– April 28, 1998
Now that the Dow has crossed 9,000, the bulls of Wall Street are talking 15,000 by the end of the century, as the bears have all silently retreated deep into the recesses of their caves.
A buoyant American triumphalism is the spirit of the hour.
Japan’s economy is disintegrating, with the Nikkei average sloshing around at 60 percent below its peak. Europe has found no solution to a permanent jobless rate of 12 percent; and the Asian tigers have been neutered and declawed. At the same time, U.S. growth continues, with low inflation, low interest rates and full employment.
But, suddenly, red flags are flashing overseas. The April 24 cover story of The Economist is titled “America’s Bubble Economy.” The lead editorial in the April 22 Financial Times, “Addressing the U.S. Bubble,” echoes The Economist. Both publications pointedly warn of a market crash, and both fault the U.S. Federal Reserve.
“Soaring share prices, merger mania and rising prices for property and works of art all suggest that America is developing a bubble economy,” writes The Economist. Price inflation may be low, but the Fed is ignoring an astronomical “asset inflation” being driven by an explosion in the U.S. money supply — 10 percent last year — and the expansion of the Bank of Japan’s balance sheet by an incredible 50 percent. This money is pouring into U.S. markets, blowing air into asset prices that cannot forever defy the laws of gravity.
As the Financial Times notes, the Dow has soared 65 percent in two years, with stocks now selling at 28 times earning — a record — and dividend rates at a paltry 1.4 percent. At that yield, an investor would have to wait 71 years before his dividends recouped his purchase price. Stocks are less of an investment than an enormous gamble on accelerated prosperity, as more and more signs point to a cooling off.
There are other indications the United States is drifting into uncharted waters. Consumer debt and debt on home equity set new records in 1997. So, too, did personal bankruptcies. In February, the U.S. merchandise trade deficit hit an all-time record of $222 billion, even though the anticipated tidal wave of Asian exports has not yet hit the U.S. coast. The Cato Institute, however, tells us not to worry; trade deficits apparently just don’t matter. Well, we shall find out, for the projections are that the U.S. merchandise trade deficit could easily be over $300 billion a year by century’s end.
While Asia’s nations purchase at most 3 percent of U.S. gross domestic product, Asian economies have just begun to feel the impact of last year’s currency and market crashes. Japan’s economy shows no signs of revival, with its national debt at 100 percent of GDP and its budget deficit running at 6 percent of GDP, an equivalent for the United States of a national debt of $8 trillion and a deficit of nearly $500 billion.
Comparing 1998 to the days just before the Great Crash of 1929, The Economist writes pointedly: “The Fed needs to raise interest rates now. Uncertainty is no excuse for Mr. Greenspan to sit on his hands. In the late 1920s, the Fed was also reluctant to raise interest rates in response to surging share prices, leaving rampant bank lending to push prices higher still. When the Fed did belatedly act, the bubble burst with a vengeance.”
The Financial Times concedes that hiking interest rates “may expose the leveraged and fragile elements of the (U.S.) financial system. But it is nonetheless time for a pre-emptive strike. The alternative is far more worrying.” What goes along with that alternative? A continued rise in the Dow to Alpine heights, until a far more severe crash occurs.
Considering that the immediate result of an interest rate hike would be a dramatic market pullback, blamed on the Fed, the Fed may be reluctant to call that fury upon itself.
Though these ominous warnings from such respected voices may not be well received in today’s euphoria, they need to be taken seriously. For if these publications are right, America is headed for serious economic turbulence, and it is not far off.
To this writer, the Financial Times and The Economist are speaking painful but necessary truths. The U.S. economy may be the strongest and freest on Earth, the marvel of mankind, but all these U.S. companies simply cannot be worth all that money. Like Wile E. Coyote of the Roadrunner cartoons, the Dow can defy the laws of gravity only so long.
Yet, the optimism endures. The Economist quotes an editorial from Forbes magazine that eerily mirrors the hubris of the present: “For the last five years, we have been in a new industrial era in this country. We are making progress industrially and economically not even by leaps and bounds but on a perfectly heroic scale.” So wrote Forbes in June of 1929, four months before the crash.