Whew, am I glad that the stock market and the "new" economy are taking a beating! How mean of me to rejoice in your portfolio losses? Let me explain.

Am I glad that the US stock market  and the "new" economy are taking a beating!     Let me explain.

In February 2000, just before the stock market broke, I published a column in which I argued that there is nothing new about the "new" economy, and that the old economy works just fine. Similarly, I wrote, that the "old" laws of economics still hold, and that those who argue otherwise are sorely mistaken. Boy, was I ever right.

In short, the story is this: during the 1990s, we had several years of 30 percent annual growth in stock market valuations, far above the historical (i.e., average) 10 percent or so annual market increases. Therefore, a string of minus 20 percent years is what we "deserve". I am rounding off the numbers of course, but you get the point.

The only way that an above historical average return would have been economically justified is by means of increases in the underlying productivity of the economy. Productivity increases rely on commensurate increases in various forms of capital. These include human capital (e.g., education and work experience and skills), physical capital (e.g., investments in tangible plant and equipment), and social capital (e.g., properly functioning laws and law enforcement).

Measured productivity did indeed increase somewhat in the 1990s but not nearly enough to economically justify the stock market bubble. After all, while investment in physical capital boomed, human capital stagnated. In fact, the US continues to need to import many of its brightest people. And social capital, of which the Arthur Andersen accounting scandal is but one manifestation, collapsed.

Hubris drove the market, and an the economist is not surprised at the pull-back. Ultimately, stock market valuations must be in line with the so-called "economic fundamentals," that is with the underlying productivity of the economy and long-term profitability of its companies. For the long-term investor, such as myself, not much harm has been done. Still, economists have found that short-term gyrations of the sort we have witnessed do result in real economic losses because of the uncertainties these wild swings generate. (For example, uncertainty results in disproportionately high "protective" measures, and thereby underinvestment in the economy.) To prevent and mitigate such swings is the proper role and duty of the government's various supervisory bodies and agencies and that's one area where the country needs to shore up in the year or two to come.