NYTimes.com Article: Sometimes the Economy Needs a Setback

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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.

http://www.nytimes.com/2001/09/09/opinion/09GRAN.html?ex=1001147153&ei=1&en=898b\
8611aaca6946

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