End of the boom years: Trouble for boomers

Some of my recent blog posts have been about the growing disparities of wealth and income in this country. An editorial of The Nation magazine ("Time to Act on Inequality" 4/23/07) reported: "Income inequality is growing ferociously in America ... The top 1 percent of Americans are now getting the largest share of national income since 1928."

The citation of 1928 is of great interest. Income and wealth disparities tend to widen during long waves of economic expansion and peak just before a transition into a period of contraction. We know that the late 1920s was a major turning point for the world economy; the crash of 1929 inaugurated the Great Depression.

Unfortunately, a similar pattern is playing out now. The stock market volatility we've been seeing since 2008 is a consequence of the fact that the most recent long expansionary phase of economic and financial activity ended after the real estate bubble burst.

The financial markets generally trended higher between 1982 and 2007. In addition to widening income/wealth disparities, that expansionary period was (typically) characterized by increasing investor exuberance and risk-tolerance on a global scale.

But the long wave of "boom" started to turn toward "bust" four years ago. This is not good news for the baby boomers. Rising asset values during the years of expansion fostered the impression that the equity in their homes and 401(k)'s would fund an affluent retirement. Economic contraction is now jeopardizing that anticipation.

Financial markets experience long waves of expansion and contraction because there is a momentum of sentiment that affects generations of investors. Hyper-exuberance characterized the climate of the 1920s, leading to a boom and then the inevitable bust of 1929. During the Great Depression (1930-1942), stock investors were so burned over so long a time that a sentiment of fear and disdain became ingrained. The generation of investors that came of age during the forties was decidedly conservative, prone toward putting their money into bonds rather than stocks, and prone toward avoiding debt.

When investors are in a conservative mood they save more and invest less. With portfolios underweight in equities, stock prices will be low relative to their true value. At some point, as time passes and fear subsides, the high levels of potentially investable funds (savings) start to be committed to the markets in order to take advantage of the low stock prices. From a depressed level the stock market starts to move higher. This results in portfolio performance exceeding expectations . . . and the sentiment starts to shift.

As the expansion gains momentum, investors gradually lose their apprehensiveness regarding risky investments and debt. A self-reinforcing process is set in motion. Investors see that others are getting higher returns on stocks than on bonds. Most assets trend up in value, so leverage and speculation are rewarded. During such a period it pays, for example, to tap the amassed equity in one's home and use the funds to buy stock or even a second property for investment - because asset values are appreciating at a rate that more than covers the cost of the second mortgage.

Then the markets start to get "frothy" as accelerating positive sentiment and speculation push prices high relative to underlying value. This happens over a long enough period that a whole generation of investors gets used to high prices and fails to perceive the condition of overvaluation. A collapse then becomes inevitable. During the ensuing contractionary wave sentiment again reverses and asset prices tend to fall below their true value for an extended period of time.

There are short-term ups and downs in the markets, of course, just as there are short business cycles between recessions. But the long waves of expansion and contraction encompass time periods that correspond to macro-level shifts in generational sentiment. The stock market hit a peak of about 380 (Dow Jones Industrial Average) in 1929; lost almost 90% of its value at the lowest point of the Depression in 1932; continued to struggle for another ten years beyond that; and did not surpass the 1929 high point again until 1954.

The boom of the fifties and early sixties culminated around 1966. In real terms (adjusted for inflation) financial investments then sank for about sixteen years, hitting a low in 1982. The unusually high inflation of the time masked the fact that there was an "invisible crash" during the 1970s which was just about as damaging to investors as was the Depression of the 1930s.

During long contractionary periods the economy is plagued by high unemployment, problematic rates of inflation or deflation, currency crises, asset value depreciation, bankruptcies, and growing poverty levels. In the social arena there is resonance for a fundamental critique of the system. We saw that during both the 1930s and the 1970s. The latter was the period during which members of the baby boom generation came of age and were very active in movements for social change. But many ultimately became sanguine about "the system" as it rewarded them materially during their prime working years circa 1985 to 2005, years of expansion and (ultimately) high asset values.

Perhaps the boomers will become re-energized to work for social change in retirement. As the downturn accelerates it will again become clear that fundamental changes are badly needed.