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Jewish World Review April 11, 2001 / 18 Nissan, 5761

Anya Schiffrin

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Consumer Reports

Scary parallels to 1929 -- YOU know things are bad when 1929 is the precedent. Last week, as the Nasdaq hit its lowest level in two and a half years, stock charts were faxed and e-mailed around Wall Street comparing the index's 68 percent dive to the Dow Jones Industrial Average's 87 percent collapse preceding the Great Depression. "Similarities are uncanny!" exclaimed one fax.

No one expects a depression or the bank runs and dust bowls of the '30s. The Nasdaq bubble was largely contained to technology, unlike the broad scope of 1929's Dow. But Wall Street's sudden fixation on the parallels between the two stock crashes shows how dark the mood has become: Driving stocks lower is a sense that the economy could fall into a longer and more brutal recession than everyone had expected.

The new depths of investor pessimism stands in contrast to a sense among Federal Reserve bankers that the economy can avoid a painful recession. Fed Chairman Alan Greenspan pointedly avoided commenting on rate cuts during a speech to the Senate last week, but said he expects the economy to pick up later this year. Other Fed officials made speeches that brushed aside recession concerns. "Have we been in a recession?" asked Robert McTeer, president of the Dallas Federal Reserve, in a speech quoted by Reuters. "The answer is no."

And yet several leading economists are expecting further action from the Fed. "More cuts are needed, and the Fed will deliver them," says Alan Blinder, a former Federal Reserve governor. Fed alumna Janet Yellen says she wouldn't be surprised to see the key federal funds rate drop a full percentage point to 4 percent. "It's like someone slammed their foot on the brake," Yellen says.

The reasons behind the economic slowdown are well-known. Manufacturing is declining because inventories have piled up too high. As stock prices tumble, consumers are spending less, driving demand down further. But some prominent economists say that even more aggressive remedies may be necessary. The reason: The causes of the current economic malaise have more in common with pre-war downturns like the Great Depression than the postwar recessions most Americans are used to.

In other words, it's not a question of new economy vs. old economy anymore. It's a question of the very old economy. Stephen Roach, chief economist at Morgan Stanley, and Larry Summers, former Treasury secretary, have noted that pre-war recessions often resulted from the collapse of asset values, especially stock prices. That boom-or-bust cycle largely disappeared after the war, and recessions tended to be caused by inflation.

The bad news is that bubble-induced recessions last 22 months on average, twice as long as inflation-caused recessions. That lends support to the view on Wall Street that the economy will take longer than a quarter or two to right itself. A two-year recession would take a harder toll on consumer spending and corporate investment than we've already seen.

"The Nasdaq bubble has infected the real economy," says Roach, who warns of "significant cost-cutting with cutbacks in both capital investment and labor."

Roach sees another eerie parallel to 1929: The Fed tightened monetary supply when it should have loosened it. Today the Fed is easing rates, but not quickly enough for Roach and others. The half-percentage-point cut in the federal funds rate to 5 percent in March shows that the Fed sees the current slowdown as part of the "garden-variety inventory cycle," Roach says.

Not all economists are so pessimistic. Some point out that the business cycle has sped up, so recessions will naturally be shorter than before. Thanks in part to economist John Maynard Keynes, whose theories paved the way for modern economic policy, governments are better prepared to manage downturns. And because new technology becomes obsolete quickly, companies will need to invest to replace it, which should help demand recover quickly.

Bradford DeLong, an economic historian at the University of California at Berkeley, says another key difference in the new economy is that investments can be moved to other areas relatively easily. It's not like the old days when a new factory would sit idle because it could not be used.

"Our new-economy capital stock is more flexible and so much less vulnerable to the over-investment trap," says DeLong. "A chemical factory can only be used to make chemicals. But a server farm and its fiber-optic cables can be used to organize and control any component of the economy." If so, the economy this year will finally show just how new it really is.

Anya Schiffrin writes for The Industry Standard. Comment by clicking here.


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