Bubble and Burst

8/9/2019 Bubble and Burst

1/36

Less Than A Bubble,

More Than A Burst

Randall DoddFinancial Policy Forum

EPI Brownbag

November 1, 2002


2/36


3/36

COINCIDENT INDICATOR. Industrial production picks up the turning point early in this cycle, but not far from the three month lag

in the prior recession.

Industrial Production

889092949698100

102104106108110112114116118120122124126128130

132134136138140142144146148150152


4/36

COINCIDENT INDICATOR. Total business sales (retail, wholesale and manufacturers) picks up the turning point, and does so in a

sharply defined manner. Figures are seasonally adjusted but not adjusted for inflation.

Total Business Sales

800000

850000

900000

950000

1000000

1050000

1100000

1150000

1200000

1992.0

1

1992.0

7

1993.0

1

1993.0

7

1994.0

1

1994.0

7

1995.0

1

1995.0

7

1996.0

1

1996.0

7

1997.0

1

1997.0

7

1998.0

1

1998.0

7

1999.0

1

1999.0

7

2000.0

1

2000.0

7

2001.0

1

2001.0

7

2002.0

1

2002.0

7


5/36

COINCIDENT INDICATOR. Crude Oil prices is not a typical coincident economic indicator but it worth a look. The price hike

occurred after the prior recession started (note bold vertical lines in chart) and the hike started prior to

the current one. The high prices nonetheless acted as a drag in both.

WTI Oil

10121416182022242628

30323436

1989.

01

1989.

07

1990.

01

1990.

07

1991.

01

1991.

07

1992.

01

1992.

07

1993.

01

1993.

07

1994.

01

1994.

07

1995.

01

1995.

07

1996.

01

1996.

07

1997.

01

1997.

07

1998.

01

1998.

07

1999.

01

1999.

07

2000.

01

2000.

07


6/36

LEADING INDICATOR. New orders for investment goods picks up the turning point almost six months early, and does so in a

sharply defined manner. Figures are seasonally adjusted but not adjusted for inflation.

New Orders: Capital Goods

30000

35000

40000

45000

50000

55000

60000

65000

70000

1992.0

1

1992.

07

1993.0

1

1993.

07

1994.0

1

1994.

07

1995.

01

1995.

07

1996.

01

1996.

07

1997.

01

1997.

07

1998.0

1

1998.0

7

1999.0

1

1999.0

7

2000.

01

2000.

07

2001.

01

2001.

07

2002.

01

2002.

07


7/36

Unlike in prior recession, real consumption has not declined. The pace of growth has slowed in

comparison to the last half of the 1990s. If the Wealth Effect has played a role, it has not been strong

enough to turn consumption negative. (annual rate of % change from quarter to next)

GDP $96

-4%

-3%

-2%-1%

0%

1%

2%

3%4%

5%

6%

7%

8%

89.

1

89.

3

90.

1

90.

3

91.

1

91.

3

92.

1

92.

3

93.

1

93.

3

94.

1

94.

3

95.

1

95.

3

96.

1

96.

3

97.

1

97.

3

98.

1

98.

3

99.

1

99.

3

00.

1

00.

3

01.

1

01.

3

02.

1

02.

3


8/36


9/36

Real Weekly Wages Stay Up. They dont continue their progression upwards, but by staying up they sustain consumption.

Weekly Wages

250

255

260

265

270

275

280

285

1991.

01

1991.

07

1992.

01

1992.

07

1993.

01

1993.

07

1994.

01

1994.

07

1995.

01

1995.

07

1996.

01

1996.

07

1997.

01

1997.

07

1998.

01

1998.

07

1999.

01

1999.

07

2000.

01

2000.

07

2001.

01

2001.

07

2002.

01

2002.

07 300

320

340

360

380

400420

440

460

480

500

520


10/36

Wealth is likely to have dampened consumption spending, but not much. It appears to have had an

arresting impact on real retail sales. Retail sales make up 50% of Consumption, health care and

housing make up another about 15% each. The remaining 20% is an unknown for me.

Retail Sales ($82)

115000120000

125000

130000

135000

140000

145000

150000

155000

160000

165000

170000

175000

1992.

01

1992.

07

1993.

01

1993.

07

1994.

01

1994.

07

1995.

01

1995.

07

1996.

01

1996.

07

1997.

01

1997.

07

1998.

01

1998.

07

1999.

01

1999.

07

2000.

01

2000.

07

2001.

01

2001.

07

2002.

01

2002.

07

Stock market peak


11/36

Household Debt -- nominal value, SA Consumer debt, in nominal terms, has risen throughout the recession (unlike the decline in non-

revolving debt during the prior recession). Growth in revolving, i.e. credit card, debt has flattened

off considerably only to begin rising again in the last few months.

Consumer Debt

200,000

300,000

400,000

500,000

600,000

700,000800,000

900,000

1,000,000

1,100,000

1990.0

1

1990.

07

1991.0

1

1991.

07

1992.0

1

1992.

07

1993.0

1

1993.0

7

1994.0

1

1994.0

7

1995.0

1

1995.0

7

1996.

01

1996.0

7

1997.

01

1997.0

7

1998.

01

1998.0

7

1999.0

1

1999.0

7

2000.0

1

2000.0

7

2001.0

1

2001.

07

2002.0

1

2002.

07

RevolNon-Rev


12/36

Auto Debt - rate and terms Rates have fallen substantially since the start of the recession, and the terms of credit have also eased

at maturity has risen and the loan/value has jumped up. (At finance companies, terms are not as

favorable at banks.)

Auto Debt

40

50

60

70

80

90

100

1990.

01

1990.

07

1991.

01

1991.

07

1992.

01

1992.

07

1993.

01

1993.

07

1994.

01

1994.

07

1995.

01

1995.

07

1996.

01

1996.

07

1997.

01

1997.

07

1998.

01

1998.

07

1999.

01

1999.

07

2000.

01

2000.

07

2001.

01

2001.

07

2002.

01

2002.

07

02

4

6

8

10

12

14

MaturityLoan/ValueRate


13/36

Household Debt - Mortgage Debt Total home mortgage debt owed by households has risen rapidly and has not been affected by the

recession. Home Equity debt, which is a component of total household mortgage debt, has risen

far more rapidly since early 1999 and the torrid pace has slackened only slightly since2000:III.

Mortgage Debt

2,000,000

2,500,000

3,000,000

3,500,000

4,000,000

4,500,000

5,000,000

5,500,000

6,000,000

6,500,000

7,000,000

90.4

91.2

91.4

92.2

92.4

93.2

93.4

94.2

94.4

95.2

95.4

96.2

96.4

97.2

97.4

98.2

98.4

99.2

99.4

00.2

00.4

01.2

01.4

02.2

100,000

120,000

140,000

160,000

180,000

200,000

220,000

240,000

260,000

280,000

300,000

Mortgage

Home Eq


14/36

Mortgage Interest Rates. Rates have fallen substantially since the start of the recession, after rising through 1999 and first half

of 2000.

Mortgage Rates

45

6

7

89

10

11

12

1987.0

1

1987.0

7

1988.0

1

1988.0

7

1989.0

1

1989.0

7

1990.0

1

1990.0

7

1991.0

1

1991.0

7

1992.0

1

1992.0

7

1993.0

1

1993.0

7

1994.0

1

1994.0

7

1995.0

1

1995.0

7

1996.0

1

1996.0

7

1997.0

1

1997.0

7

1998.0

1

1998.0

7

1999.0

1

1999.0

7

2000.0

1

2000.0

7

2001.0

1

2001.0

7

2002.0

1

2002.0

7


15/36

While the amount of total household debt and consumer debt have increased greatly, the cost of debt

service (principle and interest) as a percentage of disposable household income has NOT. In fact

current ratios are lower than in the mid-1980s and no more than 2% points higher than the beginning

of the decade. This cannot explain much of the slower pace of consumer spending.

Debt Service Burden

456

789

1011

12131415

80.1

81.

1

82.1

83.1

84.1

85.1

86.1

87.

1

88.1

89.

1

90.

1

91.1

92.

1

93.1

94.1

95.1

96.1

97.

1

98.1

99.

1

00.

1

01.

1

02.

1

Total DebtCsm Debt


16/36

Delinquencies at banks are not high, especially in comparison to the last downturn.

Delinquencies at banks (where payments are 30 days past due) are measured as the

percentage of debt written-off and expressed as an annual rate for each month. This does not

include debt at non-bank financial institutions.

Debt Delinquencies

1

2

3

4

5

6

7

8

87.

1

88.

1

89.

1

90.

1

91.

1

92.

1

93.

1

94.

1

95.

1

96.

1

97.

1

98.

1

99.

1

00.

1

01.

1

02.

1

Real EstatelCredit CardsTotal Cs mC&ILoans+Leases


17/36

Although delinquencies are not high, especially in comparison to the last downturn, the amount ofcharge-offs is rising.

Charge-offs are measured as the percentage of debt written-off and expressed as an annual rate for

each month.

Charge-Offs

0

1

2

3

4

5

6

7

8

9

85.

1

86.

1

87.

1

88.

1

89.

1

90.

1

91.

1

92.

1

93.

1

94.

1

95.

1

96.

1

97.

1

98.

1

99.

1

00.

1

01.

1

02.

1

Real EstateCredit CardsTotal Cs mC&ILoans+Leases


18/36

Wealth Effect Most losses likely amongst richest 9%. In 1998, the SCF showed that 80% of

total unrealized capital gains were amongst the top 9%.

SCF (1998) showed that stock ownership concentrated amongst wealthiest 10%of households (82.2%) and top 1% (42.8%). Bottom 89% held less than 18%.


19/36

Both the large cap S&P500 and the NASDQ Composite peaked about the same time in March of 2000.

This differ in how they have fallen before and after September 11th and before and after October 16th

of 2002 (hereafter known as Enron Day. The NASDQ Composite fell 66% from its peak by September

10th, then rose 9% by Enron Day and has then fell again by 35% by October 9th 2002. The S&P500

fell 28% from its peak to September 10th, then rose 6% by Enron Day and then fell 29% by Oct. 9th.

Equity Indices

0100200300400500600700800900

100011001200130014001500

1990.

01

1991.

03

1992.

05

1993.

07

1994.

09

1995.

11

1997.

01

1998.

03

1999.

05

2000.

07

2001.

09

0500

1000

1500

2000

2500

3000

3500

4000

4500

5000

S&P500NASDQ Comp


20/36

Margin Debt The chart shows that the use of margin debt (debt/market capitalization) declined sharply starting in 1986

as the bull market gathered steam. Margin debt flattened out in 1991, was up and down a bit until 1995,

while the bull market charged onwards. When margin use rose decidedly in 1998 it did so as the market

rose to its peak in March 2000. They fell together, then margin use surged and then fell back again.

0

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

14,000,000

16,000,000

18,000,000

20,000,000

52.1

53.1

54.1

55.

1

56.

1

57.

1

58.

1

59.1

60.

1

61.1

62.1

63.

1

64.1

65.

1

66.

1

67.

1

68.

1

69.

1

70.

1

71.

1

72.

1

73.

1

74.1

75.1

76.1

77.1

78.1

79.

1

80.

1

81.

1

82.

1

83.

1

84.1

85.1

86.1

87.1

88.1

89.

1

90.

1

91.

1

92.

1

93.

1

94.

1

95.

1

96.1

97.

1

98.

1

99.

1

00.1

01.

1

02.

1

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Margin Debt

Market Cap

Value/Debt


21/36

Margin Debt -- smaller interval The chart shows that the use of margin debt (debt/market capitalization) declined sharply starting in 1986

as the bull market gathered steam. Margin debt flattened out in 1991, was up and down a bit until 1995,

while the bull market charged onwards. When margin use rose decidedly in 1998 it did so as the market

rose to its peak in March 2000. They fell together, then margin use surged and then fell back again.

0

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

14,000,000

16,000,000

18,000,000

20,000,000

81.

1

82.

1

83.

1

84.

1

85.

1

86.

1

87.

1

88.

1

89.

1

90.

1

91.

1

92.

1

93.

1

94.

1

95.

1

96.

1

97.

1

98.

1

99.

1

00.

1

01.

1

02.

10.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Margin Debt

Market Cap

Value/Debt


22/36

Stock Prices: The Bull Charge

Two Reasons First -- fundamentals Low inflation, low interest rates

Low volatility of GDP

Long-wave of tech innovation

Longest expansion in US history

Second -- financial Higher plowback rate

Higher firm specific ROE

Problems Herding - although with some rational basis,

and poor assessment of risk Difficult to price new technologies

Manipulation from skewed market analysis

Manipulation from false reports on market


23/36

Stock Prices: The Bear Dance

Two Stages First -- March 2000 to Oct 2001 Fed raised rates starting Spring 99

Rising market volatility Lowered E1 forecast

First - part two Sharp fall in long-term E forecast

Second -- Oct. 2001 to Oct 2002 Despite Fed lowering rates

More market volatility

Worse earnings forecasts

Sharp, negative Enron corrections

Some firms lower


24/36

This is a different picture of the role of government expenditure than you might expect. It has become

a source of volatility to the U.S. economy! It has has a positive net effect although its magnitude is

modest. Non-defense federal spending is also volatile, and has been negative twice since the current

downturn.

Government $96

-20

-15

-10

-5

0

5

10

15

20

25

30

35

40

45

89.

1

89.

3

90.

1

90.

3

91.

1

91.

3

92.

1

92.

3

93.

1

93.

3

94.

1

94.

3

95.

1

95.

3

96.

1

96.

3

97.

1

97.

3

98.

1

98.

3

99.

1

99.

3

00.

1

00.

3

01.

1

01.

3

02.

1

02.

3

Total Fed Non-Def


25/36

Note that S&L, while presumed to be more cyclical, has been less volatile from quarter to quarter.

Defense spending has been much more volatile from quarter to quarter, and over this period it has been

counter-cyclical even if the reason for the changes has not been primarily macroeconomic

management.

Government $96

-25

-20

-15

-10

-5

0

5

10

15

20

25

89.

1

89.3

90.

1

90.3

91.1

91.

3

92.1

92.

3

93.1

93.3

94.

1

94.3

95.

1

95.3

96.1

96.

3

97.1

97.

3

98.1

98.3

99.

1

99.3

00.

1

00.

3

01.1

01.

3

02.1

02.3

Def S&L


26/36

The role of real net exports has been novel. Usually real imports decline during a downturn due to the

fall income and overall consumption and investment spending. This occurred in both the present and

prior downturns. This time this was matched with a great degree of correlation by a downturn in

exports! This is unusually and suggests that the U.S. economy is more positively correlated with

economies in the rest of the world. (Chained 96 dollars, and net exports are on right axis.)

International Trade

500

600700

800

900

1000

11001200

1300

1400

1500

1600

90.

1

90.

3

91.

1

91.

3

92.

1

92.

3

93.

1

93.

3

94.

1

94.

3

95.

1

95.

3

96.

1

96.

3

97.

1

97.

3

98.

1

98.

3

99.

1

99.

3

00.

1

00.

3

01.

1

01.

3

02.

1

02.

3

-550-500-450

-400-350-300-250-200-150-100

-50050100

ExportsImportsNet Exports


27/36

The Strong Dollar. The dollar appreciated prior to the start of the recession and continued up until 2002. Since then it has

depreciated against the Euro, Sterling and Yen

Exchange Rates

5060

7080

90100110120

130

140150160

170

1990.

01

1990.0

7

1991.0

1

1991.0

7

1992.

01

1992.0

7

1993.0

1

1993.0

7

1994.0

1

1994.0

7

1995.0

1

1995.0

7

1996.0

1

1996.

07

1997.

01

1997.0

7

1998.0

1

1998.0

7

1999.

01

1999.0

7

2000.0

1

2000.

07

2001.0

1

2001.0

7

2002.0

1

2002.0

7

UK Japan Euro-DM


28/36

The role of Investment appears to play a more important role. While investment in residential

structures has played a persistent positive role, that for non-residential structures has turned down and

continues to decline. More importantly, investment in equipment turned sharply downward, and is

only slowly recovering.

Investment $96

100

200

300

400

500

600

700

800

900

1000

1100

90.

1

90.

3

91.

1

91.

3

92.

1

92.

3

93.

1

93.

3

94.

1

94.

3

95.

1

95.

3

96.

1

96.

3

97.

1

97.

3

98.

1

98.

3

99.

1

99.

3

00.

1

00.

3

01.

1

01.

3

02.

1

02.

3

StructEquipRes


29/36

The composition of the changes in investment is telling. Growth is entirely attributed to Information

Processing while that for Trans and Industrial continues to decline. (Again chained 96 dollars.)

Equipment Investment

50

100150

200

250

300

350

400

450

500

550

600

90.

1

90.

4

91.

3

92.

2

93.

1

93.

4

94.3

95.

2

96.

1

96.

4

97.

3

98.

2

99.

1

99.

4

00.

3

01.

2

02.1

Info Process ing

Industrial

Transport


30/36


31/36

Change in Inventories. Inventories took a sharp drop, much larger than in the prior recession. Orthodox Keynesians take

note. (Changes from quarter to next in chained 1996 dollars)

Inventories$96

-100

-80

-60-40

-20

0

20

40

60

80

100

120

90.

1

90.

3

91.

1

91.

3

92.

1

92.

3

93.

1

93.

3

94.

1

94.

3

95.

1

95.

3

96.

1

96.

3

97.

1

97.

3

98.

1

98.

3

99.

1

99.

3

00.

1

00.

3

01.

1

01.

3

02.

1

02.

3


32/36

Change in Inventories. Not just the prior recession, but all prior recessions in the post-war era.

Inventories$96

-100

-80

-60

-40

-20

0

20

40

60

80

100

120

47.

2

50.

3

53.4

57.1

60.2

63.

3

66.

4

70.1

73.2

76.3

79.

4

83.

1

86.2

89.3

92.4

96.

1

99.

2

02.

3


33/36

Inventories and Inventory Sales Ratio. Inventory sales ratio rose just as the stock market fell and real retail sales flattened out. The drop in

sales pushed up I/S ratio initially before liquidation of inventories (which is shown beginning in early

2001) turned ratio downward.

Inventories

800000

850000

900000

950000

1000000

1050000

1100000

1150000

1200000

1992.

01

1992.

07

1993.0

1

1993.0

7

1994.

01

1994.0

7

1995.

01

1995.0

7

1996.0

1

1996.0

7

1997.0

1

1997.

07

1998.0

1

1998.

07

1999.0

1

1999.0

7

2000.

01

2000.

07

2001.

01

2001.0

7

2002.

01

2002.

07

1.3

1.4

1.4

1.5

1.5

1.6

1.6


34/36

SUMMARY: CAUSES Not just any one factor. Over determined as Freud would say, or as the great wit and

sage, we made too many wrong mistakes.

Three themes:

Market Crash:

Fed raised interest rates and deflated market

Virtuous tech cycle came to an end: part stumble, part exhaustion and part hitting of wall

One word, Enron

Rest Of World slowed

U.S. is more correlated with ROW and especially during downturn

US dollar stayed up

Investment Crunch

Tech boom stumbled, played out

Higher interest rates

High dollar

Higher capital costs

Drought of new capital


35/36

PROSPECTS CONSUMPTION

depends on employment and wages

further household debt accumulation less likely, especially if housing prices fall. Maybe moreretailer credits.

Wealth effect NOT likely to turn positive in near term.

INVESTMENT

Inventories show little gain even after liquidation

Equipment is coming back, though mostly computers and other info processing. Industrial

and transportation and other is still slack.

Structures are smaller in magnitude but still declining. This may need to wait upon new

business start-ups. Market rebound may help.

Residential has not slowed and thus not likely to speed up and therefore not likely to

contribute to turn-around and rebound.

GOVERNMENT

CR for Fed spending, eventually national security spending will surge.

S&L is pro-cyclical, but not in a leading way.

NET EXPORTS

Misery loves company. US growth increasingly correlated with ROW and thus will find

downturn is aggravated and upturn is awaited.

Export component did show some growth in 2002:III.

US dollar remains strong, though may drop with another Fed ease.


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POLICY PROPOSALS MINIMUM WAGES

will help consumption

INVESTMENT TAX CREDITS Bigger bang for buck, and targeted to sector that has turned down the most.

LOWER INTEREST RATES

Fed can lower rates to help stock market, lower cost of capital and possibly ease drought on

new capital

REAL REFORM OF FINANCIAL MARKETS

gets financial markets working again. True for energy markets as well as stock markets. RENEW GLOBAL GROWTH

reform IMF policies towards expansion

resolve LDC debt problems

reform Japanese financial system

reform EU macropolicy to eliminate downward bias

ROLL-OUT BROADBAND Auction spectrum in order to free resources for further innovation.

Bubble and Burst

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Transcript of Bubble and Burst