Why The Stock Market Matters

My father was a career enlisted man in the United States Air Force. I was in the third or fourth grade when he graduated from high school. My mother graduated from high school after I was married. My dad worked for several companies after his Air Force career. He was working for Disney when he died. My mother worked part time in child care from time to time.

I tell you this to show that this is not a wealthy family. When my dad died, my mother received the standard Disney benefits. My guess is that those benefits were more generous than average for American business, but not extravagant.

My mother put the death-benefit funds at a bank trust department. They invested the funds in a portfolio that is standard for widows. Some of the funds were put in fixed securities. Some were invested in stocks that were considered safe. These funds, along with some fixed income securities, represent her liquid assets. Her only other assets are her survivor’s share of my father’s pensions, and a small condominium.

What has happened to her portfolio? Let’s look at the Dow for an indication. The Dow peaked at 14,164.53 on October 9, 2007. It was down to 13,264.82 by the end of 2007. It was only 8,776.39 at the close of 2008. Today, Monday, March 09, 2009, the Dow closed at 6,547.05.

Since its high, the Dow has lost 53.79 percent of its value. It lost 33.84 percent of its value in 2008. So far this year, it has lost another 25.40 percent. These are huge losses.

If we apply this year’s average daily loss, we are less than three days from a Dow value of 6,422.94. This was the value of the Dow at the closing on December 4, 1996, the day before Greenspan gave his famous quote on the market’s irrational exuberance. Remember that? It was a very long time ago. We’ve lost more than a decade’s gain in a remarkably short time.

When asked about the stock market, President Obama dismissed it as unimportant: “You know, the stock market is sort of like a tracking poll in politics,” he said last week. “It bobs up and down day to day, and if you spend all your time worrying about that, then you’re probably going to get the long-term strategy wrong.” It is just a guess, but I’m thinking that if his poll numbers had declined over 25 percent this year, he’d be spending some time worrying.

A friend of mine dismisses the stock market losses as paper losses. He claims that the firms, factories and other assets still exist. I don’t buy that. If that is the case, why would we have mark-to-market rules? The fact is that many assets have vanished. They are gone. Many more are reduced in value. Certainly, today’s present value of future earnings — the fundamental source of stock value — is far below what it was on October 9, 2007.

Wealth has disappeared, and that disappearance has serious consequences to real people. Which brings me back to my mother: The combined impact of stock and real estate values has caused her net worth to fall over 50 percent. She’s half as wealthy as she was just a short time ago. That is a problem for her, and it is a problem for America.

Economists are notorious for disagreeing. However, the belief that people spend out of wealth is about as close to a consensus as one can find. My mother will confirm that belief with her actions. The children and grandchildren will get smaller gifts on their birthdays and at Christmas. She will travel less. She will eat out less. She’ll cut her spending.

There will be other impacts. My siblings expect an inheritance, and that inheritance is a significant portion of their wealth. Right now, with the inheritance being less than half of what it was, their wealth is down a lot. That means they’ll be spending less. That is a problem for America.

This sort of wealth destruction is happening to families across the country. It is happening to rich families and to families that are far from rich. The Dow has declined an average of about 50 points a trading day this year. Millions of American families, responding to the steady erosion of wealth, are cutting back their spending plans. This feedback from the stock market to the economy will likely swamp any stimulus plan.

The message is clear. The stock market matters. Its freefall must be halted before the recovery can begin.

Bill Watkins, Ph.D. is the Executive Director of the Economic Forecast Project at the University of California, Santa Barbara. He is also a former economist at the Board of Governors of the Federal Reserve System in Washington D.C. in the Monetary Affairs Division.