This week marks the tenth anniversary of the “Bear’s Lair” column. The first such column appeared on November 6, 2000, the eve of the Presidential election, with the headline “Dow crashes, Bush/Gore stunned in polls.” Its central thesis was that whoever won the election the following day would be a one-term President because of the impending collapse of the economy and the Dow Jones index falling to 3,800. It thus combined two features of this column in the subsequent decade: relentless bearishness and bold but completely erroneous predictions!
Not all its predictions were erroneous; some of them were merely early. The column assumed a normal and fairly lengthy recession after the dot-com bubble, without Greenspan’s massive Fed intervention of 2003-06 (though it correctly blamed Greenspan for the sloppy monetary policies in 1995-2000 that had caused the bubble.) Its prediction of a budget deficit of $500 billion was thus prescient, although it was a recession too early and did not assume a massive half-baked “stimulus” from either of the apparently moderate Bush or Gore. (The Al Gore of 2000 was in transition from the “New Democrat” of 1992 to the environmental fanatic of today. His 2000 campaign bore portents of the future, which may indeed have lost him the closely fought election — in retrospect the benignly moderate 1992 Gore would surely have won it.)
Another column, published the following day, was also interesting; it described the favorable Republican Congressional result as a demonstration of public choice theory because Congress, freed from the fiscal discipline of the 1994-98 Gingrich years, had presented the electorate with $92 billion of free spending handouts, apparently without any ill-effect since the budget surplus kept increasing. Of course as we now know, that $92 billion was just the beginning of the deluge and the surplus was to be very temporary indeed. Still as we (perhaps) again elect a Republican Congress it’s worth bearing in mind that it was the 1998-2006 House Speaker Dennis Hastert, not George W. Bush, who set the nation’s finances on the path to ruin.
Finally, from the first Bear’s Lair, looking forward: “HOT TIP FOR 2005 — GATES/BEZOS INC., THE BOWLING ALLEY AND DANCE HALL OPERATORS.” That would have been fun – though it takes a rather 1930s view of what a long recession might look like. Of course one had no experience of them back then…
Overall, I think it’s fair to say that the first decade of the Bear’s Lair’s life has vindicated the column’s relentlessly pessimistic view on the U.S. economy, although decay has taken a lot longer to arrive than the sharp collapse the column initially predicted. The more interesting question is the trajectory of the next decade. Will bearishness again prove fairly prescient or, as the relentless billionaire broker Ken Fisher keeps telling us, should we now expect “Good News for the Bulls?”
Unlike in 2000, when bearish commentary was thin on the ground, it is now quite possible to find outlooks a lot more bearish than this column’s. Stephan Richter’s piece in the Globalist “The Weimar Republic and the Ominous Rise of Jon Stewart” is one such – the likelihood of the U.S. going Nazi in the short term is infinitesimal, though below I discuss one possible scenario under which it would become less unthinkable.
It is unlikely that the next decade will repeat the last one. Such a repeat, continuing the last decade’s trends on a straight-line basis would have the stock market in 2020 close to current levels while the U.S. economy is a tattered relic and the Federal budget deficit hovers around 20% of Gross Domestic Product. That position would be completely unsustainable; the stock market would only be around the current level in nominal terms if hyperinflation had ensued, pushing prices through the roof and making the real value of the stock market much lower. In such an event, the budget deficit would have become un-financeable, causing the Federal government to default.
While I don’t have huge confidence in U.S. politicians, I think they’re better than that. The self-indulgent policies of the 2000s, increasing government spending and particularly waste while allowing consumers to gorge themselves on debt at low interest rates, were only entered into because the position in 2000 appeared so rosy. Presumably if he had known it would lead to an unsustainable bubble followed by a decade of economic difficulty, Greenspan would not have increased the money supply so rapidly in the late 1990s and later. Presumably if they had known it would lead to trillion dollar deficits and massive long-term growth in government the Republican Congressional majority of 1999-2000 and later would not have indulged themselves in so much pork-barrel spending and waste.
Today the U.S. economic position is obviously much more difficult and so it is at least probable that, if politicians and the Fed don’t behave themselves economically, the populace will replace them with some who will. The economic outcomes of the decade can indeed be examined based on two factors: the responsiveness of the electorate to economic hard times, and the responsiveness of the U.S. economy to changes in monetary and fiscal policy. On the political side, next week will show how sharply the electorate has reacted to the current economic mess; determining economic responsiveness will take a little longer. However, there are essentially four scenarios:
At one extreme, we can postulate a situation in which electoral responsiveness to economic difficulty is low, while economic responsiveness to mistaken fiscal and monetary policies is also low. In that case, an electoral swing next week somewhat smaller than expected, with the Democrats retaining both houses of Congress, could be followed by a continued very slow economic recovery, allowing current lax fiscal and monetary policies to continue for several years even though unemployment remained stubbornly high.
With electoral responsiveness still low, that could allow President Obama to be re-elected in 2012 in an apparently modestly improving economic environment (albeit with inflation already beginning to surge.) In that case the likelihood must be for a second 2008-style financial crash early in Obama’s second term, from a bursting of the bubbles in commodities, junk bonds and other financial assets. The policies of zero interest rates and fiscal stimulus would not then be available to re-start the economy, since inflation would already be substantial and rising and the budget deficit would already be at a level causing Greece-style difficulties in the bond markets.
That’s the situation in which the Weimar Republic analogy begins to be appropriate. Germany in 1931 was less than a decade away from hyperinflation, its borrowing capacity in international markets was zero and its banking system was defaulting. In such a situation severe economic hardship is inevitable. If the political system is unresponsive (as was Germany’s coalition-bedeviled Weimar Republic) an extremist figure who appears to offer a way out of difficulty through economic autarky and invasion of countries with raw materials becomes electorally irresistible.
In a second scenario, electoral responsiveness is low, keeping the current policies in place, but economic responsiveness is high. In that event the inflationary crash comes well this side of 2012. That would produce an economic environment sufficiently unpleasant for even a low-responsiveness electorate to change horses in 2012. With better policies, in place (because of low electoral responsiveness) until 2020 even if unemployment remained high in 2016, economic recovery would presumably be assured thereafter.
The third, opposite scenario has high electoral responsiveness, producing a Republican House and Senate next week, but low economic responsiveness. In 2012 that would bring modestly lower budget deficits and modestly tighter money (with Bernanke continuing in place but being badgered by an assertive GOP Congress.) Since economic responsiveness is low, no crisis would occur before 2012, making that election something of a wildcard, depending on who got blamed for continued economic sluggishness by a high-responsiveness electorate. Beyond 2012, the crystal ball gets murky in this scenario, as the wildcard of the 2012 election would have an enormous effect on the economic trajectory.
Finally, there’s the possibility of high economic and electoral responsiveness. In this case an assertive GOP Congress reduces the federal deficit, but Bernanke’s continuing lax money causes the current bubble to burst and inflation to surge well this side of the 2012 election. At that point, Bernanke would presumably be removed, possibly by impeachment, and a Volckerite monetary policy would be imposed. The 2012 election would still be uncertain – the Volckerite monetary policy would itself cause economic pain, and the electorate might blame Congress and the Volckerite Fed for its effects. However whoever won the 2012 election tighter monetary and fiscal policies would be likely to remain in place, since in a responsive economy they would already be showing positive effects before the 2013 Administration and Congress had time to change them.
Two of these four scenarios will be eliminated by Tuesday’s election, although it is of course possible that some intermediate outcome will make the position unclear. As for economic responsiveness, and the outcome to which it leads, we will only determine that by experience, probably as usual unpleasant.
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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.)