August 07, 2009
There is an inexplicable, but somehow widely held, belief that stock market movements are predictive of economic conditions. As such, the current rally in U.S. stock prices has caused many people to conclude that the recession is nearing an end. The widespread optimism is not confined to Wall Street, as even Barack Obama has pointed to the bubbly markets to vindicate his economic policies. However, reality is clearly at odds with these optimistic assumptions.
In the first place, stock markets have been taken by surprise throughout history. In the current cycle, neither the market nor its cheerleaders saw this recession coming, so why should anyone believe that these fonts of wisdom have suddenly become clairvoyant?
According to official government statistics, the current recession began in December of 2007. Two months earlier, in October of that year, the Dow Jones Industrial Average and S&P 500 both hit all-time record highs. Exactly what foresight did this run-up provide? Obviously markets were completely blind-sided by the biggest recession since the Great Depression. In fact, the main reason why the markets sold off so violently in 2008, after the severity of the recession became impossible to ignore, was that it had so completely misread the economy in the preceding years.
Furthermore, throughout most of 2008, even as the economy was contracting, academic economists and stock market strategists were still confident that a recession would be avoided. If they could not even forecast a recession that had already started, how can they possibly predict when it will end? In contrast, on a Fox News appearance on December 31, 2007, I endured the gibes of optimistic co-panelists when I clearly proclaimed that a recession was underway.
Rising U.S. stock prices “ particularly following a 50% decline “ mean nothing regarding the health of the U.S. economy or the prospects for a recovery. In fact, relative to the meteoric rise of foreign stock markets over the past six months, U.S. stocks are standing still. If anything, it is the strength in overseas markets that is dragging U.S. stocks along for the ride.
In late 2008 and early 2009, the “experts” proclaimed that a strengthening U.S. dollar and the relative outperformance of U.S. stocks during the worldwide market sell-off meant that the U.S. would lead the global recovery. At the time, they argued that since we were the first economy to go into recession, we would be the first to come out. They claimed that as bad as things were domestically, they were even worse internationally, and that the bold and “stimulative” actions of our policymakers would lead to a far better outcome here than the much more “timid” responses pursued by other leading industrial economies.
At the time, I dismissed these claims as nonsensical. The data are once again proving my case. The brief period of relative outperformance by U.S. stocks in late 2008 has come to an end, and, after rising for most of last year, the dollar has resumed its long-term descent. If the U.S. economy really were improving, the dollar would be strengthening “ not weakening. The economic data would also show greater improvement at home than abroad. Instead, foreign stocks have resumed the meteoric rise that has characterized their past decade. The rebound in global stocks reflects the global economic train decoupling from the American caboose, which the “experts” said was impossible.
Though the worst of the global financial crisis may have passed, the real impact of the much more fundamental U.S. economic crisis has yet to be fully felt. For America, genuine recovery will not begin until current government policies are mitigated. Most urgently, we need a Fed chairman willing to administer the tough love that our economy so badly needs. That fact that Ben Bernanke remains so popular both on Wall Street and Capital Hill is indicative of just how badly he has handled his job.
Contrast Bernanke’s popularity to the contempt that many had for Fed Chairman Paul Volcker in the early days of Ronald Reagan’s first term. There were numerous bills and congressional resolutions demanding his impeachment, and even conservative congressman Jack Kemp called for Volcker to resign. Had it not been for the unconditional support of a very popular president, efforts to oust Volcker likely would have succeeded. Though he was widely vilified initially, he eventually won near unanimous praise for his courageous economic stewardship, which eventually broke the back of inflation, restored confidence in the dollar, and set the stage for a vibrant recovery. Conversely, Bernanke’s reputation will be shattered as history reveals the full extent of his incompetence and cowardice.
As congress and the president consider the best policies to right our economic ship, it is my hope that they will pursue a strategy first developed by Seinfeld character George Costanza. After wisely recognizing that every instinct he had up unto that point had ended in failure, George decided that to be successful, he had to do the exact opposite of whatever his instincts told him. I suggest our policymakers give this approach a try.