I spent most of 1998 being wrong–at least about the U.S. economy. Everyone should hope that my record in 1999 proves equally poor, because I have been prophesying the end of the Great American Boom of the 1990s. It couldn’t withstand foreign recessions, an overvalued stock market and overextended consumers. It would inevitably slump, and a U.S. recession would then worsen already weak overseas economies. All this did not happen in 1998; I think it probably will in 1999.
This fatalism may betray stubbornness or stupidity. I prefer to think that the economy fits Stein’s Law, coined by economist Herbert Stein of the American Enterprise Institute. “If something cannot go on forever,” says Stein’s Law, “it will stop.”
At least two aspects of the boom, I suspect, cannot last forever. One is the huge surge in stock prices, which (as of Dec. 24) were up 27 percent in 1998, as measured by the Standard & Poor’s Index of 500 stocks. This follows gains of 34 percent in 1995, 20 percent in 1996 and 31 percent in 1997. The second thing that cannot continue indefinitely is the national shopping spree. The consumer savings rate is usually 4 percent to 6 percent of disposable income; in 1998, it was almost zero. Consumers spent nearly 100 percent of their current incomes.
Ominously, these two tenuous trends are connected. Americans are spending so much in part because they feel so wealthy. Economist Bruce Steinberg of Merrill Lynch notes that higher stocks have “added roughly $8 trillion to household net worth during the past six years.” (Net worth is what people own minus what they owe.) In turn, strong consumer spending shields production and profits from the baleful effects of foreign recessions. This props up stock prices.
People may still follow a monthly ritual of “saving.” But that’s offset by stock sales or borrowing. So there’s a mutually reinforcing confidence game. High stock prices boost consumer spending; and strong consumer spending boosts stocks. If either falters, the other may follow suit.
Speculative fever has surely infected the market. Internet stocks are the usual suspects. Consider Amazon.com, the online bookstore. Its stock went public (meaning it was sold to general investors) in May 1997 at $9 a share. A year ago, it traded at about $25 a share. It’s recently traded at around $320. Now this company has never made a profit. For the first nine months of 1998, it lost $78 million ($1.60 a share) on sales of $357 million.
Amazon.com may ultimately be fabulously profitable. One Wall Street analyst predicts it will earn $10 a share within five years. This would be about $500 million which, of course, roughly equals its present annual sales. Even if this does happen–and even if the stock remains at its current price–the profits would provide a meager 3 percent return on its $320 price. Why do people buy such stocks at such lofty prices? Maybe because they hope to sell to someone else at even loftier prices.
Look at trading volumes. On a typical day, almost a third of the available shares of Amazon.com stock are bought and sold. Many investors are not “holding for the long term.” They’re aiming for a quick kill.
It would be reassuring to think that this speculative frenzy afflicts only Internet stocks. But I am suspicious, and so are some Wall Street types. “We’re in one of the great (speculative) bubbles of all time,” says Barton Biggs, the chief global stock strategist for Morgan Stanley Dean Witter. “It’s the ascendancy of greed over fear.” At present prices, the stock market has a price-to-earnings (P/E) ratio of about 31 or 32, using the S&P stock index. (A stock has a P/E of 30 if its price is $90 and its per-share profits are $3.) These are record levels.
What now sustains confidence is confidence. The economy has done well; so people expect it to do well. Perhaps it will. Unemployment is low, inflation is trivial. People expect interest rates to drop further. But few of the threats of 1998 have vanished. Japan’s economy is still shrinking; Latin American economies are still weakening; the U.S. trade deficit is still growing; global overcapacity in many industries is still expanding. These trends imperil jobs and profits: the props of confidence. The shopping spree could end; stocks could drop; a recession could ensue.
At any rate, that’s how it seems to me. But my own confidence admits to self-doubt. Over the years, I’ve interviewed many economists, who have provided many interesting and even important insights. But only one economist said something truly profound. “I have spent my life,” he noted, “waiting for the inevitable.” What he meant is that the real world, with its infinite complexity, often confounds mere logic. So a recession may be inevitable; but I’m still waiting.
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