Han Dieperink: Back to the 1990s
This column was originally written in Dutch. This is an English translation.
By Han Dieperink, written in a personal capacity
The stock market has been rising more than 20% a year for two years in a row. Statistically, this increases the probability of a worse stock market year, but the second half of the 1990s is an important exception. The good stock market years of 1995 and 1996 were followed by no less than three more good years, immediately followed by three negative years. Is a repeat performance realistic?
Comparing the current period with the second half of the 1990s is very valid in several respects. In 1995, for example, there was also a soft landing, after which central banks also kept interest rates high for an extended period. The Bundesbank mastered the art of threatening to raise interest rates for a long time, while an interest rate cut eventually followed. In recent years, as then, inflation levels were temporarily higher.
Analogy 1990s
That soft landing of 1995 followed the “interest rate hump” in the year 1994. That while in early 1994 it was widely expected that long-term interest rates would remain low for the time being, similar to the post-Orona period in which the Federal Reserve also stated that interest rates would remain “low for longer. No one anticipated in early 1994 that long-term interest rates would rise by as much as two percentage points. However, the economy was picking up, and in the economic models of the time, more inflation should automatically be the result.
More productivity thanks to IT and globalization
The fall of the Iron Curtain and German unification brought an influx of cheap labor in Europe, and that depressed inflation in the 1990s. Inflation was also depressed in the United States during that time, but for different reasons. Economists constantly predicted that inflation would rise, in part because they were calculating too high a rate of natural unemployment.
In practice, however, many companies turned out to cut costs, helped by productivity improvements, about half of which were due to technology (the continued development of the personal computer, the advent of e-mail, cell phones and, of course, the Internet). The remaining productivity improvements came from the wave of globalization after the end of the Cold War, compounded by IT and improved telecommunications.
Japanese deflationary engine
There is another factor that allowed inflation to surprise on the downside in the 1990s and that is the bursting of the double bubble in Japan. After the Plaza and Louvre deals in the 1980s, low interest rates in Japan created a bubble in Japanese real estate (the area of the imperial palace was more expensive than the entire state of California) and a bubble in the stock market (Japanese banks were at 200 times earnings and Japan at almost half of the world index). The bursting of those bubbles caused deflation, which Japan freely exported to the rest of the world.
Irrational excess
In December 1996, Alan Greenspan gave a speech in which he spoke of “irrational exuberance,” referring to the financial markets. Even then, these had soared. In retrospect, Greenspan admitted that he had underestimated the productivity effects. The economy was able to grow strongly without rising inflation.
Alan Greenspan made sure, by the way, that if anything could threaten that growth, central bankers were on the alert to prevent the economy from slipping into recession. The problems surrounding the Asia crisis, the Russia crisis and at the same time the LTCM crisis were prevented with active monetary policy. In that environment where economy and inflation nevertheless remained just right, the analogy to the fairy tale of Goldilocks and the three bears arose.
Uber Goldilocks now
As in the 1990s, we now face an acceleration in technological development. The impact of artificial intelligence is greater than that of the cell phone, the Internet or the PC. It is more comparable to the effects after the Second Industrial Revolution. That one was about automating human muscle power. This time it is about automating human brainpower. That affects not only the manufacturing part of the economy, but also the service side. In practice, it amounts to even more growth without inflation. Even better than the fairy tale of Goldilocks in the 1990s.
New positive effect globalization and IT
As then, globalization plays a role now. Despite all the talk about deglobalization, true globalization has always been motivated by the possibility of lowering prices. Consumers may be against globalization, but at the end of the week they walk out of the supermarket with two bags full of globalized products.
Globalization is now largely through the services side of the economy. Post-corona, the world has become smaller. Working at home, shopping at home and learning at home makes distances much shorter. People working in the service economy can therefore be 2,000 kilometers away instead of 20 kilometers. And with more than 250 million English-speaking students in India, there is then more competition in the job market.
Chinese deflationary engine
China's trade surplus is heading toward $100 billion on a monthly basis. While everyone was watching property prices in Beijing and Shanghai, China has quickly become the export champion. Not only in electric cars, but also in things like solar cells and wind turbines to nuclear power plants. In fact, just about anything can be bought for a fraction of the price via Alipay or Temu.
The world's factories are in China. A lot of manual labor is still done there too, but nowhere, thanks to robotization and automation, is productivity development going as fast as in China. All of the country's economic growth right now is more than entirely due to productivity growth. Provided countries accept these cheap products (and thus do not surround them with high tariff walls), inflation here can remain low.
Proactive role of central banks and governments
Greenspan was already moving in the field of tension between the free market and a (monetary) government that wanted more and more control over the economy. Post-Corona, the government guarantees just about everything. There is a pot of money waiting for every group in society that gets into trouble.
There was a time when monetary and fiscal policy pointed in the same direction, but in recent years fiscal policy has continued to stimulate while monetary authorities have put on the brakes. This has created relatively high levels of government debt, forcing monetary authorities to push for the policy of financial repression, which allows debt (as a percentage of GDP) to remain bearable and even to decline over time. Inflation is then no longer a problem, but a solution.
2025: Back to the 1990s
The parallels of today's environment to that of the 1990s are many. Even now, Greenspan could give a speech about irrational exuberance. There may even be hype (after 1,000% rise in Nvidia stock, that is easy to sustain), but the peak of that hype has not yet been reached in terms of both valuation and sentiment. The impact of artificial intelligence is greater, so is the impact on economic growth and inflation. Higher earnings growth is the result, and regardless of artificial intelligence, the stock market is too cheap rather than too expensive.