Hey, this is exciting. Maybe terrifying. Wall Street's panic has been dizzying. To the superstitious, ominous coincidences are obvious: The Great Crash of 1929 also occurred in October. What does today's stock collapse mean? Sorry, you won't find instant wisdom here. The best we can do is to provide some perspective.
Caution Number One: Treat all market commentaries (including this one) skeptically. No one really knows what's happening, and almost everyone has ulterior motives. Brokers and government officials who talked soothingly of a "correction" aimed -- unsuccessfully -- to avoid a panic. Beware also of those who moralize about the "crash." If the stock boom symbolized the Reagan prosperity, then a collapse is supposed to show the prosperity rested on selfishness and greed. For some, that would be satisfying. It may also be bad economics.
Caution Number Two: The stock market's bark is typically worse than its bite. Even the Crash of 1929 didn't "cause" the Great Depression. Although the market's collapse helped end the 1920s' boom, mistakes in government policy converted a business downturn into the Depression. The Federal Reserve permitted the banking system to disintegrate. Between 1929 and 1933, two-fifths of the nation's 25,000 banks went out of business. Consumers' deposits were frozen; business loans contracted. By 1933, unemployment was 25 percent.
What triggered the 1987 panic is anyone's guess. There were bad trade figures last week; the United States and West Germany were quarreling over interest rates. In a sense, the cause doesn't matter. Panics are driven by fear. For much of the year, market analysts were saying that stock prices were too high based on traditional measures -- profits, interest rates, underlying corporate assets. Investors rationalized away unanswered questions. The market subsisted on faith, and once selling pressures developed there was no strong case for anyone to buy.
The market always bounces around. Monday's collapse was followed by yesterday's partial recovery. Only with hindsight do we know which of these bounces has broader economic significance. All that's possible now is to examine the current decline.
How does it compare with previous postwar drops?
Generally, it's much worse. Since 1948, there have been 10 major market declines. The largest drop -- from December 1972 to September 1974 -- was 46 percent. Declines have averaged 23 percent and have been gradual; it's taken stock prices an average of 14 months to hit bottom from their peaks. By contrast, this collapse has been deep and swift. Stock prices reached their peak in August. Even after yesterday's rise, they were down nearly a third from that peak. (All calculations are based on the Standard & Poor's index of 500 stocks.)
Mitigating the severity of the plunge is the enormity of the previous stock boom. Huge paper profits accumulated. When the boom began in August 1982, stocks on the New York Stock Exchange were worth $1.1 trillion. By August of 1987, their value exceeded $2.9 trillion. The boom lasted twice as long as the postwar average (30 months), and the price rise was more than three times bigger.
Does the collapse signal a recession or economic slowdown?
It could. In theory, the market is a leading indicator. Rising prices reflect hopes of higher production and profits, while falling prices indicate fears of poor sales and profits. Indeed, a falling stock market has preceded every postwar recession with the exception of the brief 1980 recession, according to Geoffrey Moore, head of the Center for International Business Cycle Research. On average, the stock decline has occurred nine months before the onset of recession. But a market decline isn't an infallible recession signal, Moore said. At least three drops (those of 1961-1962, 1966 and 1976-1978) weren't followed by recessions.
Until recently, most economists have been optimistic about the outlook. Consider the average 1988 forecast of 51 economists surveyed by the Blue Chip Economic Indicators newsletter. It predicted 2.8 percent economic growth and a stable unemployment rate at about 6 percent. But recent rises in interest rates could weaken growth. Some economists now expect rates on conventional mortgages to hit 12.5 percent; for most of the year, they were 10 percent or less.
Couldn't the market's drop itself depress the economy?
That's possible. The theory is simple: A rising market encourages consumer spending by making people feel wealthier; a falling market has the opposite effect. Actually, though, too few Americans may own stock for market changes to influence consumer spending significantly. Probably less than 25 percent of families own stock, according to Federal Reserve surveys. In 1983, the median investment was worth $4,016; that may have jumped to $12,000 by 1987. Only among families with more than $50,000 income are stock investors a majority.
Of course, the stock market crash could also affect a lot of noninvestors. Consumers could get nervous and delay spending, especially on big items like cars, furniture and appliances. Businesses could also cut investment plans until the outlook becomes clearer. Some firms may need to make bigger contributions to their pension plans, leaving less money for investment in plant and equipment. A rising stock market had reduced the need for pension contributions.
Once the market starts falling, what's to stop it?
Stocks could get "cheap." In August, stock prices were roughly 22 times profits. Price-earnings ratios that high hadn't been seen since the early 1960s. The market's decline now brings stock prices to about 14 to 15 times earnings, which -- though high compared with the 1970s -- is more in line with the 1960s and 1950s. Will that tempt buyers? Many investors who sold now have large amounts of idle cash. But there's no guarantee that they'll come back into the market, especially if they figure prices are going lower or that a recession will cut profits.
There are lots of questions and few good answers. By their nature, economic panics defy easy analysis. But the stock market panic is just that -- a stock market panic. The crucial question now is whether the stock collapse portends an upheaval in the real economy of jobs and production. In the end, the stock market mostly reflects what happens in the real economy; its influence on the economy is secondary. The parallel with the 1930s becomes relevant. The 1987 market collapse is roughly the same size as 1929's. What's forgotten is that by early 1930, stocks had staged a substantial rally.
The Depression deepened only because governments couldn't cope. The United States didn't protect its banking system. Protectionism flourished. Cooperation among governments was modest. Major nations were on the gold standard, and each acted to protect its gold reserves. Similar mistakes today would be disastrous. West Germany and Japan need to expand their economies to help stimulate the rest of the world. The United States needs to reduce, gradually, its budget deficits. Everyone needs to avoid protectionism.
The fabric of economic confidence is strong. But once torn, it's hard to mend. The stock market collapse is only a preamble. To what? No one knows. What counts now is how consumers, businesses and, most importantly, governments react.