Blessedly, 2009 did not turn out to be the utter catastrophe many once feared it would be—no bank runs, no bread lines, no sport-hunting of the rich. But it’s far from certain whether the worst has been truly averted, or, to use a phrase that became fashionable, the can was merely kicked down the road. The signals are, at best, mixed. Jobs are still being lost, if not at the same wildfire rate. Many small businesses lack credit, not to mention customers. So what lies ahead?
Between the yahoos who tout every market uptick as the stirrings of the next boom and the doom peddlers who cling to their prophecies of societal breakdown, a consensus has cohered around what investment strategist John Mauldin, a hero of the blogosphere, calls “the muddle-through economy,” a protracted period of elevated unemployment rates and sluggish growth. Federal Reserve chairman Ben Bernanke, who once spoke of “green shoots,” now describes the “considerable headwinds” that the economy faces. Goldman Sachs economist Jan Hatzius sees double-digit unemployment persisting through the end of 2011.
Within this school of forecasters, a popular approach is to characterize the United States in terms of other countries’ trademark miseries. So we are Japan— a major Paul Krugman meme—staring down the barrel of our own “lost decade” of deflation, zombie banks, and cultural inertia. Or we are Europe, afflicted by the “sclerosis” of high structural unemployment and gigantic government. Or, as former IMF official Simon Johnson asserts, we are “a banana republic,” debasing our once-mighty currency by recklessly printing it to cover our debts.
But describing current conditions is only part of the game. Correctly calling the next crisis is the great status bake-off of economics. Which is why it was bracing to receive a recent investment newsletter from one of the most distinguished pessimists on Wall Street with this headline: “On the Coming Shortage of Labor.”
It was not a joke.
The bi-weekly newsletter, Grant’s Interest Rate Observer, is published from a picturesque office on Wall Street overlooking Trinity Church. The proprietor is a former journalist turned finance philosopher named James Grant, who—in addition to turning out the newsletter, which costs subscribers $850 a year, and hosting conferences at the Plaza Hotel that feature some of the sharpest minds in the investing business—has written six books, including a history of debt (surprisingly engaging) and a biography of John Adams (better than David McCullough’s, some say). But his ample intelligence has often left him out of sync with the animal spirits that rule Wall Street. Over a quarter-century in which the economy mostly boomed, Grant stayed mostly gloomy. His view has been that the economy is a Frankenstein creation of cheap credit that drove up prices and instilled a false sense of prosperous stability.
At critical moments, such as the great collapse of the eighties boom, this analysis proved brave and useful, swelling Grant’s subscriber rolls and turning him into a star of sorts. But it also led to him advising caution and restraint as some of the most vigorous bull markets in history commenced. Indeed, the nineties was not kind to pessimists. “In this business,” he says, “everything is cyclical, including one’s evident IQ. One goes from genius to moron all too quickly. And so I went from being regarded as one of the brighter people on Wall Street to being, let’s see, a perma-bear, and there was truth in that. I wasn’t supple enough, wasn’t flexible enough. I was in love with our story, which had been so successful, and didn’t see the world change.”
Having made this mistake more than once, Grant is determined never to make it again. The financial crisis ratified many of his core convictions about the pitfalls of debt and loose monetary policy, and the panic of people who didn’t see the crisis coming produced great opportunities for those who did. The transition from bear to bull was difficult for Grant, but before 2008 was over, he was recommending to his subscribers that they shop for bargains, including, yes, houses in Detroit. “One year ago, we turned bullish on tradable bank debt, certain ‘toxic’ mortgages, junk bonds and other such unwanted debris,” he says. “In March, we turned bullish on bank stocks. And now we are bullish on the economy.”
Grant’s optimism is built on two pillars. The first is his analysis of cyclical trends. Like a rubber ball thrown against pavement, the U.S. economy has historically bounced back with a force roughly approximate to that with which it fell. So the tepid recoveries of the early nineties and early aughts, the ones that preoccupy many analysts today because job growth was so torturously slow in both cases, were just the predictable aftermath of what Grant describes as “toy recessions.” A better model for our present circumstances, he says, is the early eighties, when the economy was in shambles (double-digit unemployment then, too) and then suddenly, to the shock of learned people everywhere, staged a stupendous recovery. Yes, there are seemingly unique impediments to such a recovery this time around—the indebtedness of U.S. consumers, to name one—but there are always such seemingly unique impediments, and the U.S. economy has repeatedly demonstrated the power to adapt.
This is especially true in the emotional, highly fraught area of unemployment. In a worrying climate of dying professions, it’s hard to get a grip on what takes their place. “Though we humans do our best,” he wrote, “we usually underestimate the capacity of market economies to reinvent the nature of work.” How exactly it will work this time, says Grant, we don’t know. We never know until after the fact.
Consider the now-conventional analysis of the U.S. economy over the last decade: It was, we have had drilled into us, built on the swampy ground of real-estate speculation and the feverish spending of borrowed money. Okay, sure. But it was also about the explosion of information technology, the concomitant surge in productivity, and unprecedented access to low-cost labor, both domestically (Latin American immigrants) and globally (Chinese), which lowered the prices of goods and services for all Americans. These conditions, unlike the housing market, have not gone away.
Grant’s second cause for optimism is an observation about human nature, summed up by an epigram he borrowed from the late British economist Arthur C. Pigou: “The error of optimism dies in the crisis, but in dying it gives birth to an error of pessimism. This new error is born not an infant, but a giant.” As peculiar as our economic circumstances may seem to us right now, the way people behave has a certain reassuring constancy—which is to say, we freak out and then we get over it.
Though economic forecasting is a major part of what his subscribers pay him for, Grant considers much of it a pseudo-intellectual parlor game. “Mindful that the future is a mystery,” he wrote in recent newsletter, “we do not pretend to know what nobody can know.” The past offers only so much help. In the industrial history of the United States, there have only been about 30 economic recoveries, a minuscule sample size. (If somebody touted a medical breakthrough based on a study of 30 patients, who would rush to sign up for this new wonder drug?) As for the data itself, consider that the dominant measure of economic activity, gross domestic product, is an antique that does a poor job of capturing the intangible investments that abound in the information economy. The numbers that drive the markets up and down, like jobless figures, are glorified guesses subject to constant revision. The latest issue of Grant’s Interest Rate Observer notes that annualized GDP growth for the third quarter of 1983 has been revised ten times, including just this fall! How much can we possibly know about the future if we’re still unsure about 1983?
Grant, too, harbors deep concerns about what lies beyond the bounce-back. He sees long-term problems in the government’s massive efforts to save the economy, especially the low interest rates that Bernanke shows little inclination to raise. “Inflation is upon us,” he says. “Not too much money chasing too few goods, but too much money. The object of the money’s desire varies from one cycle to another. It could chase skirts, toothpaste, and automobiles, as it did in the seventies. Or it could chase stocks, houses, or income-producing buildings, as it did a few years back.”
Grant, in other words, hasn’t forsaken pessimism so much as postponed it. Hyper inflation could produce the kind of volatility that enables traders to make a killing while the rest of us suffer sticker shock in the breakfast-cereal aisle. Then it’ll be the sport-hunting vigilantes who are doing the chasing.