As a Bear, one has had few good belly-laughs in the last ten years. But we Bears were rolling in the aisles watching market action after the Fed interest rate cut on Wednesday, with the Nasdaq rising 14 percent in one day and then giving most of it back to end down on the week. Talk about a sucker rally!

The Fed’s interest rate cut was the first recognition by policymakers that the U.S. economy may be facing something more sever than a slowdown, maybe even a recession. They still don’t get it. What the economy is actually facing is more of a bottomless pit. The trick now, and we see no evidence that anybody at the top except possibly the mildly bear-friendly Larry Lindsay is even thinking about it, is how to bridge the pit in the shortest possible time.

Between 1996 and 2000, ending last March, the United States enjoyed a huge burst of misguided investment, most of which is now proving to be worthless. One remembers similar bursts in 1979 and 1981, in oil drilling operations, and 1967 and 1969, in conglomerates and pretty well everything ending in “onics.”

The infamous comparison is of course 1927 to 1929, and Keynes and his followers attributed the whole of the Great Depression to the 1920’s over-investment and speculation. But actually 1929 values were not as excessive as those in 1999 — Radio Corporation of America, for example, 1929’s Cisco, never got beyond 28 times earnings (and RCA’s earnings, unlike Cisco’s, did not have the huge stock options valuation question hanging over them).

Lovers of the Internet proudly celebrate the fact that Internet penetration reached 25 percent of the U.S. public in only seven years, compared with 55 years for equivalent penetration by the automobile. This is not however a wholly positive statistic. The automobile required a huge amount of infrastructure investment before it was really useful; more important, much of the investment in Internet infrastructure, particularly in the telecoms, broadband, and hand-held areas, may well prove to have been far in advance of need.

It is as if the McKinley Administration had taken an Eisenhower approach and built a superhighway network in 1900; three Locomobiles an hour puttering noisily down I-95 would have done nothing for economic growth and the money would have been wasted.

It should not be supposed however that the 53 percent drop in the Nasdaq Composite Index has solved the problem. The Old Economy, at the peak, was nearly as overvalued as the new, and its valuations remain sky-high, with the S&P 500 Index at roughly twice its historic average price-earnings level.

The Dow Jones Industrial Index, too, is more than 60 percent above the level at which Greenspan decried “irrational exuberance” and is still higher than last July.

There is thus a great deal of air to be wrung out of stock market valuations, a great deal of explaining to be done by those companies which have given away the majority of their earnings to management in stock options and a great deal of hand-wringing by consumers as their assets shrink rapidly while their debts, enlarged by a negative savings rate over the last two years, remain obstinately unmoved. All this MUST cause a substantial recession; it is question of how big, for how long, and what should be done about it.

The Greenspan approach, dropping interest rates at the first sign of weakness, is ineffective in dealing with an overvaluation of this size, and carries huge dangers. In order to maintain at current levels financial markets (which he professes not to care about) and the economy (which he does care about) Greenspan must drop rates far and fast, probably by 2 percent or more on the Fed funds rate in the current quarter. Not only will this cause a re-ignition of inflation, which has trended up, not down even as the economy has weakened, it will also, by weakening the dollar, cause a flight of foreign capital which will exacerbate the very problem he is trying to solve. What is more, once Greenspan has cut interest rates he is out of ammunition.

If the recession continues to deepen after he has cut interest rates as far as he prudently can, or even after he has cut them effectively to zero, which would be highly imprudent, then there is nothing further he can do to stimulate the economy.

At that point, the United States will be reliant on fiscal policy, filtered through a highly eccentric political process, which itself will be battered by screams of outrage from the heartlands. If interest rates are close to zero, and cries for fiscal stimulation through government spending are answered, then you can kiss the U.S. economy goodbye until at least 2015. (The date may sound excessive even by Bear standards, but these things can last a LONG time — remember that the Japanese recession has been running 11 years, the 1930’s recession ran 12 years before war came and the British farming recession lasted from 1873 to 1939.) The deflationary, growth-sapping effect of diverting so many resources to new government programs, at a time when resources are scarce anyway, will work as surely here in the 2000s as it did in the US in the 1930s, or in Japan in the 1990s.

At this point, it is a great pity that incoming Treasury Secretary Paul O’Neill is a good friend of Alan Greenspan. Since Greenspan has been largely responsible, by lax monetary policy, for the bubble’s inflation and his current policy is exacerbating the problem not solving it. What the economy needs at this point is for the new administration to request, firmly, Greenspan’s immediate resignation to install a new Federal Reserve Chairman — or rather, re-install an old Federal Reserve Chairman, Paul Volcker, still active and eager at 73. He might not be attracted by the Fed Chairman’s salary, but one trusts that the incoming administration could arrange an $8 million book contract to soften the financial pain of resuming office.

Let it be clear: Volcker would not be cutting interest rates with money supply growth at its present level, 8.7 percent per annum in the 18 months to November 2000, and still 5.5 percent in the three months to November. Indeed, Volcker was never really happy with the Fed Funds rate in single digits; his idea of a prudent monetary policy involved something in the high teens. Of course, inflation, thanks to Volcker himself, is lower than it was from 1980 to 1982. So, probably, Volcker would be content with only a moderately tight monetary policy — say 12 percent on the Fed Funds rate.

Such a monetary policy would of course very quickly wring out the excess valuation in the stock market. In a repeat of 1987, or possibly two repeats of 1987 laid end to end, the Dow could be expected to be around 5,000 by year-end.

At that point, valuations would be reasonable, though not at that level truly cheap, and the basis for a recovery would have been laid out. The Bush tax cut could then be used to reflate the economy, as the incoming administration has suggested.

For 2001, however, if I were GOP Senator Bear, I would be filibustering; it would be dangerous to introduce the tax cut before valuations have fully deflated, or like Japan, the United States might find itself in a slump with both monetary and fiscal policy weapons exhausted. However, provided the Dow is below 5,000, by spring 2002, after investors have suffered one full year (2001) of pain and another three months (early 2002) of despair with no recovery in sight, a tax cut could be highly beneficial. Of course, at that stage the U.S. budget surplus would have turned into a yawning and ever-widening deficit, and every lobby in the country will be screaming for Keynesian deficit spending, but these voices should be ignored.

A tax cut in April 2002, concentrated on marginal rates but with an abolition of the estate tax, should be just what the economic doctor ordered.

Electorally, April 2002 is also about right; it allows the economic benefits of the tax cut to begin to appear before the 2002 midterm elections. (The 1982 tax cut, which took effect in July, was just too late to prevent serious GOP losses in November, even though by November the stock market recovery was in full exuberant swing). A GOP victory in the November 2002 midterms would be necessary for economic health; a big swing to the Democrats, coming at a time when the stock market was less than half its 2000 high and unemployment (a lagging indicator) was still rising, would presumably produce a tsunami of deficit spending at a time when the recovery was still fragile.

Of course, at the same time as the tax cut, it would be necessary to ask Volcker to return to retirement, possibly with another book deal. He would by that stage have done his job of puncturing bubble valuations as quickly and thoroughly as possible. As in 1982, he would in the short term be enormously unpopular, but in the long run he would have short circuited the process of value stabilization that will otherwise make the 2000s such a miserable decade.

The U.S. economy has been heading for a recession since 1996 and because the downturn has been so long delayed, so much capital has been misused, and the U.S. current account deficit and savings rates have moved so far from equilibrium, the recession is almost certain to be a deep one. Trying to avoid it, by modest interest rate cuts and indeed tax cuts before a bottom of sound valuation has been reached, is both dangerous and futile.

Turbo-economics such as outlined above, which leaps the economic chasm by accelerating the downswing, is by far the optimal solution.

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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.