The U.S. has been increasing in global economic importance

Economic decline has accelerated as a result of failed economic policies.

A Critical Assessment

The End of Affluence: The Causes and Consequences of America's Economic Decline, by Jeffrey Madrick. In this 1995 book, the author says American productivity is in irreversible decline, and he predicts that disputes over affirmative action, immigration, welfare reform, Social Security, environmental policy, and health care will lead to social chaos.

Facts

The U.S.'s share of global GDP is higher today than 12 years ago. After declining from an estimated level of 75% of the world's GDP at the end of the Second World War to 25.1% in 1995, it--amazingly--increased to over 27% in 2006. What's so amazing about this small increase?  The U.S. was--against the odds--defying the trend experienced by other developed nations which lost almost a full ten share points during this time period, from 53.2% to 43.9%. Developing economies increased from 21.7% to 28.9%. The biggest share losers were Japan, France, and Italy.⁵

      The U.S. is also ranked number one in competitiveness by the World Economic Forum, a Switzerland based think tank that grades 131 countries in 12 categories, including the quality of institutions, infrastructure, innovation, and macroeconomic stability. America's number one ranking is due, they said, to innovative companies, efficient capital markets, and a flexible workforce.

Assessment: When Perception Becomes Reality

One thing that politics and the financial markets have in common is that "the perception of reality" tends to become reality. In 1996, Alan Greenspan, then chairman of the Federal Reserve Bank and the nominal guardian of the U.S. banking system, said in a speech on central banking that the equity markets were "irrationally exuberant" and had separated themselves from reality.

       Despite that observation, the markets continued even higher for nearly five more years before eventually dropping. Literally hundreds of billions of dollar were made by those who stayed "irrationally exuberant" until the third quarter of 2001. In 2002, under intense pressure from current events and other factors, the market finally collapsed.

      When Greenspan made those remarks in 1996, the NASDAQ index of stocks was at 880.In 1999 the NASDAQ had traded as high as 4700, which was a gain of 430%. The momentum was strong, and perception was reality. By October 2001, the NASDAQ was trading down, at 790, a five year drop of 10%. The market psychology was based largely on hype; however, it remained real and very strong for a while. But eventually the reality shifted, and the facts had to rule.

      In politics, if enough people believe in a politician or a political theory they can make that belief a reality by putting those people or ideas into positions of power. Whether that belief gives you Adolf Hitler, Soviet-style communism, or Richard Nixon does affect the reality. But if the facts are that the perception is wrong, the reality they've created will eventually adjust to truth. In that case, a dictator like Adolf Hitler will self destruct, communism will fall on its own sword of economic inadequacy, and Richard Nixon's inability to play by the rules will eventually destroy him.

      In early 2008, Bear Stearns, an investment bank that had been around since 1923, was put out of business by fear of what might happen. Jimmy Cayne, the company's chairman, saw his $1 billion of stock fall to a value of $20 million. Alan Schwarz, who had become president in 2007, watched his company simply disappear. What happened was a typical "run on the bank." Banks and investment banks have hundreds of billions in securities on their balance sheets that are funded on a day-to-day basis. They are secure but highly leveraged entities. Even with plenty of equity, careful risk controls, and a solid record of profitable business dealings, the day the bank can't finance their daily position in securities markets is the day they are effectively out of business.

      I know that personally. In 1991 when I was a managing director for the investment bank Salomon Brothers and running one of their European businesses, the company endured a near-death experience. A group of Salomon Brothers traders in New York had conducted illegal activities to profit from a U.S. Treasury Bond auction. They had successfully made dozens of millions of dollars by the activity, but were eventually caught.

      An indictment of the firm would have shut down the entire multi-billion dollar company. The market responded immediately and, because of the potential risk involved, funding for the company dried up. Quick action and support encouraged by the Treasury and the U.S. Federal Reserve saved the company. But, because of just a few people in one location, a global, multi-business American financial standard bearer almost disappeared. Once again, the perception of weakness became reality.

       Markets go up and down, and the business cycle continues. Dynamic, growing capitalism creates what the Austrian economist Joseph Schumpeter called "creative destruction." The markets become overly enthusiastic and over commit capital during optimistic cycles. Then they become overly negative and destroy good businesses during the down cycles. The good news is that this sort of volatility creates dynamism, with new winners and better opportunities in each cycle. As the old joke goes, the stock market has completely and accurately discounted six of the last three recessions--meaning that the market often mystifies the naysayers. Despite the prophets of doom on Wall Street and beyond, the economy in the first decade of the twenty-first century remains stronger than many people think, and with some perspective we can see that fact. Whatever the current emotional state of the financial wizards and the 24/7 financial news analysts, the economy remains strong, and America is still number one.

      If Joseph Schumpeter was right and the cyclical nature of the markets creates positive momentum, we will see this positive long term impact eventually in the mortgage markets as well. The explosion of sub-prime lending over the past several years has put many homeowners at risk as they stretched to buy homes that were expensive compared to their income. News of a larger than normal number mortgages going into default as these homeowners ran into financial difficulties led predictably to the perception of accelerating weakness. The "creative destruction" that hit the markets at that point led to the destruction of a lot of bank capital; but after all was said and done, many people who could never have bought a home without a sub-prime boom ended up owning a home.

      Even in the midst of the turmoil, it's a safe bet that America will continue to move toward a higher ratio of home ownership in the months and years ahead. We don't know that for a fact just yet, but we can see that the underlying economy is strong, and that's a good sign. And what we do know is that, whatever the current weakness, over time American resilience will prevail. During the last seven years the American economy has outperformed the majority of developed countries, and that momentum is a sure sign of strength.

       --Dennis Keegan, author