As our country struggles daily to cope with a pitifully weak recovery, often there’s an irresistible urge to reflect on the powerful economic expansion that began in March 1991 and ended in March 2001. Players on both sides mightily try to take credit for this boom period in an attempt to influence voters who, because of age, ignorance or forgetfulness, don’t know the truth. The Democrats argue that the driving force was their man Bill Clinton and his policies, which included higher tax rates. Many Republicans point to their sweeping conquest of the House, the Gingrich-led crowd’s “Contract with America,” and the implementation of policies that ultimately forced Clinton to proclaim that “the era of big government is over.”
Which side deserves the credit? Neither. They’re both wrong. The driving force behind the ‘90s was the technology and dot.com boom and an associated abundance of confidence and optimism about the future. This force transcended all politics and parties. It produced plentiful capital that fueled all our markets, allowed innovators to innovate, and empowered businesses to increase productivity. Many, both inside and outside of government, believed and proclaimed that we had experienced a major structural change to a “new economy.”
Americans benefited big time. Unemployment was down; wages were up; inflation was low; and individual portfolios were skyrocketing. The paper net wealth of Americans grew an astounding $18.3 trillion. The ratio of net wealth to disposable income grew from 4.9 percent to 6.4 percent, the highest level since 1952. Price/earnings ratios began to move out of sight – often out of existence because there were no earnings on which to calculate the ratios. Everyone’s monthly investment statement showed growth each month. The only question was: how much growth? The Internet was becoming a reality and promised the future. Companies with an Internet strategy, but no earning and meager revenues, could attract investors, then more investors and then watch their stock prices balloon as the demand fed on itself. It was up, up and away.
During the boom, Americans grew confident with their ever-escalating investment portfolios and were anxious to spend. Consumer spending outstripped all disposable income. As a result, Americans solidified their position as the worst savers in the industrial world. Experts estimate that the personal savings rate in America dropped from 8 percent to less than zero, and the share of Gross Domestic Product that households consumed rose 6 percent.
So a big question was: if Americans were spending all their income, where was the capital coming from – the capital that made everything possible? The answer: Offshore. Foreign money flooded into our stock markets, our financial institutions, and our government. The importing of foreign dollars allowed America to expand in the short run while its citizens progressively fueled demand by spending everything they earned. In 1993, net foreign investment was less than 5 percent of growth investments in the United States. By the end of the ‘90s, it had spiked to 23 percent.
The high employment and escalating income levels of the ‘90s heyday produced a bonanza for federal government coffers. By 1999, there was actually an on-budget surplus, something we hadn’t seen since 1960. Higher earnings had pushed annual income tax revenues past the one trillion dollar mark for the first time, and the government’s public debt had actually dropped. In early 2000, the Congressional Budget Office projected ever-escalating on-budget surpluses through the year 2010, which would reduce the total public debt to under a single trillion dollars by 2010. Every year into the future was projected to just get better.
Of course, the surpluses never came. The new economy never materialized. Everything begin to shift in 2000 as the realization set in that this joyride was not a bona fide boom, but rather an over-hyped bubble that was about to burst. The difference between a boom and a bubble is the aftermath; the first retracts to something that resembles an acceptable norm, while the latter produces across-the-board misery. The burst began as some, then many, and then all concluded that the future profitability expectations of new investments were grossly overoptimistic, particularly those related to the technology and dot.com boom. Foreign capital began to disappear, which triggered a big drop in the value of the dollar.
All Americans witnessed that, just as capital giveth, the lack of capital taketh away. Unemployment skyrocketed. Our capital markets crashed. Monthly investment statements became something to hide from, not hang on the frig. Companies quickly found themselves swimming in excess manufacturing capacity. Venture capital for new growth and innovation was nearly impossible to find.
As the equity markets crashed, the huge historic gains in the ratio of consumer wealth to disposable income completely disappeared, retracting to pre-1993 levels. The tech-heavy Nasdaq Composite lost 78 percent of its value, and even the stalwart S&P 500 got hammered, losing 49 percent of its value during the same time frame. Trillions of dollars in equity value had gone up in smoke in a few short years following the bubble’s burst.
But for those who sucked up the hit, it wasn’t about a trillion dollars. It was about having the nerve to open and look at monthly statements to see the losses that mounted every month. For many older players, it was about dashed retirement dreams or, at best, long-delayed retirement hopes. For younger players, who anxiously entered the market in the ‘90s, with expectations of riding the upward momentum to riches, it was about getting KO’d in their first round.
The pumping up and ultimate burst of the ’90s bubble teaches five lessons that are directly relevant to the economic hole that we are now stuck in.
First, a robust economic recovery requires an optimism and confidence about the future. It’s a must if we have any hope of attracting serious private sector capital that will fuel innovation, job creation, and productivity. Our challenge today is to overcome the gloom and doom fears that now grip and divide the country.
Second, much of the needed capital must come from offshore. We need a nimble, adaptive environment that competes favorably on the world stage – a stage that is rapidly evolving and demanding more. Yesterday’s standards don’t work. The job will never get done with rampant instability and government deficit spending to fund high-risk ventures that are unfit for the private sector.
Third, when it comes to real increases in government revenues, there is no substitute for a robust private sector that drives up employment and income levels. Tinkering with the tax code and rates (up or down) will never do the job so long as the economy continues to limp.
Fourth, we can’t afford the burst of another bubble. The ’90s burst was followed by the 2008 housing bubble burst that many saw coming, but lacked the political will or muscle to avert. It set off the mess that has bogged us down for the last four years.
But today’s real scare is the new bubble that is inflating. The ‘90s bubble was based on a belief that capital could forever fund enterprises and jobs that made no economic sense. The housing bubble was based on the premise that home values would forever escalate to support subprime mortgage loans and related securitization gimmicks that made no economic sense. The newest bubble assumes our economy can support government borrowing levels that make no economic sense – levels that no one could have imagined just a few years ago. Who could have imagined perpetual annual trillion dollar deficits and the shameful downgrade of obligations backed by the full faith and credit of the United States?
We have witnessed in Greece and elsewhere very miniature versions of what a debt crisis burst in the U.S. would look like. The challenge now is to patiently deflate this scary bubble over time and avoid the unfathomable consequences of a painful burst. It will require something that was lacking with prior bubble bursts – a common sense respect for the basic laws of money.
Finally, voters should understand that the histories and underpinning of prior bubble bursts can be easily twisted and distorted by those who seek to claim credit for the highs and either ignore or assign blame for the lows. Generally, those who play this game aren’t credible.