The End of a Bubble Based Economy

We can learn a lot from history, but, too often, we don’t pay attention to the lessons of the past. We are now in an economic position that parallels one of the most devastating economic events in the history of the U.S., the stock market crash of 1929 and the Great Depression that followed. Consider the 1920s. It was a time of rapid economic growth and the stock market was showing exceptional performance. It was becoming common knowledge that the way to get rich was to buy and sell stocks because they were only going to go up. It was such a sure bet that a man could get a loan to buy stocks even though he didn’t own enough resources to pay back the loan. Even the banks knew that the stock market was a sure thing. Lending rules were discarded. It was economic euphoria. In the space of five years the value of the stock market had seen a five-fold increase.

On September 3, 1929, the DOW reached a record peak value at 381.17. About three weeks later, on September 23, 1929, people began to sell, reaping great profits, then the market went up again a week later and then it turned downward. A month later, on October 24, 1929 (Black Thursday) 12.9 million shares were traded, a new volume record. On October 28, a Monday, the DOW lost 13% of its value. The next day, (Black Tuesday) 16.4 million shares were traded, another new record, and the DOW lost another 12% of its value. Wild fluctuations in the stock market continued for about three more years. About six months after the market had crashed, the DOW had even recovered to a value of 294, but the fluctuations continued, and the DOW inexorably lost value until it finally hit bottom on July 8, 1932. It had fallen to an unbelievable value of only 41.22. It would not go above its record high of 381.17 until 1954, twenty-five years after the crash.

The principle lesson to learn from this is that the economic disaster was caused by an irrational euphoria, to borrow a phrase from Alan Greenspan. People thought that the stock market was a surefire way to get rich quick. This was a self-fulfilling prophecy, for a while anyway, because as more people bought stock the market went up. Everyone could see that, even the ordinary workingman. So they borrowed money to invest in the market. The geniuses of finance at the banks were happy to lend money to completely unqualified borrowers because they also knew that you couldn’t lose by investing in stocks. It was a Ponzi scheme, a pyramid scheme, a bubble, call it what you will. The bankers should have known. The government should have known. It was an economy out of control running on false hopes.

After watching the rise of the new tech-based economy in the late 1990s, Alan Greenspan declared that this rapid rise of these upstart industries was due to irrational exuberance. He decided to nip it in the bud, so to speak. (I’ll write more about all that another time). So, he started a relentless process of increasing interest rates. The plan was to make the cost of credit too great for the fledgling tech startups and they would have to stop expanding. He was right, sort of. On March 10, 2000 the dot com bubble came to an end as the Nasdaq, that newcomer, tech-based, stock exchange, hit a high value of 5,048.62. About two years later on October 9, 2002, the Nasdaq hit bottom at 1114.11. Investors had lost about $5 trillion in the slide that occurred after Greenspan saved us from our irrational exuberance.

With the new, tech-based economy a smoking ruin, and the old economy of manufacturing big stuff like bricks and locomotives going nowhere, Alan Greenspan decided to decrease interest rates to stimulate the economy. The thing is that everyone had learned their lesson about tech, so they weren’t going back there. And, everyone still knew that the old economy was moribund, so they weren’t going to put their money there either. Greenspan kept dropping interest rates and then, before you knew it you could borrow money really cheaply, but what was there worth investing in? Then the sages in Washington stepped in and quietly made a change in the tax laws, just to help out us homeowners. The old tax law had a provision created for people who were about to retire and downsize their big old family house. They could take a once in a lifetime tax exemption on the profit on the sale of the family residence up to a value of $200,000. (I think that’s the number – it was quite a while ago). Well, the financial geniuses in DC changed the law. The tax laws now said you could get a $500,000 tax exemption on the profits from the sale of your house every two years, as long as you lived in it for a little while. That, my friends, is a sure moneymaker. Why, all you have to do is buy a fixer upper, fix it up, and live in it a few months, and then flip it! You will make a nice profit every time and it’s tax free!

Before you could say “Alan Greenspan” we had morphed into a housing bubble economy. Our highly educated bankers and financial managers, having learned absolutely nothing from history, gleefully handed out loans to anyone who could still draw a breath, no questions asked, as long as the loan was for buying a house. That’s because everyone knew you could make a fortune buying and selling houses. So everyone started buying and selling houses and the economy took off again. The problem, of course, is that it was another one of those Ponzi, pyramid, sort of deals and eventually there were too many houses and nobody to buy them and no one could actually pay the mortgage payments are live in the houses and POP! There went the economy again, sort of a financial blowout on the one and only wheel of the financial vehicle we are riding in.

So here we are, drifting along. We’ve already spent George Bush’s $600 stimulus checks, and we’re still drifting. The DOW is wildly fluctuating. The government has lowered interest rates as low as they can go. So what now? Shall we turn to the financial geniuses of Wall Street, the marvelous bankers with their keen knowledge of the workings of our economy for guidance? Maybe we should bring Alan Greenspan back with his oh-so-delicate touch on the interest rate controls. Maybe George-in-the-White House will have another inspiration and give us all another 600 bucks.

Here’s the thing that our Republican government and our big businesses don’t want you to know: it’s not about you. It’s about the world economy, not yours. You see, our major businesses, all of them, are multi-national now and we import and export lots of stuff, although some of our imports and exports don’t literally go through the U.S. (I’ll leave that for another time.) One of the things we’ve exported is our economic engine. Yes! We are driving an economic vehicle with its only tire blown out, and now we find out the engine is missing too! See, we don’t make anything anymore. And that, my friends, is our problem. We have become an economy that only functions on bubbles instead of steady growth based upon honest trade. Here’s the scary part for our bubble-based economy: I don’t see any more bubbles in sight, do you?

We’ve had our housing bubble market crash, but we probably haven’t reached a sort of “1932 bottom” yet. But we will, and what will we do when we get there with our one flat tire and no engine? Will we bump along into our own 21^st century version of the Great Depression or will another magic bubble come along to save us? Time will tell.

However, there is another way out you know, a way that actually makes sense – but I’ll tell you about that another time. Meanwhile, here’s 600 bucks, have a ball.