Don't Hit the Panic Button
By Christopher Farrell
Nothing, it seems, is going right with the economy. California's electric-utility crisis is crippling the Golden State. Companies are shedding workers at a ferocious pace, most notably Old Economy Chrysler announcing plans to slash its workforce by 26,000, or 20%, while New Economy Amazon.com will lay off 1,300 people, or 15% of its employees. GE appears to be planning to cut at least 75,000 jobs over the next two years (see BW Online, 2/1/01, "At GE, Neutron Jack Is Back"). Consumer confidence has taken its biggest plunge since the last recession a decade ago, and new orders for capital goods have been down three months in a row.
Venture-capital financing fell more than a third in the last three months of 2000 vs. the previous three months. Following two years of warp-speed growth, the U.S. economy expanded at a measly 1.4% pace in the final quarter of 2000, and the nation's chief economic forecaster, Federal Reserve Board Chairman Alan Greenspan, says economic growth is "probably very close to zero." It's as if the economy went from irrational exuberance to irrational depression in a matter of months.
Time to panic? Hold on. To worry that the economy could be headed for a '30s-style Depression would be wasted effort.
WHAT'S THE MESSAGE?
For one thing, the money mandarins at the nation's central bank aren't idly standing by while companies and consumers retrench. The Fed slashed the federal funds rate, the benchmark interest rate it controls, a full percentage point in less than a month -- a first since Greenspan took the helm in 1987. Republican and Democratic legislators alike are rallying around a massive tax cut to lift citizen confidence. The only remaining question in Washington is whether the new Bush Administration will get its full $1.6 trillion tax cut or a few hundred billion less. Despite the spate of bad news and deepening gloom, the odds are that the economy's flirtation with recession is probably nearing an end.
Of course, the big question hanging over the economy is the message in the market: Does the 25% rebound in the Nasdaq since Jan. 2 signal a revival of the economy's high-tech sectors and a renewed faith in the durability of the extraordinary pickup in productivity growth that began in the mid-1990s? Or is the gain merely a relief rally -- something that reflects the fact that Washington is finally taking steps to stem the economy's downward spiral? If the latter, then the idea that America is "the furnace where the future is being forged," as Leon Trotsky once remarked, is as wrong as the quaint notion that communism's triumph was inevitable. But I doubt it.
In the short run, the meaning in any market move is impenetrable. But whether you believe there's long-term value in the stock market largely rests on how you interpret recent history. Many economists, analysts, and investors look at the mind-boggling high-tech frenzy of 1995 to 2000 as a "bubble" of historic proportions. Reminiscent of the bubble in the early 1900s or the stock mania of the late 1920s, investors took leave of their senses in the 1990s, seduced by the fantastic tales of equity promoters and plungers. At the market's peak, many high-tech companies had price-earnings ratios of more than 100, and p-e's of 50 to 60 were commonplace. When the bubble burst, more than $3 trillion in equity wealth vaporized, the dot-com universe imploded, and the economy stumbled.
I don't buy it. I think the phrases "stock market bubble" and "fools and their money soon parted" greatly underestimate what happened to the economy in the 1990s. The cumulative innovations of the past several decades, especially in information technologies, emerged from the economic periphery and entered the business mainstream.
To be sure, many Internet-based business models didn't make sense and, yes, quite a few dot-com ideas represented little more than the triumph of marketing over common sense. But business models were tested at an astonishing pace. For instance, it took time before it became apparent that pure Internet banks and Internet brokerage firms were severely handicapped against competitors with both bricks-and-mortar and Internet distribution channels.
Yes, capital is swiftly leaving poorly conceived dot-com enterprises, but capital is still seeking high-tech outfits with better profit prospects. Says David Hale, global economist at Zurich Financial Services: "As with any capitalist process, there's a risk that investors may commit too much money to a favored sector and thus depress profitability. But there are so many different qualitative dimensions to the current technology boom that it is unlikely to produce a boom-bust cycle comparable to those which have occurred in traditional commodity-producing industries."
The key is productivity growth and worldwide capitalism. The spread of information technologies, along with a highly educated workforce and flexible capital markets, doubled the growth rate of output per hour in the 1990s. Thus far, the productivity gains appear to be long lasting. As Greenspan told the Senate budget committee on Jan. 25, "the apparent sustained strength in measured productivity in the face of a pronounced slowing in the growth of aggregate demand during the second half of last year was an important test of the extent of the improvement of structural productivity."
What's more, the demand for today's high-tech products, from wireless phones to computer networks, is global. Stock market financing, which is better suited to fund innovation, is also taking a more prominent role in the bank-dominated economies of the world, such as Continental Europe. "We haven't even touched a small fraction of the demand for computers, software, and the like in a world market," says Boyan Jovanovic, economist at the University of Chicago. "I don't think this is a bubble, no."
The current economic and social environment is nothing like the Great Depression of the 1930s. For instance, America's unemployment rate in the 1930s was about six times greater than it is currently. Yet parallels are frequently drawn between the economy and stock market of the 1920s and 1990s, with the obvious, ominous take on the 1930s and 2000s.
A remarkable 1930 essay written by economist John Maynard Keynes is an antidote to the gloomier analogies. "We are suffering just now from a bad attack of economic pessimism," he wrote in Economic Possibilities for Our Children. "I believe that this is a wildly mistaken interpretation of what is happening to us. We are suffering, not from the rheumatics of old age, but from the growing pains of over-rapid changes, from the painfulness of readjustment between one economic period and another."
In coming years, there's a distinct possibility that the efficiencies from the current wave of innovation will pale next to the development and diffusion of new technologies. A Depression? Not by a long shot.
Farrell is contributing economics editor for BusinessWeek. His Sound Money radio commentaries are broadcast over National Public Radio on Saturdays in nearly 200 markets nationwide. Follow his weekly Sound Money column, only on BW Online
Edited by Beth Belton