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"It was the best of times, it was the worst of times." So wrote Dickens in his famous opening to A Tale of Two Cities. Dickens continues with, "it was the age of wisdom, it was the age of foolishness, ... it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair."
Dickens intended that this description be applicable to all times. And, not surprisingly, his sentiments provide a good summary of modern times, both generally and economically. In this chapter we examine competing arguments regarding the U.S. economy. In one camp are the worst-of-timers—the doom and gloomers who predict a financial hangover that will last for years or decades. On the other side are the best-of- timers—the bright-eyed new-agers who predict a magical world filled with material abundance and leisure.
Revolution lurks just offstage throughout A Tale of Two Cities. The story begins in 1775, and Dickens' readers knew that by the end of the century the streets of Paris would run red from the reign of terror. Revolution also lies at the heart of the debate about the modern economy. While the current revolution is less bloody than that experienced in eighteenth-century France , it is no less fundamental.
The Industrial Revolution loosened the connection between physical labor and economic wealth. With machines we no longer needed to work like animals. Even with machines, however, we still needed to work. Now the information technology revolution promises material luxury without work.
Even though he had never seen a computer, the famous economist John Maynard Keynes summarized the optimistic view in his 1930 essay, "The Economic Possibilities for Our Grandchildren." 1 In it Keynes looks forward to a materially rich world filled with leisure. He imagines that his grandchildren will have so much abundance they will work very few hours and spend the rest of their time on artistic and intellectual pursuits. In fact, Keynes worries about the lack of work to fill the day:
we shall endeavor to spread the bread thin on the butter—to make what work there is still to be done to be as widely shared as possible. Three-hour shifts or a fifteen-hour week may put off the problem [of too little work] for a great while. For three hours a day is quite enough.
If such a world is to exist for our grandchildren, information technology seems destined to play a major role.
Published in 1859, A Tale of Two Cities contained a cautionary tale. It warned that those who do not prepare for change well might end up at the wrong end of a guillotine. Specifically, Britain had to be careful to avoid the bloody aspects of change that befell (and beheaded) French society.
Similarly, the specter of the Japanese economy hangs over the United States . In the late 1980s, the Japanese economy was surging and analysts
confidently predicted future greatness. Over the last 15 years, the Japanese economy has stagnated, unemployment has risen dramatically, and confidence has waned. Japan still leads in many economic categories, but also has a suicide rate that is among the highest for industrialized countries.
So what path will the United States follow? Will it be Keynes' vision of examined leisure created by information technology, or will we stumble down a painful path similar to that taken by post-bubble Japan ?
We will develop the answer to this question throughout this chapter. To understand the problem we will have to wade knee-deep in economic statistics of debts, deficits, and productivity. When I ponder the U.S. economy, however, I do not think only of economic data. In addition, I think often of a high school classmate of mine—Steve—and his behavior in the fall of 1975.
In 1975 I was a junior in high school on a mediocre cross-country running team. Actually both the team and I were mediocre—so bad that our archrivals and state champions, Grosse Pointe North, used our competitions as practice days. Rather than drive to our competitions, "North" would run eight miles just to get to the starting line. They'd then run the three-mile race, defeat us handily, and run the eight miles back home. They didn't want to waste a training day by running just a few miles against such a pathetic team as ours.
Into this gloom came the "new guy," Steve, a young man with a great natural talent for running. Although he had not been on the team in previous years, he showed early promise and soon became the best runner on our team.
The funny thing about Steve, however, was that he didn't sacrifice much to be a great runner. While my friend Jim and I made sure to eat right and go to bed early, Steve was not averse to having a few drinks the night before a competition. He would even sometimes arrive at a Saturday morning race hungover, his natural talent usually allowing him to outrun the rest of us. Though on the mornings after particularly hard evenings, we were not sure whether Steve's talent or Steve's hangover would prevail. Had the excesses of the previous night been extreme enough as to overwhelm Steve's ability?
The U.S. economy faces a similar battle between hangover and talent. The United States has demonstrated an unmatched ability to innovate and produce. Our economic system seems to have a natural talent for making products both cheaply and well. Impeding that talent, at least over the next several years, is the financial hangover caused by the excesses of the 1990s.
What condition will win out? The hangover or the talent? To find out we'll delve into some macroeconomic issues. When I was an MBA student at MIT, the economist Lester Thurow said, "If you like reading [dry] data tables, then you should consider becoming an economist." The shoe that Lester described fit me perfectly; after a few years I returned to get a Ph.D. and became an economist.
When I tell people at social functions that I am an economics professor, a very common response is "that was my worst course in college." I have met literally dozens of people who took one economics course, found it distasteful, and stopped. Part of this dislike of economics comes from the standard teaching style (boring!), but part is due to the very nature of the subject (including dry data tables). As hard as it is for me to understand, I have learned that some people do not enjoy reading economic statistics.
Furthermore, some people can succeed financially without studying economic numbers. Take my friend David who works as an oil trader in the New York Mercantile exchange. He does his trading in a crowd on the floor of exchange—just like the people shown screaming at each other on TV and in movies, David makes his living by buying and selling oil. In fact, David once joked that his epitaph ought to read, "He yelled for cash."
David's yelling has resulted in quite a bit of cash. His lifetime earnings are north of $10 million, and he has earned more than $1 million in some years.
How does David make his money?
In the early days of trying to figure out David's secret, I used to grill him. "Do you think that the United States will start constructing new nuclear power plants and thereby reduce demand for oil? How did the 1991 oil fires set by Saddam Hussein's troops affect the future capacity of Kuwaiti production?" To all of these questions, David would calmly answer, "I do not know." He even joked that to make money he wouldn't even need to know the number of gallons in a barrel of oil (42).
What is David's secret? He summarizes it by saying, "I know when the buying is real and the selling is real." David stands in the crowd, listens, observes, and acts. He capitalizes on emotional signals from his counterparts, and he uses little or no formal economic analysis.
So is it possible to make money just by exploiting knowledge of sentiment, with no economic analysis? The answer is yes, but I believe it is possible to make even more money by combining economic analysis with the science of irrationality. That is the course that we will follow in the rest of this book, and it requires that we delve into the economic details.
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We begin with the economic evidence in favor of the worst of times, and then move to the arguments in favor of the best of times.
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