News Release: Faculty Experts, Finance and Economics

Apr. 15,  2009

Everything You Wanted to Know About the Economy But Were Afraid to Ask

Finance experts from Emory University's Goizueta Business School recently tackled questions from Emory Magazine readers about all aspects of the economy, from housing and retirement to boom and bust cycles.

The full article, and more economic coverage, can be found in Emory Magazine's 2009 winter issue.

Q: If bubbles and crashes are cyclical and (seemingly) inevitable, why do financial experts never anticipate them? Never mind accurately predict, but even expect the end of the latest expansion? Why is “this time” always different?

A: You seem to be asking two questions. The first is why experts can’t predict the timing of economic cycles. The answer is that no business cycle is like the last one, since the structure of the economy and exogenous events (say, weather or wars) are always changing. Until recently, a number of economists were arguing that the days of sharp economic cycles were gone forever!

Your second question seems to ask why experts (and others) often behave as though a downturn in the economy will never happen. Part of the answer to this question is connected to the first: if I don’t know when the end is coming, what am I supposed to do about it? Alan Greenspan’s famous “irrational exuberance” warning occurred in December 1996. If you had heeded his advice and sold then, you would have missed another 75 percent run-up in the Dow Jones Industrial Average. Like the clock that is right twice a day, his crash finally came in 2000—but the Dow still stayed above its level of December 1996.

—Assistant Professor of Finance Ray Hill

Q: I will be 65 tomorrow. In such a bad economy, I wonder about the merits of my selling a house vs. a “reverse mortgage” and staying here. The house is too large for me now. But should I wait out the turnaround we all hope for soon?

A: Have you considered renting? The rental market is really (really) heating up. People who would have been in a position to purchase a home are not having luck either selling their own home to acquire the equity needed to buy a new home or getting approval for loans—these people are turning to renting.

Obviously you understand that getting a reverse mortgage doesn’t help you unload the house—your responsibility to repay the “reverse” starts when you do sell the house. Given that the interest rates on a “reverse” are pegged to the rates of T-bonds (which are at or near zero), it is probably not a good time to use this instrument.

I recommend that you rent your house out, rent a smaller, more affordable condo, and talk to a tax accountant about the implications regarding the rental income. You might be able to take care of all your concerns—your house, a smaller living space, and some extra income.

—Assistant Professor of Finance Tom Smith

Q: Is it accurate for media outlets to speculate in real time why the Dow and NASDAQ rise and fall? They tend to attribute the rise and fall to other current headlines (political elections, U.S. automakers, past employment figures). It seems they are mixing up macroeconomic signals and microeconomic practices.

A: The media (and many stock traders) seem compelled to offer their audiences an explanation for every movement in the stock market indices. As you suggest, however, most of the time these “explanations” are simply unverifiable speculation about events that happened to occur at the same time as the rise or fall in the stock market.

Commentators usually couch their explanations in anthropomorphic language, as if the market was a single-minded person. Instead, the “market” is the sum of thousands (millions?) of investors, all processing information and forming expectations in different ways. When an event is significant, completely unanticipated, and its effect is obvious (say, the 9/11 attacks), the media’s explanations will probably be correct—but who needs an explanation from CNBC on those occasions?

—Assistant Professor of Finance Ray Hill

Q: How long do you think this financial slowdown will last? For baby-boomers who were relying on their investments in the stock market to help fund their retirements, and given the slowdown in the real estate market, what do you suggest now as investments for the coming years?

A: Most economists predict the slump will continue through 2009 with modest growth returning after that, but some of the worst-hit real estate markets may take longer to bounce back. Don’t be afraid to invest your long-term money in the stock market, however. Stocks have had a horrible year, but the stock market tends to improve before the rest of the economy, so you’ll miss out if you wait for good news.

A rule of thumb is to invest “100 percent minus your age” of your retirement money in stocks. If you are 60 and nearing retirement, you should have roughly 40 percent of your retirement money in diversified stock funds (with some exposure to international stocks) and the rest mainly in fixed income securities like bond funds. The idea is that at 60, most people will live for at least two more decades, and bearing the risk of stocks will provide added return in the years to come.

—Associate Professor of Finance Clifton Green

Q: Until recently we saw the U.S. dollar depreciate against the EUR, GBP and the JPY, among other currencies. The boost to exports resulting from a weaker dollar was considered one of the few opportunities to help the U.S. Recently, however, and perhaps as a result of the world financial crisis, the dollar has regained some of its value. What is your opinion regarding the strength of the dollar going forward and the impact that will have on the ability of the U.S. economy to grow by becoming more investment- and export-oriented, as opposed to mostly consumer-oriented?

A: The U.S. dollar fell in value at a strong and relatively steady pace from its high values from 2002 right up to September 2008. The weaker dollar meant that U.S. products, both goods and services, were now relatively inexpensive compared to the products produced by many of our trading partners. America gained competitiveness, boosting exports of products. Further, we could now better compete with imports coming into the U.S. market.
Importantly, U.S. exports were also boosted by a second factor—the increased demand stemming from rapid economic growth abroad, particularly in emerging markets (U.S. exports nearly doubled from the recession of 2001 until autumn 2008). This was a crucial spur to the American economy, as this increased demand for U.S. production offset the rapid decline in housing construction starting in the summer of 2006, enabling us to stave off recession until 2008.

Now, however, the crystal ball of U.S. exports is murky, at best. Recession abroad will curtail demand for U.S. exports. Roughly 70 percent of our Gross Domestic Product has been household consumption. Given the frightening job market and losses in both stock and real estate wealth, it is hard to see this sector restoring U.S. economic growth. The remaining solution is a massive fiscal stimulus package of government spending increases and tax cuts—it seems to be the one engine that can pull us out of recession. The good news is that, if this can spur U.S. economic growth, consumption and business investment will return to growth. Best of all, the U.S. can help lead the world to faster economic growth, and the beneficial growth trend in U.S. exports can resume.

—Associate Professor of Finance Jeff Rosensweig, director, Global Perspectives Program

Q: Everywhere you look, the cost of goods, services, and materials has risen during the past two years. Now with lower fuel costs that affect the transportation cost of the goods we purchase, will the mega-retailers, restaurants, and other companies reduce their retail prices or enjoy the additional profits?

A: If just fuel costs were going down, we might see lower prices and higher profits for retailers and restaurants. Since August of 2008, however, the consumer price index has either dropped or stayed constant each month so we have actually entered a period of general deflation (not just lower fuel costs). These declining prices are not an opportunity for higher profits in the retail and restaurant sectors (which are both highly competitive) but, rather, an indication that sales are down and their businesses are really suffering as we enter a recession. Rather than higher profits, we are seeing business failures in these sectors (e.g., Circuit City).

—Assistant Professor of Finance Ray Hill


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