Miracle or Mirage?
The Great American Boom may be over, but the construction of myths about its nature and why it has ended has just begun. The International Monetary Fund blames the Federal Reserve and the European Central Bank for not having opened the floodgates of money at full. Other Keynesians put the blame on the consumer, who is seen as neglecting his duty of keeping on shopping.
The chairman of the U.S. central bank continues to worry about what the wealth effect really means and hardly suppresses his amazement about the vanishing productivity boom. Soon, the September 11 attacks may serve as an all-encompassing explanation of why the good times have ended.
But was the past decade really so good? Even official figures suggest a more moderate view. When comparing the boom of the 1990s with other periods of expansion, the foremost difference of the 1990s appears to be the exorbitant increase of debt levels at households, businesses, and in the external accounts, along with high equipment investment and less so economic growth and productivity increases (see table).
Even without taking into consideration that output is statistically inflated (see Statistical Illusions, The Economist.com, Nov. 8, 2001), the debt accumulation in the United States that has occurred in the private and external sectors of the economy and in the semi-governmental agencies is highly disturbing because this expansion of credit was accompanied by a virtual breakdown of private savings, where the rates turned negative in 2000 and 2001.
In addition, prices may not have been so tame as officially published, because hedonic price index calculation is being applied now to almost one-fifth of gross domestic product. This technique, which imputes astonishing quality improvements to all kinds of items (including college textbooks), tends to exaggerate the value for the individual consumer. Besides lowering the inflation rates, this procedure also boosts real growth and productivity, particularly in a phase when the production of high-tech goods is booming. Currently, the technology sector represents less than 8 percent of total manufacturing output, but it contributed two-thirds of the increase in manufacturing output between 1995 and 2000.
Early in 2001, the easing of monetary conditions--along with the implementation of tax rebates--became widely seen as the prime means of keeping the boom going, and since September the money supply has virtually exploded. But with very few exceptions, the caveat can rarely be heard that excessive credit growth as measured in relation to nominal gross domestic product and relative to the savings rate causes transformations in the real economy that go beyond mere aggregate level effects.
Making the boom continue at home and abroad has been the prime focus of U.S. monetary policy for quite some time. But among the unintended consequences emerge the broadly based lowering of perceived risk levels in the financial markets and a global spread of careless investment activities. The presumption of the existence of an effective lender of the last resort became a common learning experience for the financial-market actors during the 1990s. As shown by the debt-driven expansionism of many New Economy enterprises, risk considerations increasingly had been substituted for the relentless aim of gaining market share.
Pointing to increased speculation or irrationalism when explaining apparent excessiveness would miss the point, however, because excessive asset price inflation must have a footing in a loose monetary base, and there must be sufficient credit creation by financial institutions. With Japanese bonds moving toward historically low yields and the Federal Reserve always ready to act, the International Monetary Fund joined in as the third party, as a gushing source of liquidity when emerging economies were concerned.
The readiness of monetary authorities to provide ample liquidity has led to the dramatic trade-off that, while a stop of these measures would reveal the distortions immediately, the preference has shifted toward the continuation of this policy, as long as fresh money and further credit expansion may be expected to do its job.
In the past decade, debt accumulation has become so massive that now almost any measure seems justified to maintain its structure; but with each step aimed at "stabilizing the system," temporary respite is bought at the cost of more systemic fragility. By ignoring that monetary and fiscal impulses change relative prices and the capital structure of an economy, the policy formulations based on the analysis of aggregates leave aside the consideration of the effects that take place at the micro-level and emerge symptomatically as macroeconomic disequilibria. When measures to "keep the boom going" are applied repeatedly, profound transformations of the capital structure will occur. Step by step, the economic system will become less efficient due to misallocations.
The emergence of a recession signals a misdirection of investment due to discoordinated economic plans that need correction. Plans and economic actions must undergo revision in order to establish a new tendency toward equilibrium. But with new liquidity and active demand management, the process of reassessment and correction gets postponed, and the trend toward a widening of disequilibria is made to continue.
In contrast to this view, current economic policies are guided by the expectations that massive monetary and fiscal stimuli would make the downturn short and mild at worst or could prevent it at best. But what makes the current situation special is the dimension of the required adaptation. The credit expansion has brought forth a plethora of erroneous economic activities, which potentially affect the entire economy. At the root of these misallocations lie errors due to misleading signals from a monetary rate of interest, which has deceived economic actors about the sustainability of funding of their various projects, including consumption.
For longer than a decade, monetary policy in the United States has treated with benign neglect the extreme expansion of debt and money and the rise of asset prices, banking instead on the beneficial effects that may come from attaining a new plateau of productivity growth. The value of money--a function that modern economic systems entrust to a central planning committee--has sent false signals to the whole economy, and like the "planning errors" familiar from the centrally planned economies of the past, wrong investments have taken place at a formidable scale.
The existence of investments that do not generate profits implies that capital has been squandered, making the economy poorer. Working off that burden will be a time-consuming process accompanied by lower levels of consumption. Only if indeed the expected higher level of productivity growth can be attained, the monetary policy concept may work all right. But what if the rather mediocre numbers that were attained in the 1990s are already exaggerated?
Trying to boost economic activity again when recession has struck will make the situation worse, as the necessary adaptation process gets postponed. The temporary relief would demand a higher price later on when declining productivity rates lurk as the dim consequences of the policy of "stabilization."
In the past, when confronted with the failure of demand-side policies, Keynesian apologists eagerly blamed the authorities for having done nothing or "too little, too late." This excuse no longer holds for current policies. In the past months, high-powered money is expanding at over 30 percent on an annual basis, and government expenditure is rising drastically. This has helped the stock markets to recover and has so far prevented the wealth effect from becoming more negative. But business activity does hardly respond to the stimuli. On the contrary: the tendency for profits continues its downward path, and layoffs are on the increase.
How might the story end? In terms of the Misesian theory of business cycle, unfunded debt-driven expansions will end in a bust. But each business cycle has its peculiarities. In the current cycle, money--i.e., the U.S. dollar--is rapidly becoming a cheap commodity. This alleviates the debt burden, but it is also points to inflation should the monetary expansion continue at its current frenzied speed. When the Federal Reserve is forced to change course and raise interest rates again, a stock market crash and recession will be almost certain to occur. The window for a "soft landing" has narrowed.
There is a lot of talk nowadays that the U.S. economy might follow the Japanese experience and move toward a period of prolonged stagnation accompanied by deflationary tendencies. But the situation of the economy in the United States is decisively different from that in Japan at least in one important respect: In the U.S., the private savings rate is very low and negative for households; and while Japan entered its slump as a creditor nation, net foreign debt for the U.S. is approaching $2 trillion in U.S. dollars. In fact, the Japanese savings overhang may rather have dampened the downturn there; but when debt exposure is as large as it is currently in the United States, contractions have the tendency to trigger a downward spiral of economic activity.
The position of the United States is unique, and blunders of economic policy can be more easily digested than elsewhere. But even for a globally dominant economy with the privilege of issuing the prime international reserve currency, economic laws do hold, and in the end, the U.S. dollar is also just another paper currency. In the past years, the exchange rate of the dollar has benefited from the lack of alternatives. The uncertainties surrounding the euro run deep, and gold is being kept low due to central bank interventions. Due to internal and external dollar-dominated indebtedness, the demand for the U.S. currency is high because of rescheduling and refinancing, and even at the current speed with which supply is expanding, the rate does still hold fairly well.
But what about new investors? Will the creditors continue to believe that the U.S. dollar is a good store of value in the future as well? And what about the assessment of the economic outlook in general? What will happen when the knowledge becomes more widespread that a substantial part of the apparent superior growth, the surprisingly tame inflation rate and the amazing technological progress may have been a statistical mirage? Then a drastic reassessment must occur.
 While the surplus of the central government budget received high publicity, it has been largely ignored that the other public sector, i.e. independent and other quasi-public entities of the United States, issued debt instruments amounting to almost $800 billion in 1999. Consolidating these figures for 1999, new net debt issues by the private and public sector together reached $2 trillion (U.S. dollars) in that year. The trend has continued in 2001; in the first half of 2001, government-sponsored enterprises like Fannie Mae and Freddie Mac issued coupon securities and bills amounting to $590 billion (U.S. dollars). (See Federal Reserve Board, Monetary Policy Report submitted to the Congress on July 18, 2001, p. 15.)
 "The challenge of measuring and modeling a dynamic economy," Remarks by Chairman Alan Greenspan at the Washington Economic Policy Conference of the National Association for Business Economics, Washington, D.C., March 27, 2001
 The first stage of this learning experience may even go back to 1987, when the U.S. Federal Reserve Bank staged the rescue of the U.S. stock market and--together with the government--urged global monetary expansion. The Japanese authorities, by exuberantly following this advice, triggered an asset bubble whose fallout continues to plague the Japanese economy up to the present.
 As Rothbard among others has shown, this popular version of explaining the Great Depression is a fairy tale. The policy of tinkering with the economy, i.e. ad hoc interventionism, began in World War I; it was the trademark of all administrations in the U.S. and of the governments in Britain and on the European continent until it reached its epitome under Roosevelt. See Murray N. Rothbard, America's Great Depression (Auburn, Ala.: The Ludwig von Mises Institute,  2000).
 See Antony Mueller, "Financial Cycles, Business Activity, and the Stock Market," Quarterly Journal of Austrian Economics, vol. 4 (Spring 2001).