Keith Rankin's Thursday Column - Another Black October?
October is silly season on Wall Street. The Octobers of 1929 and 1987 are well known. More recently, in 1997, the United States stockmarket did a bungee, while in New Zealand our sharemarket's gyrations were described as a "dead cat bouncing". Might 1999 be another bad October?
Certainly the September declines in NY and NZ equities are inauspicious. More important are the uncanny parallels between the US economy (and its relationship to the emerging capitalist nations) in the 1920s and in the 1990s. (Despite the economic similarities, Presidents Coolidge and Clinton had only one thing in common; the letter "C".)
In the 1920s, the US economy just grew and grew. In the middle of that decade, USA became a creditor to the emerging economies of Central and Eastern Europe, and Latin America. In 1927, the flow reversed. A loss of confidence - or a perception of diminishing returns on foreign investments - led to a repatriation of American capital and a consequent growth of US stock values. The 1997-98 Asian/Russian/Brazilian crisis has an uncanny similarity to the Eastern European / Latin American / Australasian crisis of 1927-28. The path of the Dow Jones Index from 1997-99 is reminiscent of its growth path in 1927-29.
In the late 1920s, the US was the technological leader in all of the industries that defined the 20th century. The parallel with the high risk technological stocks of the late 1920s is very close to the love affair with the 'information superhighway' stocks of the late 1990s. By the end of the decade, these are/were the most overvalued. And their value is entirely dependent on the belief that their values will keep rising. Many Internet companies pay no dividends. Adding to nervousness about computer-related stocks is the sense of uncertainty surrounding the Y2K computer bug.
For a month now, overvalued shares paying no dividends have been falling in value. For many of the 40% of Americans exposed to Wall Street, it is becoming increasingly obvious that it's time to bail out of these stocks.
I believe that the probability that there will be a major 'correction' in the US stockmarket is very high. The more important question is whether a crash on Wall Street will lead to a worldwide economic depression.
To answer this question, we must note that the rise of the Dow in 1927-29 was due to an international crisis that began in 1926-27 within the countries that had previously received masses of US capital. World primary product prices plummeted, and US investors in primary products retrenched. The Wall Street crash of 1929 was a symptom rather than a cause of world depression, just as a crash in 1999 will be a symptom of a crisis that began with the flight of capital from Thailand. Perhaps we are in a benign phase of a five-six year global crisis that began in 1997.
The Great Depression of the 1930s was a "great" event for three main reasons:
1. opportunistic national policies in the 1920s led each industrialised country to try to simultaneously export more and import less
2. a significant growth of inequality between capital and labour, with in particular the US economy producing wage goods at a much faster rate of growth than the growth of the wages of its workers
3. the US Federal Reserve failed to open up its vaults in response to the liquidity crisis following the Wall St. crash
Here it is important to note that points (i) and (ii) are related. Outside of the United States, wage growth was constrained as each country sought to achieve competitiveness through reduced labour costs. Inside the US, working class demand was maintained by consumer credit at a time when America really needed a strong union movement.
Similar problems exist today, in both the United States and in the struggles for competitive advantage between the industrialised nations. We depend more on credit and less on wage growth to maintain global demand for wage goods (ie the goods and services that western wage and salary earners like to buy).
There is a very real likelihood that the American attitude to trade will trigger off a depression following a financial crisis. President Clinton told us, at APEC, that the United States was running a high balance of trade deficit as its duty to global economic stability. He failed to say anything about his country's balance of payments current account, which is almost certainly in surplus. As crazy as it might seem, I am sure that Mr Clinton doesn't understand the difference between the trade balance and the current account balance. Or, if he does, he appears to not appreciate the significance of that difference.
Simple confusion between the 'balance of trade' and the 'balance of payments' is likely to lead the United States to adopt a defensive trade policy at exactly the post-crash moment that the world will be looking to the United States for an accommodating trade policy.
Given the confusion of President Clinton and his advisers, it may be up to US Federal Reserve Chairman, Alan Greenspan to save the day. One popular theory of 1929 is that the death of the trusted and longstanding Fed chief Benjamin Strong months before that crash was the cause of the Depression. Strong's successors were too weak, Milton Friedman argued, because they failed to print the money needed to resolve the liquidity fallout from the crash.
I am sure that there will be worldwide stockmarket dramatics this October. But there will be no world Depression. Accommodating monetary policies in New York, Tokyo and Frankfurt will lead to an orderly unravelling of debts, a rationalisation of Internet companies, and an orderly reinvestment in Asia.
New Zealand is more problematic. We have laws - in particular the 1994 Fiscal Responsibility Act (FRA) and the 1991 Employment Contracts Act (ECA) - which oblige us to repeat our policy mistakes of 1930-32. Further, the 1989 Reserve Bank Act (RBA) may lead to high interest rates at a time when our currency is depreciating (in response to US capital being repatriated). We will need the exact opposite; an accommodating (ie easy) monetary policy.
I believe that New Zealand will face a severe downturn from mid-2000 to mid-2002, regardless of which parties form the next government. The good news will be that a huge fall in our real exchange rate will trigger a boom that will last the rest of the decade. The 2000s, like the 1930s, will eventually prove to be a decade of high growth for New Zealand.
I just hope that we don't panic and blame the newly elected MPs for problems conceived by the governments of 1984 to 1994. (Single-party government in New Zealand came to an end in 1994.) MMP (or an alleged surfeit of MPs) will not be the problem if we face a hair-raising economic ride over the next three years. It will be the FRA, the ECA, the RBA and the naïve commitment to free trade that we must revisit.
October 1999 need not be black. In the event of a financial panic, what is needed is cool heads and an imaginative multi-partisan political response.