No More Rabbits In The Hat

The Lehmann Letter (SM)

Everyone wonders: Why is this recession so much worse than earlier recessions? Why is it dragging on for so long? Why is the recovery so weak?

To answer that, we must familiarize ourselves with earlier recessions and recoveries.

•Before the 1990s Dot-Com Boom. Household spending on homes and autos led the business cycle after World War II. As borrowing and spending surged, inflation and interest rates rose. That brought an end to the boom, and recession began. When inflation and interest rates fell due to recession, and encouraged renewed borrowing and spending, a new expansion began. That's why recessions were brief, recovery strong and unemployed workers in construction and manufacturing were quickly recalled to work.

•The 1990s Dot-Com Boom. In the early 1980s the Fed brought an end to the earlier boom-bust cycle and its inflationary bias. The economy slumped going into the 1990-91 Gulf War and remained weak for a couple of years after that. But the dot-com boom brought surging recovery and expansion without inflation. This time business, not households, led the charge as industry invested in personal computers, software applications and the Web. The economy and employment recovered and expanded sharply. We had pulled a rabbit out of the hat.

•The 2000-2001 Dot-Com Bust and the 2002-2007 Real-Estate Boom. Shrinking business capital expenditures, not contracting household purchases, generated the 2000-2001 dot-com recession. Once again concerns about a weak recovery and expansion arose, but the 2002-2007 real-estate bubble generated another expansion. That was the second rabbit we pulled from the hat.

•The Present Predicament. The bursting of the 2002-2007 real-estate bubble led to the present doldrums. The economy has passed from asset inflation to asset deflation, and the economy will remain weak as long as asset deflation prevails. We can't snap back quickly the way we did in the 1960s and 1970s when falling interest rates released an economy that had been temporarily stalled by rising inflation and interest rates. Nor is there a high-tech expansion available to rescue the economy; nor will low interest rates produce another asset inflation. There are no more rabbits in the hat.

Once upon a time we were blessed by a self-correcting business cycle that always brought snappy recovery and expansion from each recession. When that failed, the 1990s dot-com boom and the 2002-2007 real-estate bubble rescued us. Now we're in a jam and it could be a long time before we pull out of it. To repeat, there are no more rabbits in the hat.

© 2010 Michael B. Lehmann