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How the centurys booms ended

By Jacob Schlesinger and Nicholas Kulish

THE WALL STREET JOURNAL

Feb. 1  The Roaring Twenties crashed to a halt about the time of the stock-market plunge of 1929. See The Wall Street Journal's coverage of "The Longest Boom: An Economic Milestone"

When you look at the mistakes of the 1920s and 1930s, they were clearly amateurish. Its hard to imagine that happening again  we understand the business cycle better.  GREG MANKIW, Harvard economist

THE BOOMS of the 1960s and 1980s were crushed by rising inflation and the Federal Reserves vigorous efforts to tamp it down. Asias period of long, fast growth ended in the late 1990s with the sudden flight of foreign capital. What will bring the great turn-of-the-millennium boom  which Tuesday becomes the longest expansion in U.S. history  finally to an end? One way to predict the future is to look to the booms of the past.

The usual cause of death has been a particularly vicious strain of macroeconomic disease, like inflation, combined with the ineptness of policy makers treating it. Bad luck  oil shocks and war  have also been to blame.

Remarkably, few of these culprits are afoot in America today. One reason: Economists and policy makers have learned from recent history. When you look at the mistakes of the 1920s and 1930s, they were clearly amateurish, says Harvard economist Greg Mankiw. Its hard to imagine that happening again  we understand the business cycle better.

Now, a generation of Americans raised on the belief that the 1950s and the 1960s were an unrecoverable oasis of prosperity has collectively changed its mind. Last month, the Conference Boards consumer-confidence index hit an all-time high, breaking the old record set in October 1968. Most folks, in other words, see nothing but sunny skies well into the future.

In the past, such ebullience was a telltale sign that the end was near. Yale University economist Irving Fisher declared that stock prices have reached what looks like a permanently high plateau  just days before the crash of 29. In 1968, the Commerce Department dropped the title, Business Cycle Developments from a monthly publication, concluding that the business cycle was dead.

It wasnt. Although the boom of the 1960s lasted longer than each of the prior expansions since 1854  the first year covered by the National Bureau of Economic Researchs official business cycle history  it, too, faded into recession or worse.

Virtually every U.S. expansion since World War II has ended with the same script: Inflation picked up, the Fed cracked down, and the economy fell into recession. The longer growth lasts, the more likely cost pressures build. Falling unemployment forces companies to offer higher wages and pass on costs to customers. Supply shortages may emerge and factories may struggle to keep up with demand, allowing sellers to hike prices.

At the end of the 60s boom, the consumer-price index was rising at an annual rate of 6.2%. At the end of the 80s boom, inflation crossed 5%.

In 1999, in contrast, the CPI rose a tame 2.7%, as global competition surged and Internet shopping caught on. A recent comparative shopping survey by Lehman Brothers found that a London Fog trench coat costing $225 in a store could be had for just $89.95 online, while a dose of Viagra selling for $57.69 from a conventional pharmacy was selling for $45.60 on the Web. That kind of competitive pricing works to keep inflation down.

Another reason for low inflation  and the economys overall good health  is the 1990s surge in productivity, or output per worker hour. That measure of efficiency determines an economys long-term sustainable growth rate. Through the 1960s, productivity grew at an annual rate of 3%. From the early 1970s through the mid-1990s, it slumped to about 1.5%. Since 1995, thanks in part to computers and a massive capital-spending boom, many economists believe the growth of productivity has rebounded to near 1960s levels.

The expansion and diversification of financial markets have also extended the boom, by creating trillions of dollars of new wealth and spreading it widely among consumers. And Americas growing reliance on capital markets to finance companies has made the allocation of funds more efficient.

The ability of manufacturers to manage inventories more skillfully has made the current expansion more even-keeled. In the past, companies during good times built up huge stockpiles in anticipation of growing demand. If demand fell, production plunged to work off excess inventories, accelerating a downward spiral. Thanks to just-in-time production methods and more sophisticated market-monitoring techniques, inventories remain slim by historical standards. Last year, the Big Three auto makers kept enough extra cars on lots to meet just 64 days worth of demand  down from 77 days a decade earlier.

The expansion and diversification of financial markets have also extended the boom, by creating trillions of dollars of new wealth and spreading it widely among consumers.

This is also the first major expansion since the 20s driven entirely by private sector spending. The government played a big role in fueling the 60s and 80s booms, but that also spurred inflation and drove interest rates higher. Through the 90s, budget deficits shrank, disappeared and ultimately turned into surpluses. Now, the government is even paying off the old outstanding debts of those earlier, profligate eras.

Debt reduction helps everyone by getting the government out of competition for loans, which makes interest rates lower overall, President Clinton crowed last week as he vowed to make the federal government debt-free by 2013  for the first time since 1835.

Sudden, unforeseen shocks can always jolt an economy. But the U.S. today seems better able to absorb one blow that has helped to kill previous expansions  a spike in oil prices. Thanks to greater energy efficiency, and a shift away from energy-intensive industry, spending on oil makes up just 3% of gross domestic product today, down from 8.5% in 1981. Even with the sport-utility-vehicle craze, American vehicles are, on average, 5% more fuel efficient than a decade ago.

Now for the trouble spots:

Though inflation remains low, labor markets are the tightest theyve been in a generation, with the unemployment rate hovering near 4%. Some desperate employers are starting to jack up compensation to keep and retain workers.

The latest Fed survey of regional economic conditions found Iowa fast-food restaurants offering health benefits to part-time workers. Retailers around the country brandished starting bonuses, tuition reimbursements, health clubs and child-care benefits just to keep cash registers manned during the holidays.

Fed Chairman Alan Greenspan fears that those kinds of costly incentives could soon lead to the old wage-price death spiral. Thats why the central bank raised interest rates three times last year, is widely expected to do so again Wednesday and possibly several more times by mid-year.

The stock markets surge is another source of concern, with share prices well above what any of the old formulas could justify based upon earnings, dividend payments, interest rates. The Standard & Poors 500-stock index was trading at 31 times earnings at the end of last year, double the average rate for the past 40 years. Internet superstar Yahoo! hit a whopping price/earnings ratio of 735. The 1920s saw a similar bidding up of shares, particularly in new technologies  one of the hot themes then was radio. Then, as now, investors borrowed heavily to buy stocks, and borrowed heavily against their market-driven wealth.

The collapse of the 1920s bubble weakened what turned out to be a fragile economy  and the heavy amount of debt held by investors magnified the force of the market crash.

A blow today could be more severe. The market is more integrated into the economy than ever before: Nearly half of all households own shares, thanks to the explosion of mutual funds and 401(k) plans. And the proliferation of new financial instruments  including new flavors of derivatives and asset-backed securities that are untested by a severe downturn  may magnify the damage in a crash.

Then theres the trade deficit, which hit a record $26.5 billion in November, the most recent month available, fueled by Americans insatiable demand for foreign goods. Sales of pearls and precious stones from abroad rose 15% over the prior year; imported furniture rose 22%. Thats accompanied by a growing dependence on foreign capital to finance American business and American markets. Foreigners have more than $6 trillion invested in the U.S., while Americans have just over $2.5 trillion invested abroad.

A loss of confidence in the U.S. economy  triggered say, by a plunge in the value of the dollar  could touch off a stampede by foreign investors to pull out of American markets. Thats what burst Asias bubble in the late 1990s.

In the past, relatively minor setbacks often became calamities because of policy blunders. The 1929 great crash became the Great Depression, in part because the Fed kept the money supply tight even as the economy was contracting, and President Herbert Hoover raised taxes to balance the budget. Inflation got out of hand in the 60s and 80s because the Fed had been too loose with money supply, and because Lyndon Johnson and Ronald Reagan spent beyond their administrations means.

Today, the government looks better poised to handle an incipient downturn. For the first time in modern economic history, fiscal policy is being run the way the textbooks say it should be during good times: The governments big budget surpluses help damp growth and prevent the economy from overheating.

The surpluses also give President Clinton and his successors more room to stimulate the economy with spending increases or tax cuts should conditions soften. Weve reloaded the fiscal cannon, as Treasury Secretary Lawrence Summers puts it.

The Fed, meanwhile, is more vigilant than ever about pre-empting inflation before it gets out of hand, and quicker to ease up when the economy looks weak. Thats why Mr. Greenspan is raising interest rates now, and why he was quick to cut rates after the 1987 stock market crash and during the 1998 Asian crisis.

We cant smooth out every shock, but I feel confident that the Federal Reserve can basically keep us close to a fairly steady path, says Christina Romer, an economic historian at the University of California at Berkeley. Weve entered an era where, if policy makers stick to the consensus among economists, we wont have as many cycles.

Yet for the government to act wisely, it has to be able to forecast accurately, a skill that hasnt yet been perfected. Even Mr. Greenspan has sometimes called things wrong. In October 1990, he told his Fed colleagues that the economy has not yet slipped into recession  even though it was later determined that the downturn had started three months earlier.

Good times tend to breed a cockiness that makes people forget that times can turn sour, and lead to the very excesses that make the economy shaky. Former Treasury Secretary Robert Rubin is often hailed as one of the patron saints of this expansion. When Mr. Rubin was recently introduced at a public appearance, the master of ceremonies said the debate in Washington is whether Bob Rubin is the best Secretary of the Treasury since Alexander Hamilton, or the best Secretary of the Treasury including Alexander Hamilton.

You know, Mr. Rubin responded, they were having that same debate about [then-Treasury Secretary] Andrew Mellon in 1928. * * *

Whats a Boom? And Who Decides?

A boom, or expansion, begins at what economists call the trough of a recession, the point when growth starts to pick up. It ends at the peak of economic activity, the time when growth conclusively slows and the economy shrinks.

There is no precise formula defining these turning points. Some textbooks say that that an expansion ends with two consecutive quarters of negative gross domestic product growth. But most economists and policy makers agree that an expansion begins and ends when seven men on a panel of the National Bureau of Economic Research say so.

According to the independent Cambridge, Mass., think-tanks Business Cycle Dating Committee, a recession is a recurring period of decline in total output, income, employment, and trade... and marked by widespread contractions in many sectors of the economy. (You can read the whole explanation at www.nber.org/cycles/html).

That definition allows for a lot of discretion, and sometimes disagreements. One of the countrys leading business-cycle experts, Victor Zarnowitz, makes the case that the last recession may not have really ended in March 1991.

While production of goods and services was increasing, the economy didnt create any new jobs for months afterwards. In most expansions, both output and employment increase, says Mr. Zarnowitz, research director of the New York-based Foundation for International Business And Economic Research.

If job creation were required to declare an expansion underway, he adds, the current boom didnt really start until September 1992  or a full 18 months after the record books indicate. That would mean this expansion would have to last until August 2002 before claiming to be the longest.

Its important to note than an expansion is not necessarily a boom. Harvard economic historian Claudia Goldin notes that the longest expansion on record before World War II, and the sixth-longest in American history, was the one spanning the 50 months between March 1933 and May 1937. To non-economists it just felt like the Great Depression because that long, steady growth was starting from such a low level.

It also takes a long time after the fact to be certain when a turning point has occurred. The NBER didnt decide until December 1992 that the current expansion had begun the spring of the previous year. The July 1990 onset of the preceding recession wasnt announced until April 1991  or a month after it had officially ended.

In fact, today is really too early to declare conclusively that this boom sets the longevity record. Official government data showing whether or not the economy grew in January wont be released until later this month. The NBER says on its Web site that if the economy continues to expand past January, then the United States will be in record territory. Data proving that wont come out until March.

In declaring the record, politicians and commentators  including this newspaper  are relying on the fact that growth was strong through December and that anecdotal evidence shows no signs that business has eased significantly since.

-- snooze button (alarmclock_2000@yahoo.com), February 03, 2000

Answers

Betting against the bull has been incredibly unprofitable (in general) for the past decade. 'Boomers' will no doubt continue to pour money into their favorite fund which pays 30% 'interest' (Hey, I've heard folks use those exact words!) year after year until TSHTF - - OR -- they get to the point where they're making net withdrawals for retirement -- whichever comes first.

Now I realize that doesn't shed a whole lot of light on the subject of "when does the bull get gored" (or is it 'bored') but that IS the way things are. There are many interesting ways in which the smelly stuff could impact upon the rotating blades, but are you willing to bet against this BULL??? There have been so many who've tried--and failed. I've read that the bull could go on for another 3-7 years subject to periodic exciting downdrafts & upsurges--and that MAY be the way to bet...but it's Soooooo scary joining the herd of lemmings when the 'threat' of the cliff constantly seems to lie just ahead. Perhaps this is just the so-called "wall of worry" that the market loves to climb. Maybe THIS time really is different...and the good times will never end... Wanna bet?

-- BullandBear (WallOf@Worry.com), February 03, 2000.

I met Claudia Goldin a couple of years ago when we shared a conference panel on economic histories of domestic work. Although this article doesn't say so explicitly, she is an NBER member and a highly respected scholar. I take her assessment very seriously.

-- silver ion, Ph.D. (ag3@interlog.com), February 03, 2000.

Andrew Mellon in was the sec treas. who said "I shall give the economy another shot of Whiskey." The article is partially incorrect in stating that interest rates were kept artificially high. Further anyone who dismisses smoot-Hawley from a discussion on the causes of the length and severity of the depression is not informed. Lastly I think a better economic comparison is through the early 1800s. The manufacturing revolution was a boom to productivity and ultimately the economy. Computers are finally hitting the revolutionary phase VIA the internet and are increasing productivity a trend I think will increase for some time. 735 times earnings? no doubt that's a problem, but time will tell just how serious. Much of the paper money generated in the boom is still just that to it's owners ,paper. A loss of paper is less likely to devastate the economy. As Bunker Hunt so eloquently stated "A billion ain't what it used to be."

-- Hank (reardon@not.now), February 03, 2000.

This so-called "expansion" shares many characteristics of previous booms and adds a few special touches. First, look at a chart of margin debt. It is more parabolic than the NASDAQ. The increase in both public and private debt this decade is over $10T. The increase in capitalization on the bourses is $10T. Perfect match. The new touches are the accounting gimmicks that only the Clinton administration could come up with. The productivity numbers are phony, based on increases in computer MHZ, nothing else, the surplus is phony, the jobs growth numbers are phony, the list goes on and on. Not until the sheeple baby boomers can wallpaper their big houses with worthless dollar bills will they realize they have been taken for a ride. The private bankers at the Federal Reserve have set up middle class America to take the big fall.

-- Dave (champeaudavid@yahoo.com), February 03, 2000.

Response to * How The Century?s Booms Ended * - Telltale Signs That The End Is Near Now - MSNBC -

>> Much of the paper money generated in the boom is still just that to its owners - paper. A loss of paper is less likely to devastate the economy. <<

This is a common misconception. In 1929 it was widely believed that the stock market crash was simply a matter of Wall Street and its speculators getting their comeuppance, that average folks on Main Street who had not participated in the market would not be affected.

Instead, factories closed and workers went begging. Food was dumped on the ground because it was selling too cheap to repay its own cost in the field, let alone the cost of transport to market. These are examples of real wealth that went idle for lack of "paper" wealth. People didn't understand how this could be so. They were stunned.

Paper is how real wealth is transferred and how financial obligations are defined. When a very large amount of paper is devalued, the entire web of financial obligations is shaken deeply. Debts that were undertaken in the belief that one had the assets to cover them easily are either paid by diverting money from other expenses or defaulted on.

When the valuation of the stock markets falls by 50% to 90%, it is as if the river of money has dried up at one of its major sources. It's not just the people nearest the source who go dry. People who are downstream, including people who never realized they were imbibing money from that source, start to get very thirsty, too.

-- Brian McLaughlin (brianm@ims.com), February 03, 2000.

Response to * How The Centurys Booms Ended * - Telltale Signs That The End Is Near Now - MSNBC -

Fisher wasn't the only one who was very bullish in the fall of 29. The WSJ was also very bullish, As far as I know the WSJ has never correctly called a recession or bear market.

-- Dave (dannco@hotmail.com), February 03, 2000.