Greenspan’s Right

On Meet the Press yesterday, former Federal Reserve Chairman Alan Greenspan said a U.S. economic recovery is “going to be a slow, trudging thing,” and that he “would get very concerned” if stock prices continue to fall.

He went on to say that a drop in stock prices is “…more than a warning sign. It’s important to remember that equity values, stock prices, are not just paper profits. They actually have a profoundly important impact on economic activity.”

He’s right.

And we should be worried about this.

The masses that feels like they are hanging on by a thread, but at least their 401K has recovered somewhat, could easily become very discouraged at significant return to lower stock prices.

The result of that would be to spend less, which in turn would slow the economy, which in turn would lower stock values further, which would push people to spend even less.

If the downward spiral isn’t broken fairly quickly, which is easier said than done, then the description of the economy recovery being “a slow trudging thing” would start to sound good.

Downward spirals can last a long time. Look at what happened to Japan over the last two decades.

In the last 20 years the Nikkei 225, the broad measure of the Japanese stock market, has fallen from a high of 40,000 to around 10,000 today. The last 20 years in Japan show clearly that a major modern industrial nation can go long periods in a downward spiral.

Will we slide this much or this long?

We already lost a decade as the Dow is basically at the same place it was 10 years ago and the NASDAQ is down over 50% from 2000 highs. So one could view this as 10 years down, 10 years to go.

Looking out the foggy windshield doesn’t often provide clarity, but it’s where we should be looking nonetheless.

Greenspan’s right. If the markets continue to slide, the economic road ahead may be not only twisty and bumpy, but downhill.

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