Even some of the Bear’s normally bullish competitors are currently accepting that a recession is inevitable — four down days in the stock market will do that. Of more interest, however, is the question of what kind of recession we are to be favored with, and how long it will last.
If it is deep, and involves a serious stock market decline, it may also be long. The Japanese recession has already lasted over 10 years.
Last week, the Bear postulated a decline in the Dow to 3,800 over the next four years, based on valuation considerations, a similar decline to that seen in Japan in the 1990-98 period. For many people, such a decline, if short lived, would not prove a disaster. After all, few people other than professional traders lost a great deal of money in the 1987 crash, when the Dow dropped just under 40 percent — indeed, the index ended that year higher than it began it.
However, if you accept the postulate of a decline of 60 -70 percent in the stock market, it behooves you to accept that the recession may be a long one, Japan being the obvious current example.
This is much more serious.
Provided we are not wholly invested in dotcoms, we can all survive a stock market crash. Indeed, the more resilient of us can even survive a brief stock market crash that temporarily wipes us out financially. But we only have one life, the working portion of which is at the outside 50 years in length, and hence a 10 year recession eating up a fifth of our working life and (if we are unlucky enough to lose our jobs) making our skills rusty even after the recession lifts, is a much more serious and indeed life-threatening matter.
Not only are accounts of the Great Depression full of stories of impoverished Okies, they are also full of poignant stories of young men and women with a brilliant future before them, who struggled with adversity for more than a decade, were then swept up in war, and were afterwards too old to re-establish their lives on a reasonable basis.
The Lost generation became truly lost not in World War I, a brief and un-traumatic event for the United States, but in the Great Depression, which ate away their most productive middle years and left only old age to come.
Naturally, if the recession is fairly mild, it is also likely to be fairly short, lasting a maximum of two to three. In this case, the natural, self-correcting mechanism of the economy will kick in and right matters. The problem arises if the recession is deep, when it would be essential that we learn from the policy mistakes made both in the United States in the 1930’s and in Japan in the 1990’s, so the recession does not become unnecessarily prolonged.
U.S. policy in the 1930’s and Japanese policy in the 1990’s were quite similar. In both cases, after an initial period of denial, the government attempted to lever the economy out of recession by Keynesian deficit financing, while bizarrely raising the overall level of taxation to keep the budget under control.
Initially under Hoover in 1931-1932, and throughout the last 10 years in Japan, this has been the government’s primary answer to recession. After Roosevelt’s inauguration in 1933, government ‘investment’ continued, but was accompanied by another factor also seen in Japan in the 1990’s: strong resistance to necessary, if painful, economic restructuring, and heavy-handed ‘patriotic’ direction of capital and industry in general, through the NRA in Roosevelt’s case.
This allowed politically connected companies and banks, in the Japanese case, and politically connected trades unions, in the Roosevelt case, to impose huge additional burdens on the shaky economy. In both cases, the result was the same — a prolongation of the recession far beyond its natural duration, at an incalculable cost in human unhappiness (in the Japanese case) and despair (in the Depression).
In the 1930’s a number of other approaches were also tried. Stalin, in the Soviet Union, imposed the ultimate command-and-control economy but, as we now know but were unprepared to accept at the time, failed to raise Soviet GDP back to the level prevailing in 1912-1914. Only in the 1950’s, with a relaxation of state controls, did the Soviet system see real growth beyond Czarist levels.
Germany, Japan and Italy, on the other hand, tried a more successful approach: build up the military, thus absorbing unemployed people and resources, and then invade defenseless neighbor countries, hoping to recoup from their resources the cost of the military build-up.
Economically, this worked quite well until Hitler took it too far in 1939-1941, but in a nuclear-proliferated world, one devoutly hopes that nobody tries it again.
The one major country that tried something different in the 1930’s was Britain, and it worked. ’Thank you, Mr. Chamberlain’, caroled British pop fans after the 1938 Munich agreement, not in retrospect Neville Chamberlain’s finest hour. They would better have done so in 1934-1935, when Chamberlain, as Chancellor of the Exchequer, had put Britain’s economy back on a growth track, three years before significant military build-up, and well before her competitors.
Chamberlain increased tariffs, but only marginally direct taxes, to balance the budget, and engaged in a strict program of economy, avoiding deficit spending as far as possible, while maintaining Bank Rate at a low 2 percent. He regarded Keynes as a charlatan, and refused to follow his advice, cutting income tax rates when it became possible rather than increasing spending.
Unproductive industries, notably textiles, shipbuilding and coal, were allowed to decay, with only modest help being given to distressed areas. This led to pockets of deprivation, such as North-East England, which were exploited politically by the Labor Party, but more important, it allowed the remaining resources of the economy to be applied by the free market to the most productive uses.
The consequence of Chamberlain’s policies was an astonishing boom, concentrated in South-East England, in engineering, light industry and automotive products, which reduced unemployment, even in the depressed areas, from 25 percent in 1932 to 14 percent in 1936. Had World War II not intervened, it is likely that Morris Motors, not VW or Toyota, would have seized the U.S. small car niche from GM and Ford. A private sector housing boom, accompanied by road development as housing was built and cars proliferated, was also a feature of the era.
As Chamberlain said, in his incomparably un-Churchillian speaking style: “In view of our incorrigible habit of self-deprecation, it does not seem unpardonable to point out that nowhere else can you find a parallel to the results which have been achieved here.”
One would hope, therefore, that a U.S. leader in a serious recession would follow Chamberlain, not Hoover or Roosevelt. In particular he (or she — yes Hillary, we include you!) should avoid heavy devotion of resources to unproductive uses, since the huge wastage of resources in the dot-com boom will be the main deepener of the recession.
The recession president should above all avoid attempting to prop up the market before it has reached its natural bottom, or directing industry where to put its money. By allowing the financial hurricane to blow itself out, and values to collapse to a point from which they can recover, he will ensure that excess investment is wrung out of the system and the market falls to a point at which investors can be confident they have a good deal.
Technological innovation and new ideas will continue, at the frenetic rate we have come to expect in recent decades, so there will be plenty of opportunities for sound, productive investment, in new technologies which were unavailable in the bubble of 1996-2000, once investors are sure they step on a firm footing of sound valuations.
In summary a deep, painful recession lasting 4-5 years is far less damaging than a moderate one lasting a decade. Ensuring the recession ends as quickly as possible is far too important to be compromised by trying to mitigate its force before a bottom has been found.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
This article originally appeared on United Press International.