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Irwin Kellner
Dec. 8, 2009, 12:01 a.m. EST · Recommend (1) · Post:
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As housing falls, so falls the economy
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Bullishness was signaling current gold volatility
By Irwin Kellner, MarketWatch
PORT WASHINGTON, N.Y. (MarketWatch) -- Looking back over the decade now drawing to a close, it's clear that the United States economy experienced a number of ups and downs that might well have been avoided with the correct economic policies.
A raft of uncertainties held hiring in check, mainly abetted by banks not lending.
This wasn't what forecasters were expecting when they looked into their crystal balls 10 years ago, at the close of the 1990s. Then, the consensus was for smooth sailing as far ahead as the eye could see -- not surprising since the economy had boomed during most of that decade, logging in a record 120 months of growth.
If there was a concern 10 years ago, it was that an ongoing budget surplus would soon result in Washington eliminating all its outstanding debt, thus leaving no Treasurys for the Federal Reserve to use in conducting its open-market operations.
This period of reduced demand for funds was expected to push interest rates down to levels not seen since the 1930s. Concomitantly, inflation was projected to be a thing of the past.
Besides such factors as reduced money growth, there were technological advances such as the Internet, which allowed price comparisons by consumers while reducing costs to business as more and more shopping was done online.
During the Future of Finance Intuitive in Britain, Chancellor of the Exchequer Alistair Darling fields questions from the audience about the role of regulators and how it might evolve in the coming years.
Ironically, these last two predictions turned out to be fairly accurate, in spite of the fact that the overarching concern soon became not too little government debt -- but too much of it. As for economic growth, it lasted an above-average six years, and then fell into what has been billed as the worst downturn since the 1930s.
The roller-coaster began 10 years ago, as the new millennium was about to dawn.
Afraid that the Y2K phenomenon might cause computers to think that year 2000 was actually 1900 and thus shut down, the Fed injected gobs of liquidity into the banking system so that the banks would have enough funds in the event that public concerns led to a possible surge in the demand for cash.
As you might imagine, all this money caused a bubble to develop in the stock market. The Nasdaq /quotes/comstock/10y!i:comp (COMP 2,190, -4.74, -0.22%) , for one, nearly doubled in the last few months of 1999.
Once we crossed the millennium and nothing happened, the Fed promptly withdrew these excess funds. This burst the stock bubble and set the stage for the decade's first recession, which began a year later, in March 2001.
Although this recession was mild, lasting only eight months, Fed officials soon began to worry that the U.S. economy was on the cusp of deflation. As a consequence, the monetary mavens once again shot a boatload of liquidity into the markets, laying the groundwork for the next bubble -- first in housing and then the stock market.
These bubbles were aided and abetted by deft and deceptive financial engineering, along with a usual suspect: greed. A credit crunch developed around the middle of 2007 when it became apparent that most of the new instruments that were cobbled together were nothing more than a house of cards.
Housing was already collapsing, but the stock market continued to rise until October, when the Dow peaked at 14,165. The decade's second recession began two months later.
Because it resulted from a financial crisis, which led to an all-out panic in the following year, this latest recession in many respects turned out to be the worst downturn since the 1930s.
Banks and other institutions, both financial and nonfinancial, had to be bailed out. A big stimulus package was enacted but it failed to stem a surge in layoffs.
Labor was hard hit because of technology, outsourcing and a raft of uncertainties that caused businesses to forego hiring. These included taxes, energy, health care, policies dealing with the environment and most important, a marked reluctance on the part of the banks to lend.
For its part, besides high unemployment, the Fed once again worried about deflation. That said, the central bank once more flooded the system with liquidity -- so much so that new bubbles have already developed in stocks, gold, oil and other commodities.
The financial markets have recovered but still remain jittery -- witness their reaction to the flap over Dubai World. Meanwhile, the federal deficit has ballooned to unprecedented levels, creating problems of its own.
As we prepare to enter the second decade of this millennium, the road ahead looks rocky. Let's hope that policy-makers get it right this time.
Irwin Kellner is MarketWatch's chief economist.
- NickL30 | 12:54 a.m. Today12:54 a.m. Dec. 8, 2009
One of the hallmarks of markets dominated by bullish exuberance is high volatility -- those unexpected air pockets that can take your breath away. So recent day's sharp gold declines were anything but unforeseeable.
10:57 a.m. Dec. 7, 2009 | Comments: 438
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