SYNOPSIS: The upcoming business cycle will probably be a quick dip and a sharp rise. Maybe.
It's a thin line between love and hate. This time last year all the talking heads were adamant that the new economy had abolished the business cycle. Now we're told, after only a few months of slowdown, that we can kiss prosperity goodbye. The economy isn't perfect? Then it must be hopeless. Optimists believe that the economy's path will be "V shaped" — that it will experience a brief slowdown, then bounce sharply back. That's what happened in our worst postwar recession, in 1982. More cautious types worry that the path will be "U shaped" — that while the economy will eventually recover, recovery will take longer than the optimists expect. The most recent recession, in 1990-91, followed that path: unemployment didn't drop again until the second half of 1992.
For investors, the difference between a V and a U shouldn't be very important. If they stayed calm, investors would realize that a year of depressed earnings doesn't justify a big fall in stock valuations, especially not the valuations of technology companies whose big profits will come, if they ever do, some years in the future. Or as one rare sensible analyst put it, "This year's bad numbers are next year's great comparisons." Indeed, in the slowdown of the early 1990's earnings slumped but stock prices continued to rise.
But today's investors seem much more high-strung. After acting as if the unsustainably high earnings growth of the late 1990's would last forever, they now seem to believe that the current slew of bad earnings reports is the shape of things to come, indefinitely. And the new pessimism is no more realistic than the old optimism.
True, ultra-pessimists insist that we're going to "L" — that we not only will have a slump, but it will be many years before the economy recovers the lost ground. That is, they believe that we are about to enter a slump like that of the U.S. in the 1930's, or Japan in the 1990's: an economy that stalls and resists all attempts to jump-start it. As the examples suggest, such things do happen — but rarely.
To believe that an L-shaped slump is about to happen here, you have to believe that we are about to enter a "liquidity trap," that the Fed will not be able to get the economy moving again even by cutting interest rates all the way to zero. Do you really believe that? And no waffling, please, no wise-sounding remarks about how monetary policy won't be as effective as some think. The Fed can easily and quickly cut interest rates as much as necessary, as long as zero is low enough. So either we're headed for a liquidity trap or we aren't. And assuming that we aren't, which is by far the more likely scenario, we're talking about a quite temporary slowdown.
That still leaves the shape of the slowdown uncertain: a sharply pointed V or a drawn-out U? And the answer is . . . I don't know. There are just too many uncertainties. For example, right now consumers say that they are pessimistic but still seem to be spending. Which way will they resolve their cognitive dissonance?
But if I had to make a guess, I'd vote for a V. My main concern right now is that the V may be in the process of changing from a lower-case to an upper-case letter. That is, the panic in the financial markets, and even more so in the financial media, may make this slowdown more severe than the mild slump the fundamentals really warrant.
Or to put it a different way, the atmosphere right now reminds me not of the protracted slowdown of the early 1990's but of the recession that wasn't: the financial panic of fall 1998. That was very scary, but things turned around quickly. It's true that so far the Fed's efforts to turn sentiment around haven't worked. Of course, in 1998 Treasury Secretary Robert Rubin helped Alan Greenspan calm the markets, while until a few days ago this administration seemed more interested in accentuating the negative.
Nonetheless, now as then there is an upside to what is starting to look like a case of self-fulfilling pessimism: often it doesn't take much to turn a vicious circle into a virtuous circle. This slowdown may turn out to be nasty and brutish; but my guess is that it will also turn out to be short.
Originally published in The New York Times, 2.25.01