A new economy in the new millennium?
A new year, a new decade, a new century, a new millennium—take your pick—started yesterday. Just what will this new period hold for the economy of the United States and the world? I’m too cautious to hazard a guess, but many others are less inhibited.
Take James Glassman and Kevin Hassett. Their new book, Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market, was piled high in many bookstores during the Christmas rush. They take a look at the economy and stock markets, argue that conventional wisdom is wrong, and conclude that the Dow-Jones industrial average could hit 36,000 in the foreseeable future.
Or take Harvard Business School Professor William A. Sahlman. In the November-December issue of Harvard Business Review, Sahlman argues that the U.S. economy “is just fine, thank you. And it will remain that way for years and years to come if government just manages to stay out of its way.”
Are we really in a totally new economic era as well as in a new millennium of the western calendar? I am skeptical, but one has to give the devil his due. These guys are not flim-flam artists. After all, Hassett has a Ph.D. in Economics from the University of Pennsylvania and was an economist for the Federal Reserve! Glassman was a columnist for the Washington Post and is now a Senior Fellow at the American Enterprise Institute. Sahlman also has a doctorate.
Their book and article make interesting reading and contain some useful insights on the economy, even if one does not swallow their arguments hook, line and sinker.
The authors of Dow 36,000 focus fairly narrowly on the value of stocks. They argue in essence that everyone has been wrong calculating the true value of stocks, and that this collective misunderstanding led to a colossal undervaluation of equity markets.
Call me a dismal economist, but this fails the test of both economic theory and real-world economic history. Most economic theory assumes that markets are efficient, that is market prices and factors of supply and demand incorporate all available information. Little discrepancies may arise, but arbitrage quickly closes any gaps.
This theoretic assumption is illustrated in the old joke about two economists walking down the street. One looks down at the sidewalk and exclaims, “Look, there is a $20 bill lying on the sidewalk.” His colleague neither breaks stride nor looks down, but replies, “Don’t be silly, if there were $20 lying on the ground, someone would have picked it up already.”
One does not need that degree of belief in the efficiency of markets to be skeptical about an argument that a fundamental misconception is not only widespread, but universal. That sounds a lot like the phenomenon of “mass hypnosis” that repeatedly popped up in the Superman books I read as a boy.
On the historical side, many U.S. stock indices have risen by factors of four or more over the past 10 years. Glassman and Hassett say it may rise by nearly the same degree in the next few years without becoming “overvalued.” There is no historical instance that I am aware of in which markets rose by that much except in speculative bubbles that soon collapsed.
But there need not be danger in any single individual following their advice. They advise investors to put a substantial portion of their portfolio in equities and leave it there, without trying to time or beat the market. That is sound advice for many people even if the market does not continue climbing as it has.
Sahlman on the other hand looks at the real economy, production, employment and incomes. His argument essentially encapsulates the “new economy” argument that many people have been making over the past few years. There have been substantial, poorly measured increases in productivity in the U.S. in recent years. Economic policy is sounder than it was from 1965 through 1990.
Global economic linkages put much more competitive pressure on producers, forcing even greater productivity increases and holding down the kinds of inflationary pressures that frequently developed in the past when the U.S. economy was more isolated. Most of his article consists of examples of how new e-commerce firms are reducing costs, improving productivity, and speeding innovation.
I find this argument much more plausible than that of Dow 36000. Over the last two centuries Western countries have experienced tremendous economic growth. But this growth has not all happened at a uniform plodding pace. Britain, the U.S. and Germany all experienced distinct 10- to 30-year bursts of innovation and growth punctuated by other periods of slower growth.
New technology –canals, textile machinery, telegraphs, railroads—often was a key factor in spurts of strong growth. The U.S. economy had relatively good productivity growth from the end of World War II into 1973. The next two decades were more painful economically. Productivity growth was lower, inflation and unemployment much higher for some time. Income growth slowed and government finance became much more troublesome.
It is entirely plausible that this sluggish interlude has ended and that we are once again in a period of strong growth that well may last for another decade or more. Past economic stagnation did bring about much of the business restructuring that Sahlman emphasizes, and that restructuring is now bearing fruit.
All that said, history is full of examples of visionaries who predicted future limitless prosperity, just before the economy hit a downdraft. Even long periods of strong growth were punctuated by recessions, before and after the birth of the Federal Reserve. The new millennium may see continued prosperity, but it is highly unlikely that the business cycle has disappeared from history.
© 2000 Edward Lotterman
Chanarambie Consulting, Inc.