Questions raised by stock market's slide yield few certain answers
Here are the best answers that, in my judgment, economic science can give to the questions most frequently asked about the recent international stock market crisis. After the 1929 stock market decline, there followed the Great Depression. Will history repeat itself?
A depression like that of 1929-33, or of 1892, or 1873, or 1837, is highly unlikely.
Why? Are people smarter? Corporations better informed?
We probably aren't that much smarter, though corporations do have better data bases and bigger computers. But these factors have little relevance.
We live in a mixed economy in 1987, and not in the pre-1933 system of pure capitalism. So 8,000 American banks will not fail, and millions of homes and farms will not go into foreclosure.
Populist democracy makes all the difference in this Age After Keynes. That is why you should not expect a serious and lasting slump.
Has the ``correction'' now been made in Wall Street? Is this bargain time for canny investors?
No assurance of this is possible. Economic history reports cases where grave drops like those of October '87 have been followed by even graver drops. The record also tells of cases of recovery, some of which were lasting and some abortive.
Economic analysis is equally uninformative: The worldwide speculative bubble of 1982-87 could have lasted into 1988 or '89; it could have been pricked in 1986.
Those scores of corporations that have announced programs to buy back their own stocks may be heroes or fools. Only time will tell. One thing is certain. The riskiness to expect in stocks, up or down in coming months, has increased fivefold - and costs of insuring against volatility have already risen in the options markets.
Hasn't the Tokyo market performed better than markets in New York, London, Sydney, or Hong Kong?
Yes, so far. But is that reassuring or ominous? The Japanese bubble, by the usual objective tests, is about the worst of all. The Japanese government and the official Bank of Japan have been leaning on brokers, money managers, and insurance companies not to dump their stocks. There are no guarantees on how long such moral suasions can stay effective.
Do we know what caused the market decline?
Future history books will tell a story much like the following:
1.The trigger that set off the implosion is unimportant. It was the worldwide explosion in five years of capital gains that usually accrue in 20 years that constituted a self-fulfilling speculative mania or bubble. Any trigger might prick the bubble at any time.
2.Actually, it was near-term strength rather than weakness in the United States, German, and Japanese economies that provided the main trigger. That strength raised interest rates and hurt bond prices. It created a rational fear of a weaker dollar ahead. It induced the Federal Reserve, the Bank of Japan, and the West German Bundesbank to encourage tighter credit policies.
3.Common stocks rose nevertheless nearly all summer. Finally, they succumbed. The new index futures markets, using fast computers, speeded up the rate of panicky decline. But it is not crucial that we were able to get in a few days price drops that used to take a few weeks.
Suppose we agree the loss of about $800 billion in American net worth, and a similar decline abroad, is unlikely to lead to a great depression. Still, doesn't that suggest a 1988 recession?
Could be. In September the evidence was fairly strong against an American and worldwide recession before election day in November '88. Now the forecasters are shading their projections somewhat as follows:
1.The odds today are slightly in favor of a ``growth recession'' in 1988.
2.What was expected to be about a 3 percent real GNP growth rate in 1988's four quarters is now marked down to below 2 percent. This is still positive growth, but at a rate not quite adequate to provide jobs for all of the population increase and the workers displaced by continuing productivity improvements.
What policies would now help?
Most important, the Federal Reserve should support the bond market and keep credit easy enough to offset threatened weaknesses in consumer spending and retrenchments in investment spending.
Should the dollar be supported?
Not in the judgment of most experts. Probably the dollar will float downward relative to the yen and mark. That will be in accordance with economic law and not a psychological aberration.
Should the Reagan fiscal deficit be reduced, if that means a tax increase and if a growth recession threatens?
The structural budget deficit is a festering sore. Reducing it is not a panacea for stock recovery or continued prosperity. Still, if Alan Greenspan's Federal Reserve offsets any untoward depressive effects of budget-deficit reduction with incremental money expansion, I'd favor the bipartisan compromise on tax raises and expenditure cuts - not primarily to bolster stock prices but rather to boost America's saving rate. But we should stay flexible, and delay strong fiscal corrections if next spring's business news turns really sour.
Are you optimistic or pessimistic?
I am realistic. Perpetual capital gains can never be delivered by any party's policies. The damage to Main Street from Wall Street fireworks, fortunately, can be contained by feasible actions that are not irresponsible with respect to future inflation and with respect to either market incentives or humane aspirations.
Paul A. Samuelson, institute professor emeritus of economics at the Massachusetts Institute of Technology, won the Alfred Nobel Memorial Prize in Economics in 1970.