Dec. 3, 2001
It's now official—the economy is in a recession. The fact that the economy is in bad shape isn't exactly news to the millions of people out work and looking for jobs, but now the economists know it too.
People should be pretty mad at the economists and the rest of the policy wonk crew right now. The vast majority of the profession saw nothing but blue skies, completely missing the coming of this downturn, even though the cause was almost impossible to miss.
Apparently, these policy whizzes didn't notice the stock market bubble sitting in the middle of Wall Street. When the ratio of stock prices to corporate earnings reached more than twice its historic average in late 1999, it shouldn't have taken too much expertise to realize that we had an unsustainable stock bubble. And guess what? Unsustainable stock bubbles collapse—that's because they're unsustainable.
When the bubble burst, the investment boom in telecommunications and high tech went with it. So did a lot of consumption spending. People were consuming based on their stock market wealth. When their stock portfolios fell by 30, 40, or even 50 percent, a lot of people realized they had to start to doing some serious saving to pay for their retirement or their kids' education. This reduced consumption, coupled with the falloff in investment, has led to our current recession.
Why didn't the policy crew notice the stock bubble and try to limit the damage? By coincidence, President Bush's Social Security Commission issued the outlines of its plans to privatize Social Security in the same week the recession became official. This coincidence is interesting, because much of the attention of Washington economic wonks has been devoted to overhauling Social Security. Many of them were so preoccupied with the problems of the Social Security system that they failed to notice the huge stock market bubble waiting to burst.
To put this in perspective, while Social Security is expected to face problems, the government's projections show that these problems are far in the future. According to the Social Security trustees, it can pay all scheduled benefits for nearly 4 decades into the future. Even at the point when it is projected to face a shortfall, the problem will not be qualitatively different than problems that Social Security faced in the fifties, sixties, seventies, and eighties.
Because the wonks have done such a good job at scaring people, this basic point is worth repeating. The Social Security trustees projections—the starting point that everyone accepts as the basis for the Social Security debate—show that Social Security can pay all benefits, with no changes whatsoever, until 2038. Even after that date, it would always be able to pay a larger real (inflation adjusted) benefit than what current retirees receive.
But this was the problem that warranted center stage in Washington policy circles. Meanwhile, the stock market was developing a bubble of approximately $9 trillion. This bubble led firms to undertake enormously wastefully investment decisions—laying fiber optic cables that may never be used, rushing to set up wireless phone systems far beyond any plausible projections of demand growth, and setting up Internet sales systems for products that no one wanted.
It also led many families to throw away much of their savings on grossly over-valued stock. Many middle class families face a much poorer retirement today because of the savings they lost in the crash of the stock bubble. The folks trying to save Social Security 40 years from now apparently never thought about this one.
It will not be easy for the economy to recover from the stock market crash. There are many economists who are chirping that the worst is over and that recovery is just around the corner. It is important to keep in mind that none of these people saw the recession coming in the first place. There is no reason to believe that their economic vision has improved in the last year.
Clear eyes do not show a pretty picture. The stock bubble still has to deflate further. Stock prices continue to be near record highs relative to corporate earnings. That can't be sustained unless profits are going to soar faster than we have ever seen—faster even than our chirpy optimists are predicting. Rather than leading a rebound in consumer spending, a sinking market is likely to worsen the recession.
This recession may prove long and painful, but the country may get at least one benefit from this downturn. The policy wonks may finally stop talking about distant problems in the Social Security system and instead focus on the real problems in front of their faces.