Sometimes the Economy Needs a Setback
By JAMES GRANT
The 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. |
