Will The Global Economy Emerge Stronger?
February 25, 2009
It’s been another tough session for U.S. stocks, and the DOW as on Monday is testing 7197, which prior to this week had been its lowest previous intra-day level of the current decade, touched in October 2002. Before then, the DJIA had not been below 7197 since May 16, 1997. Much is being made of the fact that key U.S. equity market indices like the DOW have lost half their value since peaking in October 2007. It’s been 504 days since the DOW closed at its cyclical high of 14165. Following a similar interval after Japan’s Nikkei-225 set its all-time high of 38916 in December 1989, that index had fallen by 34%, thus significantly less than the DOW has done. And where does the Nikkei reside now, more than 19 years after its high-water point? It closed today at 7461, 80.9% under its peak.
Since the start of the U.S. financial problems in 2007, conventional wisdom has repeatedly espoused the view that this will not be nearly as bad as what happened to Japan because U.S. policymakers stimulated more expeditiously than their Japanese counterparts and attacked the bad bank balance sheets much more quickly. I do not find such contrasts to be compelling. The current crisis is much more serious because it is not confined to a single economy. One of the more persuasive talks at the Columbia-sponsored conference I attended last Friday was by Professor Aliber of the University of Chicago in which he drew connections between the Latin American debt crisis, Japan’s lost decade, the Asian crisis and the present financial turmoil. Each in a sense beget the next meltdown, because massive imbalances in the distribution of savings and investment were never addressed and therefore festered. So if there is indeed a connection running through the last thirty years of financial market history, the behavior of Japanese equities might indeed not be such a bad guide to what lies ahead in the United States. That’s why I expect the DOW to sink eventually below 6000 and probably get to at least 5000. At that point, it will be some 65% below peak, a bargain compared to what Japan has experienced.
Another speaker at the conference, Professor Jeffrey Sachs of Columbia, made the point that $40 trillion dollar of worldwide wealth has been lost. That’s only a figure for the story up to now. This process of disappearing wealth continues to evolve, and we may have not even seen its most virulent segment play out yet. So the model that Sachs outlined has to be applied to a moving target, what economists like to call dynamic equilibrium rather than static equilibrium. Nobody knows how large the ultimate downsizing will be, and to say that unemployment is going to peak at 9-something or even 10-something percent is simply a premature estimate because all the feedback mechanisms are unlikely to be closed off.
Initial press coverage of the Obama and Bernanke performances yesterday had been favorable. One aspect of Obama’s address gave me a sense of deja vu, however, and that was the upbeat message that the nation is going to come out of the crisis stronger than ever. In the 1990’s, Japanese officials accentuated the positives and minimized the extent of their economy’s structural deficiencies. Upbeat rhetoric without hard and painful policy initiatives proved to be just talk. Saying things were going to be okay didn’t make it happen.
U.S. officials seem better grounded in reality, and expressions of confidence by them is better than the alternative so long as a good plan of action is designed and executed competently. Where the current crisis seems most scary is that a firm understanding of all its complicated dimensions remains elusive. The main impression I came away with at last week’s conference was that everybody had a somewhat different theory. World leaders are really in uncharted waters. Investors will see through the facade if the wrong policy advice is followed. The renown economist Joseph Schumpeter spoke of a process of creative destruction associated with innovation in a capitalist society. In order to free resources like labor and capital for more dynamic activities, it is necessary that some endeavors disappear, and that is why business cycles are inevitable and indeed necessary for long-term economic development. The theory was used to describe the evolution of commercial activity, but a look at history suggests that it applies as well to nation-states. Economic and military powerhouses have come and gone. It may be that the Western world will recover in better shape than ever, but other possible scenarios exist, too. And here’s a final thought. The Second World War was catalytic in burying the Great Depression once and for all. World War Three in a nuclear age would not have the same effect.
Copyright 2009 Larry Greenberg. All rights reserved. No secondary distribution without express permission.
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