Market to Obama: I'm Just Not That Into You

Weakness in stocks has a huge economic impact.


"I think he overestimates his ability to take people .. and, sort of, charm them into being nice," Barney Frank, has famously said of Barack Obama. And while America's Charmer-in-Chief has worked his magic with the Women from Maine and some of the Blue Dog Democrats, not so much with the Rump Republicans in the House.

And not so much, it would appear, with the Investor Class, both here and overseas. The Dow Jones industrials fell 4 percent yesterday, dropping below 7,000. The market barometer is now down a whopping 30 percent since Election Day, including an 18 percent drop over the past three weeks. That, even as President Obama's plans to stimulate the economy, fix the banking system and bailout struggling homeowners have come into sharper focus.

One could view the slow-motion crash as a financial vote of no-confidence in the White House's ability to effectively fix America's economic mess and lead the rest of the world out of its tangle. (No confidence in the spending-heavy stimulus plan that treats 2009 as a wash. No confidence in the work-in-progress Geithner plan that seems intent on forcing banks to take losses. And certainly, one could argue, no confidence in a long-term economic plan will raise taxes by $2 trillion (including interest expenses and cap-and-trade costs) over the next decade as well as increasing government's role in healthcare and energy.) Or maybe, to be fair, investors think nobody has any answers. To Wall Street, the Long Boom looks to have morphed into the Long Bust.

But who cares about Wall Street, right? Those are the folks, Obama says, who are pretty much responsible for this entire mess. But it's not that simple. The plunging stock market is much more than a vote of no confidence. Consider the following: In dollar terms, we are talking about a loss of around $9 trillion in wealth, a good chunk of which has been borne by the retirement and savings plans of millions of Americans. An analysis by the Employee Benefit Research Institute found that the typical retirement portfolio of $50,000 to $100,000 lost 15 percent of its value in 2008. Investors in the $100,000 to $200,000 range suffered a loss of 21 percent. And folks with more than $200,000 lost more than a quarter of their savings, on average.

Of course, these are just "paper losses," right? Just numbers on a page. Nonsense, as Bernie Madoff's clients know all too well. As such, there's an economic response by anxious people who suddenly see years of investing gains vanish with little hope of rapid return. They save more and spend less. The personal savings rate, after briefly going negative in mid-2005 and staying under 1.0 percent thereafter, has now vaulted up to around 5 percent. And you can be sure that much of that additional savings is going somewhere besides Google and Apple stock. It's going into traditional low-yielding assets such as savings accounts, checking accounts, CDs, and money market funds. Indeed, some economists predict the savings rate will inch back up to the high single digits, where it was in the 1980s.

Bad news. America has shifted from an income economy to an asset economy during the past generation. Even though incomes continued to grow, our asset wealth grew far faster, both homes and stocks. This meant we could save less -- at least as defined by government statisticians who don't count capital gains -- and spend more. Economic analyst Edward Yardeni took a look at the impact of an 8 percent savings rate. He calculates that if the savings rate went back to 8 percent in the fourth quarter of last year, real GDP would have been down by 17.9 percent instead of 3.8 percent. "Obviously, no one is saying that the saving rate should rise so much in such a short period of time," he explains. "However, if consumers really do decide to save more on a long-term basis, then the size of the economy would shrink since consumers account for so much economic activity."

And it is not just consumers. As former Federal Reserve Chairman Alan Greenspan noted in a recent speech, stock prices have a significant impact on private capital investment as well:

In a paper I published in 1959, I related the American ratio of the market value of existing corporate assets, that is, stock prices, to the replacement value of those assets. It correlated quite well with machinery orders going back to the 1920. ... Such analyses suggest that much of the recent decline in global economic activity can be associated directly and indirectly with declining equity values. When we look back on this period, I very much suspect that the force that will be seen to have been most instrumental to global economic recovery will be a partial reversal of the $35 trillion global loss in corporate equity values that has so devastated financial intermediation.

In short, save the stock market, save the world. Indeed, while Americans should reduce their debt and save more, a good chunk of that savings needs to go into wealth-building assets. And by that I mean stocks and bonds. Obama needs to rekindle America's love affair with investing. Indeed, this could be a once-in-a-generation opportunity to let people start investing some of their payroll taxes into the stock market. Buy low, sell high. Indeed, even many of left-of-center analysts contend that unless Rising Asia becomes Disappearing Asia, excess global labor supply will continue to push down hard on wages. Families have to earn income from assets as well as a job. Free-marketeers prefer Social Security privatization, while liberal might be more comfortable with government financed "baby bonds" for kiddies.

But more immediately, we need to bolster the stock market. Roger Farmer, an economics professor at the University of California, Los Angeles, has suggested the Fed boost the market by purchasing indexed securities linked to the broad market. The goal is to boost business confidence as way of bringing down unemployment. As he put it in a recent paper: "If confidence is low – the private sector places a low value on existing buildings and machines. Low confidence induces low wealth. Low wealth causes low aggregate demand, and low aggregate demand induces a high-unemployment equilibrium in which the lack of confidence becomes self-fulfilling."

A simpler way, I think, would be to eliminate the capital gains tax -- or, at the very least, suspending it for a year or two followed by its reinstatement at a lower rate. Also extending the 2001 and 2003 tax cuts while coming up with a plan to fix entitlements. Now those would be confidence building moves that could help reignite the Long Boom.

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