On the edge of a precipice

The US stock market collapse could trigger the biggest global recession since the 1930s

Three years ago Time magazine carried an article by James Cramer, the founder of TheStreet.com, an online magazine fully dedicated to the worship of mammon. Extolling the virtues of a life dedicated to buying and selling shares from home, it was called "Yeah, Day Traders!" Cramer's message was simple. Forget teaching, forget tilling the land, forget making trucks or mending bones; instead make a living from speculation. There had, the article insisted, never been a better time "to trade for a living".

In his splendid book on the triumph of extreme capitalism*, Thomas Frank called 1999 the summer of corporate love, and he was spot on. Just as in 1967, the promise was of liberation from the straight world of the past; the difference was that the drug of choice was not LSD but money. And the gurus of the revolution were not the Beatles and the Stones, but men like Cramer and James Glassman, who predicted that the Dow Jones industrial average would not stop at 10,000 but rise inexorably to 36,000. A suitable epitaph for the summer of corporate love would be John Lennon's for the Beatles when they split up three years after Sgt Pepper: "The dream is over."

Today the talk is not of when the Dow will hit 36,000 but how low it will go. Today, a magazine that used the headline "Yeah, Day Traders!" would be in danger of being torched by the small army of investors who have seen the value of their portfolios shrivel since the bubble burst in the spring of 2000. Today, the issue is whether the price of collective market insanity will be a serious global recession or, even worse, a full-blown slump.

There is an army of pundits out there willing to say that there is little to worry about. Policy makers everywhere are oozing reassurance, intoning the mantra that the economic vibes are good. Lawrence Lindsey, George Bush's economic adviser, was at it in the Financial Times yesterday, insisting that a recession in the US was "unlikely".

In reality, of course, nobody knows for sure what is going to happen. Financial analysts have their charts which are supposed to be able to predict the future from the past, and these now spell trouble. Economists who look at the hard economic data say that cheaper money and higher spending means things are getting better. But both presuppose that economics is a science rather than a modern form of alchemy, and that the practitioners in its black arts are anything more than highly-paid witch doctors. The only theory that is really relevant to the stock market is chaos theory. The recent history of the dollar is a case in point. For at least the past five years, the strength of the US currency has been eating into corporate profitability and contributing to a record trade deficit. Markets knew that the dollar was overvalued, but kept on buying it regardless. Over the past two months, the mood has changed and the dollar has fallen by 14% against the euro, breaking through the one-for-one parity level yesterday for the first time in more than two years. When will the fall be arrested? Who knows? On some estimates, the dollar is still 30% overvalued, but a rapid fall of that size would feed back into the equity markets, with foreign investors rushing for the door.

All of which explains why policymakers are a lot more concerned about the recent downward spasm in share prices than they are letting on. The sharp fall in American consumer confidence reported last Friday was a clear indication that the public mood has been affected by the declines on Wall Street triggered by the $3.8bn accounting fraud at WorldCom. Alan Greenspan, chairman of the Federal Reserve, America's central bank, is giving testimony to Congress today but his words will be less important than the Fed's actions when it meets next month to set interest rates.

Greenspan's real fear is that the US economy will become locked in a downward spiral in which falling share prices lead to weak consumption, which in turn puts pressure on company profits and - eventually - the financial system itself. Asset prices would collapse and corporations be forced to slash prices in order to generate cash flow, leading to a period of deflation in which lower interest rates failed to stimulate growth. It could never happen, say the optimists. In fact, it already has - in the world's second largest economy, Japan. There, the country has had four recessions since its bubble burst at the end of the 1980s. Prices are falling, consumers are hoarding cash; it would take but one more shove to push the banks over the edge into systemic crisis. Greenspan has been studying a voluminous report he ordered into the Japanese experience; that's how worried he is.

The best that can be hoped for is that there are no more stories of boardroom wrongdoing over the coming weeks, and that some better (and honest) figures from some of the titans of corporate America produce a rapid recovery in share prices, which then boosts consumer spending. This would not provide a cure for the economy's ills, which are caused by excessive hi-tech investment and excessive borrowing during the bubble years, but it would at least buy Greenspan some time.

F ar more worrying would be a continuation of the falls in share prices over the next couple of weeks. In those circumstances, the Fed would then come under strong pressure to cut interest rates at its August meeting, and would almost certainly bow to it. There is, however, no guarantee that it would be effective in restoring confidence. Why? Firstly, it would be a small cut of only 0.25 percentage points from the already low level of 1.75%. Secondly, it might be counter-productive, seen as a sign that the Fed was panicking (which it would be). Finally, the relevant level of interest rates is the one being paid by companies and consumers on their loans. These have not been coming down nearly quickly enough to prevent financial distress.

The underlying problem is that since the mid-1990s, share prices are up by 200% but corporate profits - as measured by sober government statisticians rather than dodgy auditors - have risen by 40%. It is conceivable that Greenspan would have to cut, cut and cut again before Wall Street responded. Even then (and assuming there is no invasion of Iraq to complicate matters), there is a risk that the easing of policy will simply lead to a re-run of this year - a short-lived burst of euphoria followed by the realisation that companies cannot produce the earnings expected of them. Greenspan and Bush would then be in an even worse quandary than they are now, having used up nearly all the shots in their locker. Meanwhile, Europe and Japan - heavily dependent on a US recovery to keep their economies ticking over - would be faced with the prospect of deep, prolonged recession.

If this sounds gloomy, that's because it is. It would be the most critical moment for the global economy since the 1930s. There would, however, be one silver lining: people would ask how we got into this mess in the first place. The answer is that policy makers, dazzled by Cramer, Glassman and their friends in the financial markets, deliberately removed the brake pedal from global capitalism. And, as any engineer knows, the brake pedal is what allows the machine to travel safely at speed. Without it there are only two speeds - dangerously fast and dead slow.

The "Day-Trader" mentality is what got us into this mess. Yuppies checking their stocks every five minutes on their Palm Pilot while sipping cappuccino at Starbucks, like they were Gordon freaking Gekko, make me ill. I'm actually glad that self-absorbed era is now over and that the nation can get back to real work.

BTW, I'm not against investing in the stock market. I've been investing monthly since 1982. But I buy my stocks for the long haul. I haven't sold a single share in 20 years and I probably won't for another 15-20. I'm in for the long haul and see the current bear market as an opportunity to obtain more shares for my modest monthly contributions. And if I lose it all, what the heck. I would have blown it all on beer and pizza anyhow (and I still get plenty of that).

While the author is spot-on that stock prices need to come down dramatically, I think he is very wrong about thinking we will become the next Japan. Japan has very limited resources, nearly no physical room for growth, and very little immigration. (Believe it or not, immigration -- hated by Paleo-conservatives and Buchananites alike -- fuels great growth in an economy) Additionally, we do not have nearly the level of socialistic interference in our corporations as Japan does, although in this regard we seem to be striving for parity.

The best things we can do to reinvigorate the economy are to A) Lower taxes where possible, B) Shrink government ruthlessly, C) Sell or give federal land to private citizens.

Also the commercial real estate market in Japan was a big part of the bubble and a cause of great pain to Japanese banks. Commercial real estate in the U.S. takes its knocks and gets up to do it again. I AM a bit worried that the GSEs are the next big disaster. But that don't make us Japan.

Does anyone know how the indexes are relative to long-term trends. I was never a chartist, and I'm sure this measurement isn't simple (PE ratios will still suck when we hit bottom, for example) but would like to take a shot at figuring out if we have crossed below the trend line.

I still remember all those Japanese tourists swarming L.A. when the economy over there was still good. One day I was walking past Lawry's Prime Beef restaurant on the corner of La Cienega and Wilshire when a Japanese guy holding an aluminum foil bag came walking out of there and up to me with a very puzzled look on his face.

"Waffo doggee bak?" he asked me.

"Huh?" I replied.

"Waffo doggee bak?" he repeated.

Then it sunk in. He was referring to the bag he was holding and he was asking me what a doggy bag was for. Obviously they ordered way more Prime Rib than they could eat and the restaurant gave him and his colleagues doggy bags to take the prime rib home. A light went on in my head and I bowed elaborately to the Japanese and gave this response:

"Ah so! Ancient American custom. They give you doggy bags and then you give to first person you meet."

I held my hands out and the Japanese enthusiastically deposited their doggy bags into my greedy hands.

"Ah! Tank you berry much," they exclaimed in gratitude for the honor I bestowed upon them for allowing them to give me their doggy bags.

I then quickly proceeded home and had the best Prime Rib dinner (with lots leftover for the next day) that I ever ate.

I've been thinking the same thing.

It's called contrarianism, and there are books on the subject. The underlying truth is that there's no money in going with the crowd. The idea is "Buy low, sell high" and that means you have to be moving against the crowd both ways, buy and sell.

But here's a caveat. It can take those 60 million Frenchmen a long time to be wrong. Everyone was real optimistic around 1994 when the DOW was around 4500 and seemed to be heading even higher. I got "smart" because everyone else was leaning the other way and moved heavily out of stocks. So the DOW goes on to about 10,000, even with Clinton in the WH. I could have used staying in for most of that.

It doesn't take a rocket scientist to see how the same thing can happen on the down side. (Except there's a floor at zero.)

Better for them to give me their Prime Rib than to dogs which they didn't own. Somehow the concept of what the purpose of doggy bags are really for is much more difficult for them to understand than the explanation I gave. Oh, and they bowed when they handed me the bags.

p.s. I'm watching Pearl Harbor on cable right now. According to this flick, the whole purpose of the Japanese attack on Pearl Harbor was so Ben Affleck could eventually get to boink Kate Beckinsale.

The problem with the Japanese economy is that stuff isn't made there anymore. Right after the war, the Japanese made tons of cheap little products that were exported to the USA. "Made In Japan" back then meant "Cheap Product." Then the Japanese upgraded and exported high quality electronic products and cars---TVs, VCRs, radios, Toyota's, etc.. Meanwhile the Koreans and the Taiwanese sold up the cheap products that the Japanese used to. Then the Koreans and the Tawainese started selling us all those electronic products and the Japanese had no where else to go. Oh, and the mainland Chinese are selling us the cheap little products that the Japanese used to. However, I expect the mainland Chinese to eventually upgrade to fancier electronic products and computers. Maybe the Japanese will have to go back to producing those cheap little products again.

All I know is that I rarely see products anymore that say "Made In Japan."

The "Day-Trader" mentality is what got us into this mess. "Yuppies checking their stocks every five minutes on their Palm Pilot while sipping cappuccino at Starbucks, like they were Gordon freaking Gekko, make me ill. I'm actually glad that self-absorbed era is now over and that the nation can get back to real work.

That and the worthless B2B .com companies that the venture capitalists and the investment houses conjured up, took public and raped for their assets.

There were many people like Terry McAliff who used other connected cronies to turn thousands into millions at the expense of the little investors and 401Ks that followed.

Even Greenspan had to admit to the gross excess of the late 90s.

BTW, I used to think the only part of Pearl Harbor movie worth watching was the Japanese Attack. But after re-watching it a few times it strikes me how phony it looks with all that computerized air attacks and explosions. Tora! Tora! Tora! was a much better movie and we didn't have to agonize over whether some character got his rocks off by a bimbo nurse. Tora! Tora! Tora! was focused primarily on the Pearl Harbor attack.

> A) Lower taxes where possible, B) Shrink government ruthlessly, C) Sell or give federal land to private citizens.

Pretty much spot on I'd say.

Now this Eliott guy I don't understand - put the brakes on capitalism?? Isn't capitalism the driving force of our being where we are, the global superpower, high standard of living, and so forth?

But hey if all the money disappeared tomorrow, our abundant natural resources are as good as gold - the US would still eat well - that's more important than solvent banks.

The strategery is simple - people with land and guns will not starve.

Not sure how the UK would fare in that regard.

Dave in Eugene

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