This was in Saturday's Globe and Mail. I found it scary and enlightening and well worth a good slow read. If there is truth here, we all better be worrying more than we are - not that it will do a damn bit of good.
Respectfully,
Thomas Lunde
The panic has passed. Long live the panic
The world economy now depends on the American economy,
which depends on Americans continuing to shop till they drop,
which depends on the performance of the stock market ...
Could it crash again?
GWYNNE DYER
Saturday, July 17, 1999
'We have come a long way," said Michel Camdessus, managing director of the International Monetary Fund, in April, only six months after U.S. President Bill Clinton described the global financial crisis as "the worst in 50 years." So is the panic really over, then?
The markets are certainly acting as if it is. The Dow Jones industrial average shook off the Russian default last October and powered on up through the 10,000 mark, 5,000 points higher than it was when Federal Reserve Bank chairman Alan Greenspan warned against "irrational exuberance" in late 1996. Even in Asia, where the crisis began with the devaluation of the Thai currency two years ago this month, stock markets are staging miraculous recoveries, and even the real economies have begun to grow again (albeit much more slowly).
And then along comes that extremely long drink of cold water, John Kenneth Galbraith, 90 years old and as non-conformist as ever, to remind us all in the rural Ontario drawl he never lost that "the most serious [problem] is the ancient and unsolved problem of instability -- of the enduring sequence of boom and bust. The speculative crash, now called a correction, has been a basic feature of the system."
Damn. We thought the "new economic paradigm" had dispensed with all that.
Speaking at the London School of Economics last month, the Harvard sage rained on everybody's parade: "In the U.S., we are having another exercise in speculative optimism, following the partial reversal of last year. We have far more people selling derivatives, index funds and mutual funds (as we call them) than there is intelligence for the task. When you hear it being said that we've entered a new era of permanent prosperity . . . you should take cover. . . . Let us not assume that the age of slump, recession, depression is past."
Double damn. Especially since Mr. Galbraith is the world's authority on the last great depression (which, it should be remembered, came out of a clear blue sky).
In his seminal work, The Great Crash of 1929,Mr. Galbraith quotes one of the leading market analysts of the time, Professor Charles Amos Dice, who wrote just before the crash: "Led by these mighty knights of the automobile industry, the steel industry, the radio industry and finally joined, in despair, by many professional traders who, after much sack-cloth and ashes, had caught the vision of progress, the Coolidge market has gone forward like the phalanxes of Cyrus, parasang upon parasang, and again parasang upon parasang."
Prof. Dice's rhetorical flourish, which resonates oddly in the modern mind (haven't we heard this sort of talk somewhere else recently?), is a useful point of departure, because it lets us focus on what is the same, and what is different, between the current situation and that of early 1929. Not that a 1929 comes along very often, but even eight months ago some very serious players were scared that we were heading in that direction again. Some of them still are.
Not all market crashes lead to depressions, or even recessions, but the present situation is worrisome for two reasons. First, because this will be the first time we have a speculative crisis in a fully fledged and almost completely deregulated global market where everything connects to everything else. What happens to the Chinese yuan can have a direct and immediate impact not only on the stock markets, but also on the economies of all the developed countries.
Secondly, it is only the U.S. economy, still growing with astonishing speed eight years into the boom, that stands between the world and, at the least, a severe global recession. In a world where Europe has low growth, Japan has no growth, and the fragile recoveries in South-East Asia, Latin America and other "emerging markets" desperately need customers, the United States is the "consumer of last resort."
American consumers have risen gallantly to the task -- so much so that they are now spending 4 per cent more than they earn, and the U.S. balance-of-payments deficit doubled from $155-billion in 1997 to $310-billion last year. But their willingness to borrow and spend is intimately linked to the sense of prosperity they get from a rapidly rising stock market. So a crash could have much bigger effects than in "normal" times.
We are in unknown waters here: As Mr. Greenspan's predecessor as Fed chairman, Paul Volcker, is alleged to have said, the world economy depends on the American economy, which depends on Americans continuing to shop till they drop, which depends on the performance of the stock market, which depends on 50 companies -- of which half have never made a profit. Could it add up to another 1929? That seems unlikely, but there are some uncomfortable parallels.
Bubble.com
For Amazon.com, read the Radio Corp. of America, which became the sexiest stock of the 1920s without paying a dividend. For Charles Amos Dice's automobiles, steel and radio, read computers, telecommunications and the Internet, the terminally trendy high-tech stocks in today's market.
And consider that some Japanese analysts, harking back to what happened when their own overheated, over-invested "bubble economy" burst at the end of the 1980s, refer to the American economy as Bubble.com. (Japan's own economy has been in slow decline ever since 1989, but Japan only accounts for 17 per cent of the world's GDP, so it merely dragged the rest of Asia down with it. Whereas if the U.S. bubble burst . . .)
Well, all right, but is the American economic miracle really a bubble? Plenty of people will tell you that the old rules of boom and bust no longer apply, because we are now riding a wave of new technologies that virtually guarantees a generation of economic expansion. After all, wasn't there a 40-year bull market in the middle of the 19th century, driven by the new technologies of that time (steam engines, railways, iron ships, etc.)? It's the "new economic paradigm."
Robert J. Gordon has just smacked that one on the head rather convincingly. In a paper two months ago in the American Economic Review, he looked at the impact of technical advances on economic growth for various periods since 1870, and his conclusion was that the only period in which it was very big was the huge postwar boom of 1950 to 1972.
The new technologies that stimulated that boom were electricity (motors, lights, household appliances), the internal combustion engine (automobiles and aircraft), the chemical revolution (petrochemicals, pharmaceuticals and synthetic fibres), and radiowaves (telephones, radio and television). As inventions, they all actually dated back to the turn of the century or before, but the investment boom of the 1920s was aborted by the Great Depression and the Second World War, effectively postponing their full exploitation until after 1950.
Mr. Gordon's formula for calculating how much technical change contributed to GDP growth was simple. You estimate how much of the growth was due to bigger labour inputs (more people, or better-educated people) and bigger capital inputs (new machinery, etc.). What's left must be due to technological change. This is a bit rough-and-ready, but the results are so dramatic that one cannot quibble with them.
Between 1913 and 1950, by Mr. Gordon's calculations, "technical change" is adding about 1 per cent a year to GDP growth. In the golden decades between 1950 and 1972, it contributes an amazing 1.8 per cent. Then it drops back down to 1 per cent for 1972 to 1979, after which it plunges to 0.3 per cent. And computers don't change things a bit: From 1988 to 1996, the contribution of technical change to GDP growth is a measly 0.26 per cent a year. Computers, according to another study by Dale W. Jorgensen and Kevin J. Stiroh in the same issue of American Economic Review, are only contributing a miniscule 0.16 per cent.
This is not to say the "third industrial revolution" will never occur. In the first or second decade of the coming century, there may well be a real technology-driven boom: That would be quite in line with the pattern the first two times round. But if these figures are right, it isn't happening yet -- so where is the current growth actually coming from?
The usual confidence trick
It would seem that the dramatic growth in U.S. productivity is due for the most part not to high-tech, but to population growth plus worsening conditions for labour. (Real wages have been flat or falling for the bottom 80 per cent of the U.S. male labour force for a quarter-century.) Similarly, it appears that the high growth rates in the developing countries of Asia and Latin America are mostly due to high population growth and cheap labour plus the newly accessible markets for their goods that have emerged as new communications technologies have created a more integrated global economy.
>From an economist's point of view, there is nothing wrong with all this. Growth is growth. But it does suggest a global economy whose "fundamentals" are not all that secure. It all depends on the U.S. engine continuing to pull the rest of the train -- and the U.S. boom is not the inevitable result of technological progress interacting with the immutable laws of economics, but just the usual confidence trick.
It probably came quite close to a bad smash last autumn, when Russia defaulted on its debt and the hedge fund, Long Term Capital Management, threatened to go belly up with $100-billion of liabilities. If Alan Greenspan had not cut U.S. interest rates three times (in a quarter that eventually recorded a 6.1-per-cent annualized growth rate) and authorized the rescue of LTCM despite the "moral hazard" involved in bailing out reckless investors, the long U.S. boom would probably have ended right there. If it does end, either this year or next, then the entire world is facing at the least a very deep recession.
The tender shoots of recovery in the Asian economies (currencies and stock markets in Malaysia, South Korea, Thailand, Indonesia and the Philippines are about halfway back up to where they were in July, 1997) and a tentative resumption of growth in the real economies, would not survive an American recession. The United States is both their biggest export market and the main source of the money that is pushing their stock markets back up. And what is true for Asia is doubly true for Brazil's remarkably fast turnaround since its January crash.
Masters of the universe
So it really does depend on keeping up the confidence of U.S. investor/consumers (more than anywhere else, they are the same people), at least until the rest of the world economy is in good enough shape to absorb a sharp "correction" in the U.S. market without falling to pieces. That could be up to two years away, since it means waiting until massive restructuring gets the Japanese economy growing again (maybe), until the "emerging markets" have stabilized again, and/or until Europe breaks out of its long-term low-growth pattern. Two of three would do, but one is probably not enough.
That is why the Masters of the Universe are working so hard to convince us that the crisis is past: The morale of American investors must be maintained for at least another 18 or 24 months in order to avoid a smash. And the wild card is that markets almost never break because the players just get pessimistic; they respond to some shock. Like, for example, an unexpectedly bad Y2K problem that lasts well into January, or a sudden Chinese devaluation of the yuan (China predicts almost 8-per-cent growth this year, but electricity consumption is up only 2 per cent), or even something completely off the wall.
And why are they working so much harder than they would to head off just the average recession? Because they really don't know how bad it could get, and they are scared.
At every other market peak since 1929, the people in charge knew exactly what to do to avoid a depression, because it was the same market. Somewhat better regulated, but essentially the same. Now, the market never sleeps (24-hour trading around the world); and there are huge numbers of new players; and unprecedented amounts of money are sloshing around the world at the speed of light; and most worrisome of all, it includes whole families of new financial institutions (like LTCM) that have never gone through a real shakeout before.
We are in a new situation, and nobody knows the rules. It will probably be all right, but nobody knows that either. The bear is not scratching at the door any more, but I wouldn't go out of the cabin just yet.
Gwynne Dyer, a Canadian-born writer based in London, is a regular contributor to Focus.
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