Stock market crashes and Debt

From the Economist:

WHEN Chinese shares plunged earlier this month, the government tried frantically to limit the damage. It pumped cash into the market, capped short-selling and ordered share buy-backs. Although China was unusually heavy-handed, it was hardly the first country to try to bolster stock prices for fear of the economic harm a crash could bring. Alan Greenspan, as chairman of the Federal Reserve, famously created the “Greenspan put” by giving investors the impression he would cut interest rates to stop stockmarket routs.

The underlying rationale for these interventions is an idea that until recently received surprisingly little scrutiny—namely, that stockmarket busts are very damaging for the economy. The link seems clear enough in the case of the crash of 1929, which led in short order to the Depression. But it is also easy to point to contrary examples. The bursting of America’s dotcom bubble in 2000 wiped out $5 trillion in market value, equivalent to half of GDP. Yet it was followed by a shallow recession.

Not all bubbles, it would appear, are equally bad. According to two new papers*, the crucial variable that separates relatively harmless frenzies from disastrous ones is debt. In many cases, though certainly not all, stockmarket manias fall into the less worrying category.

This makes tons of sense.  What is worrying now?  We know the stock market is toppy, bubbly, frothy, overvalued, overbought, whatever you want to call it.  Henry Blodget may not be a market participant, or respected, but he has compiled some very good research showing how overvalued the US market currently is, via David Stockman.

What about current debt levels in the US?  Here’s inflation adjusted total debt and consumer debt.  Looks like we have recovered from the last debt bubble, by any measure:

fredgraph debt



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Filed under Financial, Government

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