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Hold the Hysteria

By Robert Samuelson

WASHINGTON -- Regarding the economy, it's hard not to notice this stark contrast: The "real economy" of spending, production and jobs -- though weakening -- is hardly in a state of collapse; but much of today's semi-hysterical commentary suggests that it is. Financial markets for stocks and bonds are described as being "in turmoil." People talk about a recession as if it were the second coming of Genghis Khan. Some whisper the dreaded word "depression." Meanwhile, Americans are expected to buy about 15 million vehicles in 2008; though down from 16.5 million in 2006, that's still a lot.

There's a disconnect between what people see around them and what they're told is happening. The first is upsetting (rising gas prices, falling home prices, fewer jobs) but reflects the normal reverses of a $14 trillion economy. The second ("panic," "financial meltdown") suggests the onset of something catastrophic and totally outside the experience of ordinary people. The economy, said The New York Times last week, may be on "the brink of the worst recession in a generation" -- an ominous warning.

Perhaps, but so far the concrete evidence is scant. A recession is a noticeable period of declining output. Since World War II, there have been 10. On average, they've lasted 10 months, involved a peak monthly unemployment rate of 7.6 percent and resulted in a decline of economic output (gross domestic product) of 1.8 percent, reports Mark Zandi of Moody's Economy.com. If the two worst recessions (those of 1981-82 and 1973-75, with peak unemployment of 10.8 percent and 9 percent) are excluded, the average peak jobless rate is about 7 percent.

No one doubts that the economy has slowed. Many economists think a recession has already started. Zandi is one. He forecasts peak unemployment of 6.1 percent (present unemployment: 4.8 percent) and a GDP drop of 0.4 percent. If that comes true, the recession of 2008 would actually be milder than the average postwar recession and milder than the last two, those of 1990-91 and 2001.

Broadly speaking, the story is similar for stocks. So far, their weakness is unexceptional. A standard definition of a "bear market" is a drop of 20 percent or more. Last week, the market was at times close to that. Declines would have to get much worse to qualify as momentous. Since 1936, there have been 11 bear markets as measured by the Standard & Poor's index of 500 stocks, says Howard Silverblatt of S&P. On average, they've lasted 20 months and involved a decline of 34 percent. One was 60 percent (1937-42) and two were nearly 50 percent (1973-74 and 2000-02, the last being the "tech bubble").

Some causes of the present hysteria are familiar: media hype; political finger-pointing -- always given to exaggeration; and whining from Wall Street types. But there's also another large cause: disagreement over whether the economy is highly unstable or whether business cycles are mostly self-correcting.

"This argument is as old as economics," says economic historian Barry Eichengreen of the University of California, Berkeley. "There is no more consensus (now) ... than there was 70 years ago." Those who think the economy is highly unstable talk now of an alarming "negative feedback loop" -- a "vicious circle" to most people. Housing prices fall, creating more foreclosures; losses on mortgages increase, eroding the capital of banks and causing them to curtail lending -- which weakens the economy, depresses housing prices and causes more foreclosures and losses. Just as in the Depression, a crippled financial system spreads the slump. Only forceful government intervention can break the downward spiral.

Not necessarily, if most markets self-correct. As housing prices fall, more buyers come into the market; sales and construction revive. If inventories get too high, production slows and surpluses are sold; then production accelerates. If consumers or businesses are overindebted, they reduce spending to repay loans; spending speeds up when debt burdens drop. Government can help smooth business cycles and prevent financial panics. But if it's too aggressive, it may make matters worse. That occurred in the 1970s when easy credit created double-digit inflation -- and then required harsh recessions to suppress it.

Hardly anyone adheres rigidly to either view but many favor one or the other. That explains why today's situation seems so threatening to some and less so to others.

The Great Depression doesn't settle the issue. True, massive bank failures converted an ordinary recession into a calamity; but it's also true that government policy -- excessive rigidity by the Federal Reserve -- actually aggravated the banking collapse. Still, economic conditions in the 1930s (average unemployment: 18 percent) were so different from today's that casual references to "depression" amount to fear-mongering. If catastrophe strikes, it will probably result from something we don't now know or we haven't yet imagined.

Copyright 2008, Washington Post Writers Group


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