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Old 10-14-2008, 12:30 PM   #1
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Default Easterbrook on the economy: long, level-headed, worthy

Tuesday Morning Quarterback should be required reading. In addition to some fun football talk, he always includes some talk of issues.

Gasoline Plentiful, Perspective Scarce: "Financial chaos is sweeping the world," a New York Times lead story said last week. I didn't notice any chaos in my part of the world -- every business was open, ATMs were working, goods and services were plentiful. There are economic problems to be sure. But chaos? Collapse? Next Depression? Please, media and political worlds, let's stop hyperventilating and show some perspective.

What is going on is a financial panic, not an economic collapse. Financial panics are no fun, especially for anyone who needs to cash out an asset right now for retirement, college and so on. But financial panics occur cyclically and are not necessarily devastating. The most recent financial panic was 1987, when the stock market fell 23 percent in a single day. Pundits and politicians instantly began talking about another Depression, about the "end of Wall Street." The 1987 panic had zero lasting economic consequences -- no recession began, and in less than two years, stocks had recouped all losses. (See John Gordon's excellent 2004 book on the history of financial panics, "An Empire of Wealth.") Perhaps a recession will be triggered by the current financial panic, but it may not necessarily be severe.

Politicians and pundits are competing to see who can act most panicked and use the most exaggerated claims about economic crisis -- yet the fundamentals of the U.S. economy are, in fact, strong. Productivity is high; innovation is high; the workforce is robust and well-educated; unemployment is troubling at 6.1 percent, but nothing compared to the recent past, such as 11.8 percent unemployment in 1992; there are no shortages of resources, energy or goods. Here, University of Chicago economist Casey Mulligan shows that return on capital is historically high; high returns on capital are associated with strong economies. Some Americans have significant problems with mortgages, and credit availability for business could become an issue if the multiple bank-stabilizing plans in progress don't work. But the likelihood is they will work. When the 1987 panic hit, people were afraid the economy would collapse; it didn't. This panic is global, enlarging the risks. But there's a good chance things will turn out fine.

Why has a credit-market problem expanded into a panic? One reason is the media and political systems are now programmed for panic mode. Everything's a crisis! Crises, after all, keep people's eyes glued to cable news shows, so the media have an interest in proclaiming crises. Crises make Washington seem more important, and can be used to justify giveaways to favored constituent groups, so Washington influence-peddlers have an interest in proclaiming crises.

An example of the exaggerated crisis claim is the assertion that Americans "lost" $2 trillion from their pension savings in the past month, while equities "lost" $8 trillion in value. "Investors Lose $8.4 Trillion of Wealth" read a Wall Street Journal headline last week. This confuses a loss with a decline. Unless you cashed out stocks or a 401(k) in the past month, you haven't "lost" anything. Nor have most investors "lost" money, let alone $8.4 trillion -- crisis-mongering is now so deeply ingrained in the media that even Wall Street Journal headline writers have forgotten basic economics. People who because of financial need have no choice but to cash out stocks right now are really harmed. Anyone who simply holds his or her ground with stocks takes no loss and is likely, although of course not certain, to come out ahead in the end. During the housing price bubble of 2003 to 2006, many Americans became much better off on paper, but never actually sold their homes, so it was all paper gains. Right now many Americans holdings stocks or retirement plans are much worse off on paper, but will be fine so long as they don't panic and sell. One of the distressing things about last week's media cries of doomsday is that they surely caused some average people to sell stocks or 401(k)'s in panic, taking losses they might have avoided by simply doing nothing. The financial shout-shows on cable tend to advise people to buy when the market is rising, sell when the market is falling -- the worst possible advice, and last week it was amplified by panic.

We've also fallen into panic because we pay way too much attention to stock prices. Ronald Reagan said, "Never confuse the stock market with the economy." Almost everyone is now making exactly that mistake. The stock market is not a barometer of the economy; it is a barometer of what people think stocks are worth. These are entirely separate things. What people think stocks are worth now depends on their guess about what stocks will be worth in the future, which is unknowable. You can only guess, and thus optimism feeds optimism while pessimism feeds pessimism.

There is no way the American economy became 8 percent less valuable between breakfast and morning coffee break Friday, then became 3 percent more valuable at lunchtime (that is, improved by 11 percent), then became 3 percent less valuable by afternoon teatime (that is, declined by 6 percent) -- to cite the actual Dow Jones Industrials swings from Friday. And the economy sure did not become 11 percent more valuable Monday. Such swings reflect panic or herd psychology, not the underlying economy, which changes over months and years, not single days. For the past few weeks pundits and Washington and London policy-makers have been staring at stock tickers as if they provided minute-by-minute readouts of economic health, which they do not. It's embarrassing to see White House and administration officials seemingly so poorly schooled in economic theory they are obsessing over stock-price movements, which they cannot control and in the short term should not even care about.

Consider this. On Black Monday in 1987, the market fell 23 percent. If you had invested $100 in a Dow Jones Index fund the following day, it would be $460 now, a 275 percent increase adjusting for inflation. That's after the big slide of the past month, and still excellent. So don't panic, just hold your stocks. And if you'd invested $100 in real estate in 1987, it would be $240 today, a 30 percent increase adjusting for inflation. That's after the housing price bubble burst. A 30 percent real gain in 20 years isn't a great investment -- until you consider that you lived in the house or condo during this time. To purchase and live in a dwelling, then come out ahead when you sell, is everyone's dream. Not only do stocks remain a good buy, America on average is still coming out ahead on the housing dream. (This example uses the Case Shiller Index for the whole country; because housing markets are local, some homeowners have lost substantial ground while others enjoyed significant appreciation.)

Economic problems are likely to be with us for awhile, but also likely to be resolved -- the 1987 panic and the 1997 Asian currency collapse both were repaired more quickly than predicted, with much less harm than forecast. Want to worry? Worry about the fact that the United States is borrowing, mainly from foreign investors and China, the money being used to fix our banks. The worse the national debt becomes -- $11 trillion now, and increasing owing to Washington giveaways -- the more the economy will soften over the long term. It's long-term borrowing, not short-term Wall Street mood swings, that ought to worry us, because the point may be reached where we can no longer solve problems by borrowing our way out. TMQ's former Brookings Institution colleague Peter Orszag, now director of the Congressional Budget Office, was on "Newshour" last week talking about the panic. Orszag is a wicked-smart economist -- for instance, he is careful to say pension holdings have declined, not been lost like most pundits are saying, as if there were no difference between decline and loss! The below exchange occurred with host Jeffrey Brown. Remember these words:

PETER ORSZAG: One thing we need to remember is we're lucky that we have the maneuvering room now to issue lots of additional Treasury securities and intervene aggressively to address this crisis.

JEFFREY BROWN: Wait a minute. Explain that. Lucky in what sense?

PETER ORSZAG: That people are still willing to lend to us. If in 20 or 30 years we continue on the same path, with rising health-care costs and rising budget deficits, we would reach a point where we wouldn't have that ability.
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Old 10-14-2008, 03:27 PM   #2
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Default Re: Easterbrook on the economy: long, level-headed, worthy

Now THAT is an excellent article.

It actually reflects some of what I have been saying about the ecomony being cyclical and made me think about the long-terum vs. short term borrowing in Washington, something I have overlooked.

He has a good point about the national debt as well.


Imagine if the political debate in this country was at this caliber? Sure would be nice to see.
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Old 10-14-2008, 03:32 PM   #3
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Default Re: Easterbrook on the economy: long, level-headed, worthy

It's easy to use hindsight to say what opportunities a crash gives you. The problem is that no bell rings when the market reaches the bottom to tell you to buy. Is the fall over? Maybe. Go for it.
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Old 10-14-2008, 03:36 PM   #4
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Default Re: Easterbrook on the economy: long, level-headed, worthy

Quote:
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It's easy to use hindsight to say what opportunities a crash gives you. The problem is that no bell rings when the market reaches the bottom to tell you to buy. Is the fall over? Maybe. Go for it.
true.

However, I think the point of the article is that the average person out there hasn't LOST anything right now.

My portfolio looks bad, but I am in my late 30's and won't need that money for another 30 years. By that time, there will be NO effect on my retirement from what is happening today...

actually that isn't true. My retirement that I put in every month is buying up MORE stock right now than possible a few weeks or months ago. Thus, In the end, for anyone under the age of about 55 who isn't looking at retiring for a few years, this ULTIMATELY will be beneficial to our retirement.
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Old 10-14-2008, 03:38 PM   #5
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Default Re: Easterbrook on the economy: long, level-headed, worthy

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It's easy to use hindsight to say what opportunities a crash gives you. The problem is that no bell rings when the market reaches the bottom to tell you to buy. Is the fall over? Maybe. Go for it.

Vis, my daughter goes to college next year, and her TAP529 is in the tubes over the last 4 months; it lost 30% of its value. I can 1) convert it and take the loss, 2) wait until Sept 09 and see, it might go up or it might go down, or 3) find other funding sources for the first year or two, and hit the 529 in 2010 or later. Based on my trust in the market, I'm taking option #3, because it also allows me to choose option #2 if the situation is right.

Patience.
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Old 10-14-2008, 03:39 PM   #6
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Default Re: Easterbrook on the economy: long, level-headed, worthy

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true.

However, I think the point of the article is that the average person out there hasn't LOST anything right now.

My portfolio looks bad, but I am in my late 30's and won't need that money for another 30 years. By that time, there will be NO effect on my retirement from what is happening today...

actually that isn't true. My retirement that I put in every month is buying up MORE stock right now than possible a few weeks or months ago. Thus, In the end, for anyone under the age of about 55 who isn't looking at retiring for a few years, this ULTIMATELY will be beneficial to our retirement.

Unless some of the companies cease to exist. Or, like GM could be doing soon, they file BR and flush the current investors only to issue new stock later.
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Old 10-14-2008, 03:44 PM   #7
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Default Re: Easterbrook on the economy: long, level-headed, worthy

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Thus, In the end, for anyone under the age of about 55 who isn't looking at retiring for a few years, this ULTIMATELY will be beneficial to our retirement.
I think it's more accurate to say that it will be of little consequence; everything that you had did lose a lot of value, after all, and that won't be made up by whatever you buy at the lower share price. In the end, what matters is the average, not the highs and lows.
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Old 10-14-2008, 03:46 PM   #8
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Default Re: Easterbrook on the economy: long, level-headed, worthy

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Unless some of the companies cease to exist. Or, like GM could be doing soon, they file BR and flush the current investors only to issue new stock later.

True, but that is why most retirements now use Mutual funds... it spreads the risk. So if a couple companies die out completely, and GM files BR... I lose just a portion of the wealth of my stock... but I still have so many share of the mutual fund. That fund picks itself up, dusts off, and moves into new stocks that will grow over a long period of time.
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Old 10-15-2008, 06:47 AM   #9
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Default Re: Easterbrook on the economy: long, level-headed, worthy

Funniest thing I heard was a joke by a Jewish man, I don't remember his name, who said after Yom Kippur, "We leave you in charge 1 day and this is what you do?"
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