Why Didn't We Think of That Before?

Every forecast is based on a search for past patterns and an attempt to draw conclusions from these patterns about the future. But reality is random, and always invites surprises.

Capitalism is dead. Capitalism lives. America is through. America will rise again. We need more regulation. It won't help. Netanyahu was wrong. Netanyahu was right. Now is the time to buy. No, we need to wait. The stock market will keep falling. We have already hit bottom, and the market will rise again. This time, governments are more organized and won't let it happen.

The above is just a small sample of the conflicting analyses, forecasts and prophecies that have accompanied the worldwide financial crisis of the past few weeks. From them, one can conclude that the writers and forecasters have read history books, but not when and how the crisis will end. Above all, they reflect the intensity of the fear and confusion that the market collapse has generated.

Every forecast is based on a search for past patterns and an attempt to draw conclusions from these patterns about the future. But reality is random, and always invites surprises. This is the "induction problem" that has long preoccupied philosophers: If the sun has risen every morning until now, can we be certain that it will also rise tomorrow? This question is the basis for understanding the financial crisis - as well as political and strategic surprises such as the Yom Kippur War, the September 11 terror attacks and the Second Lebanon War.

Every human decision-making system matches up expectations and actions, and economic markets are a system for matching up the expectations of buyers and sellers by setting a price for every asset or product. That is true of Tel Aviv's open-air Carmel Market, and also of Wall Street. Monetary theory seems more scientific and serious than, for instance, intelligence assessments, because it deals with numbers and is based on mathematical models rather than on analyses of speeches by Bashar Assad and Hassan Nasrallah. Ultimately, however, even the most sophisticated financial model is an attempt to guess the future on the basis of the past. Most of the time it works, and markets move upward or downward with moderation. The same is true of intelligence: Almost always, war fails to erupt and the reassuring assessments prove correct.

The problem stems from developments whose probability ranges from low to near-zero. There, at the edges of the bell curve, is where the surprises and the historic turning points lie. And after every surprise we always discover some lucky lieutenant who warned of war but was ignored. That is another expression of the human tendency to organize reality into familiar patterns. In hindsight, it is easy to identify the early signs, the processes that led to the crisis, the reasons for the war, the wise man who sold his stocks a moment before the crash. When the result is known, the reason always seems obvious.

The media tends to sharpen and inflate explanations and forecasts, which are in greater demand during times of crisis and distress. Just three months ago, in response to the sharp rise in the prices of oil, rice and corn, Western newspapers were flooded by a wave of gloomy prophecies. The experts explained that people in India and China want to travel in cars and eat American-style, high-calorie diets, and that is why there are shortages. After 200 years, they wrote, Thomas Malthus - the British economist who predicted that food production would lag behind population growth - has finally been proven correct. They predicted wars to gain control of crops. The biggest entrepreneurs and investors flocked to wind and solar power as an alternative to oil, which would soon disappear. In America, there was talk of the disappearance of the suburbs and a return to crowded cities with public transportation, due to the rising price of gas.

But summer passed, commodity prices fell back to their levels of a year ago, and all the learned explanations evaporated along with the high prices. What happened? Did the Indians and Chinese go back to traveling by bicycle and rickshaw? Did they give up meat and milk? Did Americans stop driving their cars? Or was it that prices had been inflated by speculative investments - a gamble on commodity prices - and the moment the credit lines dried up the high prices disappeared and the markets calmed down? It is hard to know, because the experts and pundits have moved on to explaining the crisis in share prices and the collapse of the banks, and have lost interest in rice and flour.

The lesson of the food crisis that never was is that one must to take every analysis and forecast with a grain of salt. No one knows what will happen, when stock markets will rise again, when it is time to buy real estate, or when Hezbollah will attack Israel. Every prediction rests on an analysis of the past, and even the most sophisticated model can only reduce the uncertainty, not eliminate it. The only things that can be said with certainty are that the future will continue to produce surprises for which we cannot prepare - and that for these, too, hindsight will produce clear and obvious explanations.