The markets, everyone says, are madly high. The Dow, which in 1980 was below 800, is still well over 11,000. The FTSE 100, which surmounted 2,000 only at the beginning of the decade, is over 6,000 despite its recent fall. Yet no one believes that British production or profits have trebled since 1990-let alone that the production and profits of US industry have multiplied 13 times since 1980. The price/earnings ratio (the ratio of a share's price to the dividend paid on that share) has just kept on rising. Quite soon, the argument runs, there has to be an almighty crash, as fundamentals reassert themselves. Of course economists pooh-pooh the stock market as an indicator of anything. But what is different now is that US consumption is higher than total US wages, which means that people are consuming their stock market gains. This means that when the market turns down and those gains disappear, there will be a large reduction in US demand, causing a slump in other economies and a world recession.
Apocalyptic though this may sound, it is merely the current conventional wisdom. Yet there are other, less gloomy pieces of history to consider, too. One such derives from the Bolshevik academic, Nikolai Kondratiev (right), who originated the theory of capitalist long cycles. Suitably refined, this theory is now widely accepted: apart from the short-term business cycle, a longer cycle exists which depends on the dynamism resulting from the introduction of new technologies. Thus the great boom periods of capitalism are the steam age, the age of the motor car, the age of computers and so on. Today, a new industrial age may be under way-the information economy based on the internet, software, multimedia and digital technology. America is the unchallenged leader in this revolution, which is why the US economy has so hugely outperformed both Europe and Japan in the 1990s. In the first period of a new industrial age-before its innovations become generalised-profitability is very high. The US stock market may simply be reflecting this fact.
Microsoft, a company which didn't exist 20 years ago, is now more valuable than any company in history. To a degree that even capitalist propagandists could hardly credit, the system has continued to recreate and re-invent itself (and creatively to destroy the huge ossified capital accretions deriving from previous cycles).
In 1990, things looked very different. In the previous year the Nikkei had overtaken Wall Street in total value-a historic displacement of the US market from the top spot it had occupied for a century. When the Nikkei passed 38,000 the Tokyo real estate market was valued at more than the whole of the US's. Then came the crash-all the way down to 14,000. It was by far the greatest annihilation of capital ever seen, dwarfing the 1929 crash on Wall Street. Everybody waited for a huge deflationary tsunami to spread out around the world, bringing ruin to every market it touched.
It didn't happen. The foreigners who had taken a bath in the market quickly retreated, but their losses were bearable-Japan had only been a minor part of their portfolios and other markets continued to boom, so the deflation was not passed on. Within Japan the financial institutions balked at the huge downward re-rating of asset values implied by the slump, and continued to support companies-and property prices. Property values were ratcheted down gradually throughout the decade, allowing a much gentler adjustment than might have occurred. Indeed, although its growth slowed to nil, the Japanese economy continued to rack up enormous export surpluses throughout the decade, adding nearly $1 trillion to the nation's reserves, allowing the state to come up with repeated reflationary packages.
Then, just on cue, the US economy started to take off and the stock markets boomed. The reason was that the implications of the fall of the Berlin Wall, overlooked at first in 1989, now began to sink in. All asset values must reflect an implied calculation of risk, and the events of 1989-91 fundamentally changed the entire risk environment. Ever since 1917 world capitalism had been menaced by the threat of communism. This necessitated the diversion of enormous sums into defence spending; into aid, to buy the loyalty of third world dictators; and into welfare spending and all manner of restraints on market forces at home, to protect vested social interests.
Already Thatcher and Reagan had begun dismantling many of these arrangements, but the events of 1989-91 meant that the changes they had wrought were consolidated, deepened and generalised. Privatisation rippled across the world and huge cost burdens were lifted from the operation of capitalist systems everywhere, producing sharp increases in profitability. The west found that the old barriers to globalisation of its economic systems no longer existed, and exploited the opportunity to inaugurate great waves of trade liberalisation.
One result was the rise of the emerging markets. It was no longer unthinkable to put money into markets which hitherto would have been seen as unimaginably risky. And the risk attached to equities fell. In the old days it might have been a reasonable bet to buy, for example, Indonesian government bonds, simply because any thought within the Indonesian government of defaulting on the money thus borrowed would have led to enormous international pressure. But that did not apply to investing in Indonesian equities. With the globalisation of capitalism and the reduced risk of expropriation (Indonesia had a very large communist party), Indonesian equities became a perfectly reasonable punt for the foreign as well as the domestic investor.
Just how much the politico-military environment had changed became apparent only when the western powers pushed at the risk boundaries of the new order by taking military action against Iraq and intervening in the Balkans, culminating in the Kosovo action of 1999. Such actions caused not a ripple of panic in the markets and even when Russia rattled its missiles and threatened intervention in the Kosovo theatre, the Dow Jones simply soared on up through 11,000.
So what are the new risks? Only the prospect of interest rate increases seems to frighten the markets now-particularly because increased labour flexibility has meant that even large devaluations (such as when Britain fell out of the EMS) or prolonged high-employment booms (such as that in the US now) fail to generate the wage-push pressures which had been such a constraint in the past.
The danger now lies partly in the post-cold war triumphalism of the markets. If the lower risk environment justifies a price/earnings ratio of 24, why not one of 34 or 54? There has to be a limit. But Hollywood seems sold on the notion that the greatest threat to the Earth now is a collision with a large meteorite. And the markets are most worried about the millennium bug.
Yet, despite our increasing sophistication, we are still not very good at predicting what the new risks are. Once the cold war was over, Islamic fundamentalism seemed to many to be the greatest threat to the west. In the event the ayatollahs have given remarkably little trouble-a lot less than the Balkans. The risks in Asia seem higher, with clashes between nuclear-armed India and Pakistan, and the possibility of a nuclear-armed North Korea hitting out in its death throes. Indonesia's bloody conflict over East Timor could deteriorate and spread, and scatter a tide of refugees to the surrounding states. China's own internal tensions might explode (possibly quite literally, in the shape of a Chinese Chernobyl). Equally, Russia could take a turn for the worse. The list could go on-and would have to include risks attendant on ecological and population factors.
The point is that we simply don't know. Of course, the markets may even be right. But triumphalism is seldom a safe emotion. It would be nice to believe that the only threats to our prosperity come from interest rate increases and the millennium bug, but an awful lot of history suggests that this is extremely unlikely.
