3/15/2010 – Asset Bubbles & Government Stimulus

One of the important unknowns that investors must grapple with currently is when the recovery will become self-sustaining allowing the government to reduce fiscal and monetary stimuli. Japan has tried several times since their asset bubble burst in the early 1990s to reduce the government’s support. Each time the economy stumbled badly resulting in 20 years of economic stagnation. 

After the stock market crash of 1929 our economy responded to major stimulus and galloped ahead by 17% in 1934, 11.1% in 1935, and 14.3% in 1936. Over this period unemployment fell by 30%. Logically in response to this strong growth spending was cut back and monetary policy was tightened to improve the fiscal condition of the Federal government. The economy promptly stumbled into another downturn in 1937.

These experiences suggest that after an asset bubble it takes a long time and a lot of support before private sector growth becomes self-sustaining.