Earn What You Spend

I’m reading Michael Lewis’ compilation, Panic: The Story of Modern Financial Insanity, and just came across this excellent article by Paul Krugman in Fortune from September 7th, 1998. 

What turned a bad financial situation into a catastrophe was the way a loss of confidence turned into self-reinforcing panic … Let’s quote from the June report of the Bank for International Settlements, an organiation based in Basel, Switzerland, that is not usually given to purple prose: ‘The effects of economic slowdowns, asset price collapses, and banking crises tend to be mutually reinforcing as the curtailment of bank credit depresses asset prices and further deepens recessions.  This in turns creates additional problems for banks that are forced to retrench still further. 

This quote could just have easily been written in yesterday’s paper rather than in 1998.  Although many like to claim that no one could have seen our current crisis coming (including Alan Greenspan), it is instructive to look at just how similar our current situation is to those bubbles of the past.

Henry Blodget has a spectacular article in this month’s Atlantic - part analysis, part mea culpa.  His central premise is this: booms and busts, bubbles and business cycles are here to stay.  So perhaps we shouldn’t be so surprised when we read an article from 1998 and find it a perfect description of our current situation.  One of my favorite paragraphs is where Blodget quotes another famed investor, who has managed to dodge so many of these busts:

In the words of the great investor Jeremy Grantham, who saw this collapse coming and has seen just about everything else in his four-decade career: “We will learn an enormous amount in a very short time, quite a bit in the medium term, and absolutely nothing in the long term.” 

So the details change, but the story remains virtually the same.  The overpriced assets this time around were housing prices - in the past it was tech stocks or overvalued currencies.  Once any bubble bursts, we see a now-familiar negatively reinforcing cycle.  Yet the largest problem is that our institutional memory is defined in quarters, not decades, so we, in the words of Grantham, learn nothing in the long term.  

Yes, each time it feels as if the world were truly ending - the news I’m reading is literally the worst in my lifetime.  But that line above Krugman wrote a decade ago - that “what turned a bad financial situation into a catastrophe was the way a loss of confidence turned into self-reinforcing panic” - sticks with me.  In the financial world, confidence is synonymous with hope and belief.  Yet as any spiritual leader of any major religion will tell you - hope is an act often done in spite of the surrounding circumstances, not because of them.   This time of year especially, we can all agree it is time for a little more hope in our lives.