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Parsing U.S. Forecasts, Recessions and Politics Part I: The End of the New Economy Recession (2001) [1]

['This Content Is Not Subject To Review Daily Kos Staff Prior To Publication.']

Date: 2025-02-24

I made the promise, or threat, last time that I was going to write up my correct calls on three previous recessions: The 2001 End of the New Economy recession, the Great Financial Crisis of 2008-09 and the Non-Event of 2022. I leave out the Covid Collapse because there was nothing to predict when it’s playing out in front of you in real time. I do regret the loss of a million American lives to presidential incompetence and psychosis. It was a huge deal, and a very good thing Democrats had the Congress and later Biden to come in on the clean-up and generate a full recovery, historically excellent and the best in the world.

I am predicting an economic crash (and have for some time) to begin this summer (June-August 2025). I use the word “crash” intentionally. This is not a recession, and its cause has little to do with the strength of the economy a/o January 19, which was stable and strong. The economic dislocation, job loss, potential inflation, market turmoil, and trade disruptions derive from a possibly intentional sabotage. But it is the manifest betrayal of Constitutional law that puts this in a new historical category.

If crashing the economy is not the actual plan, the Trump/Musk coup is an unparalleled exhibition of incompetence and corruption. They are driving a road grader over the government, alienating allies and trading partners, threatening to deport millions of productive workers, and conspiring to betray confirmed commitments, particularly to NATO and Ukraine. On this last point, Putin seems desperate to use up Trump’s political capital as soon as possible, before the fat cats can get to it for their tax cuts.

Five weeks ago Canada was our closest partner, and Russia was an adversary. Now? This is a huge mess, a generational challenge. I’m not sure Biden in his prime (which was not that long ago) could have cleaned it up. We’ll all have to pitch in. Every little thing is a big thing at this time. So whatever you can do.

The following may be useful if you need a break (as I do) from the present. Warning: It’s long (and this is just Part 1!), and it will be interesting to a limited audience.

We start with a cogent observation in the comments on my last piece [LINK] in which I proposed the present write-up.

hersco is entirely correct, and I plead guilty. Although I have conveniently forgotten the misses, I’m sure there were a few and I would have convenient explanations if confronted with the evidence. The ones you remember, of course, are the ones that pan out over time, and you watch approaching while wondering where everybody else’s head is at. The point of the present exercise is to tease out the economics in these forecasts, not to brag. I hope it is a way into economics that is not Econ 101: Dull, wrong, hypothetical, skewed, featuring archaic and bad math.

Episode 1: The End of the New Economy, the Recession of 2001

A proclamation from the most respected mainstream economist that the business cycle has ended, inflation has been tamed and stable prosperity has finally arrived for good has been a strong leading indicator of an imminent generational financial meltdown. Irving Fisher did it in 1929. Ben Bernanke did it in 2005. Alan Greenspan did it, if our translation is correct, in 1998, too, but the end of the New Economy was one of the mildest recessions on record. Greenspan extolled the new economy of unprecedented technological advancements, a well-managed monetary policy (himself) and the intrinsic wisdom and efficiency of consumer capitalism. (Later, Greenspan would extol the virtues of the adjustable rate mortgage.)

I think. It is hard to know what Greenspan said. He typically Greenspan argued both sides of every question and demonstrated far more skill in creating dependent clauses and run-on sentences than he ever did in managing US monetary policy. It was just as well he was verbally opaque, because most of the time he didn’t know what he was talking about. He was in the job because as an Ayn Rand libertarian he didn’t bother the banks too much. His faith was that institutions like banks and corporations would do the right thing because it was in the long-run interest of the institutions to do so. Call it an ideological blind spot that obscured half his vision. For example, he missed the evidence that banks and other corporations are typically managed for the short-term interests of the officers and shareholders, not the long-term integrity of the company. That’s Part II.

“Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief,” he told the House Committee on Oversight and Government Reform.

This quote is as clear as any ever made by Greenspan. The NYT headline of October 23, 2008, over which the quote appeared is clearer: “Greenspan Concedes Error on Regulation.” But it turned out, after several circuitous clarifications, that he did not consider it an admission that he had been wrong. Surprised, maybe, but wrong? Not so much.

**

It is popular these days to mention that ten of the last eleven recessions have come when a Republican was President. When it comes to the End of the New Economy recession, this is true only by a whisker, since the recession began in March 2001, not two months after Inauguration Day. The orthodox hindsight explanation for the downturn holds that it was caused by the Dot-com bust. (Another suggests 9/11 had a role, though September 11 was much closer to the end than the beginning.) My view is that the Dot-com fiasco and the various sleazy bookkeeping/stock pumping scandals had their place; they definitely weakened an extremely robust economy, but did not tip it into recession. The credit and debt structure never came under duress. Serious damage was done to the fortunes of individual players in stocks, but many of them were venture capitalists and angel investors who could afford to lose, even if they did not think so themselves. Average investors did get hurt, especially those who bought on margin, or were on the wrong end of risky derivatives. The end of the New Economy was not even a shadow of the calamity of the GFC ten years later.

The angle that led me to predict the recession when others were predicting a soft landing lay in another direction entirely – to the reason the basic economy was so robust in the first place – oil prices, and then to an unforced error by the Fed and its chairman.

The Untold Story of the Clinton Boom: Low Oil Prices

To understand the importance of oil prices, first understand that in the 1990s all energy prices rose and fell together. Oil prices often led by a bit, but they all came along. So oil prices in the late 1990s are a surrogate for all energy prices of that time. That changed in the following decade, when for example, natural gas for electricity generation came in much cheaper than the others.

The second element to understand is that everything in the economy is produced by combining labor and energy. All the finished goods, the intermediate goods, the minerals, transportation; whatever is extracted, manufactured, or executed; teaching, trucking, on and on, it’s labor and energy. (Quick note: This is not original with me. I cribbed from Andrew Oswald of Britain’s Warwick University.) So in order for prices to remain stable, if the price of one goes up, the other must go down. At the micro level, a business which produces a good or service will tend to conserve the more expensive input and shift what it can to the other. Conserving labor can be done by substituting energy in the form of technology and fuel.

Cheaper energy thus means higher productivity and higher wages. The contrary is true, if the price of energy is high, companies will reorganize their processes, not buy new machines, etc., the share to labor will go down. Of course, if prices do NOT stay in place, that is inflation.

A word about productivity. “Productivity” is universally shorthand for “labor productivity,” meaning the amount of output from a unit of labor. But its calculation involves a major flaw, since all the costs are not accounted for. The costs of climate degradation and pollution should be included in the calculation of energy inputs or as a deduction from output, and they are not. If they were, productivity would be a much different number. This is, of course, the rationale for taxes on energy that have been a favorite of all economists for decades.

Finally, a bow in the direction of the demand side principle that an economy produces what is demanded. “Effective demand” is a term of art I define as follows: Demand backed by money. Need and desire, no matter how intense, will not bring about economic demand without money. Ask the starving in Africa, or in the US, for that matter. This is straight out of Keynes. It’s not what producers decide to make that generates economic activity, its what the other economic actors have the means and intention to buy. (Consumer capitalism obviously depends on manipulating demand through advertising, an obvious fact that is ignored by the orthodoxy.) Another demand side tenet that is foundational: One actor’s purchase is another actor’s revenue.

For those of you who are still with me, I see some graphs up ahead.

Figure 1 is our starting point, real GDP per capita. Real because its measured in chained dollars. Per capita to correct for population. This is the graph we’ll use to identify the timing of the recessions.

Figure 1: U.S. Real Gross Domestic Product Per Capita

A per capita measurement gives a better idea of the scale of things. If the y axis is measured in total dollars, it becomes a number in the trillions so difficult to get your head around that it’s almost meaningless. Measured in real dollars per capita, however, we see the economy produced $68,000 for every man woman and child at the latest reading. Gasp. GDP = GDI. Gross Domestic Product by definition necessarily equals Gross Domestic Income. $68,000 per person. Hmm.

Figure 2 is the price of oil, one of the untold secrets of Bill Clinton’s success with the economy.

Figure 2: West Texas Intermediate (WTI or NYMEX) Crude Oil Price

From the start of his presidency until very near the end, oil prices were phenomenally low for Clinton. None of the high and erratic oil prices of the 1970s. Also missing from previous decades was any public interest in what the price was. It was low. Since oil is our surrogate for all energy prices, all energy prices were low. And notice further that the price in the graph is measured in nominal dollars, so the real price of energy is actually going down over most of the Clinton years. As above, a smaller price for energy meant that labor’s share or the production pie was growing.

One commenter asked, “Why do we care, if oil is also made of labor and energy?” An excellent and essential point! Because extractive industries like oil have a very low labor input, so the income they capture is a sink to effective demand. The well is drilled, the pumps are started, and labor walks away and on to the next site. (Of course, there are residual maintenance personnel, folks, be serious.) Since effective demand in consumer capitalism arises primarily from working people, the number of employed and their incomes is the important number. Big Oil gets rich, of course, just as you intuit, and very little trickles out of there.

So in brief, the economy was fragile after the Dot-com bust, then oil prices began to rise, and then Greenspan raised interest rates, right into the teeth of energy’s squeeze on labor, raising consumers’ costs as it shut down any incipient private investment. Higher energy prices and higher interest rates. One of them alone might not have screwed things up, but both led to the recession call and on to the very mild recession of 2001.

A few more words about the Dot-com bust of the 1990s. This economic event will be remembered for the “irrational exuberance” that drove stocks up past any rational value as Tech emerged with the beginnings of the Internet. It was the heyday of the day trader, the epitome of boom and bust.

Wikipedia puts it:

The dot-com bubble (or dot-com boom) was a stock market bubble that ballooned during the late-1990s and peaked on Friday, March 10, 2000. This period of market growth coincided with the widespread adoption of the World Wide Web and the Internet, resulting in a dispensation of available venture capital and the rapid growth of valuations in new dot-com startups. Between 1995 and its peak in March 2000, investments in the NASDAQ composite stock market index rose by 800%, only to fall 78% from its peak by October 2002, giving up all its gains during the bubble.

Figure 3: NASDAQ Composite Index

Investors lost big time. This included angel investors and venture capitalists, and individual investors. Again, while the venture capitalists and “angels” could afford the loss financially, if not psychologically, a significant number of pretty regular people got caught up who could not afford the losses. Some derivatives they could afford were safe, in the sense that the amount of your investment was the entirety of your risk. Others were not. Thousands were exposed when they bought on margin, essentially borrowing. When the margin calls came, they had to seel their assets all the way down to ruin.

Figure 4: Total U.S. Venture Capital Investments

These investors who got caught out over their skis share a lot with the homeowners a decade later whose financial security melted away overnight. These people felt personally burned and shamed. In other work I’m doing, I follow them into the Tea Party and then, adding some racism and fuzzy thinking, into its rebranding as MAGA. These economic events (particularly the GFC) were at the root of their grievance, no matter how it may be displayed today. I’m convinced that it was the impetus for a move to the right in American politics. I’ll go into that more in the next installment. HERE [LINK] is a time line tracking economic downturns and shifts to the right over the last 70 years.

Dot-com was a strange time where I live in Seattle. People went from waiting tables to head of HR at a start-up in one step, with no qualifications other than basic intelligence. Computer science was the career of choice for new university students angling for a well-paying profession with a future. Both avenues to wealth were disappointed.

Back in the real world, the real economy, as opposed to the New Economy, if you will, what was happening was that energy prices had broken out of their ten-year slump and were on the rise (Figure 2), cutting into labor’s piece of the pie just as labor was going back to waiting tables. No doubt it was a fragile time and one needing nuanced and sophisticated treatment by fiscal and monetary authorities. Instead it got Alan Greenspan whacking it with the interest rate hammer, raising the cost of money even as the cost of energy was going up.

It may seem arcane now, but it was baffling at the time. Raising interest right into the teeth of the energy price hikes. The obviously correct response was to mitigate that effect on demand, not amplify it. Nevertheless, the Maestro was in charge and the interest rate hikes kept coming. That is, until the recession came into view. Then, panicked by deflation in the headlights, and mumbling unintelligibly, Greenspan hurried back down the interest rate steps. He did not stop at the ground floor, but carried the rates right into the basement, to record low territory, desperate to stimulate the economy back above stagnation.

Meanwhile, the recession Greenspan engineered was just enough to chip block Al Gore’s ascendence to the presidency and allow the Supreme Court’s chosen George W. Bush to take over. The stimulation coming out of Greenspan’s new obsession with deflation, those low rates, led directly to the most serious financial crisis since 1929, the Great Financial Crisis beginning in 2008. The Great Financial Crisis. The GFC, as it played out under new Fed chair Ben Bernanke, led to the dominance of Big Money over government economic policy. But that’s more of a story for Part II. Here we simply wanted to illustrate how demand side economics works and the Neoclassical orthodoxy doesn’t, and how the Fed has been complicit in creating problems.

The Fallacy of the Interest Rate Button to Control Inflation

Before we leave this, a few words about using the interest rate button to try to affect inflation and deflation. First, that button does not work as advertised. Second, such a crude approach is just an excuse to serve the interests of the banking sector. Rather than regulate the financial sector, the Fed actively employs itself in protecting and enriching the already rich.

How is the interest rate supposed to work to dampen inflation? As I understand it, raising the target rate makes borrowing more expensive and thus discourages investment. Investment goods is that part of the economy that produces jobs and income but not (at least initially) product. So investment goods workers are providing effective demand without providing something to buy, and when that demand is added to the demand from workers who ARE producing consumer goods, the effect is to bid up the prices of consumer goods. This is demand-pull inflation. The rationale seems to be if you discourage investment, often phrased as “tamping down on an overheated economy,” just enough, you discourage the extra demand and reduce pressure prices.

However plausible in theory, there are problems. One problem is it does not work. Half the time or more inflation is not caused by this pull of excess demand from investment goods labor, but by the push of prices of inputs (primarily energy) or by constrictions in the market (think monopoly control, supply chains, failed crops, etc.) This is cost-push inflation.

As easy as it is for the reader to understand cost-push and demand-pull inflation from just reading the preceding paragraphs, it is beyond the Fed’s competence to comprehend. I kid you not. They cannot discern the difference between the two, so they treat all inflation – no matter the cause or context – with the same mechanical response, the interest rate button. So Greenspan was raising rates BECAUSE of rising oil prices. Seriously.

Some will justify the effectiveness of the button by pointing to the tremendous interest rates authored by Paul Volcker in the 1970s that supposedly tamed the inflation of the 1970s. No. Oil prices dropped. Maybe they dropped because demand was crushed by the severe recessions of Ronald Reagan’s first term. But the inflation fighters were the millions of unemployed, not Paul Volcker and his double digit rates. It was like eliminating the disease by killing the patient. Not a success.

The interest rate button and the shoddy reasoning behind it is not forced because there are no alternatives. There are. It is just the one that favors Big Money. In fact, before Paul Volcker, other tools WERE used to moderate inflation pressures. The Fed and President can and did restrict the amount of investment lending directly. They did so routinely under every president prior to Nixon. Banks can be directed to channel lending to some sectors and not to others. It was done. The President can jawbone – negotiate with actors – like Kennedy did with unions and Big Steel back when the US was the manufacturing center of the universe. If the actors renege – as Big Steel did – the government is not powerless to coerce compliance – as Big Steel found out.

A market-based approach would be to allow the investment to proceed to and to endure the demand pull inflation until completion and then watch prices fall as new production comes on line. This is what happened under Biden, and made the Fed’s ponderous puppet show of raising rates in 2022 entirely meaningless.

In the cases where inflation is pushed up by oil prices, the President can use the strategic oil reserve to release supply and reduce those prices. Both Biden and Clinton did this. Another method that is not indicated today, in this era of such grotesque income disparity, is one Lyndon Johnson used – a tax hike. In Johnson’s case a 10% income tax surcharge was enacted, largely without hysteria. Any tax hike in the present era should focus directly on the plutocracy.

Conclusion

I see we have gotten quite a distance from the subject at hand – which was: How the End of the New Economy recession was forecast. To recap, the call was based on watching the double whammy of higher energy prices and higher interest rates hit an economy weakened, but not knocked out, by the Dot-com bust.

Next time we’re going to explore the forecast for the GFC. This was the all-time epic miss for mainstream orthodox economics, and it’s a miss for which they have yet to provide a credible explanation. The GFC changed a lot in America, including the balance between the rich and the rest of us. It has, unfortunately, not changed the economics.

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