Double bubble, toil and trouble

Stock markets started 2003 in a relatively buoyant mood. The view seemed to be that the world economy would come out of a soft patch, that the Bush administration would deliver tax cuts that sustained US consumer spending and that war in Iraq would go smoothly and quickly, slashing oil prices.

The argument goes that the US recovery will be slow but sustained. Employment won't grow much but incomes will, helped by tax cuts and productivity gains. The American consumer will keep on spending. Deflation won't happen. Capital expenditure will kick in. Profits will grow slowly but reported earnings will boom as write-offs become history. So stocks are cheap by measures incorporating risk-free interest rates and by some that don't.

The problem is that this view assumes that the big imbalances of the US economy either don't exist or won't be corrected over the next cycle. I have trouble with this. The...