Greenspan: Free Markets to the Rescue!

Often when I turn on CNBC or open the Wall Street Journal I'm greeted with a headline or statement about "how the market reacted to" this or that, with the "this or that" often being a speech by Obama, Geithner, et al. Occasionally I can't help myself: I snort and say aloud, "Who cares?" I have some money in mutual funds and the like, so certainly I care whether the markets are up or down. But when did the Dow and the S&P 500 become the sole barometer of success or failure? There must be constituencies other than day traders and broker-dealers and equity salespeople with which to concern oneself.

Jon Stewart hit this sentiment on the head when he took on the belief that "the stock market is the only rational, objective indicator of a commander-in-chief's performance." With delicious delivery, he rhetorically mocked the naive assumptions of the non-Wall Streeters:

I know you what you people, you six-pack-sipping, iceberg-lettuce-eating, America-loving non-elitists, sitting down in your ivory basements, are thinking: "Isn't the Dow Jones Industrial Average just a short-twitch numerical representation of a bunch of guesses about other people's assumptions about the financial well-being of an arbitrarily chosen group of 30, out of tens of thousands of possible companies?" No! you're wrong!

It was a brilliant bit of populist comedy, but unfortunately it's not quite accurate. The stock market is more than just a playground for hedge funds; it has real effects on the real economy, and not just because "paper losses" in the markets make us feel poorer and spend less.

It took Alan Greenspan to remind me of that. Writing in the Financial Times yesterday, he says that stocks have "purchasing power": "Most automotive dealers, for example, being compensated for the inconvenience, would presumably accept shares of stock as payment for a car." (This example feels a little forced -- "presumably"? -- but he's generally correct.) More importantly, a company's stock price is its collateral; the higher its stock price, the more it can borrow and spend. In Greenspan's (convoluted and jargony) words:

Stock prices have a statistically highly significant impact on private capital investment...Analyses suggest that much of the recent decline in global economic activity can be associated directly or indirectly with declining equity values.

Of course, at this point Greenspan makes a giant leap of faith -- if only Wall Street can pull itself out of its stupor and initiate a bull market, all our problems will be solved! In his words:

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 $35,000 billion global loss in corporate equity values that has so devastated financial intermediation.

In other words, free markets can yet save the day! While I find it hard to go along with such market boosterism (do policymakers have no role in breaking the cycle of fear now gripping markets?), Greenspan's elucidation of the role of stocks in a modern economy is a useful antidote to the occasional fit of populism.