Meltdown?

The Lehmann Letter (SM)

Events in Japan have troubled stock markets around the world.

Are this morning's downturns an omen of things to come?

Pessimism is called for if one judges by the impact of Hurricane Katrina on New Orleans. It's been years since that disaster struck, and New Orleans has not recovered. Both the economy and the population have shrunk.

But San Francisco rebounded swiftly from the 1906 earthquake and fire. It was not long before the city rebuilt and the economy was humming again.

San Francisco's experience reminds us that disaster often provide stimulus. Government, business and households borrow and spend in order to rebuild. Reconstruction provides jobs. A sense of optimism returns and folks get on with their lives.

On a grander scale, World War II devastated Germany and Japan. Yet, within a decade of war's end, observers spoke of Germany's and Japan's "economic miracles" and marveled at the swift pace of their reconstruction and recovery. Both nations went on to prosper mightily in the ensuing decades.

Returning to New Orleans, however, we are reminded that rebounding from disaster is not a snap. Think about Iraq. That nation is receiving, and will receive, massive assistance. But it's not at all clear that Iraq's economic prospects are good.

Then what will determine Japan's ability to bounce back? It's useful to look beyond the immediate circumstances and consider the background. Keep in mind that Japan's economy has struggled over the past two decades. The collapse of the stock-market and real-estate bubbles - 20 years ago - cast an evil spell. That meltdown's damage to household, business and banking balance sheets haunts the economy today. When Japan returns from rebuilding it will continue to face the conditions that prevailed before the earthquake and tsunami: Stagnant demand, weak growth and the threat of deflation.

But that does not mean that this morning's stock-market swoons are an omen of things to come. The world-wide declines reflect investors’ fears and their ability to dump stocks and move funds into safe havens such as U.S. Treasury securities. As fear subsides they will move their funds back into equities and markets will rebound.

Long-run conditions and fundamentals will guide the stock-markets’ long-run progress. These include the health of household, business and banking balance sheets, the ability of businesses to generate earnings now and in the future, and the price/earnings ratio.


© 2011 Michael B. Lehmann