The Roaring Twenties crashed to a halt about the time of the stock-market plunge of 1929. The booms of the 1960s and 1980s were crushed by rising inflation and the Federal Reserve’s vigorous efforts to tamp it down. Asia’s period of long, fast growth ended in the late 1990s with the sudden flight of foreign capital.
What will bring the great turn-of-the-millennium boom–which has become the longest expansion in U.S. history–finally to an end? One way to predict the future is to look to the booms of the past.
The usual cause of death has been a particularly vicious strain of macroeconomic disease, like inflation, combined with the ineptness of policymakers treating it. Bad luck–oil shocks and war–have also been to blame.
Remarkably, few of these culprits are afoot in America today. One reason: Economists and policymakers have learned from recent history. “When you look at the mistakes of the 1920s and 1930s, they were clearly amateurish,” says Harvard economist Greg Mankiw. “It’s hard to imagine that happening again. We understand the business cycle better.”
Now, a generation of Americans raised on the belief that the 1950s and the 1960s were an unrecoverable oasis of prosperity has collectively changed its mind. In January, the Conference Board’s consumer-confidence index hit an all-time high, breaking the old record set in October 1968. Most folks, in other words, see nothing but sunny skies well into the future.
In the past, such ebullience was a telltale sign that the end was near. Yale University economist Irving Fisher declared that “stock prices have reached what looks like a permanently high plateau”–just days before the crash of ’29. In 1968, the Commerce Department dropped the title “Business Cycle Developments” from a monthly publication, concluding that the business cycle was dead.
It wasn’t. Although the boom of the 1960s lasted longer than each of the previous expansions since 1854–the first year covered by the National Bureau of Economic Research’s official business cycle history–it, too, faded into recession or worse.
Virtually every U.S. expansion since World War II has ended with the same script: Inflation picked up, the Fed cracked down, and the economy fell into recession. The longer growth lasts, the more likely cost pressures build. Falling unemployment forces companies to offer higher wages and pass on costs to customers. Supply shortages may emerge and factories may struggle to keep up with demand, allowing sellers to hike prices.
At the end of the ’60s boom, the consumer-price index was rising at an annual rate of 6.2 percent. At the end of the ’80s boom, inflation crossed 5 percent.
In 1999, in contrast, the CPI rose a tame 2.7 percent, as global competition surged and Internet shopping caught on. A recent comparative shopping survey by Lehman Brothers found that a London Fog trench coat costing $225 in a store could be had for just $89.95 on-line. That kind of competitive pricing works to keep inflation down.
Another reason for low inflation–and the economy’s overall good health–is the 1990s surge in productivity, or output per worker hour. That measure of efficiency determines an economy’s long-term sustainable growth rate. Through the 1960s, productivity grew at an annual rate of 3 percent. From the early 1970s through the mid-1990s, it slumped to about 1.5 percent. Since 1995, thanks in part to computers and a massive capital-spending boom, many economists believe the growth of productivity has rebounded to near 1960s levels.
The expansion and diversification of financial markets have also extended the boom, by creating trillions of dollars of new wealth and spreading it widely among consumers.
The ability of manufacturers to manage inventories more skillfully has made the current expansion more even-keeled. In the past, companies during good times built up huge stockpiles in anticipation of growing demand. If demand fell, production plunged to work off excess inventories, accelerating a downward spiral. Thanks to just-in-time production methods and more sophisticated market-monitoring techniques, inventories remain slim by historical standards.
Sudden, unforeseen shocks can always jolt an economy. But the U.S. today seems better able to absorb one blow that has helped to kill previous expansions: a spike in oil prices. Thanks to greater energy efficiency, and a shift away from energy-intensive industry, spending on oil makes up just 3 percent of gross domestic product today, down from 8.5 percent in 1981.
Now for the trouble spots:
Though inflation remains low, labor markets are the tightest they’ve been in a generation, with the unemployment rate hovering near 4 percent. Some desperate employers are starting to jack up compensation to keep and retain workers.
Fed chairman Alan Greenspan fears that those kinds of costly incentives could soon lead to the old wage-price death spiral. That’s why the central bank has raised interest rates four times since June and is expected to do so again next week.
The stock market’s surge is another source of concern, with share prices well above what any of the old formulas could justify based upon earnings, dividend payments and interest rates. The Standard & Poor’s 500-stock index was trading at 31 times earnings at the end of last year, double the average rate for the past 40 years. Internet superstar Yahoo! hit a whopping price/earnings ratio of 735. The 1920s saw a similar bidding up of shares, particularly in new technologies–one of the hot themes then was radio. Then, as now, investors borrowed heavily to buy stocks, and borrowed heavily against their market-driven wealth.
The collapse of the 1920s bubble weakened what turned out to be a fragile economy, and the heavy amount of debt held by investors magnified the force of the market crash.
A blow today could be more severe. The market is more integrated into the economy than ever before: Nearly half of all households own shares, thanks to the explosion of mutual funds and 401(k) plans.
Then there’s the trade deficit, which hit a record $26.5 billion in November, the most recent month available, fueled by Americans’ insatiable demand for foreign goods. That’s accompanied by a growing dependence on foreign capital to finance American business and American markets.
A loss of confidence in the U.S. economy–triggered say, by a plunge in the value of the dollar–could touch off a stampede by foreign investors to pull out of American markets. That’s what burst Asia’s bubble in the late 1990s.
In the past, relatively minor setbacks often became calamities because of policy blunders. The 1929 “great crash” became the “Great Depression,” in part because the Fed kept the money supply tight even as the economy was contracting, and President Herbert Hoover raised taxes to balance the budget. Inflation got out of hand in the ’60s and ’80s because the Fed had been too loose with money supply, and because Lyndon Johnson and Ronald Reagan spent beyond their administrations’ means.
Today, the government looks better poised to handle an incipient downturn. For the first time in modern economic history, fiscal policy is being run the way the textbooks say it should be during good times: The government’s big budget surpluses help damp growth and prevent the economy from overheating.
The Fed, meanwhile, is more vigilant than ever about pre-empting inflation before it gets out of hand, and quicker to ease up when the economy looks weak.
