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To: JDN who wrote (41684)	2/28/2001 3:02:16 PM
From: High-Tech East	Read Replies (2) \| Respond to of 64865

The latest views of Morgan Stanley Dean Witter Economists Feb 28, 2001 Global: Tales of a Different Business Cycle - Stephen Roach (from San Francisco) When we first shifted to a US recession call in early January, I stressed that the old business cycle models might not help in assessing what was to come. The reason is that there are a number of firsts in this recession that challenge the wisdom of drawing on the experience of past cycles in order to predict the outcome of the current cycle. This is the first recession of the Information Age. It is also the first contraction of an era of globalization. And it is the first downturn for the NAFTA bloc. These firsts make any cyclical forecast far more uncertain than usual. Notwithstanding the imponderables of today’s seemingly unique climate, there is a precedent much further back in economic history that may turn out to be quite relevant to what lies ahead. Before I launch into this discourse, let me give credit where credit is due. The kernel of this insight comes from former Treasury Secretary Larry Summers, with whom I spent the better part of today participating in a small client roundtable discussion. Summers made the critical distinction between two types of business cycles -- those of the post-World War II era and those of the prewar era. As forecasters, there is a perfectly understandable inclination to forecast on the basis of the modern-day business cycle. Ironically, that could turn out to be a serious mistake. The postwar business cycle in the United States is defined by two actors -- inflation and the Fed. Typically, what happens is that aggregate demand eventually outstrips aggregate supply, and inflation begins to accelerate. The Fed then leans against this inflation and an inventory correction unfolds that invariably culminates in recession. Monetary easing then triggers the subsequent upturn; as the inventory dynamic works in reverse, the economy then tracks a V-shaped recovery. I’m leaving out a lot of the detail, but the general drift is clear -- the modern-day business cycle is defined by inflation in the real economy and the willingness of the Fed to do something about it. Prior to the current expansion, there have been two basic variations on this theme -- the two long-cycle expansions of the 1960s (average duration of 99 months) and the two short-cycle expansions of the 1970s (average duration of 47 months). The distinction between these two cycles was all about inflation. During the long cycles, inflation averaged 3.1%. During the short cycles, inflation averaged 6.3%. In the business cycles of yesteryear, the story was very different. The Federal Reserve, for one thing, didn’t even exist prior to 1913. And before World War II, the Fed was confronted with a very different set of macro challenges in managing the US economy. Inflation, in the broad sense of the term, was not the burning issue it has been over the past 50 years. Prewar business cycles were more about the excesses of the classic boom-bust cycle -- a good thing that went too far. Recessions and depressions arose more out of the periodic bursting of speculative bubbles in financial assets and commodity markets than from Fed-induced inflation fighting. Recoveries came about when overhangs were eliminated and asset values were priced more "attractively." They tend to be more U- or L-shaped in nature. History offers some keen insights as to how different old cycles are from more modern ones. The key distinction lies in the duration of recession. According to the National Bureau of Economic Research, the official arbiter of the US business cycle, prewar recessions were much longer than those of the postwar period. In the seven peacetime cycles from 1945 to 1991, the average recession lasted 11 months. By contrast, in the 19 peacetime cycles from 1854 to 1945, the average recession lasted 22 months. The lesson is clear: It has taken twice as long to purge the structural excesses of the US economy prior to 1945 than it has to tame cyclical inflationary pressures since 1945. Summers hinted that today’s business cycle might have a much closer affinity with those of the prewar period than those of the postwar era. I couldn’t agree more. Inflation for all practical purposes is dead. Nor is the Fed haunted by the ghosts of that inflation; it has made it very clear that it will set policy with a view that inflation risks in the future are minimal. Instead, this recession has an eerie similarity to those of a more distant past. It may well be a by-product of a confluence of excesses that resemble the boom-bust pyrotechnics of yesteryear -- the popping of the Nasdaq bubble, a negative personal saving rate, a record current-account deficit, and a massive IT overhang. To the extent that this recession is all about the bursting of speculative bubbles and the related purging of these structural excesses, the key to the future may lurk in the cycles of the distant past. Contrary to conventional wisdom, the modern-day model of the business cycle may be of little use in gauging what lies ahead. All this bears critically on the great debate currently taking place in financial markets -- the shape of the current business cycle. Since 1945, cycles have tended to be V-shaped; the notable exception was the U-shaped upturn following the 1990-91 recession, when structural headwinds restrained cyclical vigor. Prior to 1945, however, longer-lasting contractions were more inclined to be U- or even L-shaped. If I am right in concluding that the current downturn bears a closer affinity with the pre-1945 experience, this poses an exquisite dilemma: The Fed was never really involved in combating the recessions of yesteryear. Today’s Fed has most assuredly joined the battle. Can Greenspan & Co. shape a new outcome for an old business cycle? In the end, it all boils down to whether the central bank is pushing on that proverbial string as it attempts to jump-start a structurally constrained US economy. I remain dubious that the impacts of Fed easing will mitigate the need for America to purge its excesses. That leaves me in favor of the U and against the delicious V that most forecasters and investors seem to be banking on. History often has strange ways of repeating itself. This may well be one of those times -- although the history that is relevant is from a distant past that few remember. msdw.com Ken Wilson