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New Economy Not Resting in Peace / Artikel von mises.org

verfasst von - Elli -, 23.03.2003, 20:09

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New Economy Not Resting in Peace
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By Christopher Mayer

[Posted March 21, 2003]

[img][/img] It
may still be too early to pen the postmortem on the New Economy. The final
chapters on that episode are still being written. Nonetheless, Leon Levy's
discursive memoir, The Mind of Wall Street, is a first cut,
perhaps inadvertently so, at disentangling some of the threads that helped
create the great bull market of recent vintage. 

Levy is a very wealthy man, ranked among the Forbes 400,
with a net worth of over $750 million. He is the co-founder of mutual fund
giant Oppenheimer and also founded the celebrated hedge fund Odyssey Partners,
which returned 28 percent annually during its fourteen-year life. Because of
his success, his views on markets, while certainly not in the laissez-faire
tradition, deserve some attention. A few of his observations are explored
below. 

Levy's view of history is rooted in Mark Twain's maxim that
"history may not repeat, but it often rhymes."  In Levy's
mind he has seen all of this before. With the bubble finally deflating, as
inevitably all bubbles do, investors, Levy writes,"snap out of their
trance and ruefully look back on the myths, delusions, and outright lies they
had cherished as truths when they were blinded by a rising market."

The New Economy mythology was just such a collection of
cherished falsehoods. The long boom was more an illusion than a time of real
growth and expansion. By August 2001, losses by Nasdaq companies wiped out all
of the profits from the prior five years. 

The New Economy was a prolific producer of supposed
world-changing wonders, and one by-product was the claim of increased
productivity. Ironically, even the author of the famed phrase"irrational
exuberance" was snookered into believing that the old laws of economics
had somehow been repealed. Greenspan never hesitated to use this prop (increasing
productivity) to justify ever-dizzying stock market prices. In retrospect, as
Levy points out, the productivity gains were a myth.

Levy points to the work of James Grant, among others, that
show the only productivity growth in 1990s came from the computer industry and
that most of the economy's productivity gains lagged the gains registered in
1980s. Moreover, as Levy cites, McKinley and Company has also done work in
this area that demonstrates that much of the productivity gains came from a
surge in consumer spending. 

The current economic malaise has not shaken Greenspan's
faith in the potency of productivity. In his remarks to Congress on February
11th he still cited"favorable underlying trends in
productivity" as a positive force in the economy. Robert Samuelson
addressed this issue in a Washington Post editorial titled"Economic
Darwinism". He noted that labor productivity in 2002 was 4.8%, the best
showing since the 1950. However, that productivity surge was not due to the
sorts of things that normally drive productivity in a growing economy. Instead,
as Samuelson notes, much of the increase was due to layoffs, bankruptcies and
cutbacks.

The problem with the 1990s boom and one that Levy glosses
over (his focus is on the investor psychology) was its fuel: rampant credit
and monetary expansion, which led to massive malinvestment. The Internet and
the computer revolution were supposed to break the old laws of economics.
Instead, the landscape is dotted with lifeless dot-coms and the still
smoldering wreckage of telecom bankruptcies, among other limping and wounded
industries. As Samuelson notes,"The efficient production of what's
unneeded…is still wasteful. Productivity statistics, temporarily puffed up,
were somewhat misleading."

Then, there are all those phony accounting reports. Levy
writes,"companies artificially pumped up earnings by treating ordinary
expenses as extraordinary events (Enron, Cisco), by booking earnings and
revenues long before they were realized (Computer Associates, Calpine), by
including capital gains from investments in earnings (Microsoft, General
Electric)…" and on and on it goes.

The time of reckoning was inevitable."Companies can
maintain the illusion of operating earnings for only so long," Levy
writes."In a corporate replay of The Picture of Dorian Gray,
earnings …remained eternally ebullient while hidden from public view was the
true portrait that had become disfigured by warts, goiter and pox." A
prime example would be Computer Associates, which, in October 2001, reported
record second quarter earnings of $359 million in its press release, while at
the same time it reported a $291 million loss in its filings to
the SEC using generally accepted accounting principles.

Another example: Enron, whose very name has come to
symbolize corporate deceit and sleaze, was still on target to meet its pro
forma earnings predictions as late as November 2001, even as a firestorm of
controversy raged around it. As Floyd Norris of The New York Times commented,
Enron"managed to go broke without ever reporting a bad quarter."

Such examples underscore the absurdity of the accounting
abuses of the late 1990s. They also show how economic reality was blurred by
massive credit expansion, and how naïve investors (perhaps operating under
the poor assumption that Greenspan and the Fed could sustain the bubble) so
willingly suspended their belief in the older ideas of economic progress
through hard work and real savings. The loose monetary order of the time
provided a rich soil for wide-scale malinvestments that would not have been
possible in a hard money regime.

It would all have been much more amusing if it didn't ache
so much. After all, trillions have been lost ($4 trillion in the Nasdaq alone).
As Levy writes, the bubble's"legacy is like a wretched hangover. Long
after the valuations of new-economy stocks collapsed, major companies
continued to take significant writedowns of their assets...without the prop of
an irrational stock market, investors finally tuned in to the fantasy
accounting that had become pervasive in American business, and they
slaughtered stocks whose earnings came under suspicion." 

It is still quite stunning to go over some of the anecdotal
happenings of that frenzied time. Priceline.com, a company that sold airline
tickets at discount prices, had a market capitalization greater than the
entire airline industry. By 2001, it had a value of 1/100th its
old valuation. Theglobe.com was another Internet darling, whose IPO went from
$9 to $97 in one day. In little less than one year later, its stock would go
for pennies. 

The collapse inevitably draws comparisons with the '29 Crash
and the ensuing Great Depression. A septuagenarian and child of the
Depression, Levy began his Wall Street career when the wounds of that calamity
were still raw and viscerally felt. It was a vastly different world in many
respects. Perceptions of risk, for one thing, were very different from what
they are today.

At the tail-end of 20th century America, a
pension fund manager was fired for investing in Treasury funds rather than
stocks (it was the manager of the California State pension fund), apparently
he was being too conservative. In mid-century America, it was against the
law for a pension fund to invest all but a small part of its portfolio in
stocks.

As Levy writes,"to a fund manager from the 1950s
catapulted into the late 1990s, the notion that someone could be fired for
investing in bonds would make no sense, somewhat akin to hearing that ice
cream was good for you. Back then, with the memories of the Great Depression
still fresh, those entrusted with other people's money eschewed stocks as too
risky."  While a seemingly small thing, Levy writes that the
episode served as a"tap on the shoulder," a telling reminder about
the extraordinary state of affairs of the late 1990s boom. 

These events support the idea that another contributing
problem of the 1990s boom was ideological, and it is one that still persists
in the aftermath. It was a cultural error that made a hero out of a Fed
Chairman and that put so much faith in the Fed to begin with, at the expense
of sound economics. For this reason, the best way to avoid a like situation in
the future and to reform the financial structure of the country is to destroy
the ideas that continue to support such institutions and that also continue to
support government intervention in markets. In this way, the head of the axe
is really brought to the root of the tree.

So what is Levy's view of the future?  For those
interested in prognostications, Levy offers the view that we are in"but
the third act of a five-act Shakespearean drama that portends a bad
ending."  Admitting he has no crystal ball, Levy sees a
protracted recession and lists many reasons why. Debt burdens, low savings
rates and government deficits do not form a sound foundation for new growth (government
debt appears to be the new growth industry of post-bubble America). 

In a recent interview, Levy disclosed that he has 50% of
assets in treasuries and advises investors to use stock market rallies to sell
equities—a contrarian view to say the least.

However, Levy has built his fortune by going against the
crowd, by buying assets out of favor and then selling in them when the tide
turned. It takes an incredible amount of discipline and intellectual
independence to consistently make such commitments. That is why there is a
built-in lid on the number of people that can invest like Leon Levy.
Contrarianism is a self-limiting proposition. As investment writer Steven
Mintz once observed, it is akin to the old riddle that asks how far a dog can
run into the woods. The answer is halfway. After that, he's running out.

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Christopher Mayer is a commercial lender for Provident Bank
in the suburbs of Washington, D.C.  Send him MAIL and
see his Mises.org Articles
Archive.

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New Economy Not Resting in Peace / Artikel von mises.org - - Elli -, 23.03.2003, 20:09