US economy, stock market mania and economic ghosts

Gerard Jackson
BrookesNews.Com
Monday 19 September 2005

Many readers still ask why I had been so certain that recession would strike the US, particularly in late 2000. It’s well known that economic forecasting is a dodgy business. Now all I did was to point out that Austrian economics explains that the emergence of certain economic phenomena are invariably symptoms of a looming recession.

The Austrian approach does not give a date for recessions nor does it try to quantify their depth or length, rightly stressing that such quantitative ambitions are beyond the scope of economics. Its approach to predicting trends is modest in content and qualitative by nature. That is not to say rough rules of thumb have not emerged, only that they should not be taken as rigid economic laws. For example, a monetary freeze usually results in falling output 6-9 months later while it might take 12-18 months before prices are influenced.

In December 1928 the Fed froze the money supply, by July falling output had signalled the beginning of a depression even though the stock market continued to boom until October when it finally crashed. The point is that there are considerable time lags the duration of which we can only estimate. In my opinion, emerging trends in the American economy indicated that the turning point had been reached and that recession would clearly make itself felt before the end of 2000.

I have already explained in previous articles why a recession was unavoidable and which indicators commentators should have been looking for, which brings me to stock market mania. The whole of modern economic history is strewn with stock market booms that collapsed overnight leaving a trail of wrecked lives and lost fortunes in their wake. But human nature being what it is, people never seem to learn, always managing to convince themselves that the current boom is different from its predecessors.

Hence American speculators in the 1920s were deluded into thinking that price stability, a high level of employment, increased investment and productivity heralded a “new era” and that the stock market was a simple reflection of that fact. Hence Waddill Catchings and W. T. Foster* felt free in early 1929 to assure the public that the market boom was well-founded on economic growth and justifiable confidence.

Just as Irving Fisher claimed in 1929 that the American economy had achieved a “higher plateau” of share prices and that a “new era” had arrived, Wayne D. Angell, chief economist at Bear Stearns in New York, claimed with equal certainty in 1999 “[T]hat America has at last arrived in a new era (italics added) economy . . .” Mr Angell used the old price stability thesis to argue that stable prices meant that “information [new] technologies and sound money fuel long-term, non-inflationary growth . . . [and] the economy appears vibrant enough to expand well into the future”.

This is exactly the same argument that Fisher and other price stabilisers used to persuade the American public that the 1920s boom was here to stay. It is almost as if Fisher’s spirit was –– and still is –– haunting Wall Street. This is not surprising given that Angell is still deeply influenced by Milton Friedman who in turn was influenced by Irving Fisher.

On the 15 of November 1922 the Dow-Jones Industrials closed at 95.11 and on the 29 August 1929 it closed at 376.18. By the 29 October it had plummeted to 212.33 and on 29 April 1931 it stood at 141.78. So much for Professor Fisher’s predictions.

As the Clinton boom progressed there should have been little doubt that with some P/E ratios at 30, 60 and even higher that the market was being ruled by the kind of mania that made the late 1920s notorious. More and more bought shares in the hope that they could quickly sell them at a fat profit before the crash. As the ratios rose and the mania deepened the day of reckoning came that much closer. Moreover, a cursory examination suggests that the explosion in share prices was largely confined to media and net stocks while many others languished. This too was not a good sign.

*Catchings and Foster were well-known underconsumptionists whose book laid out their ideas in considerable detail. See Friedrich von Hayek’s devastating refutation in Profits, Interest and Investment.

Gerard Jackson is Brookes’ economics editor