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And Now, the Financial Apocalypse

by J. Orlin Grabbe

When a prominent MIT economics professor takes leave of his senses, blathering on like the worst of the stock stuffers of Wall Street and financial entertainment television, and when leading academic scholars and market practitioners proclaim that a replay of the market "correction" of 1987 is highly unlikely, you know the end is here. It can't get better, or worse, than this.

"This expansion will run forever," Rudi Dornbusch writes in the July 30, 1998, Wall Street Journal. No, not for another year, or two years, or five. But forever. That ought to stick a hot poker up the ass of any bear within a hundred miles of Cambridge, Massachusetts, huh?

Meanwhile ex-MIT professor and IMF Deputy Managing Director Stanley Fischer is off in Moscow, doling out billion of dollars in IMF funds to the Russian mafia. Of course they don't tell it like it is, over at the IMF. They euphemistically refer to opening the money spigot as "stablilizing the financial system" or "buying some breathing room" (a highly technical economic term that apparently means not having to do anything as long as more money is coming in the door). But the IMF aid allows the Russian central bank to continue to intervene in the foreign exchange market in support of the over-valued ruble, which in turns shores up Russian banks at the expense of industry and other sectors of the economy. And a majority of these banks are owned by the Russian mafia. Billions for the mafia. But Fischer somehow can't factor that into his equations.

Another Cambridge expatriate, ex-Harvard Professor Larry Summers sits over in the Treasury department, guzzling diet coke and hoping to take over the job of the departing Robert Rubin, who has now devoted several years to making the world profitable for Goldman Sachs. Goldman may soon go public in an IPO--a method of printing money by issuing stock certificates that could turn Goldman partners into even bigger millionaires than they already are. Summers' most notable recent achievements were setting Suharto straight on how to correct Indonesia's economy, and repairing the IRS's botched computer modernization project. Now Suharto is gone, Indonesia's economy continues to disintegrate, and the IRS's botched computer project promises to become more botched as we approach the Year 2000.

Is it a special form of Cambridge madness? Something hovering in the air above the Charles River?

Back to the stock market. Ah, the stock market. There is no longer need of sweat of brow or precision of acumen. Just buy and hold, invest for the long run, and get ready to eat the rainbow stew. The stock market will fulfill your wildest dreams. There is no such thing as a stock risk premium anymore, according to some economists. Stocks are safer investments than T-bills, bonds, or commodities, and they have higher returns. What more do you want? Why even bother to eat breakfast? Sell the food and buy some stocks. For the l-o-o-o-o-o-o-o-o-n-n-n-n-n-n-n-n-g-g-g run. Choo choo. I hear that train a comin'.

"This expansion will run forever."

It is hard to imagine any article with worse timing than, say, "Asia's Bright Future," by Harvard Professors Steven Radelet & Jeffrey Sachs, writing in the November/December 1997 issue of Foreign Affairs. Their chipper assessment appeared just as financial markets were collapsing across Southeast Asia. Of course Asia probably does have a bright future, much as Europe could have been said to have had a bright future during the Black Death years of the 14th Century, for that appalling time of death and disease was eventually followed by the Renaissance. Give or take a century.

But Harvard has nothing on MIT. "This expansion will run forever," Dornbusch says.

Oh, timing issues are difficult. Almost two years ago I came to the conclusion that stocks had reached valuation extremes. I formed the expectation that equilibrium forces would now begin to exert pressure in the direction of more familiar historical relationships and, consequently, lower stock prices ("Sell Stocks Now," "Bye Bye, Miss American Pie"). This was based on the private observation that stock overvaluation was comparable to that prevalent in 1929.

Silly me to have believed that 1929 relationships would provide any sort of container. And even though I suggested a tongue-in-cheek scenario where stocks (the Dow Industrials) might rise to 13,000, I considered it improbable that the Dow would rise above the then current level of around 6,000. But much to my surprise, the market thumbed its nose at 1929, and proceeded to cover almost half the distance to 13,000, peaking at 9338 (on a closing basis) on July 17, 1998.

As it was, I was a year ahead of the Asian Crisis and two years premature for Wall Street's imminent stock meltdown. Call it: Give or take a couple of years.

But this: "This expansion will run forever"? Give or take a couple billion years.

Why will the U.S. economy likely "not see a recession for years to come"? Because, Dornbusch asserts--I'm not making this up: "We don't want one, we don't need one, and, as we have the tools to keep the current expansion going, we won't have one."

So there you have it. We don't want it. We don't need it. We won't stand for it. And we can keep it from happening. "We" are in charge. The forces of nature will do "our" bidding. No, I don't know who "we" are. I guess he means Cambridge professors.

The gods don't like human hubris. They have a way of cutting down those with excessive pride. Whom they will destroy they first make mad. And Rudi Dornbusch, at least on the evidence of the Wall Street Journal article, has already become a raving lunatic. What stage is next?

There is a line of logical fallacy called post hoc ergo propter hoc: "after this, therefore because of it". The fallacy that because one thing occurred after something else, the earlier event was therefore the cause of the later event. And Rudi Dornbusch seems to have fallen into it.

When Dornbusch says "we", I don't think he means you and me. Certainly he doesn't speak for me. So who is he talking about? About economists, plausibly. The ones he knows from Cambridge, equally plausibly. Rudi can certainly look over at the IMF and the Treasury, and many other places, and see some of his colleagues at work.

But where is the evidence they are doing an amazing job? ("We have the tools to keep the current expansion going.") Or even a commendable job? Or even a competent job? I can't find any.

The reasoning seems to be: "We were put in charge. And then the economy expanded. And the stock market went up." Right. And Bill Clinton made the trains run on time. Post hoc ergo propter hoc.

No danger the party will end, Dornbusch tell us: "First, there is no inflation." That's right, of course. There is a massive deflation going on in Japan and other Asian nations. I'll leave it to Dornbusch to explain why that's a positive development.

"Second, the government's coffers are overflowing with budget surplus." Oh? How is that? Dornbusch must mean: in "surplus" as long as we falsely add in the net positive cash flow on the Social Security account, which is still scheduled to go bankrupt in 2020. The last I checked, the stock of outstanding government debt was getting larger, not smaller. You can't lie to me about a government "surplus."

Finally, this gem: "Thus, only natural causes, and not the Fed, can bring the economy to a standstill. Fortunately, we have the monetary and fiscal resources to keep that from happening, as well as a policy team that won't hesitate to use them for continued expansion."

By "policy team" I assume Dornbusch means the dickheads in the administration. Now I understand. They'll pass a law against recessions. Clinton will go on TV and feel our pain, and it will all go away. The Village will gather together so that each and everyone will have their "fair" share of a rapidly diminishing communal pie.

Yes, the gods are hard at work, inciting a bunch of jerk-off politicians (and also Cambridge economists?) to recreate the Soviet Economy here in the U.S. The oh-so- successful Soviet Economy.

Like the Black Death, the disease of hubris has spread everywhere. Robert Liton, director of economic studies at Brookings, and Anthony Santomero, director of the Financial Institutions Center at the Wharton School, convened a little conference of academic scholars and market practitioners, and now inform us: "A correction may come--and may even be in process--but a repeat of the hair-raising events of 1987 is highly unlikely" (Wall Street Journal, July 28, 1998).

Now this could be simply interpreted as saying that many of the attendees have lost their hair since 1987. But if so, this is an excessively subtle point. Liton and Santomero go on to give a list of innocuous, even irrelevant, reasons why 1987 supposedly won't happen again. About the only thing they don't do is promote the notion that circuit breakers, or temporary halts in trading, have an positive effect in making a market meltdown less probable.

They instead cite material from Lawrence Harris which knocks the notion that circuit breakers are useful. But they never get around to criticizing the consensus belief in the supposed "high improbability" of a repeat of 1987. For academicians must also have their fantasies. And one of these is: Events like 1987 will not be repeated because they have been studied.

Studied or not, the imminent market meltdown will come quickly. Probably in two waves down. A "correction", a relief rally, and then the massacre. We'll see how the "policy team" makes it all go away.

"Some would talk foolishly about the benefits of creative destruction," Rudi Dornbusch writes. Yes, like me, for example.

Sorry, Rudi. You don't have a clue. Let the ruination begin.

The bay-trees in our country are all wither'd
And meteors fright the fixed stars of heaven;
The pale-faced moon looks bloody on the earth
And lean-look'd prophets whisper fearful change.
These signs forerun the death or fall of kings.

--William Shakespeare, Richard II

August 2, 1998
Web Page: http://www.aci.net/kalliste/