Bulls, Bears, and Chickens

As of Wednesday morning, the New York Stock Exchange Composite Index was below where it had been five years ago. So were the Dow Jones industrial average and what used to be called the “technology-rich” Nasdaq. The markets had a good day Wednesday. Nevertheless, your money would have done better for the past five years if you had hidden it behind the dresser.

Of course investors didn’t feel poor five years ago. In July 1997 those three indexes were up by almost half in the previous 12 months. They were far higher than in December 1996, when Alan Greenspan gave his famous warning against “irrational exuberance.” Pundits (including this one) were saying stock prices had reached heights that were unsustainable and then felt foolish as they continued to soar. By January 2000 the Nasdaq had almost tripled since July 1997.

Somehow, though, the same place doesn’t seem as exuberating on the way down as it did on the way up. It’s like passing through the same airport on your way home from a vacation. And the fact that we were popping champagne and feeling great when we were here the last time is unconsoling for another reason, too: It’s a vivid reminder that we still may have a long way to go in retracing our steps.

There must surely be a statute of limitations on bragging rights about economic predictions, especially predictions about the stock market. I claim no prize for predicting five years ago the imminence of something that finally happened the last few weeks. Like a stopped clock, almost any prediction about the economy will be correct eventually. Predictions of prosperity or catastrophe derive more from psychological disposition than from dispassionate analysis. Bulls and bears are born, not made.

Nevertheless, my rationalization for pessimism five years ago still seems sound. In 1997 the major indexes were up by 40 percent or more during the previous 12 months—the Dow had even broken 8,000!—while the economy had grown less than 4 percent. In dollar terms, the increase in value of shares on the New York Stock Exchange alone was over $2 trillion while the increase in goods and services produced by the American economy was about $280 billion. People were trillions of dollars richer, or felt that way, but there was only billions of dollars’ worth of additional stuff for them to buy.

Economists talk patronizingly about the “money illusion,” meaning the way that feeling richer or poorer can affect how people behave, and therefore affect the real economy. A rising stock market, for example, can give people the confidence to spend money and therefore become a self-fulfilling prophecy. A falling stock market can produce a recession just as easily as a recession can produce a falling stock market.

But the money illusion is backed by the full faith and credit of the United States. A person whose stock portfolio has gone up by $100,000 believes—and is officially encouraged to believe—that she has claims on $100,000 worth of additional stuff. If she sells the stock today and buys the stuff tomorrow, she may get $100,000 worth. But if claims on new stuff are proliferating faster than new stuff itself, something’s got to give.

The current popular outrage about corporate governance is mostly sublimated concern about declining stock prices, and at first it seems misdirected as a political issue. But society—and its proxy, the U.S. government—really have in effect promised many folks a level of financial security it is mathematically impossible to deliver, and the anger as this becomes clear is somewhat justified.

Optimists during the bubble/boom years offered variations on three arguments: First, that we were finally starting to enjoy the productivity benefits of the high-tech revolution (i.e., time saved at the office by computer spell-checking finally outweighed time lost by computer solitaire). Second, that we were enjoying the benefits of general agreement about the crucial importance of a stable monetary policy (i.e., there had been an “end of economics” that made the path of wisdom obvious and therefore easy to follow, just as the alleged “end of history” had ended destructive disagreement about the best political arrangement). Third, and most spectacularly, a few lunatics argued that a statistical error had blinded everyone to the fact that stocks were already worth many times their current value, and the Dow would soar to 30,000 or 36,000 as we figured this out.

Pessimists rejected all these arguments and said that actual production of new stuff could never catch up with the rising claims on new stuff. The gap could only be closed by reducing those claims: either through inflation, making $100,000 worth of stuff a smaller pile of stuff, or through a bear market, which would eat up that $100,000 before we had a chance to spend it.

Pessimists said, in essence, that the rise in stock prices was a matter of counting chickens before they hatch. But holding stocks also has been a chicken game of a different sort. Many have noted that baby boomers saving for retirement are a major source of the demand that has propelled stock prices and that their imminent retirement could have the opposite effect. The oldest boomers are still only 56, so this moment is still a few years off. Say 2008, when the first wave hits 62.

But we boomers aren’t idiots. We don’t want to cash out at the same time as everyone else. The clever thing is to enjoy the ride up until, say, 2007, and then to enjoy watching others on the ride down. But you don’t have to be very clever to figure that one out—and if too many people figure it out, it’s no longer clever. The really clever thing may be to pull out in 2006 … of course if everyone figures that out, 2005 will be the magic moment. Or maybe 2004, just to be safe …

Come to think of it, maybe we are idiots. Excuse me, I need to go make a phone call.