Friday, March 11, 2011

What Now?

The Lehmann Letter (SM)

Tsunamis! Oil! Revolution!

What now?

Many are wondering if this economic expansion has legs and wondering whether or not the two-year bull market has run its course.

On Wednesday David Leonhardt published an article in The New York Times, discussing the impediments to continued economic expansion:

In yesterday's Wall Street Journal, David Wessel did the same:

But today's Wall Street Journal carried an optimistic article about households paying down their debts and thereby improving their ability to spend:

Yet Floyd Norris of The New York Times wrote pessimistically today about squandered opportunities for financial reform:

Don't worry about who is correct, just read these articles for a good cross-section of opinions on today's most important economic issues.

But it's also important not to get one's nose too close to the bark of the tree. Step back and get a glimpse of the grove and, perhaps, a peak at the forest.

This recovery and expansion is different. Here's how it worked in the past:

Before the 1991 Gulf War, recessions were V-shaped: Inflation surged, interest rates followed prices upward, recession hit, and the economy snapped back quickly as soon as interest rates fell.

In the early 1990s a malaise hung over the economy after the Gulf War recession. Then the dot-com boom brought bubble conditions by the end of the decade.

The 2001dot-com bust came to a quick end as rock-bottom interest rates initiated the real-estate bubble. The economy surged forward until the bubble collapsed in 2008.

Today the economy is recovering and expanding, so why are smart people so nervous? For a number of reasons that refer back to earlier successes: (1) Since high interest rates didn't cause the recent bust, low interest rates won't drive today's expansion in the same manner as they drove past expansions; (2) The dot-com boom and real-estate boom were isolated events and therefore unlikely to repeat; (3) It is now hard to believe that the forces that created strong conditions in the past are with us again today. In short: Where is the source of the next boom?

That's why there is so much doubt and uncertainty as to whether or not the current expansion and bull market have legs.

© 2011 Michael B. Lehmann

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