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Hot Topic by David Lawrence The idea that there is a "new economy" does not imply that there is a "new economics." This is apparent with the reemergence of a very old economic phenomenon, the business cycle downturn. We are probably in an industrial recession right now, and the more general economy stands on the precipice of its first recession in 10 years. Fortunately, there are a couple of factors, often overlooked, that lead to the belief that any downturn will not be notably deep or long-lived. There is no question that there has been a bursting of a speculative bubble in the information technology (IT) sector. This was not a classic bubble (like tulips or Florida swamp land) because it was based upon real and permanent productivity-enhancing technological progress. The fundamental mistake that many investors made was not recognizing that IT infrastructure, equipment and software are capital goods, akin to machine tools, and like all capital goods, the industry is subject to both overbuilding and swift postponement of demand. The absolute drop-off in orders for these commodities over the past few months and the industry's complete lack of visibility - the currently popular business-speak for "we have no idea what will happen next" - are classic business-cycle phenomena in the capital goods industry. As far as the length and severity of the slowdown are concerned, it is helpful that the burst bubble was primarily equity-financed rather than debt-financed. It is true that nearly $4 trillion dollars of equity has been destroyed the past year on the NASDAQ alone, and that many people who thought they were going to be rich are not going to be. Financial institutions during this period did a fairly good job of avoiding so-called "air-ball" financing; with the exception of debt-financed overbuilding in the telecommunications industry, financial institutions should come out of this situation without a huge overhang of bad debt. People familiar with the farm depression of the 1980s and the real estate market after the S&L debacle understand how the financial hangover of bad debt can deepen and prolong a downturn. In the current environment, when confidence returns, the banking system should be poised to finance business expansion using reasonable credit standards. A second characteristic that bodes well is the absolute soundness of federal fiscal and monetary policy over the past 10 years, leaving the government with a full array of strong weapons to fight any downturn. With large surpluses, there is plenty of room for a meaningful and permanent tax cut. Likewise, if need be, the Fed has room to cut several hundred basis points from short-term interest rates. It is important to understand that the Fed's goal is not to support the stock market; it is to keep long-term interest rates low, thereby stimulating capital investment. This is best accomplished by keeping inflationary expectations down. Mr. Greenspan, perhaps alone, has the credibility to achieve this. Japan is a textbook example of the consequences of financial hangover from bad investments, and is the wildcard in the world economic situation. When the finance minister of the world's second largest economy states that his country is on the verge of collapse, this is a statement to be taken seriously. Further decline in Japan hurts us not only via a reduction in exports, but also through the possibility of U.S. plant closings and other efforts to bring money back home. The business cycle has not been repealed by the new technology - in fact, the repeated assertions to the contrary were one of the signs of the top. Recessions happen, but they always sew the seeds for renewed prosperity. Caution, not panic, is a good watchword in today's environment.
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