The Greenspan Growth Recession

WHEN RONALD REAGAN accepted his party's nomination for president in 1980 he said, "When your friend is out of a job, that's a recession. When you are out of a job, that's a depression. And when Jimmy Carter is out of a job, that's a recovery."

But today it's more complicated. If the technical definition of a recession is two quarters of negative inflation-adjusted gross-domestic-product growth, then right now we aren't even close. Yet it feels like a recession. Especially to me, living in Silicon Valley, where I've definitely got more than one friend who's out of a job. But no matter where you live, we all have one very special friend who's out of a job: the bull market in technology stocks.

Be honest: If you're reading this commentary, then you're probably the kind of person who has had a very personal friendship with the extraordinary bull market that began at the end of December 1994. It may not be dead yet, but it's definitely out of work. And it's a sad sight to see the poor thing wandering around carrying a sign saying "Will work for upticks."

What gave the bull market its job in the first place was a once-in-a-lifetime wave of technological innovation that really did change the world for businesses and consumers. This wave powered not only earnings growth for companies that both made and used the new technologies — it increased the rate of growth: Growth itself grew.

And what's so sad now, and why it feels so much like a recession, is that the wave has passed. And the bull market has gotten laid off. Because growth isn't growing anymore.

Substituting technology for labor, or augmenting labor with technology, creates growth. But if you want growth to grow, then you need technology innovation, because technology innovation creates not just more capital equipment, but more efficient capital equipment. Whether it's a new gigabit Ethernet switch from Extreme Networks (EXTR1), a new phase-shifting subwavelength silicon-etching method from Numerical Technologies (NMTC2) or even just a new easy-to-use back-to-school label-maker from DYMO, it's all about enabling people and machines to do their jobs better than they could do them with last year's technologies.

While technology innovation creates physical capital, it's financial capital that makes technology innovation possible in the first place. Technology innovation, then, is the transformative mechanism that turns mere money into productive capital.

The bull market in technology stocks got thrown out of work when Alan Greenspan disrupted the operation of this mechanism by making it impossible for money to keep flowing into technology innovation. Hold it right there — don't accuse me of blaming Greenspan for the burst bubble! This is just plain fact: Greenspan relentlessly raised interest rates, thus increasing the cost of financial capital, making riskless savings more attractive and triggering a monetary deflation that made money both tight and scarce. And at the same time, he endlessly warned about "irrational exuberance," the "wealth effect," "pre-emptive strikes against inflation" and a dozen other code phrases intended to make it perfectly clear that he thought the bull market was a bubble and he wasn't going to rest until it burst. He said he would do it, and he did it. If I'm "blaming" him, I'm simply giving him credit for something he himself strove to achieve.

And now Greenspan is learning how much easier it is to destroy than to create. It's so easy to raise interest rates until no one wants to borrow any more. But now he's learning that no matter how much he lowers interest rates, he can't force people to lend. It's the same lesson that Japan's central bank has learned over the past four years of zero interest rates, still stuck with an economy mired in a decade-long deflationary contraction.

The best thing that can come from rate cutting is mere stabilization, and that's what's happening right now. That's why the dollar has pulled back a bit from 15-year highs against major foreign currencies, and why gold and other commodity prices have bounced off 25-year lows. And that's why the market was so delighted last week to hear Cisco Systems' (CSCO3) forecast that its business was stabilizing and that the humble growth goals set forth earlier in the month were being attained. At least the rate cuts have achieved that much.

But it feels like a recession, because mere stabilization means mere growth. And we're used to growth that grows.

What would it take to get back to that? Well, as ineffectual as lowering interest rates is, we might as well go all the way and do it right if we're going to do it at all. Right now the "real" fed-funds rate (the fed-funds rate minus the forecasted inflation rate in inflation-adjusted Treasury bonds) is 1.90%. In the slowdown of the early 1990s Greenspan got it down to zero. Doing that now would put the fed-funds rate at about 1.50% instead of the current 3.5%.

But the real answer isn't about interest rates at all. It's about the Fed injecting fresh monetary liquidity into the financial system by buying government bonds in the open market. It would be in the spirit of the "quantitative easing4" that the Bank of Japan is beginning to try, and which worked so well for the U.S. economy coming out of recession in 1982.

Fat chance. Just as Greenspan signaled with perfect clarity in 1999 that he intended to burst the bubble, he's signaling today with equal clarity that he isn't going to do anything dramatic to repair the mechanism for transforming money into productive capital. The pace of rate cuts has decelerated, with puny quarter-point cuts at scheduled Federal Open Market Committee meetings rather than the dramatic surprise half-point cuts earlier this year. And public comments by Greenspan and others Fed officials have virtually stopped, compared with the continuous bubble-bursting tirades of 1999 and the desperate "prosperity is just around the corner" sermons of early 2001.

So the bull market remains out of a job. And in this recession that feels like a recession but isn't a recession, we find ourselves hanging over a cliff suspended by a rope. A rope we thought was a bungee cord. Yes, it broke our fall. But we aren't bouncing back.

It's Alan Greenspan's rope. He handed it to us when he pushed us off the cliff. So maybe it's time to update Ronald Reagan and define "recovery" as when Alan Greenspan is out of a job.

Donald Luskin is an investment manager and CEO of The Luskin Report.

http://www.smartmoney.com/print/index.cfm?printcontent=/aheadofthecurve/index.cfm?story=20010829

-- Martin Thompson (mthom1927@aol.com), August 31, 2001

Answers

I agree with most of the sentiments expressed above, except for the last one. I still think the rope is a bungee cord. E-commerce, alone, will revolutionize everything over the coming generation. Unfortunately, that will probably be past my time.

-- JackW (jpayne@webtv.net), August 31, 2001.