Saturday, February 13, 2016

Can Markets Cause a Recession?

The idea that declining stock prices can adversely affect GDP is not a topic discussed in a University classroom.  Asset prices live in their own world in academia and do not interact with the real economy.  However....

The recent stock sell off seems to have changed the mood.  If folks get gloomy because their stock holdings are losing value, does that affect consumer decisions and business decisions.  If so, how?

This issue arose in 2008.  Bank stocks collapsed even though their balance sheets, as we now know, weren't really deteriorating.  Instead, a lack of confidence in the repo market froze out Bear Stearns and then Lehman Brothers and then boom.  It was essentially a lack of confidence that led to a run on the bank.

The proper corrective, which the market would have happily supplied after Lehman, Goldman, Morgan Stanley, perhaps Citibank  declared bankruptcy, was for the new owners of Lehman, Goldman, MS, and Citi -- the bondholders -- to figure out some sort of emergency backing facility in the event of a failure of confidence in the repo market.

Instead of letting the market deal with this, the politicians entered the fray and Dodd-Frank and massive regulatory encroachment put the financial system is a box from which it cannot recover.  It was equivalent to declaring that in order to stamp out traffic accidents, you outlawed all motor vehicles.  That did the trick.  But, no doubt, there are side effects.

Now, we are there again.  A market decline is scaring folks in the real sector -- not just in America, but globally.  When this happens, things like the anti-capitalist political regimes in the US and Europe begin to be exposed and the economy begins to falter.  That's what is happening.

The euphoria of rising stock markets is gone and not coming back anytime soon.  The underlying economics of stagnant economic growth do not suggest that assets are becoming more valuable. They are becoming less valuable.

Rising stock prices and a booming oil industry provided what little stimulus the economy has had for the past seven years.  So much for that.

Now, the harsh realities of over-regulation, deficit spending out of control, a hobbled financial sector and a Hugo-Chavez political dynamic are taking over.

Yes, falling stock markets can cause problems for the real economy.  Combined with foolish government policy, falling stock prices could signal real danger ahead for the global economy.

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