Unfortunately, the projections of a continuous boom are almost certainly wrong, blessings of economists and other “experts” notwithstanding. Just as the predictions of eternal gloom in the early 1990s were wrong. And as predictions that Asia would take over the world (1980s) or sink it (1990s) were wrong. Friday’s sharp market decline, which brought the Dow’s two-week drop to almost 1,000 points, is a pointed reminder of our vulnerability. As they say, all it takes is two letters to change a boom to a ka-boom.
What amuses us outside-the-Beltway types is how Washington takes credit for the expansion. The Clintonistas say it’s their 1993 tax hike; the Reaganauts say it’s their 1980s tax cut. But ascribing the economy’s performance to Washington is like saying a ship’s captain controls the tides.
The economic tide has been running strong since March of 1991. And not because of Washington. A key factor is the incredible stock market, which is far more entwined with the real economy than it’s ever been. U.S. stocks have risen an astounding $11 trillion in value since the expansion started, according to Wilshire Associates. People taking stock profits have helped boost Uncle Sam’s capital-gains tax revenues to about $100 billion last year, up almost $35 billion in three years. Stock-option gains, which are taxed as ordinary income, have contributed billions more. The tax windfall has helped create budget surpluses that have reduced government borrowing, which has helped keep interest rates low, which helps keep the economy humming, consumers happy and corporate profits strong. It’s what economists call a virtuous cycle.
But the virtuous cycle’s getting a little wobbly, to mix a metaphor. Stocks seem to be fraying. And a sinking market can tank the economy the same way a rising one ran it up.
Take Wednesday, the day after the expansion celebration. Punxsutawney Phil and D.C. Al, two American icons, will give us their reads on the world. Phil will emerge from his burrow on Groundhog Day morning and offer insights on whether winter weather will last six more weeks. D.C. Al, better known as Alan Greenspan, will emerge later that day from the Federal Reserve Board’s monthly meeting to tell us by how much the Fed is boosting short-term interest rates.
Greenspan says he’s trying to cool off nascent inflationary pressures in the economy–but we skeptics believe his real goal is to cool off fevered speculation in some high-tech and Internet stocks. Greenspan’s fear, which seems to me to be entirely justified, is that these stocks’ prices are unsustainable, and the earlier they’re deflated the less damage the economy will suffer.
Remember that the stock market is a key to our current prosperity–and this month has shown how vulnerable the market is. But Greenspan’s jawboning and rate raising haven’t cooled off overheated issues– probably because they’re not susceptible to the forces that sink regular stocks. Higher interest rates hurt stocks because increased borrowing costs and a slower economy mean lower profits. And because future profits are worth less today since they’re discounted at a higher rate. (Details on request.) But Netniks aren’t measured by profits. And Net companies don’t borrow, they raise money by selling stock.
One reason the economy has done so well for so long is luck. Greenspan inadvertently touched off booms by cutting rates in the early 1990s to rescue the banking system and in 1998 to fend off financial fallout from a failing hedge fund. But luck goes both ways. Some day, possibly soon, a market swoon or financial panic or something will change our economic numbers to worse-than-expected from the now customary better-than-expected. And the virtuous cycle could turn into a vicious cycle, with lower stock prices cutting expected tax revenues, and so on. So by all means, celebrate on Tuesday. But let’s not bet the farm on the economic expansion’s continuing to eternity. It’s just not going to happen.
