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Going Down With the Dow

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Written by Dean Baker   
Thursday, 04 August 2011 17:17

It’s panic time on Wall Street, with the market dropping 4 percent on Thursday and almost 8 percent over the last week. Apparently they were not too impressed by the deal on the debt.

Of course the most obvious explanation for the plunge is the prospect of a collapse of the euro. The debt problems hitting Ireland and Greece have spread to two of the four euro zone giants, Italy and Spain. The prudes at the European Central Bank are going have to relearn economics very quickly. Their cult of 2 percent inflation is bringing down the house. They have come to the point where they have to choose between abandoning the cult or ending the euro.  Naturally the prospect of the dissolution of one of the world two main currencies is going to unnerve the markets.

The other big factor depressing stock markets is a set of weak economic reports that indicate the U.S. economy is barely growing. The most important of these reports was the second quarter GDP numbers that showed the economy growing at just a 1.3 percent rate. This was coupled with a sharp revision to first quarter data that showed growth of just 0.3 percent. This growth is far too slow to keep pace with the growth of labor force, meaning that the unemployment rate could continue to rise.

The big debt ceiling agreement promised to depress this growth even further. The proposed cuts to government spending effectively amounts to taking away water in the middle of a jobs drought. Good job Washington!

Those still believing in the virtues of government austerity also got a big kick in the face last week. The UK had its third consecutive quarter of near zero growth – the apparent fruits of the austerity path put in place by the new Conservative government.

It’s worth putting in a couple of calming notes. First, the stock market is not the economy. As Paul Samuelson famously quipped, the market has predicted 9 of the last 5 recessions. The people who invest in the market are the same geniuses who thought Countrywide and Pets.com had great business models. There is no reason to think that the markets are any wiser today than they were when they thought everything was just great in 2007.

Second, the double-dip recession folks seem to have forgotten how we usually get recessions. The standard recession is associated with a collapse in house and car sales. The good news is that both sectors are still so badly depressed that they don’t have too far down to go. In other words, it is unlikely that we will see the negative growth associated with a recession.

On the other hand, many quarters of very slow positive growth is really no better. This is most likely what the economy faces barring some serious change in policy in Washington. So the double-dippers might be too pessimistic, but not by much.

This post originally appeared in The Nation.

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