I cannot count the number of times I have had to explain, during a conversation over the U.S. economy (or any other government for that matter), that when I’m referring to “economies” being in trouble, I’m NOT talking about the frakking stock market. One “expert” after another always pops up with somrthing along the line of, “Oh there’s no reason to panic, and the stock market always fluctuates”. And every time I have to hold my tongue, because I want so badly to say, “NO SHIT SHERLOCK!”
Of course the stock market has fluctuations all the time that have nothing to do with the real economy. The most famous was the 1987 crash, which did not correspond to any real-world bad event that anyone could identify.
Even today, we are seeing the usual hysteria over the sharp drop in the markets in Asia, Europe, and the US. There should definitely be concern, but not over what the damn stock market is doing. The concern should be that from every corner of the earth, demand is evaporating.
Talking about the stock market when I’m expressing concerns over the evaporation of worldwide demand is tantamount to saying, “Don’t worry about global warming, it’s nice and cool here.”
Even over longer periods of stock market upheavals there is no direct correlation between the stock market and GDP. In the decade of the 1970s, the stock market lost more than 40 percent of its value in real terms; in the decade of the 1980s it more than doubled. GDP growth averaged 3.3 percent from 1980 to 1990, compared to 3.2 percent from 1970 to 1980.
Apart from its erratic movements, the stock market is not even in principle supposed to be a measure of economic activity. It is supposed to represent the present value of future profits. This means that if people are expecting the economy to slow down, but also expect a big shift in income from wages to profits, then we should expect to see the market rise. So there is no sense in treating the stock market as a gauge of economic activity–it isn’t.
Turning to this specific downturn, it seems clear that the troubles in China are the immediate cause. I’ve been saying for literally two years that China’s economy, has been built on one humungous bubble…including, but not limited to, a serious stock bubble. Its market rose by more than 60 percent from the start of the year to its peak in early June. At that point, it was more than 150 percent above its year-ago level. Even with the recent plunge, it is still more than 50 percent above the year-ago level.
It was inevitable that this bubble would burst; the only question was when. The collapse undoubtedly hurt some Chinese investors, many of whom recently entered the market, often with large amounts of leverage. The direct impact on the Chinese economy is likely to be limited; these people would not in aggregate have enough wealth so that any reduction in spending would hit the economy in a big way. But there may be a serious economic impact going on due, in part, to a political issue for the Chinese government, which “encouraged” people to buy into the market…to the point of “asking” the huge middle class (China’s middle class is larger than the U.S. entire population) to take out second and third mortgages to buy stock in order to save face internationally and prop up their flailing stock market.
And, contrary to the children’s tales about the purpose of the stock market, firms rarely finance investment through issuing shares. (The Internet bubble was an exception.) Shares are more typically issued so that early investors can cash out. So China’s investment is not likely to take a hit because of the market crash.
There is a larger issue for the Chinese economy about its ability to convert from an investment- and trade-driven economy to one driven by consumption (see: the U.S. market). This is not an easy task, and it would not be surprising if China finds it more difficult than they originally thought. I’ll leave it to people who are more expert than me to give odds, but we can say a bit about the impact on this switch (or its failure) on the US.
From the standpoint of the US economy, the main impact of a failed transition in China will be an increase in its trade surplus. A lower-valued Chinese currency will mean that it exports more and imports less. Also, slower GDP growth will be a drag on its imports. Let’s say that this effect raises its trade surplus by $200 billion above its baseline path, an amount equal to 10 percent of current imports.
If we assume that this increase in trade surplus is shared evenly between the US, Europe and the rest of the world, this implies an increase in the US trade deficit of roughly $70 billion. If we assume a multiplier on 1.5, that will reduce GDP growth over the next year by $105 billion, or a bit less than 0.6 percent.
A 0.6 percentage point hit to GDP is hardly trivial, but not the sort of thing that gives us another recession. I suppose the shift in China’s trade surplus could be even larger, but it is hard to imagine it would be too much larger.
It is also worth making a point that should be obvious: (And I’m not holding back this time….I TOLD YOU SO!) This is all a story of inadequate demand. In other words, our big problem is that we are not spending enough money. I know it would be wonderful if companies went on an investment spree, but this is not likely to happen, even if a Republican president and Congress give them all of our money. We may want consumers to spend more, but with savings rates at historic lows (the flip side of cheap money to borrow is no interest earned on savings), that will never happen.
This leaves only trade and government spending as potential sources for increased demand. The trick to improving our trade balance is a lower-valued dollar (and if that happens the gold-standard-idjuts will come crawling back out of the woodwork, screaming “Look what the Fed caused!!!). That’s a good long-term story, but hard to see much in this direction at the moment, with most other countries’ economies looking weaker than ours.
That leaves the big bad government: If we want more demand, it will have to come from the government paying for evil things like infrastructure, education, healthcare and green energy. But ask any Republican and they’ll tell you….”we all know weak growth and more unemployment is the better way to go.”
It’s going to be a rude awakening. I almost hope a Republican will be elected president so they can take the fall for their own austerity consequences, but hell, George W. Bush didn’t even allow the cost of his illegal wars to be included in his presidency’s budgets or CBO reports (I mean the man had the unmitigated gall to go to New Orleans on the Katrina Anniversary!!! and he screwed the pooch on that job so badly it’s still recovering…..THE MAN HAS NO SHAME AT ALL!!), why would I think the next Republican president would tell the truth about the economy or anything else?
Harvey A. Gold