Thursday, June 21, 2007

Self-Preventing Prophecies

One often hears about self-fulfilling prophecies. Speech anxiety is an example of this. People get speech anxiety because they are afraid they will say the wrong things and forget things they're supposed to say. But usually they would have no trouble at all saying this to a friend in private, so it is the fear of saying the wrong things in front of a crowd that causes them to sometimes say the wrong things. In other words, hadn't it been for the fear of saying the wrong things they wouldn't have said the wrong things. It is the public speech anxiety itself that causes the things speakers are anxious about.

Another example of self-fulfilling prophecies are the bank runs of the past, before active central banking and deposit insurance. Back then rumours would occasionally appear that a certain bank wouldn't be able to meet its payments. This would cause people saving in that bank to rush to it and withdraw their money. And since fractional reserve banks don't have enough money to pay everyone who in this situation would want to withdraw, this would cause the inability to meet its payments predicted by the rumour!

Less discussed are the phenomena of self-preventing prophecies. One example of this is perhaps seen now. Until a few weeks ago, most investors expected aggresive interest rate cuts by the Fed, which caused bond yields to be as low as 4.5%. These interest rate expectations were based on the expectations of weak economic growth. But now these low borrowing costs was a key factor behind the slight acceleration in U.S. economic growth we've likely seen.

But as most economic reports during the last few weeks have been relatively bullish, an increasing number of investors have realized that there isn't going to be any Fed rate cuts. This have caused bond yields to rise sharply, from about 4.5% to 5.15-5.25% during the latest week.

As this Bloomberg news story (thanks Chris) points out, the sharp increase in bond yields could have devasting effects on the already weak U.S. housing market, which in turn could end the relatively strong growth numbers which the increase in yields based upon!

So, at least as far as the bond market is concerned (in the case of the stock market, whatever effect that is at work is self-fulfilling), predictions about future economic growth are self-preventing.


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