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Here on the back page, we have no quarrel with Philosophiæ Naturalis Principia Mathematica. But applying Sir Isaac Newton's third law of motion to economics may be pushing it too far.
Equal and opposite reactions is the gist of an article that appeared in The Wall Street Journal, written by well-known economic historian Jim Grant. A generation of investors has gotten used to Grant's 'doom is nigh' warnings. Now, he says, it's a boom that is nigh.
Personal conversions sometimes mark dramatic turns. Paul of Tarsus saw a vision so bright it left him blind. The next thing you know he had changed his name and was pushing Christianity all over the world. According to Gibbon, the Roman Empire fell as a consequence. Then, on the advice of his mistress, Gabrielle, Henry IV became a Catholic, leading to the Edict of Nantes and its subsequent revocation. "Paris is well worth a mass," he said.
Even in the world of finance, there are dramatic conversions. As they say on Wall Street, a rally ends when the last bear gives up. Our old friend James Davidson, a source of inspiration for tech bears for many years, suddenly saw the light in 1999. Shares he had formerly scorned – often dotcoms with no revenue and no business plans – were suddenly added to his own portfolio. This too heralded a big change – the end of the tech bubble. Tech stocks collapsed. Most disappeared. Then Stephen Roach became vaguely bullish in 2006, after a long period of doubt and misgivings.
What is remarkable about the Grant conversion is that his vision gives off so little heat and light. His Wall Street Journal article shillyshallies around, rehearses the history of previous recessions and comes to rest in front of a flickering match: "The deeper the slump, the zippier the recovery."
Many were the sheep in Grant's flock. They feel betrayed, as if their shepherd had gone over to the wolves. We take no personal offence. And in the following few words we undertake to prove not that Jim Grant is wrong, but merely to stoke up the fire.
We look at the facts. But that is the problem. The facts are survivors. They will tell whatever tale their interrogators want to hear. As for opinions, after six months of a stockmarket rally, the once half-empty glass has become half-full. Here on the back page, we predicted it. But rather than quote ourselves, we'll let Robert Prechter say 'I told you so'. Even before the rally began, Prechter foretold its story: "Regardless of extent, it should generate feelings of optimism. At its peak, the President's popularity will be higher, the government will be taking credit for successfully bailing out the economy, the Fed will appear to have saved the banking system and investors will be convinced that the bear market is behind us."
As to Mr Obama's popularity, Prechter was wrong. But four out of five ain't bad.
Grant's brief tour of recession history seems to confirm the general principle. The further an economy falls, the further up it rises to get back to normal. This downturn has clipped nearly 4% off US GDP, more than any previous downturn since World War II. Of course, this hardly compares to the slump of 1929-1933, which took 27% off the GDP. Then, in the ranks of the unemployed stood one out of every four able-bodied workers, as opposed to just one out of every ten, according to today's statistical legerdemain. Still, the depth of the drop did not prevent a vigorous bounce; on the contrary, it seemed to demand it. After 1933, the US economy grew by nearly 10% in each of the next four years.
In the slump of 1982, GDP sank at a 6.4% rate. Again, the reaction was nearly equal and opposite to the action. "Not until the third quarter of 1984," says Grant, "did real quarterly GDP growth drop below 5%."
Economies may bounce back to normal, but you still have to figure out what 'normal' is. Imagine a US Senator bouncing down the Capitol steps. The question is whether he will get up or not when he reaches the bottom. In the 1933 example, the US economy, still youthful and vigorous, got up nicely. But 'normal' was down. He soon fell again. By the end of the decade he was on his back, with 15% unemployment and 2% deflation.
Now it is 2009. The poor fellow is down again. The feds rushed to help him to his feet. They gave him a combined fiscal and monetary shot in the arm seven times stronger – in terms of GDP – than the average postwar countercyclical lift. The juice opens his eyes. But he still staggers. The autumn of the present year may have the same bright colours as it did 27 years ago. But in all matters economic, it is its opposite. He has put on some weight over the years; he now carries three times the debt/GDP as he had in 1982. His stocks are three times as expensive, in p/e terms, too. In 1982, he had been deleveraging for more than a decade. In 2009, he has just begun.
What will happen next, we don't know. But if you see us turn bullish on this economy, it will surely be time to sell.
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Bill Bonner
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