-renowned psychologist Leon Festinger, had managed to infiltrate it. They were there to witness what happened at midnight, and in particular how the group reacted to the appearance or possibly the non-appearance of the aliens. Gather round and I'll tell you all about what happened with Leon Festinger, Dorothy Martin and the aliens in due course. But for a moment, let's leave them there in Chicago, anxiously waiting for the end of days, because I have another story to tell you. And it's not a story about crazy cult members, but about two economists. Indeed, two of the most celebrated economists who ever lived.

And what do these economists have to do with a UFO cult in 1950s Chicago? It's very simple. Just like Dorothy Martin, they try to see into the future. And trying to see into the future? It's a dangerous business. One of the economists I want to tell you about is the great British polymath, John Maynard Canes. You may have heard of him. He's a colossal figure in economics, overturning the ideas that had gone before him, and then reshaping

the post-war economic system. Many economists still call themselves Canesians. Like him or hate him, in economics, you can't get much bigger than John Maynard Canes. Except that, in his day, you could. When Canes first strode the world stage, he did so in the shadow of another man. age, he did so in the shadow of another man. In 1924, the Wall Street Journal tried to describe John Maynard Cain's this up-and-coming economist. They reached for a comparison that everyone in America would have known. Cain's said the journal was England's Irving Fisher, and Irving Fisher was the most famous economist on the planet. But Irving Fisher wasn't just more famous than Cain's, he was brilliant, as one Nobel prize winner put it, some would say he was the greatest economist who ever lived. But if you're thinking, I don't hear much about Irving Fisher these days, you're right.

He's not the household name he was a hundred years ago. If you're wondering why his reputation faded while Cain's is lived on, that is what our cautionary tale is all about. Irving Fischer and John Maynard Cames were very different men in some important ways, but they also had a great deal in common. Both were stars at their universities, Cain's at Cambridge and England, Fischer at Yale. They were both physically impressive.

Cain's was thin and very tall with piercing eyes. Fisher had the broad chest of a competitive rower. They were both skilled writers, charismatic speakers too. After witnessing Cain's giving a speech, the Canadian diplomat Douglas LaPanne was moved to write, I am spellbound. This is the most beautiful creature I have ever listened to. Does he belong to our species or is he from some other order? And Fisher and Cain's also both active investors. They weren't just ivory tower economists, but men who believed that their mastery of economics would enable them to make profitable investments. That is where their interest in forecasting

came in. An academic economist might be content to describe and explain the economist past. But to make money, Fisher and Cain's would have to catch a glimpse of the economist's future. Let's meet the young, Irving Fisher. How much there is I want to do. I always feel that I haven't time to accomplish what I wish. I want to read much. I want to write a great deal. I want to make money." He's writing from Yale to an old school friend.

Money was important, Fischer. His father had died of tuberculosis, the very weak that Irving had arrived at Yale. The young man needed to scramble for funds throughout his studies. He understood what it was to struggle financially while surrounded by wealth. At the age of 26, however, Fisher found himself with a small fortune at his disposal. He had married a childhood playmate, Margaret Hazard, who was the daughter of a wealthy industrialist. Irving and Margaret's wedding was sumptuous enough to be covered by the New York Times, with 2,000 invited guests, three ministers,

an extravagant lunch, and a wedding cake weighing £60. They commenced a 14-month European honeymoon and returned to a brand-new mansion in New Haven. It had been built in their absence as a wedding present from Margaret's father and was furnished with a library, a music room, and spacious offices. If marrying your childhood sweetheart sounds a little too wholesome, I'm just getting started. There are three things you need to know about Irving Fisher. The first is that he was a health fanatic. He abstained from alcohol, tobacco, meat, tea, coffee and chocolate. One dinnigest enjoyed his hospitality while noting his quirkiness.

Well, I ate right through my succession of delicious courses. He dined on a vegetable and a raw egg. He founded the Life Extension Institute, and persuaded William Taft, who'd just stepped down as president to be its chairman. In 1915, when he was nearly 50 years old, he published a book titled How To Live. How To Live? Now that's some real ambition. It was a huge bestseller, the free economics of its day.

And from a modern perspective, it's hilarious. I advocate a sun bath. Common sense must dictate its intensity and duration. It is important to practice thorough mastication, chewing to the point of natural involuntary swallowing. He even adds a discussion of the correct angle between the feet while walking. About seven or eight degrees of outtowing in each foot. And there's a short section on eugenics, which really hasn't aged well. But while it's easy to laugh, how to live is in many ways as far ahead of its time as

Fischer's economic analysis, describing exercises preaching mindfulness and at a time when the majority of doctors were smokers, correctly warning that tobacco causes cancer. The second thing you need to know about Irving was that he believed in the power of rational, quantified analysis. In the modern study of scientific clothing, there is a new unit, the CLOW. This is a technical unit for measuring the warming power of clothing. There's also the money. That's the third thing you need to know.

Irving Fisher was rich, and not just because of his wife's inheritance. Making money was a matter of pride for Fisher. There were the book royalties from how to live. There were his inventions, most notably a four-runner of the roller decks, a way of organizing business cards. He sold that invention to a stationary company for $660,000 in cash. Many millions of dollars in today's terms. Fisher turned his academic research into a major business operation called the index number institute. It sold data, forecasts and analysis as a syndicated package to newspapers across the United States.

He called it, Irving Fisher's Business Page. With such a platform, Fisher was able to evangelize about his approach to investment, which, broadly speaking, was to bet on American growth by buying shares in the new industrial corporations using borrowed money. Such borrowing is called leverage, since it magnifies both profits and losses. But during the 1920s, stock-mucked investors had few losses to worry about. Share prices were soaring. Fischer wrote to his old childhood friend, to inform him that his ambition had been fulfilled. We are all making a lot of money. In the summer of 1929, Irving Fisher was a best-selling author, inventor, data pioneer, friend of presidents, entrepreneur, health campaigner, syndicated columnist, and the greatest academic economist of his generation. and in that summer of 1929, a million

air many times over, Irving Fisher was able to boast to his son that a renovation of the family mansion had been paid for not by the hazard family money, but by Irving Fisher himself. That achievement mattered to him. Fischer's own father hadn't lived to see his 17-year-old boy grow into one of the most respected figures of the age. As Irving and his son watched a mansion reshaped before them, he could perhaps be forgiven his pride. John Maynard Keynes was the ultimate insider. As a schoolboy, he was educated at Eton College, just like Britain's first Prime Minister and 19 others since. Like his father, he became a senior academic, a fellow of King's College, the most spectacular

of all the Cambridge colleges. His job during the First World War was managing both debt and currency on behalf of the British Empire. He had barely turned 30. He knew everyone. He whispered in the ear of Prime Ministers. He had the inside track on whatever was going on in the British economy. Maynard, thank you England here. I just wanted to let you know that interest rates will be rising tomorrow. There's a good chap. But this child of the British establishment was a very different person to his American

rival, Irving Fisher. He loved fine wines and rich food. He gambled at Monte Carlo. His sex life was more like a 1970s pop star than a 1900s economist. Bisexual, polyamorous, eventually settling down, not with his childhood sweetheart, but with a Russian ballerina. One of Cain's ex-boyfriends was the best man at their wedding. And Cain's was adventurous in other ways too. In 1918, for example, as the First World War was raging, and the German army was camped outside Paris,

Cain's caught wind of the fact that, in Paris, the great French impressionist artist Edgar Degas was about to auction his vast collection of pieces by France's greatest 19th century painters. And so Cain's embarked on an insane adventure. First, he spoke to the Chancellor of the Exchequer, the UK's senior Treasury Minister, asking for a fund for purchasing art. £20,000. That's millions in today's money. Maynard, it's the first occasion that I've ever known you in favour of any expenditure whatsoever.

Remember, the British Treasury was four years into fighting the most devastating war the planet had yet seen. But Cain's knew how to get his way. My picture coup was a well-wind affair, carried out in a day and a half before anyone had time to reflect on what they were doing. I think the Chancellor was very much amused at my wanting to buy pictures, and eventually let me have my way as a sort of a joke. Some joke.

Is scorted by... Destroyers and a silver airship watching overhead. Cain's crossed the channel to France, with the director of London's National Gallery who had shaved off his moustache so that nobody recognized him, and just as DeGas' auction begins... The German artillery starts up. Some people panic and hurry out, canes, pounces, buying 27 pieces at rock bottom prices for the National Gallery.

Antibys a few for himself, including a Cizanne, which these days would be regarded as a better buy than anything the National Gallery director chose. It costs canes just £370. It then flea back to the English Channel and cross home with a convoy of hospital ships. Exhausted after his non-stop adventure, Cain's calls in on some friends. I've got a sassan in my suitcase. It was too heavy for me to carry, so I've left it in the ditch behind a gate."

What Irving Fisher would have made of it all? I do not know. Yet, like Fisher, Keynes was also pursuing an investment career. It wasn't just in art. He set up what some historians describe as the first hedge fund to speculate on currency movements. He raised money from rich friends and from his own father, to whom he made the not entirely reassuring comment, when all lose this high stakes gambling amuses me. Initially Keynes made money fast, but then a brief spasm in the currency markets wiped out his fund in 1920. Awkward. But he went back to his investors, including his own father, and asked them to trust him with more of their money.

I am not in a position to risk any capital myself. Having quite exhausted my resources. Remember, this is John Maynard Keynes. The man who persuaded a wartime government to speculate in a perision art auction, the man a Canadian diplomat mistook for an angel. I anticipate very substantial profits with very good probability, if you are prepared to stand the racket for a couple of months. Of course they gave him the money he wanted. Canes was back in profit by 1922.

Cain's was back in profit by 1922. So having made a small fortune, lost it and made it again, Cain's turned to the vast investments of his own college, King's Cambridge. Cain's persuaded his fellow academics to let him adopt a radical money-making strategy. He would forecast booms and recessions and move in and out of different economic sectors accordingly. Such an approach makes sense only if you actually can forecast recessions. But Keynes was the leading economist in the country, and a man who, remember, would get friendly phone calls from the Bank of England. If anyone could see into the future of the British economy, it was John Maynard Canes.

By late 1929, both Irving Fisher and John Maynard Canes were rich, famous, respected, and standing on the brink of a financial precipice. The cataclysmic Wall Street crash, followed by the Great Depression the worst peacetime economic calamity to befall the Western world. And the two greatest economists of the age, Fisher and Cain's, both of them, failed to see it coming. Experts don't have a stellar reputation for forecasting. In 1987, a young Canadian-born psychologist named Philip Tetlock became curious about the

entire prognostication racket. Tetlock had been interviewing Cold War experts, and he soon found himself frustrated by their wildly different predictions, their refusal to change their minds when they were wrong, and the endless excuses for their forecasting failures. Tetlock's response was patient, painstaking, and quietly brilliant. He began to collect forecasts from almost 300 experts, eventually accumulating 27,500 predictions. He focused on politics and geopolitics, throwing in a few questions from areas such as economics.

Tetlock sought clearly defined questions, enabling him with the benefit of hindsight to pronounce each forecast right or wrong. Then, Tetlock simply waited, while the results rolled in for 18 years. Tetlock published his conclusions in 2005, in a subtle and scholarly book, expert political judgment. He found that his experts were terrible forecasters, both in the simple sense that what they predicted often didn't happen, and in the deeper sense that the experts had a little idea of when they should be confident and when they should admit that they didn't have a clue. Expert forecasters were barely more accurate than

chimpanzees throwing darts. Most people, hearing about Tetlock's research, simply conclude that either the world is too complex to forecast, or that experts are too stupid to forecast it, or both. On April Fool's Day in 2013 of all days, I received an email from Philip Tetlock inviting me to join what he described as a major new research program. It was funded by the US intelligence services. This program continued and expanded Tetlock's long-running study in the form of a forecasting tournament. You would simply log onto a website, give your best judgment about matters you may be

following anyway, and update that judgment if and when you feel it should be. When time passes and forecasts are judged, you could compare your results with those of others. More than 20,000 people signed up, some professionals and some amateurs. Tech lock on his colleagues' run experiments on this army of volunteers, giving them different kinds of training, or assembling them into teams to see if that helped. I didn't join in. I told myself I was too busy. I suppose I was chickening out, too. But the fundamental reason that I didn't participate was because Tetlock's work had already persuaded me that the forecasting task was impossible.

But it wasn't. This vast new tournament identified a select group of people whose forecasts, while by no means perfect, were vastly better than the dark throwing chimp standard. Tetlock, with an uncharacteristic touch of hyperbole called them super forecasters. So what makes a super forecaster? The super forecasters are what psychologists call actively open-minded thinkers, people who didn't cling too tightly to a single approach, who were comfortable abandoning an old view in the light of fresh evidence or new arguments, and who embraced disagreements with others

as an opportunity to learn. The secret of super forecasting? It's a willingness to change your mind. Philip Tetlock's work on super forecasting has rightly attracted a huge amount of attention, but I think there's a message in that work that's often overlooked. A willingness to change your mind doesn't just help you make better forecasts. It helps you cope with failed predictions too. Let's return to John Maynard Keynes and Irving Fisher. Both of them remember had persuaded

themselves that their expertise in economics should lead to investment success. Both of them were wrong. The stock market crash of 1929 caught each of them by surprise, both lost a lot of money. Yet here's a curious fact, despite his failure, Cain's died a millionaire, and perhaps the most celebrated economist in the world. Fischer made basically the same mistake, yet it ruined both his finances and his reputation. Why the difference in their fortunes? In a way, the answer is ridiculously simple. Canes changed his mind and changed his investment strategy. Fisher changed neither.

But that only raises a deeper question. Why did Canes change while Fisher didn't? Why did Cain's change while Fisher didn't? Cain's had lost one fortune in 1920 and survived the experience. By 1929, before the crash, he was again pondering his shortcomings. His investment strategy, based on the assumption that he could predict the ups and downs of the business cycle, wasn't working out. He started thinking about how to change his approach. Cain's lost more than 80% of his net worth in 1929, but even afterwards, he was still rich. In short, he had plenty of evidence that he had made a mistake, he had experience of making mistakes in the past and bouncing back, and he was still

comfortably off. Why not change? By the early 1930s, Keynes had abandoned business cycle forecasting entirely. The greatest economist in the world had decided he just couldn't do it well enough to make money. As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about, and in the management of which one thoroughly believes. Forget what the economy is doing. Just find great companies and invest for the long term, and if that approach sounds familiar,

it's most famously associated with Warren Buffett, the world's richest investor, and a man who loves to quote John Maynard Keynes. Keynes is rightly viewed today as a successful investor. At King's College, he recovered from the poor performance of the early years. He secured high returns with modest risks, outperforming the stock market as a whole many times over. It's an impressive reward for being able to change your mind. Irving Fisher was in a very different situation. Irving Fisher's business page had graced newspapers across the country.

When things turned sour, Fisher was a scapegoat in front of the entire United States. The New York Times reported that the bubble had been blamed on... US Treasury Secretary Melon, former President Coolidge, and Professor Irving Fisher of Yale. And Professor Irving Fisher of Yale was in deep financial trouble. The fact that his investments were made using leverage meant that both gains and losses were magnified. What had seemed like brilliance before the crash was catastrophic afterwards. Fischer was staring in the face of bankruptcy, the loss of his house, his businesses, everything.

For example, one of Fisher's major investments was in the stationary company Remington Round. It was $58 a share before the crash, dropping to $28 within a few months. At that point, Fisher borrowed more money to invest, but the share price kept falling all the way to $1. You could imagine his desperation. But surely, being in such a tight spot would have made Fisher more likely to adapt his strategy. Not necessarily. I've received another message, everyone. Get your overcoats and stand by. Okay, okay, okay, everyone. Sit quietly in the living room. We shall act as if this were just an ordinary gathering of friends.

Remember Dorothe Martin and her UFO cult? They've persuaded themselves that the world is about to be flooded, and that they will be saved at midnight by aliens delivering them safely to planet Clarion. And remember too, that the psychologist Leon Festinger has infiltrated the cult. His researchers were there that night to observe what happened. Festinger had a striking prediction that when the aliens didn't appear, many cultists wouldn't be discouraged by the clear failure of Mrs. Martin's prophecy, or feel angry and betrayed. Instead, they would redouble their efforts to believe. Another reporter no doubt, just hang up.

Our preparations cannot be interrupted. We'll call them later if we have anything for them. Hasn't the clock passed midnight? So excited. What's wrong with that clock? It hasn't moved in a couple of minutes. That clock is closed. Look at the other clock.

I said it myself this afternoon, and it's not midnight yet. One minute to midnight. And not a plan has gone astray. At midnight, the aliens did not appear. Nobody said a word. One of the more casual cult members who had expressed skepticism before picked up his coat and hat and walked out. No comment, we have nothing to tell you.

People tried to make sense of what was happening, or rather not happening. The theories grew ever wilder. People were confused, exhausted. Leon Festinger's observers tried to ask why the saucer hadn't come. The group didn't want to talk about it. And then, at four o'clock in the morning, Dorothy Martin put her face in her hands and began to weep. One of Festinger's researchers stepped outside for some air and discussed the situation with a leading cult member. I've had a long way to go, I've given up just about everything.

I've cut every tie, I've burned every bridge, I've turned my back on the world, I can't afford to doubt, I have to believe. They went back inside. But at 4.45am, Dorothy Martin, with hand shaking, picked up a pencil, and began to write. It was, she said, a new message. Because of the faith shown by that small group of people, the earth had been spared destruction. A higher power would save not only the small cult, but the entire human race. At this, the cultists acquired new further, going out to greet the dawn and tell people the good news. They suddenly became evangelists, issuing statements to the press rather than batting them

away. Darcy, is this the first time you've called the newspaper yourself? Oh, yes, this is the first time I've ever called them. I've never had anything to tell them before. But now I feel it's urgent. We should call the Associated Press and the Unite Press. This thing is pretty important. It's a very big thing. Bigger than just one newspaper. I don't think the creator would want this to be an exclusive story. Definitely not. Definitely not. Oh no. Correct. It's got to be for everybody. It's for everybody. Correct. Yes. Festinger had been right. His view that the cultists would redouble their efforts to believe in the face of failure

was based on a theory he called cognitive dissonance. Cognitive dissonance predicts that people will start to squirm when they hold contradictory thoughts, such as, it's worth quitting my job in order to be collected by aliens, and the aliens did not show up. People often deny the obvious in order to reduce the discomfort, and the more suffering people have put themselves through on behalf of a belief, the more likely they are to cling onto it. Otherwise, all that suffering would seem ridiculous. Would it not? Festinger's theory applies perfectly to poor Irving Fisher in the 1930s. He believed himself to be a man of logic and reason,

and yet he was deeply in debt, the most famous financial basket case in the country. In fact, if people today know just one thing about Irving Fisher, it's this. Two weeks before the Wall Street crash began, he was quoted by the New York Times. Stocks have reached what looks like a permanently high plateau. How do you back away from that? Fisher went deeper and deeper in debt to the taxman and to his brokers. Towards the end of his life, he was a marginalised figure, a widower, an easy target for scam artists and their get-rich quick schemes, because he was always on the lookout for a way to revive his fortune.

He never did. Although Keynes had much in common with Fisher, he was a different kind of character. Recall Keynes' comment to his father, This high stakes gambling amuses me. The Monte Carlo gambler knew all along that while investing was a fascinating game, it was a game nonetheless, and one shouldn't take an unlucky throw of the dice too much to heart. When his investments flopped, he tried something else. Fischer and Cain's died within a few months of each other, not long after the end of the

Second World War. Fischer had become irrelevant. in a few months of each other, not long after the end of the Second World War. Fisher had become irrelevant. Cain's was the most influential economist on the planet, fresh from shaping the World Bank, the IMF, and the entire global financial system. Looking back, Cain's reflected, My only regret is that I have not drunk more champagne in my life. But he's remembered far more for words that he probably never said. Nevertheless, he lived by them.

When my information changes, I alter my conclusions. What do you do, sir? If only he'd taught that lesson to Irving Fisher. You've been listening to Corsionary Tales. If you'd like to find out more about the ideas in this episode, including links to our sources, the show notes are on my website, timhalford.com. Corsionary Tales is written and presented by me, timhalford.com. Corsion retails is written and presented by me, Tim Halford. Our producers are Ryan Dilly and Marilyn Rust. The sound designer and mixer was Pascal Weiss, who also composed the amazing music.

Starring in this season are Alan Cumming, Archie Panjabi, Toby Stevens and Russell Tovey, alongside Enzo Chilente, Ed Gachun, Melanie Guthridge, Masey Mönro and Rufus Wright, and introducing Malcolm Gladwell. Thanks to the team at Pushkin Industries, Julia Barton, Heather Fane, Mia LeBelle, Carly Milyori, Jacob Weisberg and and of course, the mighty Malcolm Gladwell. And thanks to my colleagues at the Financial Times. you