The Bear Is Cool: Overcoming Fears of Falling Stock Prices
Source Dave Anderson
Date 08/11/24/23:50
The Bear Is Cool: Overcoming Fears of Falling Stock Prices
by: Dean Baker

THE STOCK MARKET'S HISTORIC plunge over the last year has pushed the
news media into a state of near hysteria. News shows and headlines
routinely roll out the scorecard on the market's new lows in the same
way they might list the victims of a terrorist attack. Sad faced
commentators do their best to assure us that better times lie ahead,
even if they can find little reason for hope in the latest economic

The economic data are indeed grim, but the plunge in stock prices
need not be a major cause of concern to the bulk of us who have little
or no stock. The basic story is that the stock market is paper wealth,
just like bonds, dollar bills or other financial assets. The strength
of the economy depends on its ability to produce goods and services,
not sheets of paper

Even though the stock market has fallen by close to 50 percent,
the economy still has the same capacity to produce computers and
planes, to provide health care and education, and to develop new
software and drugs. The economy is every bit as productive after the
market collapse as it was before the collapse.

The plunge in stock prices destroyed paper wealth (lots of it).
This is bad news for the relatively small group of people who had
considerable stock wealth. However, for the bulk of the population,
who own little or no stock, even including mutual funds in retirement
accounts, the decline need not be cause for concern, since it has
little direct impact on the economy.

While there is a popular myth about firms selling stock to finance
new investment, in reality the stock market has rarely been an
important source of investment capital. Therefore, there is little
reason to expect that the plunge in stock prices will have a
substantial direct impact on investment or the economy.

There can be a substantial indirect impact of the plunge on the
economy. People consume based in part on their stock wealth. Close to
$10 trillion of stock wealth has been destroyed in the last year. This
implies a falloff in annual consumption on the order of $300 to $400
billion. Unless this demand is replaced, it will amplify the drop in
consumption resulting from the collapse of the housing bubble.

But, we would be telling a similar story if the FBI had discovered
and destroyed 10 trillion dollars worth of counterfeit dollar bills.
This would be very bad news for the people who held the counterfeit
money. The destruction of these counterfeit bills would also lead to a
sharp falloff in demand. The people who had their counterfeit bills
seized would suddenly be much poorer, and therefore would cut back
their spending.

But the destruction of counterfeit currency need not hurt the
economy, nor does the loss of stock wealth. The key part of the story
is that the government must act to sustain demand. The most obvious
route to sustain demand at the moment is through a large stimulus

Unfortunately, the Bush administration refuses to take the
economy's plight seriously, but a large stimulus package will be the
first agenda item of the new administration when it takes office in
January. If President Obama commits the government to spending another
$500 billion a year, or more if necessary, it can offset the loss in
demand created by the fall in stock prices and the collapse of the
housing bubble.

Of course there will be other damage created by the loss of this
stock wealth. Most importantly, the plunge in stock prices has left
many public and private pension funds severely under-funded. The
federal government can temporarily allow for somewhat more liberal
accounting standards in the case of private funds and provide limited
support for state and local governments trying to keep their funds
solvent. We can ensure that retirees will receive the pensions they
were promised.

There will be other people who will be hit by the loss of stock
wealth, including tens of millions of workers with defined
contribution retirement funds. This is unfortunate and points to the
problem of the defined contribution pension system. Workers are forced
to bear risk to an extent they probably did not recognize and almost
certainly did not want.

One of the many items on the national agenda should be the repair
of the private pension system so that all workers have access to a
secure form of retirement savings. The plunge in value of retirement
accounts should be a painful lesson to tens of millions of
hard-working people that they should never trust Wall Street or the
politicians it owns.

However, the most immediate story of the market crash is that it
is a redistribution of wealth that goes overwhelmingly in the
direction of the less wealthy. The plunge has destroyed claims to the
nation's wealth by the very wealthy in the same way that destroying
$10 trillion in counterfeit bills held by mostly by the wealthy would
destroy their wealth.

The key point going forward is to use government spending to
ensure that demand remains strong. That way, the rest of the country
need not suffer along with the formerly wealthy.

Dean Baker is the co-director of the Center for Economic and Policy
Research (CEPR).

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