Beyond the Dot.com Crash
Financier Michael Milken moderated a panel of four Nobel
Laureate economists in late March at a Milken Institute conference discussing
the state of the world's two largest economies - the United States and
Japan. Those economists are Gary Becker (Nobel Laureate 1992), from the
University of Chicago, James Heckman (Nobel Laureate 2000), University
of Chicago, Lawrence Klein (Nobel Laureate 1980), University of Pennsylvania
and Douglass North (Nobel Laureate 1993), Washington University. Excerpts
of their discussion were syndicated by NPQ's monthly column, Global Economic
MICHAEL MILKEN | If you called your broker a
year ago and told him to buy stock in the Sysco company, did you make
clear you did not mean Cisco Systems, the telecommunications network company,
but Sysco the restaurant supply company? If your broker understood the
restaurant supply company, your stock would have gone up 40 percent. If
he misunderstood you, and thought you meant Cisco the network appliance
provider and telecommunications company, you would have lost 60 percent
of your money.
What this tells you is that there is a market of stocks, not a stock market.
The Sysco/Cisco example brings that reality home.
On the minds of many people today is where are we in the marketplace?
Where are we in our economy? Are we in an environment that will enable
us to get more people working in the marketplace? Are we back moving in
a direction of 1974 where we are again asking ourselves, ''Will we ever
buy stocks again?'' Then, the stock market fell almost 50 percent in less
than two years, only to go up 80 percent in the following two years. Or
are we in an environment like 1935 where we will spend the next long period
of time trying to get back to where we once were?
In short, where are we heading?
GARY BECKER | The most important thing is to draw a distinction between
the stock values and the real economy. The stock market, particularly
the Nasdaq, has had an enormous fall-the Cisco example-by about 60 percent
of its highest value. The Dow has fallen much less. That is the market
But health of the real economy, not the market of mutual fund holdings
and financial investments, is measured by employment and productivity.
And employment is still very high and growing. Unemployment is low. It
is true that the rate of growth of the economy has slowed down and may
slow further. So far, in other words, we have only had what economists
call a ''growth recession,'' but not yet a real recession.
My forecast is that we are going to continue down for a while into a relatively
sharp, but short, real recession. And then we will come back up. The fact
that the Nasdaq has tanked doesn't mean that the economy is yet, or will
be, in a similar type of disastrous situation.
JAMES HECKMAN | Growth has slowed down for sure, but over the past
four to five years we have seen a sustained increase in productivity.
I wouldn't use the word recession. I don't see any substantial impairment
of the fundamentals.
MILKEN | A little more than four years ago the chairman of the
Federal Reserve said that there was an "irrational exuberance"
in the marketplace. At that time, the Dow Jones Industrial was selling
at 6400 and the Nasdaq was selling at 1300. So, we have had a great deal
of volatility since that point in time. Yet market prices are still up
50 percent after the adjustment from that period of irrational exuberance.
Are we still in a period of irrational exuberance or have we come down
DOUGLASS NORTH | Oh, I think we are rationally exuberant now, but
we are still going to come down some more.
As an economic historian, I am interested in whether what we are witnessing
is a wide-cast cyclical phenomenon of stock market expansions like '29,
or is it different?
Let's remember that it took 25 years for the stock market to get back
to where it was in 1929.
Certainly the information revolution of the past 25 years has some parallels
in a material sense with other great golden expansions that began with
the advent of the automobile or the dynamo in the 1920s.
These innovations led to long expansions, though they weren't so much
reflected in the stock market at the time. So, I am not sure that we have
a parallel that tells us exactly what is going to happen to the stock
What I am sure of is that a revolution in information technology is still
with us. We have not ingested that, and indeed we have quite a ways to
go. This means we may have a very sharp recession, but beneath it there
remains an underlying expansion from possibilities of the information
revolution that remain to be exploited.
BECKER | The really important event of the post-1929 period was
not that the stock market crashed, but that the economy tanked for a decade.
By 1939 the unemployment rate was still over 20 percent. There were brief
times of recovery in '34 and '35, and then the economy fell again. So,
in part, it wasn't the stock market that was driving the economy, the
economy-for lots of reasons, policy mistakes and the like-was in terrible
shape for a decade. Then, the stock market in large measure reflected
what was happening to the economy.
MILKEN | Ultimately, then, we can expect the stock market to adjust
to where the economy is, not the economy adjusting to the stock market.
LAWRENCE KLEIN | A year ago I said there was a lot of fluff in
the valuations of companies listed on the stock market that had no profits
in sight. Now there has been a correction. And, unlike 1987, the trading
technology and information available today makes the adjustment much easier.
We are all agreed here that the growth in productivity, which has started
to take off in the last two decades, is something of medium and longer
term significance. Though the financial economy was irrational, the real
economy is not in such bad shape.
MILKEN | In the real economy, we see, for example, that pharmaceutical
and biotechs have added more than $200 billion in value in the last few
years alone. Food and beverage companies have added $40 billion in value
in a similar period. And the financial-service industries have been strong.
Yet, together, the five largest companies in computer hardware and software
lost more than a trillion dollars in value over the past year-a trillion
and a half if you add the largest telecom manufacturers and telecom service
In short, the real economy that employs most people is still the same
as before the stock market correction and operating well today.
MILKEN | Let's take a look at the world's second largest economy.
The unemployment rate has been been drifting up through the past decade
in Japan. Though still relatively low by US standards, for Japan it is
a dramatic increase. A very unique situation has occurred where debt has
dropped considerably as a percentage of gross national product both in
the US and the European Union, but has significantly increased in Japan.
They have just lowered their interest rates to zero. How do these changes
in Japan affect the world?
KLEIN | Japan is caught in what John Maynard Keynes called a classical
''liquidity trap.'' And they need Keynesian spending to get out of it.
Japan did quite well in 1985 and 1986 when they invested quite heavily
in public works and a traditional type of infrastructure. That was successful
for a couple of years. But now it is investment in human capital that
will provide economic stimulus. Japan needs to rebuild their university
system as a public works project.
The Japanese education is fine k-12. It is not so good at the university
NORTH | Investing in the university system may be a long-run solution,
but in the short run Japan has to fundamentally restructure the banking
system and capital markets. They are a long way from doing that, though,
because of political resistance to closing down or restructuring the enormous
percentage of banks that are, in fact, bankrupt in Japan today.
Disaster awaits if that is not done.
BECKER | It is clear the banking system has been in terrible shape.
Real equity is very low in the Japanese banks; their real value is very
But I don't believe the Keynesian medicine will work. They tried to jump-start
the economy with government spending, and it didn't work very well. They
just ran up a huge deficit.
Japan now has a government debt/GDP ratio of about 1.4-the largest in
the Western world for sure.
It is true that, in the long term, their higher education system needs
Japan had enormous growth from 1960 to 1990. We shouldn't forget that.
There are great strengths in Japanese human capital in my judgment-hard-working
people and good k-12 education, even if higher education is not as good.
Japan sends a large fraction of their high school graduates into higher
education. In the world, they are in the top 3 to 5 percent.
Indeed, I think their human capital is a good forecaster of future potential.
I am still bullish, therefore, in the long run, about Japan.
In the shorter term, Japan clearly needs to do several things: restructure
their financial system, allow more foreign banks to come, and they need
to allow easier access into their marketplace.
There is capital out there in the world economy that might be attracted
to Japan if they opened up their economy more readily, which is still
closed in many sectors, particularly in services and some manufacturing.
That has hurt the competitive position of Japan.
KLEIN | One of the big obstacles in Japan is the lifetime employment
system. It is exactly the opposite of the large US market. Even when the
US has to downsize in manufacturing, it can count on the service economy
to pick up jobs. That is not really done on a big scale in Japan. A lot
of major companies just do not want to give up the lifetime employment
BECKER | The lack of flexibility in Japanese labor markets is a
bit of a stereotype. There is an amazing amount of flexibility that has
been introduced over the last 10 years. They now classify workers as permanent
and less permanent. Restaurant workers, for example, have a lot of turnover.
MILKEN | Japan has high savings, but they are badly deployed, with
trillions of dollars invested at negative rates of return or zero rates
of return. Japanese savings rates are not as high as they once were-almost
25 percent back in the late 1950s-but they are still very high compared
to the United States.
But what can they do with these savings?
If I wanted to have $1,000 at the end of 45 years when I want to retire,
at the zero interest rates they have in Japan today, I'd have to put away
$1,000. In the United States, where I could probably earn an average 8
percent return on my money, I'd only have to put away $31 today to have
$1,000 in 45 years. In this perspective, a high savings rate doesn't mean
So, in Japan there doesn't seem to be so much of a liquidity problem,
a lack of capital, as there seems to be a perception of a lack of opportunity
to deploy that capital profitably.
KLEIN | There is that perception because there is a loss of confidence
in the government and the economy.
MILKEN | In 1974 Americans lost confidence also. We thought New
York City was going to go bankrupt, as well as New York State, ConEd and
thousands of major corporations. So people from Canada came down here
and invested in our real estate. In '89 and '90 we lost confidence in
what is today the most valuable financial institution in the world as
measured by the marketplace, CitiGroup. It took a young sheik from Saudi
Arabia to come in here and buy CitiGroup because he believed in its future
Is it going to take risk capital from outside of Japan for us foreigners
to say we have confidence in Japan, to turn Japan around?
HECKMAN | Japan is not the United States. The economy of Japan
is not very flexible. I wouldn't look for a white knight to ride in from
Kansas. He would meet too much regulatory resistance.
BECKER | Clearly, Japan needs reforms in both financial markets
as well as labor markets to make the economy more flexible, though the
labor market is more flexible than it appears on the surface. The entry
of foreign companies into retailing and other sectors of Japan appears
to be very difficult.
There is a significant body of opinion in Japan, among their economists
and others, that this is a weakness in Japan. This is an area they have
to work on. As in most political systems, the political resistance to
allow these entries has been very strong. But it is gradually moving.
Japan is not the same Japan as it was 10 or 15 years ago, but change has
been at a glacial pace. That partly explains the fact that they have been
stagnating, more or less, for a decade now.
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