Monday, January 16, 2006

Aftermath

Barry Ritholtz recently posted this chart showing the duration of bull and bear cycles in the stock market over the past century. One of the reasons this chart interests me is the way it demonstrates the danger created by the aftermath of bull markets and particularly speculative bubbles. The latter part of the bear market during the early 1900's was marked by World War I. The epic bubble that ended in the stock market crash of 1929 led to the Great Depression and World War II; the Dow Jones average did not regain its 1929 high until the mid 1950's (a repeat of that experience would result in the Nasdaq not revisiting its high of six years ago until the year 2025). When the postwar bull market ended, the Vietnam War started. The stock market crash in 1987 didn't lead to an extended bear market in stocks, but it was followed by a severe recession and the 1991 Gulf War. And we know what happened after the 90's bubble popped: 9/11, Afghanistan, Iraq, presumably Iran, and probably more after that.

I could write for hours about this---and this post is admittedly a bit simplistic--- but the basic truism is that when bubbles pop, bad things tend to happen beyond just the immediate consequences. Extraordinary policy responses lead to subsequent "echo" bubbles and further imbalances, foreign boogymen and scapegoats distract the electorate from political, fiscal and monetary failures, real enemies try to take advantage of perceived post-bubble weakness, and politicians realize that "war is good" because the concurrent increase in government spending stimulates the economy. In the case of a synchronized global crash, which occurred during the Great Depression that preceded World War II, this dynamic is exponentially more dangerous as many nations desperately take the same route.

This is why preventing or short-circuiting speculative bubbles is so important. It’s also why---despite his retirement in a few weeks---Alan Greenspan’s legacy won’t be complete for years to come as the aftermath of the multiple bubbles he's sired continues to play out.

Something tells me this won’t be a featured topic during these upcoming speeches.

45 Comments:

Anonymous Anonymous said...

I wouldn't take that bet, TCR will win every time.

1/16/2006 2:41 PM  
Anonymous Anonymous said...

I'm a big fan of your blog - 1st time commenting. I typically admire your free market thoughts but believe this post is misguided. The 1800's show that even with a hard currency, speculative bubbles are part and parcel with the human condition. Gearing policy to try and subvert them will only make the boom and bust cycle more damaging. For example, the move to fiat money will eventually destroy our currency. The socialization of the banking sector will eventually lead to a system wide crisis rather than the mostly regional ones that occurred before the Fed's creation. I don't see how gov't policy can be used to prevent humans from becoming irrational and greedy. The best it can do is back a sound/hard currency and let poorly run financial institutions fail when the markets determine that they should.

Secondly, the speculative bubble and war cycle are correlated but I would argue the greater causal relationship is the commodity cycle and the war cycle. Geopolitical conflict has ALWAYS picked up as resources become more scarce. Japan's aggression towards the US in the 1940's had nothing to do with our depression or market bubble - it was about securing petroleum and other resources. The current bullish commodity cycle is sure to result in greater conflicts between the current major users (the US) versus the future major users (India and China) will be over the developing nations that own the resources (Middle East, Africa, etc..).

1/16/2006 2:48 PM  
Anonymous Anonymous said...

Cunning Realist, you may be onto something but I wouldn't ascribe such powers to the stock market. I'd rather see stock market crashes as proxies for deeper economic problems, precursors, forward indicators, canaries in the coal mine. Take your pick.

1/16/2006 4:51 PM  
Anonymous Anonymous said...

Was the recession after 1987 really SEVERE?

It is quite a stretch to tie the 1991 war to the 1987 stock crash.

Do not blend coincidence with Cause-and-Effect

1/17/2006 8:03 AM  
Anonymous Anonymous said...

A couple of observations:

o The baby boomers are going to be retiring in large numbers and this will affect the stock market and the job market. Should we send seniors to fight wars, instead of our juniors? ;-| Seniors will be re-adjusting their asset allocations for risk. They won't have the time left to recoup any extended market downturn.

o Are these signs the bubble has returned: increasing number of infomercials on tv selling money systems, stock market systems, etc, impervious to any risk; analysts and financial journalists growing cult status again; lots of corruption; predicting triple digit prices for stocks; Oprah having Maria Bartiromo on as an financial expert. ;-|

The one thing the Republican party has taught me are markets don't represent the true value of anything, and that they can be very easily manipulated.

1/17/2006 3:23 PM  
Anonymous Anonymous said...

I think "bad things" --wars, recessions, scandals---- will happen from time to time regardless of whether there is a bubble or not. And remember the "Go-Go years" mini-bubble in stocks rose and popped in the late '60s while the VietNam war was raging, not before the war. And the 1987 crash was more a news event than an economic event, and can't plausibly be named a cause of a recession and war four years later. I also wouldn't characterize the 1991 recession as "severe" in light of the early '80s and '70s recessions, though certain areas (e.g. So. Cal.) took a long time to ultimately recover. And remember true bubbles are very rare, and we should resist the temptaion to label every cyclical overextension of an asset class as a bubble.

1/17/2006 5:40 PM  
Blogger Roy said...

TCR, while I disagree with alot of your posts I always believe your arguments are sound and legitimate, which is why I continue reading. But the connections between the 90's bubble pop and 9/11,Iraq, Afghanistan and Iran and the connections between the 87 crash and Iraq, seem paranoid at best.
This seems awfully similar to arguements made by those predicting the end of the world. It goes something like this, the bible said the end of the world would be preceded by diseases and wars, there are alot of diseases and wars now therefore the end must be near.
It is illogical, just as it is illogical to say that since economic bubbles bursted in the 1900's, 20's, 50's, 60's, and 90's and there were wars in the times therefore it is a result.

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