August 9, 2002

Land of Broken Dreams

Since 1998 endeavored to embarrass, berate, scare and otherwise make every effort to convince readers to keep their savings out of the stock market during the bubble.  For example, in April 1999 made fun of 401K investors with a picture of a street filled with sheep (The Sheeple Shall be Shorn)  titled "401K and Mutual Fund Investors Await their Fate on Wall Street."

Wall Street's marketing machine in the 1990s re-learned a successful means of selling equity product by employing a principle first used in the 1920s stock market bubble, the mutual fund (investment trust) and the "buy and hold" investment strategy.  The message was this: timing is for losers.  The only way to make money in the long run is by holding a portfolio of stocks.  This is true but with one critical caveat.  If you buy stocks at the top of a stock market bubble, you may die of old age before your stock portfolio makes you any money.  Naive investors have recently learned what the pros have known all along when it comes to speculative investing: timing is everything.

We wrote in "A Bear Market is Born" in April 5, 2000, "...there's nothing funny about losing money.  Many husbands and wives will be having heated discussions on the topic of the market, we assure you.  We only hope that has in some way contributed to the rational decision by many to either stay out of the speculation or at least to speculate only with money that can be lost without risk to long term financial needs."  We have received hundreds of letters from our readers that told us mission was succeeding.


I read your site every night.  It is one of the best on the entire web. Your articles help me to stay rational. It is unbelievable how the CNBC crowd twists the truth.  You really have helped me not to be sucked into the lies of Wall Street.

May 17, 2000


Regarding "Let's check back with Larry Barrett in six months" (4/18/2000) thanks for the link, and the lovely commentary.  I've downloaded Larry's page as a quintessential example of speculative fervor.  It will come in very handy in my classes in finance next year!

Cheers, and thanks for maintaining this page,
Steve Keen
Senior Lecturer in Finance
University of Western Sydney
April 22, 2000

A few dozen letters received after the bubble popped reassured us that the time spent was not for nothing.


I have followed your web site with religious zeal since its inception in 1998.  I ducked the NASDAQ implosion while others have suffered. I even managed to sell at the top of the market bubble in Feb 2000!  Many thanks to your prescient web site!!!!

G. Marsh
December 3, 2000

More letters... has consistently contradicted the consensus opinion of mainstream economists, who certainly spend too much time reading each other's nonsense and unanimously agreed:
  • In 1999 that no financial market and economic bubble existed.  Technology had created a high growth, high productivity, low inflation New Economy.
  • In late 2000 that there was a financial market bubble, in fact the largest in history, but that no economic recession will follow its collapse.
  • In early 2001 that the economy was maybe suffering a mild recession, perhaps related to a negative wealth effect following the collapse of the bubble.  The mild recession would end and the economy was due to recover in the second half of the year.
  • In early 2002 that the recession in the previous year had lasted only one quarter and the economy was due to recover strongly in the second half of 2002.
  • Last week that the 2001 recession had in fact lasted for, well, three quarters rather than one as predicted in 2000 and reported up until last week.  GDP growth in Q2 2002 was actually only 1.1% versus the 5% consensus estimate, so maybe the economy won't recover much in 2002.  But not to worry, the pace of recovery will accelerate smartly in 2003.
  • Prosperity is just around the corner.  Why anyone listens to these guys anymore is a mystery to us. gave a few of blue sky prognosticators the coveted Flying Pig Award.

    The cheerful academic revisionist history of the 1930s post bubble period offered up by Schwartz and Friedman states that if only the Fed had done more or the government more that The Great Depression could have been avoided. But as Alan Greenspan himself said back in 1959, "Once stock prices reach the point at which it is hard to value them by any logical methodology, stocks will be bought as they were in the late 1920s ? not for investment, but to be unloaded at a still higher price. The ensuing break could be disastrous because panic psychology cannot be summarily altered or reversed by easy-money policies."  Collapsing asset bubbles always leave economic devastation in their wake.  Witness the condition of the high technology industry, the center of this most recent asset bubble, now approaching a state of economic dysfunction, with rising unemployment and next to no job creation.  Wishful thinking and ignorance of the dynamics of economic contraction set in motion by the collapse of asset bubbles dominates during the collapse phase, as the articles from 1929 attest.

    Comments of Press on Crash in Stocks, October 1929 (NYTimes)
    St. Louis: Country "Well Fortified" - By THE GLOBE DEMOCRAT 
    The country is too well fortified by its business and financial conditions to be materially disturbed. It was not a consequence of any impairment of these conditions, which have never been more favorable than they are at this time. 
    New York: No Catastrophe Is Seen - By THE WORLD 
    What can be said, and what very much needs to be said, is that, however sour things may look to individuals at the moment, the country has not suffered a catastrophe. Its power to produce wealth is unimpaired; its power to consume wealth is unimpaired.  There will be many cases of individual hardship, but no hardship like that which is almost normal in other countries. In very large degree the present excitement on the Stock Exchange is concerned with a gambler's change of fortune in the distribution of the surplus luxury money.  The American people has been gambling furiously, but it has been gambling largely with the surplus of its astonishing prosperity.
    New York: Productive Powers Unharmed - By THE DAILY NEWS 
    The sagging of the stocks has not destroyed a single factory, wiped out a single farm or city lot or real estate development, decreased the productive powers of a single workman or machine in the United States. All those things are still there, and when they are essentially sound, as this country is, the more magnificently they recover.
    Chicago: Bargain Prices Seen - By THE HERALD AND EXAMINER 
    The Stock Exchange has become the bargain counter of the world. It is difficult to believe that financial shoppers in this country and abroad will not take advantage of the low prices at which the very best of securities are selling. Although losses suffered by the public have been enormous, a group of investors, numbering thousands, escaped uninjured and is now ready to take advantage of the break.

    We lay blame directly on our central bankers for allowing the high technology industry to become the locus of the most extreme speculative bubble in history. We blame the Fed for failing, in the words of Former Federal Reserve Chairman William McChesney Martin, "to take the punch bowl away just when the party gets going."  The Fed waited until after the party had gotten so completely out of control that utterly ludicrous non-businesses like Enron and perfectly good businesses like Worldcom were able to slurp up billions of the vast heaps of credit created as a result of Fed policies, leading sham businesses and real businesses alike into bottomless debt sink holes.  Our position from the start is that this was allowed to happen because the Fed is run by academics and theoreticians who understand very close to nothing about business but who cannot resist the temptation of a convenient piece of exciting financial market theory and who are thus prone to manipulation by pros on Wall Street who are there to make money any way they can.  As if to prove the point about the Fed's naiveté, we dined at an event a few months back that happened to be attended by a regional Fed president from the 1990s bubble era.  We asked him, admittedly after a couple of glasses of excellent wine, "Why did the Fed finally decide to raise rates in 1999?"  Our fellow dinner guest replied, "We took a look at the telecommunications industry and said 'Holy cow!  Look at what they've done with our money!"


    Of course the damage had been done by the time the Fed finally raised rates in 1999, at least two years too late.  We hear that between 1997 - 1999 an internal political conflict raged within the Fed between the New Economy believers and the old school bankers, with papers flying and tempers flaring at more than one Open Market Committee meeting.  By 1999 the outcome was set: there would be a stock market collapse and serious collateral damage to the real economy was bound to result.  Two years into the aftermath, there may not be much to do that hasn't been tried before -- cut short term interest rates, lower taxes and increase government spending.  As card carrying members of the No Free Lunch School of Economics, we are certain that while the most harsh effects of post-bubble dynamics can be blunted, the principle of conservation of economic pain says that today's higher government spending is tomorrow's higher taxes and interest rates.  The Japanese people, for example, seem to know this and continually increase their savings the more the government spends.  They may be saving as much to pay higher taxes later as they are for fear of future unemployment.  Fear of future unemployment doesn't inspire much increase in saving in the U.S., however, at least not yet.  The consumer debt numbers that came out August 7 show households continuing to pile it on, although we wonder how much the numbers show that a growing number of unemployed are substituting credit for income for as long as the credit card companies let them get away with it.  If this is a major factor in growing credit card debt, it's not a sustainable.

    In the political environment that will prevail in the relatively near future, creating jobs for unemployed voters will take precedence over well established and uncontroversial economic theory about the benefits of free trade and free markets.  What many investors didn't lose in declining equity markets they're likely to lose to taxes and inflation in the future, although not the immediate future.  And mortgage payments, too, if they purchased an ARM and either can't or don't want to sell their underwater home (see comments on falling real estate, below) before the variable interest rate period on their mortgage starts.  But won't inflation also raise the price of homes, you ask?  Yes, but the inflationary phase isn't likely to happen until the debt deflationary phase runs its course.  And won't inflation raise stock prices, too?  Major changes in the labor costs for corporations are happening now that may negatively affect corporate profitability for years.  A decline in the ability of companies to use stock options as incentives in lieu of cash and the rise of unionization are two such trends we expect in the high tech industry. These are the kinds of trends that can create long term equity bear markets.

    Bull Market in Cash

    The end of the stock market bubble began a protracted bear market in equities and ushered in the current bull market, a rare bull market in cash.  Cash and, briefly, residential real estate.  But that bubble too will begin to collapse and as soon as this summer.  A few years from now the popular safe harbor investment of home ownership will leave a large number of homeowners paying mortgages on homes worth 20% - 30% less than what they paid for them at the top of the market, and that's if the property is in a town with a good school system and a strong tax base.  For those who bought homes in towns with marginal school systems and a tax base that's especially vulnerable to rising unemployment, home prices can fall 40% to 60% or even more before the market bottoms.

    As unemployment rises and home prices fall, indebted households will struggle to pay off debts and increase savings.  The antecedents are in place for a significant and sustained economic contraction.

    Consumers' borrowing is one of the most conspicuous danger points in the secondary phenomena of prosperity, and consumers' debts are among the most conspicuous weak spots in recession and depression.

    In other words, we shall readily understand why the load of debt thus light heartedly incurred by people who foresaw nothing but booms should become a serious matter whenever incomes fell, and that construction would then contribute, directly and through the effects on the credit structure of impaired values of real estate, as much to a depression as it had contributed to the preceding booms. Nothing is so likely to produce cumulative depressive processes as such commitments of a vast number of households to an overhead financed to a great extent by commercial banks.

    Joseph A. Schumpeter -- Business Cycles, 1939

    One warning on this prediction: in January 1999 predicted that the average tech stock was likely to lose 87% of peak value.  This prediction turned out to be optimistic, as the average tech stock in our bubble stock index fell more than 90%.  Let's hope that our prediction of the future of the residential real estate market doesn't turn out to be as optimistic.  The two year old bull market in cash is likely to persist until the future value of dollar denominated assets comes into question and a self-fulfilling dynamic of dollar depreciation takes hold, per our Ka-Poom Theory of post-bubble market and economic dynamics. Main Themes Reviewed
    Masters of the Universe

    A section headline in the August 7th Wall Street Journal reads: "The risks of a double dip recession 'are very real,' writes veteran economist and writer Henry Kaufman."  This is the double dip that Morgan Stanley economist Stephen Roach has been talking about since the early part of the year, and the recession we referred to in 2001 as the "real recession" versus the little one we had in 2001.  Readers can accuse us of following a foolish consistency for the past four years by continuously referring to the market and coincident economic environment as a bubble and then predicting a depression to follow a collapse, but we were unable to see past this inevitability based on our interpretation of history while mainstream economists insist on seeing them in the context of a run-of-the-mill inventory correction based recession.

    The WSJ headline goes on to say, "Washington should focus on the stock market, he says."  Focus what on the stock market?  The only correlation we can see between the stock market and government jawboning and stimulus is that the stock market rises when investors think the Fed might lower rates and think that this actually matters and the market tanks whenever GW opens his mouth and occasionally rallies when he doesn't.  We hope the experience of the past two years has not been lost on our readers who we have reminded with nauseating regularity -- the government does not control the markets or the economy.   If you bothered to read the Wall Street Journal article noted above, hoping to glean how the government is going to fix the stock market and improve your stock portfolio, locate the nearest white board and write 100 times, Bart Simpson style:

    The government does not control the markets or the economy
    The government does not control the markets or the economy
    The government does not control the markets or the economy
    The government does not control the markets or the economy
    The government does not control the markets or the economy

    In fact, the GW is about to learn as his father did that the exact opposite is true: the economy controls the government.  The government can affect the market and the economy in the short run, but can only improve the markets and economy in the long run by staying as far away from both of them as long as possible.

    Over capacity

    The problem of over capacity will be exacerbated by declining aggregate demand.  To the extent that the government can affect the economy in the short run, the government's number one problem from now on is how to keep demand from falling in a self-reinforcing cycle; consumers and businesses buy less, businesses reduce production and lay off workers, incomes fall, consumption falls further, businesses reduce production further, and so on.  Eventually the economy will reach a level of demand-supply homeostasis but well below current levels.  We see this cycle only just beginning as unemployment rises, severance packages are exhausted and the pool of credit-worthy borrowers dries up.


    Unemployment will reach 7% to 8% by the end of this year and 10% to 12% by the end of 2003.  What is commonly coming to be viewed as a early 1990s style "jobless recovery" is in fact the start of a significant rise in unemployment that is part of the latter stages of a post-bubble economic correction.  Primarily by reductions in labor expenses will businesses get out of their profitability rut.  This is now achieved via layoffs.  Alternatively, the Fed could allow wage rates to fall but instead insists on supporting relatively inflated wage rates through excessive money creation.  This may keep the consumption boom going for a little while longer, but at the end of the day the unemployed can't pay the mortgage or qualify for a cash-out refi that sends them to Home Depot for a new stainless steel oven for their McMansion dream kitchen.

    Fate of the Dollar

    The value of the dollar relative to the yen and euro is determined by the relative weakness of the Japanese, U.S. and European economies.  What got the overpriced dollar rolling downhill at last was the signal by the Bush administration via steel and lumber deals that the U.S. is willing to use trade restrictions to purchase political favors at home at the expense of its trading partners.  There's no more sure fire way to tank your currency that to cut a few trade deals.  What moves currencies over the rest of the year is the perception of systemic risk because a financial crisis is smoldering under the damaged financial system.  Generally, the U.S. is seen as the safest port in a financial storm, due to its relative political stability.  Unless the storm is emanating from the U.S. itself the dollar will gain in the crisis.  However, the long term outlook for the dollar remains poor.  The U.S. simply owes too much to its trading partners relative to future income prospects.

    What next?

    As we mentioned earlier, the most critical focus of the economic equation from the Fed's perspective at this stage in the ongoing collapse of the bubble is maintaining demand.  Home prices represent 70% of household assets in the U.S., a far more meaningful asset class than stocks  The Fed had a plan to pump up home prices if the economy suffered a negative wealth effect due to falling stock prices following the demise of the equity bubble.  So far this plan has worked well.  But this can't go on forever and will end soon.  So what next?

    The Stock Market

    Down, down, down, with occasional upward spikes.  April 25, 2000 predicted the DOW and Nasdaq to bottom around 5000 and 1000 respectively in ZDNet Columnist Blows the Call (4/25/2000)  With the NASDAQ now trading in the 1,200 area, we could say we're at the bottom.  In fact, we are often asked if we're at the bottom.  Because we are asked we are sure that we are not.  We suspect that our NASDAQ 1,000 prediction was likely optimistic.  A market reaches bottom only after everyone who ever cared gives up looking for a bottom.  Put another way, when we can't find an audience for the news that we're at the bottom, we're at the bottom.  But even if we are, so what?  Does that mean it's bottom feeding time?  Depends.  Do you mind that your NASDAQ portfolio meanders around like a skunk on a country road for the next several years?  Or the next ten?  Or maybe longer?  What's important is that you not buy into the NASDAQ now because you need it to go higher or think it should move higher in the next few years.  The NASDAQ doesn't care what your needs are.  Recall that the once bubbly Japanese stock market index rose to touch 40,000 in 1990 and bobbles around 10,000 today, twelve years later.  If you can afford to wait five or ten or twenty years, then buying the index (QQQ) or certain NASDAQ stocks -- but which companies will still be in business then? -- may be the right thing to do.

    The Economy

    Sssssssssssssssssssssssss.  We hope.  Hey, it beats pffffffffffffft.  But we wouldn't count on it.  Bill Gross at PIMCO, an bond market pro not disposed to hyperbole or casual chilling prognostications, says in his August 2002 report:

    It's just fair warning that with a tilting corporate bond market, the economy itself may not be far behind. Let's just hope the pinball analogy doesn't apply to the economy itself and that we soon aren't forced to declare "Game Over." Greenspan's almost out of quarters.  Corporate Tilt - Bill Gross - PIMCO August 2002
    Interest Rates

    The Fed is in a tough spot here, but then they doomed themselves to this when they failed to raise rates in the 1990s.  The most aggressive rate cutting in five decades has not helped business profits sufficiently to increase economic growth enough to inspire stocks to rise.  The high likelihood that lowering rates more won't help has to be weighed against the need for the Fed to keep its power dry for the next liquidity crisis.  Lehman Bros. stepped in earlier this week to rally Wall Street to pressure Greenspan into making a rate cut.  So now it's priced in.  So now if he doesn't do it, the market may tank.  If he does do it, he uses up precious dry powder.

    Rates will remain unchanged until the next crisis, no matter what Lehman Bros. and Wall Street wants.  No telling what will trigger the crisis or when, however.  Maybe the crisis will be precipitated by the Fed not cutting rates as the markets now expect.  Who knows.

    Housing Bubble

    Not just a housing bubble, the biggest ever.  But it won't pop for years.