If you follow @realdonaldtrump on Twitter, you’re probably aware that things are going well on Wall Street. The Dow Jones Industrial Average just hit 29,000, a number with three consecutive zeroes. As Trump tweeted recently, “STOCK MARKET AT ALL-TIME HIGH! HOW ARE YOUR 401K’S DOING? 70%, 80%, 90% up? Only 50% up! What are you doing wrong?”
For those without big stock portfolios, however, the blaring CNBC headlines might be tinged with grim portent. The last time Wall Street went hog wild, it was amid a suite of predatory and irresponsible financial practices enabled by an overly lax regulatory landscape, and when it all came tumbling down, it led to millions of regular people losing their jobs and homes.
Among those who deride stock market milestones — online leftists and disaffected millennials mostly — reactions tend to fall into two buckets. One, that only a lucky few really benefit when stocks go up. Two, that the exploding market is just a prelude for the inevitable crash, at which point we’ll all suffer. At face value, the two statements appear contradictory. The stock market “is not the economy” — until it is.
great stock market news for the wealthiest 1%, who own literally half of it https://t.co/2AvuScKlAa— Law Boy, Esq. (@The_Law_Boy) January 10, 2020
the eventual crash—which we all know is coming—is going to be cataclysmic https://t.co/bom9fX4jZB— Rob (@robrousseau) January 10, 2020
There is some truth in both sentiments. Close to half of Americans don’t own any stocks, and the richest tenth owns nearly 90 percent of the market. Meanwhile, there is no recession in recent memory that did not coincide with a market plunge. It’s natural to look at the spectacle of a huckster president hyping an already historic bull market and worry once again of the privatized gains and socialized losses that accompany financial crises.
There are two misperceptions worth addressing here: one about the relation between stocks and recessions, and another about the relation of the stock market to the financial system as a whole. Recessions are generally not caused by stock market plunges, and stocks can fall without causing a recession. And the fact that stocks are ripping higher doesn’t mean that the financial sector is up to the same shenanigans that tanked the economy in 2008.
While the association of recessions with financial markets isn’t entirely misplaced, the identification of the stock market with all of finance is.
For Millennials, children of the financial crisis and Great Recession, financial shocks and recessions are synonymous. That wasn’t always the case. Recessions before the 1980s often had “real” economic drivers, like spiking oil prices. They might have coincided with bear markets, as investors who sense trouble tend to sell assets. But that doesn’t imply causation. People grabbing umbrellas doesn’t cause rain, though seeing people grab umbrellas might be a reliable indicator that rain is coming. Still, the correlation between tanking stocks and recessions is hard to resist. One of the most-quoted quips in economics is that the stock market has predicted nine of the last five recessions. A notable false positive was the Black Monday crash of 1987, in which the Dow Jones fell 22.6 percent without triggering a recession.
Since the 1980s, however, all recessions have indeed had financial origins. In the early 2000s the popping of the dot-com bubble caused companies to halt investments, leading to a relatively brief downturn; in 2007-2008, the trigger was a combination of shaky bank balance sheets and billions of dollars in ludicrously complex financial instruments piled atop subprime mortgages.
While the association of recessions with financial markets isn’t entirely misplaced, the identification of the stock market with all of finance is. The assets that collapsed last time were a wild complex of bets on home loans and bets on those bets — not stocks themselves. Our cultural obsession with the S&P 500 makes the index into a totem for the whole financial sector. But finance goes well beyond the stock ticker.
As it stands, few economists can be found warning that the stock market is a likely recession trigger. For example, New York Times columnist Paul Krugman makes the typical Keynesian case here that inadequate demand causes recessions. Of course, mainstream economists are famously inept at predicting downturns, and orthodox economic models simply could not grasp the realities of the last crash. And there is one mainstream economist of high standing, Roger Farmer, who insists that the stock market causes recessions. But in general, it’s not the most likely culprit.
Let’s grant that while the stock market isn’t the most likely driver of downturns, it might be a good weathervane once the economic storm has already arrived. Does the current state of the financial system give us any reason to worry?
If you go looking for the same culprits as in 2008, you’ll be disappointed. Thanks to post-crisis regulations, households and banks are far less indebted in the aggregate than they were in the late 2000s. It’s harder for financial predators to ply faulty subprime mortgages, and banks are forbidden from taking on Howie Ratner levels of balance sheet risk. As the Financial Times recently noted, “The imbalances that appeared to precipitate the crash have been corrected.” (The FT’s accompanying infographic makes the point well.) This is probably cold comfort to those who were told that everything was fine before the last crisis. We’ve already gone over economists’ poor records. All I can say is that the obvious stuff is not producing obvious red flags.
If you are looking for something legitimate to worry about, consider corporate debt. If households and banks haven’t borrowed up to the hilt, many companies have. Researchers at the IMF and the Federal Reserve System have flagged corporate debt as a potential economic stability risk.
Like any single number, the level of the stock market is too broad a measure to capture everything we want it to.
The fear is that an economic hiccup could snowball into a crisis if the nearly $10 trillion in outstanding corporate debt suffers a panic-driven sell-off. That would make it harder for companies to borrow the money needed to invest, spurring plant closures, layoffs, and misery for millions, as all recessions do.
Like any single number, the level of the stock market is too broad a measure to capture everything we want it to. In part it reflects good news: Stocks go up when the mass of ordinary people have jobs and money to spend on products like Netflix and yoga pants and insulin. But a company’s stock might also rise when it defeats a union or finds a way to cut its health insurance contributions.
You don’t have to be a Marxist to make this latter point. Goldman Sachs markets a basket of stocks whose chief attraction is being immune to rising wages. A trio of fully mainstream economists recently wrote a paper which argues that fully half of the rise in share values since 1989 owes to the shift of income from labor to capital. In this view, the soaring stock market reflects an economy where workers have less power to bargain high wages and avoid precarious jobs.
The stock market is an apt symbol of the inequities of the American economy. And it’s hard to blame people for making the obvious observation that stocks are always vertiginously high before the crash. At the same time, it’s probably not a falling stock market that will cause the next recession. And the next downturn, whatever its origins, is unlikely to resemble the last, simply because there’s nothing analogous to the subprime bubble lurking in the financial system (as far as we know). Hate the stock market all you want, but don’t give it too much credit.