the US stock market & the US dollar

[Jim Devine <jdevine@xxxxxxxxxxxxxxx>]

New York TIMES, April 28, 2000

When Will Stocks Really Crumble? After the Dollar Does

by FLOYD NORRIS

The money managers panicked. The people bought.

That is the real story of the wild month that ends today. After the worst
week in Nasdaq history ended two weeks ago, Wall Street braced for a wave
of selling that did not arrive. Instead, there was a rebound.

That has happened time and again in recent years. Just as market
fundamentalists take heart from the collapse of highflying stocks and
proclaim that value now matters, the fall ends. The bears are vanquished.

If that pattern is repeating -- as I believe it is -- the most interesting
question for investors is how they will be able to tell if the next plunge,
whenever it comes, is the real thing or just another buying opportunity.

The answer is: Check the dollar and the economy. One or both of them are
likely to get into trouble before the stock market suffers a prolonged
downturn.

Why? Because professional money managers really don't matter much in the
current environment. They can move money from stock to stock, but they
cannot stay out of stocks for very long. The pressures to be fully invested
are too great. The managers may fear the Federal Reserve, which is more
likely than ever to raise interest rates after the report yesterday that
consumer spending is rising at the fastest rate since 1983. But their
customers are not worried. The Nasdaq market fell yesterday morning because
professional investors feared rising interest rates. But the amateurs were
buying, and soon prices were up nicely.

American investors are certain that stocks are the best long-term
investment. That lesson, learned over many years, will not soon be unlearned.

A recession would operate on many investors as margin calls operated on
some during the Nasdaq swoon this month; it would force selling by people
who needed to raise cash. The selling would be slow and prolonged, bringing
a gradual market erosion rather than a crash. The stock market would follow
the economy down.

for the rest, see:
http://www.nytimes.com/library/financial/columns/042800norris-column.html

COMMENT: today's New York TIMES also refers to the growth of US GDP  as
"robust." Though my dictionary is in a box awaiting the move to my new
office (don't ask), I believe that this is an incorrect meaning for the
word "robust." I would say that even though the rate of growth is high, it
is _fragile_, since it is fueled by increasing consumer indebtedness and
increased external indebtedness that are unsustainable. Both encourage
rapid returns to more normal debt/income ratios, as in discussed in the
classic article by Wynne Godley in his papers at the Jerome Levy web-page.

More and more, the US economy reminds me of 1989, where the Fed decided to
hike interest rates to prevent the rise of inflation. Then, they started
lowering rates after the US economy slowed, in hopes of engineering a "soft
landing."  This failed, because of the accelerator effect, contractionary
fiscal policy, excessive borrowing by the private sector, and high oil
prices. (Baily & Friedman's MACROECONOMICS textbook, now out of print, has
a good discussion of this, pp. 249f.) In fact, the economy went into a
recession that was quite hard to shake, so that by 1992 people were talking
about the "jobless recovery" and Bush had a hard time getting re-elected.
(He succeeded, but only by having full-body plastic surgery, so that he
could implement his policies disguised as Bill Clinton.)

I think that the Fed is playing with dynamite, that it's quite possible
that they could trigger a deep recession. As Norris says, "The stock market
would follow the economy down." The fall in the Market would then encourage
a further fall in the economy, via the "wealth effect" and by dampening
expectations.

Jim Devine jdevine@xxxxxxx &  http://liberalarts.lmu.edu/~jdevine