Tis the Season of Doubt and Worry, Even Though
Economic Grinches Won't Emerge
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Barron's ,DECEMBER 13, 1999
'Tis the Season of Doubt and Worry, Even Though
Economic Grinches Won't Emerge
By Gene Epstein
Perhaps you've heard the joke about the Jewish telegram. It
reads: "Start worrying. Letter to follow."
Maybe the economic boom is trying to telegraph a similar
message. Somewhere, underneath all this prosperity, there
must be plenty to worry about -- and the way things often go,
we may not learn what that is until after the fact, once the
boom reverts to a bust. But let's see what there is to worry
about.
The stock market is every worrier's favorite whipping boy.
The fear is that its bubble will burst, exploding the economy's
long-running boom.
This worries me a bit, too, which is one reason why I've taken
some solace in the belief that equity prices haven't overshot
their fundamentals by quite as much as conventional models
indicate ("Understated Appeal," November 11). For if indeed
we're dealing with a mere mini-bubble, a mini-correction might
be all that would be required to harmlessly deflate it, instead of
the Big One that the bears are confidently predicting will strike
sooner or later.
My own favorite scenario is that the Dow Jones Industrial
Average settles into a boring trading range that persists for a
few years, one that oscillates nicely between 9000 and 11,000,
while earnings pursue their steady climb. That way,
price/earnings ratios will gradually decline to levels that look
more normal by historical standards, and the long-term bull
market will then be poised to resume.
But of course, I may not get my wish. So, what happens to the
economy if, say, the Dow plummets to the 7000 region and
doesn't obligingly bounce back the way it did last year, but
stays there for many months?
Actually, I'm not so worried. In fact, a bear market may turn
out to be just what the doctor ordered to lower the economy's
elevated blood pressure.
Those who believe the patient will keel over instead point
mainly to the "wealth effect," which here means the influence
gains on stocks have on consumption and saving. The
stunning leap in share prices over the past decade has
motivated investors to consume more and save less. And with
more households than ever before in the market, the personal
savings rate has hit a record low, and consumption has been
growing much faster than the rest of gross domestic product.
But once the equity bubble bursts, a negative wealth effect will
set in, with a vengeance. The collapse of their portfolios will
prompt consumers to desert the malls, and the economy will
unravel.
So the argument goes. But the main problem with this Wall
Street-centric view is that it ignores the heartland. More than
half of U.S. households still don't own any stock, and about
half of the rest own very little.
And once you examine what's actually been happening to this
forgotten 75% - 80% of the population, you find that another,
far more stirring drama has been taking place, one that has
truly fueled the consumer-led expansion: As the unemployment
rate has fallen below 6%, then below 5%, and most recently to
4.1% -- the lowest level in 30 years -- labor has become
scarce. And with that, wages have soared, putting rivers of
cash in the hands of the silent majority that lives
hand-to-mouth and can be counted on to spend every penny
of it.
Couple that powerful force with yet another. Rising income
and modest interest rates on mortgages have triggered a surge
in home sales. The percentage of households owning their own
home is at a record high. And the point is, the acquisition of a
home inevitably sparks purchases of other items, such as rugs
and appliances.
Now throw in another economic stimulus -- the indirect boost
to consumption from the increase in house prices. You then
find (based on estimates from Jason Benderly of Vail,
Colorado-based Benderly Economics) that the role played by
the stock market looks diminished indeed. In fact, on a
dollar-for-dollar basis -- a dollar of stock-price gain for every
penny of extra consumption -- the equity wealth effect has
never been weaker.
Why should this be? Simply because the rise in values has
been so stunning. Prices have jumped so far, so fast, that all
those paper millionaires still don't feel like millionaires, much
less behave that way, at least not yet.
So in this wisdom's light, a 30% crash might shave, at most,
about a half-percentage-point off the rate of GDP growth, via a
negative wealth effect. Now throw in another half-point from
the indirect effects, such as Wall Street being forced to cut
jobs, and what happens? Well, the high end of the housing
market certainly would suffer and the federal government's
much touted budget surplus, which owes so much to capital
gains, might begin to melt away (although capital-gains
realizations might actually increase in the first few months of a
crash, as people unload shares to lock in any gains they still
have).
Admittedly, it's a bit hubristic to assume that all of these
effects can be quantified. Economic fate has a habit of being
more capricious than that. So take a wild card that is worth a
worry or two: how much our international balance of trade has
Wrightson Associates chief economist Louis Crandall
estimates that in 1999, the Europeans will have bought $153
billion more in stock from us than we will have purchased
from them. This particular trade surplus, part of what's on our
"capital account," is equal to roughly half of our $300 billion
"current account" deficit in goods and services. Up to a point,
then, what seems to have been happening is that we've been
taking the world's goods and selling the world stock in return.
But what would happen, asks Crandall, if the flow of foreign
money into our equity markets suddenly starts drying up?
Just to rattle us, phrase-maker Crandall posits what he dubs a
"Dow-dollar death -- spiral" (which he does label "extreme").
It works this way: The Dow falls, and foreigners quit buying
our stock. With this prop of our current account deficit
eliminated, the dollar falls, and with that our import prices rise.
Higher import prices exacerbate the bond market's inflation
fears, driving up interest rates. This weighs on the Dow, which
hurts the dollar, which boosts import prices again.
With the Dow-dollar-death-spiral in full force, that
all-important ingredient consumer and business confidence --
could begin to erode, and a full-blown recession might result.
On the other hand, a weaker dollar should boost our exports.
And at the same time, our central bank would likely be trying
to shore up confidence by cutting the fed-funds rate, the way
Alan Greenspan promised he would.
Finally, two things that don't seem worth worrying about:
Debt: Businesses and households don't appear to be
overburdened by it, as the chart on this page shows.
It's mostly misleading to be concerned about the accumulation
of debt. The real question turns on how much that debt
actually costs against your ability to pay it. The long-term
decline in interest rates has brought down the cost of
debt-servicing, while the increase in corporate cash flow and in
household after-tax income has improved the ability to bear
this debt.
When these factors are taken together, debt burdens look
pretty moderate at this stage in the economic expansion.
Y2K. Here it depends on who you are. If you need to call
911 on January 1, and the emergency-services computer
doesn't recognize that the year is 2000, you'll have a
problem. As of October 1, only 50% of the nation's 911
call centers were Y2K-compliant.
But planes will fly, automated teller machines will mostly be
operating, and phones will be working. And even if Nigeria
can't pump crude oil for a while, the U.S. shouldn't
immediately be pinched for supply, because it can dip into the
nation's Strategic Petroleum Reserve. (Merrill Lynch energy
analyst Michael Rothman assures us of that.)
There'll be plenty of localized problems, but on an economy
and society-wide basis, we should be mostly Y2K -- okay.
So: not to worry. |
