Sunday, August 21, 2011

Economy: A Self Fulfilling Prophecy?

The stock markets tanked in recent weeks. A reaction to the cooling global economic climate. Some spectators claim that the stock markets are already pricing-in a new recession. Some pundits go even further, they fear that the falling stock prices have a negative impulse on the economy. The tanking stock markets could cause a new recession, they assert. This would be a case of a self-fulfilling prophecy.

I think, these fears are overblown. In 1987 the stock markets crashed worldwide around 30% on a single day, but no recession happened after that. Maybe the crash then caused some economic counter measures - like cutting interest rates - which stabilized the economy. This was a case of a self-destroying prophecy.

We will learn soon how the real world will react to the stock market gloom. Maybe some of the consumers will reduce their expenditures because part of their wealth is invested in the stock market and they might feel less wealthy now. But we don´t see those  reactions yet. Consumer companies who cater to the well-off, like Starbucks or Victoria´s Secret are still reporting prosperous businesses.

It might also be that the falling stock prices are slowing some company investments, because some managers are getting more cautious. Some economic reports like the Philli Fed Index show that manufacturing companies in the northeast of the U.S. are indeed delaying orders.

But otherwise the weak stock market creates at least 2 beneficial impulses:

1. The oil price fell last week into the low $80s  and costs now around 30% less than in April ($114). This may animate consumer spending because people have to spend less at the gas pump and have therefore more money available for other goods.

2. The U.S mortgage rate plunged to 4,15%, a 50-year low. Mortgage debtors could now refinance cheaply and save a lot of money, which they could spend otherwise. The falling mortgage rates should also rekindle the weak housing market.

Both developments should overcompensate the negative impulses and help to rekindle the economy in autumn.

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