Three times in the last fifteen minutes of stock-market trading today, the Dow Jones Industrial Average was down 500.00 points. It never actually broke below that level. I thought of it as the smallest of blessings. Then the ticker caught up to the actual trading of shares, and the Dow finished down 512. So much for the small blessings.
We've been talking about the incredible overvaluation of the stock market, and about the gradual erosion of the bullish case for so long now that it's hard to think of what else there is to say in the wake of a day that saw the Dow and the Nasdaq both fall well below where they were when the year began. But the one thought does come immediately to mind: Now we really will find out just how important the wealth effect has been to the U.S. economy.
Americans' personal saving rate, after all, has dropped in the last couple of years to near zero, in no small part because the stock market's seemingly unstoppable rise has done Americans' saving for them. Simultaneous with that, Americans have been spending like drunken sailors about to go off to war. Even as real incomes have begun to rise, consumer spending has outpaced that increase by a considerable amount. Most Americans still have no direct tie to the stock market (in the sense that they neither own stocks themselves nor do they have pensions that are invested in the market). But those Americans who do have a direct tie to the market also have a disproportionate impact on the consumer market (since personal income is so unevenly distributed in the U.S.) And it's those Americans who have just seen hundreds of billions of dollars in imagined wealth disappear in the past week.
Those billions were, of course, imaginary, in the sense that if everyone who owned stocks tried to turn them into cash their value would immediately plummet, which is in one sense what happened today. But then credit itself is sort of imaginary, and to the degree that stock-market wealth encouraged Americans to spend, it represented the kind of expansion of credit that tends to fuel economic growth. Unfortunately, it may also have represented the kind of expansion of credit that tends eventually to lead to an over-expansion and then a crash.
If Americans were suddenly to cut up their credit cards and hunker down and begin saving, that would be a logical response that would nonetheless have recessionary implications. But it's still too early to expect Alan Greenspan to step in and lower interest rates. And the stock market has been driven so high in recent years that even with this steep dive the rate of growth in the value of stocks in the 1990s is still at historically unprecedented levels. If investors are able to recognize that, and think of how rich they are compared to what they were in 1992, as opposed to how poor they are compared to what they were in July of this year, then the market tumble may have a negligible impact. If investors focus instead on how much they've lost, then a spillover into the real economy is likely.
The stock market is, as we've said many times before, only a proxy for the economy as a whole, but it is both an imperfect proxy (in the sense that valuations do get out of whack) and it is a proxy that affects the economy when investors come to treat it as a source of genuine wealth-creation. Real wealth is only created by the transformation of time and resources into products and services. It's not created by the perpetual re-valuation of pieces of paper. Insofar as the last three years have seen us build a pyramid founded solely on that perpetual re-valuation, the last week has been a welcome wake-up call. But you do have to hope it's not a call that came too late.