Confidence Game

As the deadline for this column was Wednesday, the stock market may have recovered some of its worst-month-ever losses in the lag before publication.

But I doubt it. Losing 514 points one day, rebounding 288 the next, and slipping 45 the third is a lousy way to make a living in the stock market.

The real economic effect of the Dow's 1800-point plunge from 9337 is minimal -- so far -- as most investors have lost only their January to July gains. It had been, however, a good seven months. Investors are only now opening their new monthly statements to discover the near-20% shrinkage in their stock market wealth since the last envelope.

Whether or not the nation will maintain its confidence is a more important question than any economic issue to date. A loss of faith would show up not only in a continuing stock market decline, but in consumer behavior.

When the Dow hit 6200 two years ago -- 1300 points below Monday's close -- Alan Greenspan mentioned "irrational exuberance" in a long, rhetorical question about the impact of a stock market breakdown on the real economy. The real economy could quickly suffer from a few million conversations along this line: "Honey, let's hold off on that car for a month or two...".

Several outfits track measures of consumer confidence, and confidence correlates strongly with economic activity. People tend to be confident when the economy is good, and the economy tends to be good when people are confident. That self-reinforcing spiral leads to long periods of confidence and good economy, but unfortunately works in reverse for long stretches.

After World War II, most economists feared a renewed depression. Where would jobs be found for twelve million returning veterans? What would we use for markets in the wreckage of the rest of the world? What beneficial force would replace wartime government spending?

We needn't have worried, and most didn't: we had earned great confidence, the hard way.

That post-war confidence sustained us through the worst of the Cold War, four mild recessions, and a declining dollar. As great as that confidence was, it was not until 1954 that the Dow Jones Average reached the 381-point level for the first time since 1929. Temporary dips in 1958 and 1962 aside, the Dow cruised effortlessly to 1,000 in 1966.

It took the four-fold whammy of Vietnam, Watergate, sextupled oil prices, and the worst inflation this century to break the post-war belief in the future. The Dow lost 29% in a foreshock from 1968-70, recovered in 1971-72 and then plummeted 42% by 1974. The Dow would not reach 1,000 again for a decade.

Jimmy Carter made no friends with his "malaise" speech, but he was right. The depressed seldom wish to be reminded of their condition.

We righted ourselves in the early eighties; precisely 1983 in stock market terms. No matter how you felt about Ron Reagan, the rhetoric hit home with most folks. So did falling oil prices and a rising economy.

There has been only one rough spot since: the one-day 1987 crash, fully recovered in two years. The 1991 mini-recession may have cost George Bush his job, but the Dow was merely flat, as it was in Fed-on-the-warpath 1994. From 1990 to July 1998, the Dow quadrupled.

As a financial matter, the 20% oops-a-daisy in August can be traced to the same sources as the 1987 pratfall: too much money chasing too little value, and the Federal Reserve leaning into the economy. Both of those conditions can be overcome: confident investors would buy again, and Mr. Greenspan is tough, not suicidal.

However, all periods of high confidence come to an end, and 1998 seems to me to be the most difficult challenge since we found ourselves fifteen years ago.

A third of the world is in recession, but that's just another financial detail. The hard part is our leaderless condition (whether by choice, accident, or fault doesn't matter) at a time when the world turns out not to be as safe a place as we thought it was at the end of the Cold and Gulf Wars.

I fear that the Dow Jones Average reflected our concern for our overall situation in August, not just our finances; and will continue to do so.