Happy days NOT here again
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The Bear's Lair: Happy days NOT here again
By Martin Hutchinson
UPI Business and Economics Editor
Published 6/16/2003 6:11 PM
WASHINGTON, June 16 (UPI) -- As legend has it, the song "Happy days are here again" became the theme tune of Franklin Roosevelt's 1932 Presidential campaign, and then inspired the American people to regain their confidence and slough off the Great Depression.
The legend is of course bunkum; more important, the mythical process is not about to repeat itself.
It's generally recognized that the confidence of consumers and investors is key to getting the economy sorted out, and that during periods when confidence is lacking, such as 1932 in the United States and maybe 2000-2002 in Japan, it's very difficult to get the economy moving again. Accordingly, prognosticators of the economy tend to look very hard at indicators of confidence, believing that an upturn in such indicators presages an economic revival.
This is one of the reasons why a stock market bubble such as that of the late 1980s in Japan or the late 1990s in the U.S. and Europe is so much to be deplored. Nobody objects to people getting rich (well, only marginally, when their vulgar consumption patterns obtrude on my consciousness!) However, when year succeeds year with the stock market rising by 20 percent annually, perspectives get a bit out of whack, and it takes them time to come back into focus. In Japan at the end of the 1980s, the Emperor's palace had a value similar to the entire state of California. In the U.S. in 2000 Cisco, a company that has never made money if you take out the value of its executives' stock options, had a market capitalization of $600 billion, more than IBM and General Motors combined. In London today, at the end of a stock market bubble that has morphed into a housing bubble, my old and rather decrepit inner-city house (which, alas, I sold a decade ago) is on the market for over $1.5 million, a sum that even at my peak earning power I could only have afforded on a Japanese-type 100 year mortgage with a 1 percent interest rate.
Unfortunately, these excesses of confidence don't go away quickly. The Japanese stock market, at around 8,800 on the Nikkei index, is now nearly 80 percent off its peak level of 1990, but it didn't get below 15,000 until 1998, 8 full years after the peak. In the intervening years, the Japanese market was still in retrospect very overvalued, at the 18,000-22,000 level, for more than half a decade during which investment decisions were distorted by the overvaluation, the government made repeated attempts to restart the economy by wasteful infrastructure projects, and key Japanese indicators such as the level of public debt and the health of the banking system went into steady and inexorable decline.
In 1929-32, the United States did not suffer from this problem. President Herbert Hoover killed off world trade by raising tariffs, increased government spending sharply, then attempted to pay for it by raising income taxes at the bottom of a severe depression. By the middle of 1932, the U.S. stock market was down almost 90 percent, and whatever the U.S. consumer was suffering from, it wasn't an excess of optimism.
As former Federal Reserve Board vice chairman Preston Martin indicated to me last week, U.S. policymakers, in particular Fed Chairman Alan Greenspan and President George W. Bush, have been determined this time around to avoid the mistakes of both the U.S. 1930s and (they hope) the Japanese 1990s. The former determination is more wholehearted than the latter, since the general U.S. view is that Japan's problems have mysterious Japanese causes, such as their government's inability to "reform," and their banking and insurance system's frailty, so they have few lessons for the U.S.
Actually, that's a myth. In 1993, 3 years after the Japanese economy peaked, the Japanese banking and insurance systems were very much stronger than today, the level of government debt was half what it is now, and observers generally assumed that it was only a matter of a short time before the Japanese economy bounced back, and resumed its inexorable assault on U.S. business. Even in early 1995, the yen peaked at 80 to the dollar, far in excess of any conceivable estimate of its purchasing power parity, while Japan has run a payments surplus throughout the period since 1990.
In other words, Japan in 1993 looked if anything healthier than the U.S. in 2003. The U.S. banking, insurance and pension sectors, in particular have today much further to fall as bad debts and low interest rates stage repeated and prolonged assaults on those institutions' balance sheets. As the U.S. federal deficit climbs towards Japanese levels, and the Fed massages interest rates towards the near-zero levels that Japan has enjoyed for the last decade, the contrasts between the two economies seem far less glaring than the similarities.
Since March, the U.S. stock market has surged, with the fastest price rises in the most speculative stocks and those such as E-Bay that are most obviously repeating the mistakes of the late 1990s. Since 2001, there has been a tsunami of mortgage refinancing, much of which has been recycled into consumption. Both these symptoms clearly indicate that confidence in the U.S. is not currently too low but too high.
The money supply injection of 2001 and the tax cuts of 2001-2003, have convinced businesses, investors and consumers that, the bubble of 1996-2000 was a modest one with few ill-effects to follow, so that valuation levels still quite close to those at the peak can continue to be justified. As in Japan in the early 1990s, investment is being misapplied into markets that have still not found their bottom, which will consequently lead to further overcapacity.
Can anyone doubt that the vulgar McMansions, costing close to $2 million, that are still being erected in such numbers on both coasts will be mere monuments to folly in a few years time? Just as in Westchester County, New York, it is possible for those of modest income to rent or buy moldering old stockbroker fantasy houses, replicating English country mansions, because such houses were so overbuilt in the 1920s, so in fifty years time it will be possible (for eccentrics only, I would guess) to buy 1990s replica California dream palaces of unimaginable luxury -- and fungus growing up through the tiling of all six oversized Jacuzzi bathrooms.
Around 2075, when the world is again struggling to recover from an overheated bubble economy, our descendents will, one hopes, learn from our mistakes. Ideally, they will raise interest rates sharply when the bubble appears, in order to deflate it before it gets too big. If they miss that opportunity, then when the bubble begins to deflate they will still raise interest rates, while keeping public spending and taxes under control. This will ensure a rapid return by the stock market to levels at which it is attractive, as happened in 1929-32 (33 months, top to bottom) without the additional deflationary effect of the Smoot-Hawley tariff and the Hoover tax rises. Once the market has reached an appropriate level (find a 70 year old banker, too old to have been involved in the bubble, to tell you when this is, but it will be at a somewhat LOWER valuation level than was common before the bubble) they will cut interest rates sharply and cut taxes. This will re-start the economy from a level at which new investment once again produces goods and services that people want. Thus, they will move from a 1920s economy to a 1950s economy with just a few years of recession, rather than with two decades of depression and war.
This time around, that option is no longer available. Interest rates have been cut too far, and the public sector deficit is out of control. Meanwhile "confidence," that elusive quality, is still too great, allowing investment to flow into E-Bay and other remnants of the crazed 1990s, rather than into the solid blue chips and sober start-ups, in some new sector, that will form the basis of the next economic expansion.
As for Japan, that country may now have purged its 1980s bubble and be ready to expand again. Gross Domestic Product figures for the first quarter have come out higher than expected, while Japanese corporate profits, particularly for the larger companies (which one would expect to benefit first in an upturn) have also improved significantly over the past year. It can thus be hoped, with some degree of realism, that over the next couple of years Japan will, quietly and unobtrusively and to general disbelief, lead the world out of the present unpleasantness and, after several more years of purging, into renewed economic growth for the United States and Europe.
No, happy days are not here again. The 1950s are still a long way off. The recent run-up in the stock market is based on air and soap, nothing more. The run-up in home sales and prices since 2001 is equally based on below-normal interest rates and marketing hype. Happy days will not return for the U.S. economy until the twin imbalances, of overvalued stock prices (which must halve from current levels) and an unsustainable trade deficit have been worked out of the system. Given the determination of current policymakers to delay and avoid such purging by all means possible, it will be a good few years yet.
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(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
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