The twin events of September 11 and the bursting of the 1990s' economic bubble -- as their effects unfold -- may be deeply reshaping American public opinion and public policy in a manner now but dimly perceived. The political effects of Sept. 11 were fairly obvious in the last election cycle, where they weighed more heavily on voting decisions than did the economy. President Bush's leadership on the terrorism front (which includes the wars in Afghanistan and Iraq as part of the broader war on terrorism) continues to provide him buoyancy. The rippling diplomatic and military changes that September 11 (and Mr. Bush's actions thereafter) has put in motion are reshaping the international community and America's sense and definition of national security. So far, the loyal opposition has not conceived a politically and substantively plausible alternative policy with which to confront the president, so he is likely to continue to politically benefit from this one-sided national issue. But the political and policy effects -- if any -- of the burst bubble has yet to become the topic of much public discussion.
Politicians and commentators have not yet thought to analyze the political effect of the burst bubble, I suspect, because economists have not yet discerned the economic effect. This is a tricky business, because there may be no special effect. The economy may just be sluggishly recovering from a cyclical downturn. If so, the conventional policy prescription of fiscal stimulus -- combined with the natural recuperative rhythm of the economy -- will at some point in the next year yield sustained growth, lower unemployment and higher profits. If that is what we are experiencing, then the political impact of the economy will be routine and predictable.
Following that assumption, the only major difference between this and past recoveries would be the higher rate of public stock ownership. During the Reagan years, about 15 percent of the public owned stock -- thus few voters cared deeply about the level of the Dow. Now about 60 percent (and over 70 percent of likely voters) own stock, making the lost wealth effect of a depressed equity market a more cogent political fact. But hints of evidence -- admittedly ambiguous and inconclusive -- are emerging that suggest that this is not a normal recovery, but rather that we are only partway through the singular economic effects of a burst bubble. If that turns out to be the case, then conventional policy and political calculations will have to be discarded.
In its simplest terms, an economic bubble is a sustained and ever-heightening increase in the price people are willing to pay for something -- beyond its natural and sustainable value. The ever-higher prices seem reasonable even to normally rational purchasers. For mysterious reasons or quirky events, the moment comes when -- suddenly -- purchasers are disabused of their delusions and refuse to pay the irrationally high prices. The mania ends, and prices begin to go down until -- for whatever reason -- the markets decide that the level of real value has been reached. At that moment the bottom of the down side of the burst bubble has been reached, and regular economic activity can recommence.
The question of the moment is whether stock, real estate and other inflated prices have returned to that natural point -- or if they have further to go down. And if they have further to go down -- how much further? The greatest danger of such a process is that as prices for such inflated assets go down, they may induce a general deflation of the value of the currency, which tends to have a contracting and deadening effect on most economic activity. The two most conspicuous examples of a burst bubble leading to deflation and contraction of the economy are the Great Depression of the 1930s and Japan's contraction, which is now entering its second decade. These examples are imperfect comparisons to the present conditions, but are suggestive of what may be in store for us -- though one hopes at a much lower magnitude of economic pain.
Whether this actually happens cannot yet be known. But Federal Reserve Bank Chairman Greenspan's announcement last week that deflation is at least a possibility puts the question on the table. And his concern is punctuated by the consistently overly optimistic economic predictions of both the government and most private sector economic panels over the last many months, as well as by the gloomy assessment of leading CEOs that they anticipate continuing further layoffs and cost cutting -- rather than new capital investment -- for the foreseeable future. Tax cuts are almost always a good idea. They would be particularly useful during a deflation. But President Bush would be wise not to overpromise a growing economy soon as a result of his tax cut plan. If we are in for an economic storm, tax cuts may help keep us afloat, but are unlikely to be strong enough to bring us quickly to safe harbor. Neither Republicans nor Democrats seem prepared yet to propose the policy or play the politics of deflation.