There’s a story, probably apocryphal, that Joseph P. Kennedy narrowly dodged the stock market crash of 1929 when he made the decision to sell everything after his shoeshine boy gave him a stock tip. Kennedy did not think as highly of shoeshines as I do, and his reasoning was that when even that guy is at the craps table, it’s time to cash in and walk away from the casino.
My own version of that came when I was working at a midsized newspaper in Texas in the late 1990s. We had a very generous retirement/profit-sharing plan, and the company that ran it had a telephone number that you could call after the markets closed each day to check your portfolio. (This was back in the dark ages, when the telephone rather than the Internet was still considered the authoritative means of communication.) So in the afternoon when we’d get the little beep from the Associated Press terminals announcing the market close, you’d see a roomful of newspaper reporters and copy-editors, average salary probably about $27,000, sprinting to their telephones to check their portfolios. Some of you will remember how much fun being a stock investor was in the 1990s. That was the thing that made me suspect that it was going to end badly, which it did, to the tune of about $5 trillion.
Everybody has their Underoos backward today because the sharp and ugly downturn in the Chinese stock market is roiling exchanges in Europe, as, and the Americas. A few thoughts about that.
First, even the most casual observer had to know this was coming, eventually. It is difficult to say exactly when and how any given house of cards will collapse, but you don’t have to be a structural engineer to know that the collapse is coming. Gordon Chang, among others (I have made my own modest contribution), has been warning for years that the combination of bad loans, murky banking standards, the domination of economic decision-making by political and military leaders, and the propping up of non-viable enterprises and industry sectors together ensure that what’s been happening in China can’t go on forever. There is real growth in China, a consequence of the evolution (and, at times, forced conversion) of a largely agrarian society into one with a modern economy with a mix of manufacturing, other industry, and services. That’s a trick that a country only gets to do once. After that, real growth requires real investment, and that means free markets and reasonably transparent, liberal institutions. China has been trying to stimulate its way around the need for basic reform, and here’s where that leads.
Second, China’s problems are, inevitably, our problems, at least to a certain extent. China is our second-largest trading partner (behind Canada), the third-largest consumer of U.S. exports (behind Canada and Mexico). Chinese institutions, both governmental and quasi-governmental, are significant investors in U.S. government debt. It’s a connected world, and there isn’t really anything that can—or should—be done about that.
Third, there are some things that you can do to insulate your own economy against global shocks and even against domestic financial-market downturns, and they’re pretty basic. The first is to have a strong economy of your own; we do, but it is not nearly as strong as it could or should be. We need fundamental tax and regulatory reform, having, as we do, a corporate tax rate that is simultaneously the highest in the developed world and so riddled with favoritism that actual liabilities vary wildly from industry to industry and from firm to firm, along with regulatory institutions such as the EPA that behave in unpredictable and at times lawless ways. We need lower debt-to-GDP and deficit-to-GDP ratios. We need public institutions that are more open, transparent, and effective—and much less corrupt—one of the important ways in which we lag significantly behind Canada and northern Europe.
Stock prices in the short term can be a cause, but in the long term they are an effect: They are the result of what the publicly traded firms do, what they are able to do, and what they are allowed to do by government. We have a nearly incomprehensible diversity of real economic production in the United States, from farms and oil wells to software and aerospace manufacturing. A bump in the stock market can certainly cause disorder and disruption in those activities, but a thousand barrels of oil a day is a thousand barrels of oil a day whatever the S&P 500 or the DAX or the SHCOMP is doing.
Of course, it’s easier to enact real economic reform when the markets are up and growth is strong, but we never do that, because during the good times we convince ourselves that reform isn’t necessary. But it is necessary, and we must not mistake short-term volatility in the stock markets for the real problem.