The billions of people in the world who don't invest in the US stock market have one big concern about America's plunging stock prices. Will the puncturing of the stock market boom incite a crumbling of the US economy, one that will spread to the rest of the world? That question is vital, because many financial bubbles have, indeed, been followed by a collapse of output and employment.
We can only guess at the answer, but my guess is that the US will escape with only a modest slowdown. My optimism may seem misplaced in a period when the stock market falls nearly every day, and when other countries have historically seen stock market collapses incite economic collapses as well.
It also seems misplaced given the US' weak economic leadership. President George W. Bush recklessly put a tax cut for the rich above all other economic concerns. He is a protectionist, not a free trader. Now both Bush and Vice President Dick Cheney are under scrutiny for possible corporate misdeeds while they were in business.
So why am I moderately optimistic? Examining the links between the stock market and the rest of the economy may explain this.
During a stock market boom, when share prices are bid up high by strong investor confidence, the stock market helps create an overall economic boom. Consumers who own stocks feel richer, so they buy more. These same consumers borrow money on the basis of their stock market wealth, in order to buy new homes, cars, and other expensive items.
Moreover, companies find it easy to borrow or raise new equity for capital investments, thereby creating a boom in business investments. Banks lend on easy terms to households and businesses that own high-valued stocks, believing that stock market wealth is good collateral. To secure a "piece of the action," foreign investors pour money in.
When a stock market boom ends, and prices collapse, these patterns reverse. Consumption and investment fall. Foreign investors flee. Bank loans are tightened. These factors add up to an economic slowdown. It is likely that the US will now experience some measure of slowdown, as occurred in the recession of the past two years.
But two forces can turn a mild slowdown into a severe recession or even depression: stock market decline can lead to a full-fledged banking crisis, as occurred in Japan, Mexico, and most recently Argentina. Banks may find that they can't get repaid during a stock market bust. Banks may then face bankruptcy, and thus severely restrict new lending. In extreme cases, bank depositors fear for the safety of their deposits, and flee from the banks. Such depositor panic adds to the banking crisis; foreign investors may suddenly flee, as visions of easy wealth turn into financial panic. Suddenly the country is thrown into a balance of payments crisis, in which it cannot service its foreign debts. This disrupts trade and production.
My moderate optimism comes from my belief that the US will avoid both a banking crisis and a balance of payments crisis. Some US banks are likely to report large losses as a result of the stock market collapse. Yes, it is possible that the US dollar will keep losing value. But neither is likely to turn into a full-fledged crisis.
US banks still appear strong -- well capitalized, reasonably well supervised, and with only moderate levels of non-performing loans. As for debts owed to foreign creditors, the good news is that America owes money to them in US dollars rather than another currency.
The US won't "run out of dollars" to service its foreign debts, in the same way that Argentina or Korea ran out of dollars needed to repay foreign creditors during the past decade. The greenback may therefore lose value as investors flee the US, but probably without provoking a more serious crisis.
Remember too that the US can use expansionary monetary policy to offset, at least in part, any slowdown that arises. The Federal Reserve can continue to cut interest rates, if necessary. These interest rate cuts probably can't stop a slowdown from occurring, but they can help to ensure against a full economic collapse.
History's most famous stock market crash followed by an economic collapse began in 1929. America's stock market plunged in October 1929, and the US and much of the world then fell into a Great Depression. But that famous and disastrous era demonstrates the principles that I am stressing today.
The key reason for the Great Depression of the 1930s was not stock market decline, but the collapse of America's banking system that took place during 1930 to 1933. Since there was no deposit insurance in the US at that time, bank depositors panicked when some banks began to fail. That panic incited a widespread banking failure. Moreover, the Federal Reserve did not feel free to expand the money supply at the time because the US adhered to the gold standard.
My optimism shouldn't disguise my unhappiness at the US' poor economic management. The Bush administration's reckless tax cuts and protectionist trade policies should be reversed. Corporate abuses need to be exposed and punished. But in the end, the US economy is productive, flexible and highly innovative, and is likely strong enough to withstand recent irresponsible public and private economic management.
Jeffrey D. Sachs is Galen L. Stone Professor of Economics and director of the Center for International Development at Harvard University.
Copyright: Project Syndicate
Taiwan’s fall would be “a disaster for American interests,” US President Donald Trump’s nominee for undersecretary of defense for policy Elbridge Colby said at his Senate confirmation hearing on Tuesday last week, as he warned of the “dramatic deterioration of military balance” in the western Pacific. The Republic of China (Taiwan) is indeed facing a unique and acute threat from the Chinese Communist Party’s rising military adventurism, which is why Taiwan has been bolstering its defenses. As US Senator Tom Cotton rightly pointed out in the same hearing, “[although] Taiwan’s defense spending is still inadequate ... [it] has been trending upwards
The first Donald Trump term was a boon for Taiwan. The administration regularized the arms sales process and enhanced bilateral ties. Taipei will not be so fortunate the second time around. Given recent events, Taiwan must proceed with the assumption that it cannot count on the United States to defend it — diplomatically or militarily — during the next four years. Early indications suggested otherwise. The nomination of Marco Rubio as US Secretary of State and the appointment of Mike Waltz as the national security advisor, both of whom have expressed full-throated support for Taiwan in the past, raised hopes that
There is nothing the Chinese Nationalist Party (KMT) could do to stop the tsunami-like mass recall campaign. KMT Chairman Eric Chu (朱立倫) reportedly said the party does not exclude the option of conditionally proposing a no-confidence vote against the premier, which the party later denied. Did an “actuary” like Chu finally come around to thinking it should get tough with the ruling party? The KMT says the Democratic Progressive Party (DPP) is leading a minority government with only a 40 percent share of the vote. It has said that the DPP is out of touch with the electorate, has proposed a bloated
In an eloquently written piece published on Sunday, French-Taiwanese education and policy consultant Ninon Godefroy presents an interesting take on the Taiwanese character, as viewed from the eyes of an — at least partial — outsider. She muses that the non-assuming and quiet efficiency of a particularly Taiwanese approach to life and work is behind the global success stories of two very different Taiwanese institutions: Din Tai Fung and Taiwan Semiconductor Manufacturing Co (TSMC). Godefroy said that it is this “humble” approach that endears the nation to visitors, over and above any big ticket attractions that other countries may have
RSS