Posted on 09/09/2001 6:37:12 AM PDT by RJCogburn
Sometimes the Economy Needs a Setback
By JAMES GRANT
he weak economy and the multi-trillion-dollar drop in the value of stocks have raised a rash of recrimination. Never a people to suffer the loss of money in silence, Americans are demanding to know what happened to them. The truth is simple: There was a boom.
A boom is a phase of accelerated prosperity. For ignition, it requires easy money. For inspiration, it draws on new technology. A decade ago, farsighted investors saw a glorious future for the personal computer in the context of the more peaceful world after the cold war. Stock prices began to rise — and rose and rose. The cost of financing new investment fell correspondingly, until by about the middle of the decade the money became too cheap to pass up. Business investment soared, employment rose, reported profits climbed.
Booms begin in reality and rise to fantasy. Stock investors seemed to forget that more capital spending means more competition, not less; that more competition implies lower profit margins, not higher ones; and that lower profit margins do not point to rising stock prices. It seemed to slip their minds that high- technology companies work ceaselessly to make their own products obsolete, not just those of their competitors — that they are inherently self-destructive.
At the 2000 peak of the titanic bull market, as shares in companies with no visible means of support commanded high prices, the value of all stocks as a percentage of the American gross domestic product reached 183 percent, more than twice the level before the crash in 1929. Were investors out of their minds? Wall Street analysts were happy to reassure them on this point: No, they were the privileged financiers of the new economy. Digital communications were like the wheel or gunpowder or the internal combustion engine, only better. The Internet would revolutionize the conveyance of human thought. To quibble about the valuation of companies as potentially transforming as any listed on the Nasdaq stock market was seen almost as an act of ingratitude. The same went for questioning the integrity of the companies' reports of lush profits.
In markets all things are cyclical, even the idea that markets are not cyclical. The notion that the millennial economy was in some way "new" was an early portent of confusion. Since the dawn of the industrial age, technology has been lightening the burden of work and driving the pace of economic change. In 1850, as the telegraph was beginning to anticipate the Internet, about 65 percent of the American labor force worked on farms. In 2000, only 2.4 percent did. The prolonged migration of hands and minds from the field to the factory, office and classroom is all productivity growth — the same phenomenon the chairman of the Federal Reserve Board rhapsodizes over. It's true, just as Alan Greenspan says, that technological progress is the bulwark of the modern economy. Then again, it has been true for most of the past 200 years.
In 1932 an eminent German analyst of business cycles, Wilhelm Röpke, looked back from amid the debris of the Depression. Citing a series of inventions and innovations — railroads, steelmaking, electricity, chemical production, the automobile — he wrote: "The jumpy increases in investment characterizing every boom are usually connected with some technological advance. . . . Our economic system reacts to the stimulus . . . with the prompt and complete mobilization of all its inner forces in order to carry it out everywhere in the shortest possible time. But this acceleration and concentration has evidently to be bought at the expense of a disturbance of equilibrium which is slowly overcome in time of depression."
Röpke wrote before the 1946 Employment Act, which directed the United States government to cut recessions short — using tax breaks, for example, or cuts in interest rates — even if these actions stymie a salutary process of economic adjustment. No one doubts the humanity of this law. Yet equally, no one can doubt the inhumanity of a decade- long string of palliatives in Japan, intended to insulate the Japanese people from the consequences of their bubble economy of the 1980's. Rather than suppressing the bust, the government has only managed to prolong it, for a decade and counting.
Booms not only precede busts; they also cause them. When capital is so cheap that it might as well be free, entrepreneurs make marginal investments. They build and hire expecting the good times to continue to roll. Optimistic bankers and steadily rising stock prices shield new businesses from having to show profits any sooner than "eventually." Then, when the stars change alignment and investors decide to withhold new financing, many companies are cash-poor and must retrench or shut down. It is the work of a bear market to reduce the prices of the white elephants until they are cheap enough to interest a new class of buyers.
The boom-and-bust pattern has characterized the United States economy since before the railroads. Growth has been two steps forward and one step back, cycle by cycle. Headlong building has been followed by necessary tearing down, which has been followed by another lusty round of building. Observing this sequence from across the seas, foreigners just shake their heads.
Less and less, however, are we bold and irrepressible Americans willing to suffer the tearing-down phase of the cycle. After all, it has seemed increasingly unnecessary. With a rising incidence of federal intervention in financial markets, expansions have become longer and contractions shorter. And year in and year out, the United States is allowed to consume more of the world's goods than it produces (the difference being approximately defined as the trade deficit, running in excess of $400 billion a year).
We have listened respectfully as our financial elder statesmen have speculated on the likelihood that digital technology has permanently reduced the level of uncertainty in our commercial life — never mind that last year the information technology industries had no inkling that the demand for their products was beginning to undergo a very old-fashioned collapse.
Even moderate expansions produce their share of misconceived investments, and the 90's boom, the gaudiest on record, was no exception. In the upswing, faith in the American financial leaders bordered on idolatry. Now there is disillusionment. Investors are right to resent Wall Street for its conflicts of interest and to upbraid Alan Greenspan for his wide-eyed embrace of the so- called productivity miracle. But the underlying source of recurring cycles in any economy is the average human being.
The financial historian Max Winkler concluded his tale of the fantastic career of the swindler-financier Ivar Kreuger, the "Swedish match king," with the ancient epigram "Mundus vult decipi; ergo decipiatur": The world wants to be deceived; let it therefore be deceived. The Romans might have added, for financial context, that the world is most credulous during bull markets. Prosperity makes it gullible.
James Grant is the editor of Grant's Interest Rate Observer.
But, but........I thought it was Bill Clinton, not Bill Gates, that we have to thank for the prosperity of the '90's??
BTTT
In life and society all things are cyclical, and to ignore that fact is dangerous.
Bump for a very good article!
The stock market always (or at least almost always) is a pyramid scheme in the short run. What was a more extreme, and very Clintonesque, about the latest cycle was:
(1) Government statistics that were even less reliable than in the past due to fudge factors (hedonic -spelling?? - adjustments).
(2) The low numbers of investors who remember what a severe bear market (e.g. 1973-4) and the almost total absence of investors who remember the great depression. Effectively a full class of investors dumbed down to the risks of the stock market. When asked about what he though of the stock market J.P. Morgan responded: "It will flucuate." IMO, in this respect, not much has changed in 80 years.
(3) The best "new era" big lie since the radio / automobile revolution of the twenties.
(4) Stock futures have made market manipulation a much easier proposition. Whether this manipulation is the result of a "Plunge Protection Team" or merely the work of few of the big firms scalping a few extra points I won't venture a guess.
However, for a the truly perfect version of a "ponzi scheme" my nominee is residential real estate where it is almost impossible to truly cash out short of the grave since we all have to live somewhere. In effect, most of those who believe that they have cashed out are merely paying off another level of the pyramid and once again taking their place at the bottom.
Unless you cashed out of the Silicon Valley real estate market, and bought into the Houston market!
Another possibility is selling the 3-4 bedroom house once the kids are gone, and getting a 1 bedroom townhouse.
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