Bull!: A History of the Boom and Bust, 1982–2004

by Maggie Mahar

Washington’s critics contended that the administration had created the illusion of recovery, ginning up the economy with easy credit and, in the process, leading both shoppers and investors to believe that things were far better than they were.

Often, they took cash out of their homes, either by signing up for a home equity loan, or by refinancing and shouldering a larger mortgage.

As for the banks, they were understandably happy to write these adjustable rate loans, even when home owners could not (or chose not to) make a down payment.

Washington Mutual,

“interest-rate only” option.

Short-term debt also climbed.

“Excluding mortgages, the average personal consumer debt is now about $18,654 per person—up 41 percent from 1998,” John Mauldin, editor of Thoughts from the Fro...

Nevertheless, the bulls argued that the pile of deb...

Bears remained concerned: despite low rates, by March of 2004, the amount the average family now paid to service debt was approaching an all-time...

One thing was clear to even the most bullish observers: consumer spending alone coul...

Washington’s hope had been that consumer spending would lead to productive investment: if consumers created enough demand, they reasoned, this would spur businesses to make new capital investments, expand their businesses, increase production, and create enough new jobs to replace not only those that had been lost, but those needed to absorb new graduates entering the workforce each year.

TWIN DEFICITS

Skeptics argued that a recovery based on debt was no recovery at all.

In 2000, the United States was running a $237 billion budget surplus; by 2004 the surplus had turned into a $521 billion deficit.

The war on terrorism, which was expanded to include a war in Iraq, accounted for only a part of the government’s debt: from 2001 to 2004, spending outside defense, homeland security, and defense-oriented foreign aid had jumped 23 percent, or more than 7 percent annually.

Then there was the trade deficit. The United States continued to consume more than it produced, which meant that the gap between imports and exports was widening. By the end of 20...

For years, foreigners had been financing that deficit by using the dollars they received for their ex...

Yet the United States continued to depend on foreigners to buy its debt: in 2003 kind strangers owned more than a third of all government bonds.

If they began to pull back, the only way the United States could attract new buyers would be by raising the yields that it paid bond investors. But that, in turn, would make it all that much harder for Washington to service its debt.

This is what worried investors such as Warren Buffett: “For a time, foreign appetite [for U.S. debt] readily absorbed the supply,” Buffett noted in his March 2004 letter to Berkshire Hathaway investors. “Late in 2002, however, the world started choking on this diet, and the dollar’s value began to slide….” Yet, Buffett observed that an ongoing trade deficit meant “whether foreign investors like it or not, they will continue to be flooded with dollars. Th...

With that in mind, in 2002 Buffett had waded into the foreign currency market for the first time in his life, hedg...

“grew increasingly bearish on ...

Buffett was no...

Chairman Greenspan’s critics argued that by flooding the world with dollars the Fed had been trying, quite literally, to “paper over” a financial crisis, and in the process had only postponed what Jim Grant called the...

The artificial stimulus of easy money might keep the economy going through 2004, they acknowledged. But, below the surface, risk built.

Risk Built

Gazing at Washington’s twin deficits, Peter Bernstein did not try to conceal his alarm: “Of one thing we are certain: current trends are not sustainable,” he told his clients. “The imbalances are now enormous, far more glaring than at any point in the past…. A hitch here or a tuck there has little chance of success. When it hits, and whichever sector takes the first blows, the restoration of balance will be a compelling force roaring through the entire economy—globally in all likelihood. The breeze will not be gentle. Hurricane may be the more appropriate metaphor.”27

GMO’s Jeremy Grantham shared...

“The lesson learned from 2003 is very clear,” Grantham observed, “never, ever underestimate the desire of an administration to be reelected, or the substantial cooperation that the Fed will typically provide [emphasis his].”

“potentially dangerous levels of debt”

“a financial blac...

His warning was blunt: “The outlook for 2005 and 2006 looks about as b...

For this reason seasoned investors, including Dudack, Bernstein, Grantham, Leuthold, Russell, Jim Grant, Bill Gross, and Marc Faber, continued to emphasize alternative investments: commodities, oil, natural gas, foreign currencies, and emerging markets topped many lists.

Some recommended gold as protection against a falling dollar. Others bought commodities as a hedge against inflation: “We now have about 10 percent of our equity portfolio invested in oil, and 15 percent in industrial metals,” Steve Leuthold reported in April of 2004.

“Over the next five years, global demand will outstrip the means of production in these sectors, and s...

“Of course the government has an interest in keeping the CPI [consumer price index] as low as possible: the higher the CPI, the higher the cost-of-living adjustments for programs like Social Security,” he added. “But, the CPI is also used to calculate the extra dividends that TIPS investors receive if inflation rises. If the CPI continues to understate inflation, investors won’t receive the full protection that they’ve been promised.”

As for the United States, in the summer of 2004, many investors sensed that much hinged on the upcoming presidential election.

They knew that whoever took office in January of 2005 would face enormous economic problems: a half-trillion-dollar budget deficit, a trade deficit approaching another half trillion, plus roughly a trillion dollars in consumer debt.

At the time, just one thing was certain: if Washington’s policy makers wanted to avoid pushing the nation into a “financial black ho...

the analysts’ supervisors.

However, his observations on the rise in Internet stocks are peppered with descriptives such as ‘bubble,’ ‘euphoria’ and ‘tulip bulbs’—language usually associated with Internet skeptics.”

New York Business, 22 March 1999,

John Kenneth Galbraith, A Short History of Financial Euphoria (New York: Whittle Books, in association with Penguin Books, 1990),

William G. Shepherd, “The Size of the Bear,” Business Week, 3 August 1974; William Gordon, “Poppa Bear Market,” Barron’s, 26 August 1974.

Despite his reservations about valuations, Russell acknowledged that the bull dominated the market throughout much of the late nineties. But in August of 1998, he began to warn readers that they were in the first phase of a bear market. (See Richard Russell’s Dow Theory Letter, 4 August 1998, and 26 August 1998). By October of 1999, his advice to readers was unequivocal: “Get OUT of stocks and get into T-bills or T-notes or the highest-rated munis bonds” ( Richard Russell’s Dow Theory Letter, 6 October 1999).

Russell’s Dow Theory Letter, 8 August 2001,

Index (CPI), dating back to 1913 (the first year for which the CPI is available),

James Grant, The Trouble with Prosperity: The Loss of Fear, the Rise of Speculation, and the Risk to American Savings (New York: Times Books, 1996),

For an extended discussion of economic and psychological factors driving financial cycles, as well as cycle theories, see Marc Faber, Tomorrow’s Gold, Asia’s Age of Discovery (Hong Kong: CLSA Books, 2002),

(“Looking Ahead, What Financial Cycles Mean for the 21st-Century Investor”) for information on the complementary economic and psychological factors that drove the bull market of the nineties to an unhappy end.

“market timing”