So what's wrong with that?

Extending expansions long beyond their bedtime eventually produces a very tired economy. Consequently, when a weary economy finally turns in for a rest, it crashes. We've enjoyed a long run, true, but we've paid a price for it that will come back to bite us.

The price we pay is the accumulation of what Mr. Greenspan calls "imbalances" -- a euphemism for dangerous conditions such as overvalued stocks or too much debt. When these imbalances grow exceedingly large, they undergo forcible corrections in the process of "rebalancing," and the economy suffers: stock markets crash and lenders experience defaults and delinquencies, for example, causing the economy to contract.

As the U.S. economy has expanded over the past decade, we have accumulated five major economic imbalances. We have:

1. Printed too much money since 1995, to fund the chairman's rescues.

2. Become exceedingly dependent on oil from unstable parts of the world. (More than half of U.S. oil needs are met by imports. For the first seven months of 2001, OPEC furnished 28.4% of oil consumed in the U.S., of which about half came from the Middle East.)

3. Bid up prices of common stocks to unrealistic levels of valuation (S&P 500 price-to-earnings ratios in the mid-30s in 1999, compared to a more normal 15, and dividend yields below 1.3%, compared to a more normal 3%).

4. Burdened consumers with too much debt. (As a percentage of disposable income, mortgage debt climbed to a record 69%, compared to 59% in 1991, and consumer credit rose to a record 21.5%, compared to 16.4% in 1992.)

5. Given too many dollars to foreigners in exchange for imports. (Trade deficits are more than twice as high as they were when the dollar suffered a 50% devaluation beginning in 1985.)

The creation of these imbalances begins with "printing" too much money in repeated efforts to stave off the normal ebb of the economic cycle.

In truth, the Fed doesn't actually print money; it just adds new reserves to the banking system by buying U.S. Treasury debt instruments with newly created money, per the instructions of the Federal Open Market Committee chaired by Mr. Greenspan. The new money is, in effect, nothing more than a series of bookkeeping entries between the Fed and the banks. However, it spends just like the folding green, and that is the point. Once it is in the banking system, the new money will be either spent on goods and services, or invested. So far so good, as long as the money supply expands at about the same rate as the economy.

However, when the Fed prints more new money than there are new things to spend it on (as in recent years), prices go up, and you get either consumer price inflation or asset inflation. For example, print too much money and investors may drive up stock prices to unrealistic levels of valuation: asset inflation. The positive "wealth effect" from stocks, added to the ready availability of credit from a banking system flooded with reserves, prompts consumers to overspend, leading not only to consumer price inflation, but also to huge trade deficits and excessive consumer debt loads. High stock valuations, coupled with strong consumer demand, also encourage corporations to take on excessive levels of debt.

The weight of each of these imbalances can disable major parts of the economy when they unravel. History teaches us that these imbalances eventually "rebalance." As the imbalances are corrected, bad things happen, and indeed, have been happening for the past year. For example:

Too much money creates asset inflation and/or consumer price inflation. We saw unprecedented asset inflation in the stock market develop between 1995 and 2000 as P/E multiples skyrocketed into the high 20s for the Dow and into the mid-30s for the S&P 500, while dividend yields dwindled into insignificance (see Figure 2). History teaches us that the steeper stocks rise, the deeper they fall, as the Nasdaq demonstrated over the past year and a half (see Figure 3). We saw the resurgence of consumer price inflation beginning in January 2000 when the 12-months-trailing consumer price index climbed above 3% and stayed there until just recently.

Oil dependency leads to high oil prices, as sustained growth in oil demand eliminates the surplus of deliverable oil. High oil prices create inflation and siphon resources from consumers, thereby discouraging domestic personal and corporate spending and depressing stock and bond prices. We saw this happen when oil prices climbed from $10 a barrel into the mid-$30s beginning in 1999, adding to the resurgence of inflation, higher interest rates and lower stock prices in 2000. There could be more to come if Middle Eastern tensions reach the point where oil supplies from the region are cut off, given the growing U.S. dependency on foreign oil.

Overvalued stocks lead to stock market crashes, wiping out savings and thereby prompting cutbacks in consumer and business spending. We have already had a taste of this "loss-of-wealth effect" on consumer spending as a result of the Nasdaq crashing. If the Dow follows suit, as seems likely, sagging consumer spending will be further depressed. Crashing stock prices also led to the major cutbacks in business investment in plant and equipment that began in late 2000. We've seen devastation in the tech sector, following the crash of the Nasdaq.

Excessive debt leads to defaults, bankruptcies, credit crunches and cutbacks in consumer and business spending. We are seeing the early consequences of excessive debt; bankruptcies have skyrocketed and delinquencies are rising. Consumer confidence has sagged, and consumers have virtually stopped borrowing in recent months, dragging down the growth in consumer spending. These signs, coupled with the pall cast by the attack of Sept. 11, point to further significant retrenchment in consumer spending.

Overvaluing the dollar eventually leads to a "flight from the dollar," producing a devaluation of the currency -- as in Mexico in '95, Asia in '97-'98, for example -- causing interest rates to rise, stocks to crash and the economy to contract. We haven't seen a dollar devaluation yet, despite soaring trade deficits. The reason for that strength is that international investors, while fearing U.S. economic weakness, fear weakness in Japan and Europe even more. Consequently, their strong demand for dollar-denominated investments has supported the dollar. However, in the wake of Sept. 11, the dollar has been wavering. Devaluation of the dollar is likely to be the last domino to fall.

Unfortunately, the effects of one imbalance tend to exacerbate others. Here's how they all tie together: Since 1995, by increasing the money supply (M2) at rates well above the 5% upper limit of its target range (and above the growth rate of the economy), the Fed pushed stock prices up to unrealistic levels of valuation, setting the market up for a crash. (Ironically, as he fueled the spectacular bull market with floods of new money, chairman Greenspan famously questioned its "irrational exuberance"!) Printing too much money also rekindled consumer price inflation, pushing up interest rates in 2000.

Likewise, oil price hikes in 1999 and 2000 aggravated inflation, which added to the upward pressure on interest rates and sent the overvalued stock market into a tailspin in 2000. The plunging Nasdaq decimated business spending in the tech sector. In addition, the combination of high interest rates and falling stock prices in 2000 crushed consumer confidence and spending, which then forced additional cutbacks in industrial production and business spending. Production cutbacks triggered layoffs, which caused consumers to trim spending even more, creating a downward spiral between consumer spending and production since the second half of 2000. The accompanying rise in unemployment, combined with the loss-of-wealth effect from the crashing stock market, triggered a surge in debt defaults, prodding banks to trim lending, resulting in the beginnings of a "credit crunch" that further depressed economic activity.

A sagging U.S. economy is depressing other economies around the world dependent upon exports to the United States. Economic deterioration in the U.S. may eventually cause foreigners to lose confidence in U.S financial markets. Consequently, they will be inclined to dump their dollar-denominated investments, which will further depress U.S. stocks and bonds, and put upward pressure on interest rates, adding to the U.S. economic malaise. So, you don't have the weight of just one imbalance to deal with, but rather the accumulated weight of all of them tumbling in succession like dominoes.

Ironically, the economy's present vulnerability to a serious recession derives from the Fed's single-minded pursuit of perpetual prosperity. If monetary policy remains neutral, with the money supply expanding at about the same rate as the economy, inflation will remain under control and the economy will expand and contract in normal business cycles typically lasting about four or five years. Imbalances built up during the expansion phase of the cycle will largely be rebalanced by manageable corrections during the contraction phase. Just as breathing requires not just inhaling life-giving oxygen but also exhaling toxic carbon dioxide, so too do economic cycles require recessions to correct excesses build up during expansions. Debt is reduced by repayment or default, stock prices retreat to more normal levels of valuation, the currency is devalued and trade deficits turn into surpluses. Without these healthy corrections, imbalances continue to grow, eventually becoming so immense that they overcome all attempts at monetary or fiscal stimulus, and a crash results. Consequently, the unintended effect of the Fed's policy to promote perpetual growth is to trade a series of small, manageable recessions for one big one at the end of a long super-cycle.

Before Sept. 11 the economy had reached the point where immense imbalances were starting to overpower the Fed's aggressive monetary stimulus, and the economy bordered on recession, much to the surprise of mainstream economists. Now the added weight of the consumer pullback triggered by the Sept. 11 attacks seems to have pushed the economy over the edge into recession.

The Fed now faces an unpleasant choice. It must decide whether to ratchet up the monetary expansion even further in an attempt to revive the economy (which will surely rekindle inflation without restoring much vigor to the economy as long as the imbalances remain uncorrected) or moderate the expansion of the money supply (which will help dampen inflation while allowing the recession to correct the imbalances). The latter alternative, while more painful initially, would nonetheless speed the process of correcting imbalances and set the stage for sound, sustainable recovery sooner rather than later. Arguing in favor of a salutary recession, however, is about as popular in Washington today as was Galileo's view of the heavens in 17th-century Rome.

For strategic and political reasons in the aftermath of Sept. 11, the Fed probably will feel compelled to prop up the ailing U.S. economy with a flood of new money, regardless of the inflationary consequences. Monetary statistics after the attack confirm this conclusion. In the week following the attack, M2 was up a staggering $164.5 billion, an annualized 13.7% rise. Continuing such aggressive monetary stimulus would delay the rebalancing process, leaving the economy wallowing in stagflation for an extended period of time, weighed down by excessive debt, overvalued stocks, inflation, relatively high long-term interest rates and an overvalued dollar. Such monetary stimulus ultimately becomes self-defeating, since floods of money aggravate inflation and push up long-term interest rates, dampening economic activity and depressing stock prices. So don't expect another "soft landing" to restore the Goldilocks Economy. Eventually, the rebalancing process will not be denied, leading to a serious, possibly cataclysmic economic contraction as the resolving event of the current economic super-cycle engineered by the Fed.

Needless to say, this outlook implies a highly defensive investment strategy, avoiding stocks to preserve capital. With money market instruments yielding around 3%, this is a message most investors don't want to hear. Nevertheless, bearing in mind the Chinese definition of a crisis as the combination of danger and opportunity, contrarian investors who ride out the crisis in the safety of money market instruments will find themselves amply rewarded with opportunities to buy stocks at fire-sale prices when fear grips the market and today's bulls become bears.

It's worth remembering that the greatest opportunity in the 20th century to buy stocks was at the bottom of the market at the depths of the Great Depression in 1933, when the Dow was selling at roughly 12% of its 1929 peak. Stocks quadrupled during the next four years -- a compound annual rate of growth of about 41%. Clinging safely to the sidelines at a time of crisis could just be the most valuable information you can get and the most expensive advice to ignore.

Economist and market strategist David L. Smith, of Kingwood, Texas, is the author of Cyclical Investing Reports. He can be reached at davidlsmith@iname.com.