St. Louis Post Dispatch, June 23, 2000
Knight-Ridder/Tribune Media Services, June 13, 2000
Turn on the tube and you will find the Presidential candidates sparring over real and imagined economic problems far removed in time and space from the lives of ordinary citizens. Social Security's troubles, according to the numbers accepted by Republicans and Democrats alike, are at least 37 years away. If
they ever arrive at all.
Paying off the national debt over the next 15 years has become the centerpiece of the Gore campaign. A long wait for a payoff that, in terms of its impact on the economy, is barely measurable.
With all this future-babble it's easy to think that the only threats to our economy are decades away. And at first glance, with unemployment near 30-year lows, and inflation under control, it does seem that way.
But the health of the national economy has some shaky underpinnings. Aside from the Federal Reserve's apparent determination to pull the rug out from under this economic expansion by raising interest rates-- a crucial here-and-now issue that neither Bush nor Gore wants to talk about-- there a couple of bubbles that could deflate at any time.
Bubble number one: the stock market. Current stock market valuations are not sustainable, unless we are headed for a new era of such fantastic growth as this nation has never seen. About three years ago, economist Dean Baker of the Center for Economic and Policy Research was the first to do the math. Other leading experts, such as M.I.T.'s Peter Diamond, have recently gotten similar results.
The problem is that stock prices are already at twice their historic level relative to earnings. So long as investors keep buying, of course, these prices can still rise. But over the long run, there is no reason to hold stocks other than for a share of the company's profits. And no one is projecting the kind of profit growth that would justify the average price of stocks today.
Eventually the market itself-- the institutional and individual investors that own stocks-- will understand this problem. When that happens, there will be a change in market psychology. And a serious decline in stock prices.
How much would the stock market have to fall in order for stocks to provide their historic average rate of return? If we use the standard economic assumptions about future profits and growth-- e.g. those used by the Congressional Budget Office-- the answer is about 40-50 percent.
A drop of this magnitude would have a harsh impact on the rest of the economy, as the households who have lost $9 trillion in wealth-- more than $30,000 per person-- cut back on their spending.
Bubble number two is in our currency, the dollar. We have a record trade deficit right now. A broader measure of this imbalance is called the current account deficit-- this includes not only trade in goods and services, but also such net international payments as interest and dividends. Our current account deficit is now running at a record 4.5 percent of our national output.
At this rate, our foreign debt would rise from about 24 to 67 percent of our economy by the end of the decade. Remember, this is foreign debt, not the national debt (which is not a problem because it is owed mainly to ourselves, and is shrinking as a share of our economy). At some point, the foreign exchange markets will decide that our rate of foreign debt accumulation is not sustainable. They will then begin to pull their money out of dollars, and the international value of the dollar will fall.
Unfortunately, our two bubbles are related, so that a slide in one market could set off the other. For example, if foreign investors see the dollar falling, they could pull their money out of the US stock market, causing further dollar depreciation, then more stock selling, and so on. Or the spiral could start with a big drop in the stock market.
Since both of these bubbles are kept afloat by investor psychology, they could deflate next week, or they could continue expanding for years. There is no way to predict which will happen.
Japan's Nikkei stock index peaked at 38,712 in 1989. More than a decade later, it is still less than 17,000.
The one thing we do know is that the bigger the bubbles grow, the more damage will be done when they eventually deflate.
And so it is particularly irresponsible to ignore these imbalances as they worsen.
But politicians of both parties tend to tiptoe around anything that might upset Wall Street, especially in an election year. So we don't hear too much right now about these bubbles.
But we will.