NOW THE WORLD will learn about the fire walls between the stock market and the real economy of jobs, incomes and production -- and whether they work. Those fire walls have been built with great care in the 58 years since 1929 to prevent a financial panic from spilling over into the kind of general collapse that became the Depression. Dire though it has been, this past week's stock market crash is still limited to stocks. Long-term interest rates are up a little and the dollar is down, but so far the damage is confined.
The crucial question is whether it can be kept confined. In yesterday's drop alone, some three-quarters of a trillion dollars in assets evaporated. Unavoidably, that is going to have a severe impact on the rest of the economy. It translates immediately into houses that won't be built and cars that won't be bought. Some kinds of companies are going to be squeezed hard for cash. Will they go under? The possibility of a recession next year is now much higher than it seemed a week ago. But recessions are controllable.
The market's fall is irrational, overshooting even the most pessimistic assessment of the economy's future. The Dow Jones Industrial Average has dropped by one-third since the peak last August, but the companies it represents haven't lost a third of their value. The crash has been feeding on itself as each hour's losses forced people to keep selling regardless of value.
The 1929 crash came at a point when the American economy was already sinking steeply into a recession. The present one comes amid steady expansion. That's a crucial difference. But there are other differences that are less favorable. This country is now an international debtor, as it was not 58 years ago, and that makes it vulnerable to the flows of foreign investors' money. Worse, it has backed itself into a position in which its government has very little latitude to shift policy. The budget is locked in a corrosive quarrel that President Reagan seems unwilling to resolve. Interest rates are usually a government's readiest instrument for adjusting the economy to unexpected blows, but not this year in the United States.
If the Federal Reserve Board tries to lower interest rates, the exchange rate of the dollar will fall and inflation will rise. If it tries to raise rates, it will make a recession more likely. If foreigners join the panic and try to pull their money out of this country, rates will rise regardless of the Federal Reserve's intentions. All those years of huge deficits have left the United States government immobilized and incapable of acting independently.
That's unfortunate, but maybe not fatal. Historians draw three great lessons from 1929-33. First, don't engage in perverse policy that makes things worse, like tightening monetary policy in a deepening recession or passing a flagrantly protectionist Smoot-Hawley tariff. Second, remember that the international linkages are much more important than politicians thought in 1929, and those politicians greatly aggravated their countries' misery by trying to go it alone. Third, recognize that leadership is essential and that it has to come from the United States. You have heard an intolerable amount of bosh over the past seven years about the deep and infallible wisdom of markets. In fact, markets are perfectly capable of nervous breakdowns. You have just witnessed a historic example of it. They need regulation and, in times of trouble, strong guidance. There was very little of that in the months and years after 1929. How about 1987?
The past week's crash is, among other things, an intelligence test. It will show whether the United States, Japan and Western Europe are capable of understanding what has happened, and of working together to deal with the conse-quences. There is nothing inevitable or foreordained about the movement of the economy in the coming months. It will measure the quality of the people who hold power in the world and, above all, in this country.