THE OUTLOOK
WESBURY, BRIAN
The Great Debate BY BRIAN WESBURY The economy is not well. Unemployment is rising, consumption slowing, the manufacturing sector is in recession, and consumer confidence is collapsing. A deluge of...
...Business managers, or so the theory goes, were so excited by rising stock prices and rapid productivity growth that they over-invested in excess capacity...
...In other words, because it was convinced an "overinvestment" bubble needed to be burst...
...experience of the last 18 years is the quintessential example...
...Japan's recipe for long-term recession includes high tax rates, deflationary monetary policy, and Keynesian pump priming which has pushed government spending up dramatically Japan's federal debt is now over 120 percent of GDP...
...Investment in new technology boosted productivity and output, and, in turn, this increased job and income growth...
...The disastrous policy mistakes of the '30s America or the '90s Japan are unlikely to be repeated here...
...In addition, federal taxes rose to the highest share of GDP since 1944 and the regulatory burden became stifling...
...TWO VIEWS Among the market blamers, many (including the Fed chairman) attribute the current economic downturn to "over-investment...
...As a result, even though the high-tech investment boom is a long way from being over, fears that a 1930s U.S.-style or 1990s Japanese-style bust is under way will hang like a cloud over the markets...
...In addition, the Smoot-Hawley Tariff Act was signed into law in 1930 and, for the hat trick, Herbert Hoover sharply increased taxes in 1932...
...As taxes rose, purchasing power eroded and demand growth slowed relative to supply...
...There is light at the end of the tunnel...
...Some bullish economists point to stronger than expected auto sales and robust housing starts as proof the economy is just fine...
...Higher interest rates and excessively tight money squeeze the entire economy, not just the domains of alleged excess...
...In fact, deflation was the rule and the CPI was falling by 1 percent per year between 1925 and 1929...
...in the 1920s and 1930s and Japan in the 1980s and 1990s...
...THE ECONOMY IS SELF-CORRECTING Excess investment, if it occurs, is self-correcting, creating falling prices as competitors battle for market share, reducing profits and slowing future investment...
...The federal funds rate should fall to four and one-half percent by June, no longer squeezing the demand-side of the economy...
...However, tax cuts appear to be moving much too slowly...
...SAYS LAW The great rebuttal to the bubble theory that recessions are caused by over-investment is Say's Law—supply creates its own demand...
...It is hard to imagine that any economy could perform well with all of these anti-growth policies piled on top of each other...
...Economic growth does not end because the economy gets tired...
...In the late 1920s, for example, the Federal Reserve raised the discount rate (there was no federal funds rate at the time) from 3 percent to 6 percent...
...should get back on track later this year...
...Profits grew rapidly, the economy experienced record length expansions, inflation fell, and P/E ratios soared...
...The U.S...
...As a result, the Fed has been forced to cut rates much more quickly than it desired and The high-tech boom is just beginning...
...Another wave of investment will follow...
...The other side sees impending recession as a result of faulty U.S...
...Taxes as a share of personal income grew from 11.8 percent in 1992 to 16 percent in January 2001...
...If we learn from recent mistakes, today's slowdown will be merely a "pause that refreshes...
...In 2000, the Federal Reserve pushed the real federal funds rate to its highest level since 1989, just before the last recession...
...Broadband access will vault Internet use into a new orbit and another wave of high-tech investment will follow the last...
...We need no "bubble" to explain the Great Depression...
...Add to these problems the resurgence of regulation under Clinton...
...In the late 1920s, inflation was nonexistent...
...A deluge of negative corporate earnings reports THE OUTLOOK and falling stock prices have made investors fearful...
...As a result, the real discount rate rose to 7 percent...
...In November and December of 2000 alone, the administration added 18,000 pages to the Federal Register—an annualized rate of 108,000—the highest ever...
...They blame the market, in other words...
...History shows that recessions and THE AMERICAN SPECTATOR ¦ April 2001 57 depressions are not inevitable market cycles...
...As investors wait for the full impact of any legislation, growth will slow...
...Many high-risk companies would have gone bankrupt no matter how fast or slow the economy grew...
...The Federal Reserve is cutting interest rates more rapidly than it has since 1982, and the economy and financial markets in the U.S...
...they are caused by policy mistakes...
...The computer and telecommunication revolution probably has another 20-plus years to run...
...Higher productivity boosted real incomes and pushed individuals into higher tax brackets...
...One side looks at our economy as a series of alternating cycles 1999 and early 2000 have engendered a retrenchment" in the economy...
...The short-term debate—recession or not yet recession—pales in comparison to the real intellectual debate taking place outside the newspaper pages, between two opposing views of economic history...
...a tax cut has become a certainty...
...The high-tech boom is just beginning...
...Recession is not the inevitable climax of economic growth, it's a product of bad decisions from Washington, D.C...
...The Japanese collapse in the '90s is a similar story...
...THE INVESTOR CLASS Nevertheless, the future looks bright...
...policy decisions that can and should be changed...
...Others point to falling durable goods orders and the manufacturing slump as evidence recession is already here...
...Access to capital began to dry up...
...caused by swings in business and consumer attitudes...
...The goal of monetary policy should be price stability, not discouraging investment, while fiscal policy should focus on creating the best environment for business that is possible...
...As Alan Greenspan said in February, "excesses built up in blame the economic slowdown on human foibles is a typical Washington response to its own mistakes...
...at the same time demand growth was pinched...
...58 THE AMERICAN SPECTATOR ¦ April 2001...
...In truth, these examples, rather than supporting the bubble theory, underline how bad policy creates economic havoc...
...The Fed did this not to fight inflation, but specifically because it was convinced that the stock market was too high...
...In the short run, this will temporarily hold back what should be another great boom in economic growth...
...By blaming consumers and businesses, policy-makers are attempting to inoculate themselves from any blame for the economy...
...The revolution probably has another 20-plus years to run...
...In 2000, the number of pages in the Federal Register reached 83,000, the second-highest total after the record 87,000 pages in 1980...
...More than half of Americans own stock, making pro-investment pressures on policy-makers more intense than ever before...
...Bubble poppers become self-fulfilling prophets of doom...
...In addition the Bush Administration is moving forward on tax cuts and regulatory relief...
...See above chart...
...To make matters worse, the Fed pushed real interest rates to an excessively high level (see chart page 57).This reduced demand-side growth and created a liquidity squeeze...
...To ignore these policy issues and blame the current slowdown on supply-side excesses courts disaster...
...Thanks to the use of static modeling, a slowly phased-in tax cut is the most likely scenario...
...HISTORY The idea that over-investment causes economic downturns is not new...
...All this bad news is creating new debate...
...This excess capacity was guaranteed to cause a steep drop in investment and stock prices...
...Policy matters...
...This "perfect storm" of policy mistakes—a confluence of regulations, taxes and tight money—has destroyed the benefits of high-tech investment during the past year...
...Investors who understand this and stay on the right side of the debate will be rewarded handsomely...
...However, blaming all of the current economic troubles on this so-called "bubble" ignores other evidence...
...WHERE TO FROM HERE...
...This created a liquidity squeeze and caused a collapse in stock prices...
...Irrational consumers and businesses take the blame when things go wrong, but get little credit when things are going well...
...Financial markets react much more quickly to policy mistakes and high-tech information flows allow companies to adjust rapidly...
...Periods claimed as evidence for this "bubble theory" of recession include the U.S...
...To ignore these factors and A "perfect storm" of policy mistakes—a confluence of regulations, taxes, and tight money—destroyed the benefits of high-tech investment during the past year...
...Investments that make sense when the economy is growing at 4 percent may well seem excessive if we slow it down to 1 percent...
...Profit margins collapsed and P/E ratios contracted...
...Bursting the bubble theory that overinvestment creates recession will pay huge dividends in the decades ahead...
...Attempting to short-circuit this process by artificially slowing down growth rates has the potential to make any correction worse...
...Nonetheless, problems were brewing...
...While it is true that there was some dumb investment during the recent boom, it is not clear that the economy needed to go through a recession because of it...
Vol. 34 • April 2001 • No. 3
