Calm down about the stock market, and remember 1987 : LUSENET : TimeBomb 2000 (Y2000) : One Thread

I am an economist. Let me teach you a few little-known things about the stock market.

First, it is much less important to the overall economy than you might think. Sure, everyone is obsessing over it now. But the fact is that less than 2% of new business expansion is financed through the stock market. Almost all the activity on the NYSE and NASDAQ is simply a shifting from one asset to another. Granted, the ability to do that is an important support of the real economy, but is hardly a determinant of its overall direction.

Are you thinking about 1929? It is almost universally believed that the stock market crash of that year "caused the Great Depression." But actually it didn't. THE STOCK MARKET HAD LITTLE TO DO WITH THE GREAT DEPRESSION. Economic activity in the U.S. was falling months prior to the crash. We slid into a quite ordinary recession, which lasted until March 1931. Only then, with several bank failures unrelated to the stock market, did the Depression really begin. The major cause was the cascading wave of bank failures that reduced the U.S. money supply by 30% in less than two years. The Federal Reserve, to its shame, could have prevented the collapse but did not. This is not the place to go into why it failed to act, but you can bet they are not going to let that happen again.

Find this hard to believe? Then let's take up a matter than the 1929 people hate to think about: October 19, 1987. On that day, the NYSE crashed more than twice as badly as it did in 1929. Remember? The Dow fell 508 points that day, which is the equivalent of about 3,000 points now. Imagine the Dow falling to 8100....tomorrow! Yet what was the real aftermath? Virtually nothing; it was hardly a blip in the cyclical expansion of the late 1980s. One reason is that the Fed, unlike 1929, was in there with panic control the next day. It's exactly the same story as the Fed's response as to Y2K: it pumped reserves into the banking system that were largely held as "excess" and did not blow up the money supply or reignite inflation. (Yes, M3 has risen rapidly lately, but that is a poor money supply measure.)

More importantly though, CONSUMER SPENDING IS LARGELY UNAFFECTED BY EVEN SHARP TURNS IN THE STOCK MARKET. The overwhelming evidence is that consumer spending is based largely on longer-run considerations, such as what income and wealth are expected to average over a term of many years. (Why else do young people borrow to go to college or buy a house that is several times their current income?) It is estimated that the $1 trillion loss in stock valuation on that single day in October 1987 lowered consumer spending in the end by no more than $40 billion.

-- Unreel (, January 06, 2000



Tell it to the Japanese.

-- Me (, January 06, 2000.

Me, that was a good point. But it looks like Unreel's quote is accurate for the US market.

The Japanese psyche is far removed from our addictive wanted-it- yesterday culture.

-- Hokie (, January 06, 2000.

Thank you. This is very reassuring, frankly. I would like to think that the stock market can lose ground without shaking us to our roots. I appreciate this information--interesting, too.

-- Mara (, January 06, 2000.

In 1987 there was not a pervasive feeling of a market bubble, financial mismanagement and string pulling, a federal government out of control, and controlled news releases, and a bit of an expectation of impending problems. The results of a major "event" will be different given the psyche of the populace at the time.

-- REvans (, January 06, 2000.

I'm not an economist, but I do remember 1987 vividly. REvans makes a good point -- there were few doubts about the underlying strength of the economy. Also, people today play down the role that program trading had in that event -- brokers' computers automatically sent sell orders when individual stocks dropped to a particular level, based on customer instructions. Each sell order triggered another drop, which triggered more sell orders etc. etc. Those programs have been changed since then. Also, remember that Reagan was president and Bush was set to succeed him. The Republican PTB were in no way going to let the Crash of 87 dominate the Reagan legacy or spoil Bush's ascendance to the throne. Buy orders flooded the market within two days of the final floor. It was the beginning of the now far more sophisticated Plunge Protection Team strategy, and it held off the recession for two years.

-- Cash (, January 06, 2000.

Cash and Evans: Think back a little harder about 1987. Were we confident then, relative to today? In 1987 unemployment was about 6.5% versus 4.1% now; the federal budget was running $200 billion annual deficits versus $100 billion surpluses now. And there was a lot of "bubble" talk as the DJIA was soaring to 2200.

And what could be more confidence-building than today's combination of 4% unemployment and 2% inflation? That's a mix most economists did not believe possible for the U.S. economy just a few years ago. And I admit that includes me. It points strongly to high gains in productivity -- the best possible economic news.

-- Unreel (, January 06, 2000.

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