Coronavirus, The Stock Market, And The Economy

The problem with this story is that companies rarely issue new shares of stock to finance investment. Most often large share issues are done to allow early investors to cash out some of their holdings. Companies will also issue shares to adjust their debt position. For example, if they issued bonds that pay a high-interest rate, high share prices may give a company an opportunity to issue shares and use the money to retire some of its debt. However, it is rare that a company issues shares to directly finance investment.

The one major exception to this rule was during the stock bubble of the late 1990s. In that bubble, new companies, many of which did not even know how they could make a profit, were often able to raise hundreds of millions, or even billions, on initial public offerings. In that context, the plunge in the market from 2000 to 2002 did lead to a sharp reduction in investment, as this channel of financing largely disappeared. (The Nasdaq, where most of these new companies were listed, lost more than 80 percent of its value from peak to trough.)

The plunge in the market in 2000-2002 also had a major impact on consumption, as more than $10 trillion in stock wealth (roughly $20 trillion relative to today’s economy) was destroyed. Stock wealth was clearly driving consumption at the end of the 1990s boom, as savings rates fell to what were then record lows. (The housing bubble pushed the savings rate even lower.) It was not only the wealth itself that drove consumption but the expectations of future stock rises. It was common at the time for otherwise sane people to expect that the stock market would produce double-digit nominal returns for the indefinite future.

Anyhow, this sort of causation from a stock plunge to a recession is not plausible today. Investment is already weak and clearly not being driven by the stock market. And, savings rates are considerably higher than they were in the years of either the housing or the stock bubble. Losing 10 percent of the market’s wealth will surely have some negative impact on consumption, but almost certainly not enough to cause a recession.

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Charles Howard 1 year ago Member's comment

Dean Baker It’s been a rollercoaster market in recent days for equity investors, and today we appear to be on the downward leg for that ride.

Gary Anderson 1 year ago Contributor's comment

Well, it is in Maryland now. It will eventually hit DC and we will see if Trump gets more serious.