Headed for a Fall?

Most notable economic slumps and stock-market collapses in the United States have come in the years after presidential elections: Witness the string from 1837 through 1929 to 1981. Political leaders and Federal Reserve officials have been skillful at filling the punch bowl in election years and postponing the hangover 12 months.

But if 2000 is the year when the usual rule fails--if Federal Reserve Chairman Alan Greenspan raises interest rates two or three notches and takes away the election-year refreshment--the economic and political climates could start changing as quickly as the weather. And in a speech Thursday, Greenspan’s language did get a bit tougher.

Meanwhile, the public’s outlook for 2000 is jauntily simple: punch bowl, punch bowl, punch bowl. The flush times also explain why the presidential-nomination favorites in each party are heirs, not talents. Vice President Al Gore is a senator’s son, in addition to being President Bill Clinton’s anointed successor. Texas Gov. George W. Bush is the son of a former president. Both are the choices of their parties’ fat-cat lobbyist and big-contributor wings. Both have spent their smug careers walking down red carpets. Neither has the remotest qualification to be a national crisis manager. All of which is, alas, one of the missing discussions in U.S. politics.

While we’re talking about possible crises, another missing discussion in U.S. political economics involves the eerie parallels between the current financial situation and that of precrash 1929. The results may not be the same, given the number of regulatory stabilizers now built into the system, but the risks are high--and one of the most surprising and unnerving involves Greenspan and the Fed.

Greenspan, as most know, has been making occasional remarks about excessive stock-market speculation since 1997. Now, three years later, the principal market indexes have roughly doubled. None of his muted words and minor-league rate increases have cooled rthe expanding bubble. The unnerving aspect is that the last time the Fed went through similar hand-wringing and hesitancy was back in 1925-29.

The first trickle of concern about the Roaring ‘20s’ speculative bubble came in 1925, when the New York Federal Reserve Bank reduced interest rates to buoy shaky European currencies. This easy money, in retrospect, helped feed that year’s big market leap. Again, in the spring of 1927, rates were reduced to take pressure off European currencies, a move that dissenting Fed board member Adolph C. Miller later called “one of the most costly errors” of the early 20th century. Stock indexes and stock speculation soared. In 1928, the Fed raised interest rates in two small steps, but with the markets so giddy, these piddling moves had no impact.

By early 1929, a nervous Congress was seeking advice from the Federal Reserve Board. The board warned about the dangers of speculation but, nonetheless, blocked the New York Fed from implementing a proposed rate hike, from 5% to 6%. In February and March, concern about possible Fed action gave the stock indexes some bad days, but no actions followed, just confusing words. Finally, in August 1929, the Federal Reserve boosted the rediscount rate by a full point, from 5% to 6%. The market indexes barely paused, but the Great Crash was only weeks away.

It’s quite a tale, and Greenspan, being an economic-history and data aficionado, undoubtedly knows it. What’s so surprising is that he has managed to have somehow repeated so much of it--and even added some new speculative encouragements. Consider: In October 1987, when the stock market crashed, Greenspan was the new Fed chairman who flooded the system with liquidity and pushed the market back up. During the savings-and-loan crisis of 1989-92, he supported bailing out multimillion-dollar commercial-bank depositors, without regard to the $100,000 federal deposit-insurance limit. In 1997, despite his talk about overexuberance in the market, he produced only one ineffectual quarter-point rate increase. Then, in the autumn of 1998, when the Asian financial crisis was hot and the stock exchanges shaky, Greenspan undercut the discipline of the markets by bailing out a big hedge fund, Long-Term Capital Management, which had several former Fed officials on its board, and he cut interest rates three times to prop up weak Asian and Latin American currencies and the Dow Jones.

Last year, he took back those three cuts. But despite his expressed fears of market excesses, the Fed chairman proposed no additional hikes. In fact, in December, Greenspan unnecessarily flooded the banking system with money to deal with Y2K, and that action has been credited with fueling the December spurt in the Nasdaq composite index. Small wonder the market yawned the day after his Thursday speech.

Far from being a St. George out to slay the speculative dragon, Greenspan, by eliminating risk and blocking market correctives for financial misjudgment, has become one of the current speculation’s principal architects. Now, he faces the challenge, at the Fed’s Feb. 1-2 meeting, of deciding whether to begin a stringent corrective process of raising rates or merely impose a relatively minor increase and so avoid election-year boat-rocking but risk a bigger mess in 2001. Precedents for hedging abound. In 1972, Fed Chairman Arthur F. Burns sat on rate increases to help President Richard M. Nixon in his reelection, and, in early 1980, Fed Chairman Paul A. Volcker backed off more rate increases when his first hikes brought a quick, if short recession. These maneuvers pushed slumps and stock-market dives into 1973 and 1981, respectively.

The current wisdom is that Greenspan will raise rates in February and again later, taking away the punch bowl. But a look back at U.S. economic history reveals how many major slumps and crashes somehow slid into the years following elections: 1837, 1857, 1873, 1929, 1937, 1969, 1973 and 1981. So it is easy to see why a minority of pundits expect Greenspan to fudge. The current recovery is close to being the longest on record, and the administration is eager to have that banner to wave in November.

Nor are the analogies between the Fed of 70 years ago and the Fed of today the only parallel between the two eras. Both periods shared the hope that a new economy had put an end to the old business cycle. Both also experienced a record gap between rich and poor, tied to the stock indexes, which roughly tripled from 1925 to 1929, and did so again from 1995 to 1999. In both periods, trading volume soared, new speculative techniques proliferated and more pumped-up alternatives to the New York Stock Exchange arose, the Curb Exchange and regional exchanges in the late 1920s, and the Nasdaq in the 1990s. Two other key similarities are both decades’ massive increases in consumer debt and new dimensions of advertising to make people buy things they don’t need.

There is also another parallel weighty enough to stand with the Fed’s speculative complicities: the kindred importance of technology and pie-in-the-sky notions of where the markets might be going.

Technology stocks are usually the vanguard of major market upsurges and crashes. They are what Americans love not only to worship but to gamble on. Railroads, for example, were the key to the rise of the New York Stock Exchange in the 1840s, and railroad speculative excesses were principal triggers of the panics, crashes and downturns of 1857, 1873 and 1893. In 1929, the greatest speculative excesses and price collapses were tied to the next wave of technology stocks: automobiles, radio, telephones, aeronautics and electric utilities. By 1932, many of these new industries had lost 90% of their 1929 value.

The Nifty Fifty, which led the way to the bottom of the 1973-74 stock-market slide, were full of technology names. And now, we have the Nasdaq, up 85% in 1999 alone, whose Internet stocks, the railroads of cyberspace, have been unweeded by one of the market’s periodic convulsive cleansings. It is hard to imagine more fitting leadership for the Crash of 2000 or 2001.

Meantime, Greenspan, who probably rereads the chronicles of the Federal Reserve in the 1920s at least once a month, must make a big decision. Will he be a profile in courage, raising rates significantly to let some air out of the speculative bubble, risking one of the 30%-40% market declines that have traditionally been expected once a decade or so? Or will he follow his own recent precedents (and those of previous Fed chairmen) and keep the easy-money spigots open, with only a few grumbles and one faint-hearted quarter-point tightening, for the sake of election-year affluence and complacency?

Both major parties favor a surging market, which creates purring contributors and smiling voters. The Democrats represent much of the new technology, communications and entertainment money--think of them as the Nasdaq party--while the GOP stands for the older-wave wealth of automobiles, chemicals, agribusiness and family trusts. Both Gore and Bush are front men for the current cockiness of high stock indexes, big campaign contributions and consumer complacency, and it is difficult to imagine them retaining their appeal in an economic crisis. It’s the Reform Party that asserts it will profit from a slump. One of its two presidential possibilities, New York real-estate developer Donald Trump, has even predicted a crash and proposes to raise money (to support Social Security and other programs) by levying a one-time 15% wealth tax on America’s great fortunes.

The Federal Reserve Board’s February meeting overlaps the critical New Hampshire primary. And this Greenspan primary--the decision that the Fed and its chairman make for conscience or collaboration--could prove to be even higher-stakes balloting. *