What Scared the Markets?

A great global political contest has been going on for a decade between policies that are favorable to the creation of wealth, and policies that are not. On the constructive side are economists and politicians who favor moderate tax rates, free trade, stable money, deregulation, and privatization. These views, which are commonly associated with supply-side economics, have more or less dominated public policy since at least 1982, particularly in the United States and the United Kingdom. On the other side, however, there are still many powerful advocates of punitive taxation, trade warfare, beggar-thyneighbor exchange-rate gyrations, and a return to heavyhanded and unpredictable government regulation. These latter views were the source of disastrous policy experiments from 1969 to 1980, as they were also from 1929 to 1937, and the ideology behind them remains fashionable in the press and academia. What has happened to world stock markets since August 25, and particularly since October 14, is that the forces of darkness have appeared to be gaining the upper hand in the United States, Germany, and Japan. Those who want to restore the policies of the Seventies cannot pretend surprise that following their advice would also restore the depressed stock prices of that era.

Stock markets are quite efficient in evaluating the best available information about future opportunities for profitable production. But risks can change very suddenly with new information, and the biggest surprises are invariably matters of government policy, such as new trade barriers, taxes, or monetary-policy blunders. Investors have no choice but to attempt to guess the ever-changing probabilities of destructive government policy changes before they actually happen, because nobody wants to be the last one to run for cover. To sink all the world’s stock markets requires some extremely bad news. If we can figure out what that bad news was, then the situation can easily be changed by governments’ simply not doing what the markets fear they will do.

About the Author

Alan Reynolds

Alan Reynolds, National Review’s economics editor from 1972 to 1976, is a senior fellow at the Cato Institute and the author of Income and Wealth.

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A great global political contest has been going on for a decade between policies that are favorable to the creation of wealth, and policies that are not. On the constructive side are economists and politicians who favor moderate tax rates, free trade, stable money, deregulation, and privatization. These views, which are commonly associated with supply-side economics, have more or less dominated public policy since at least 1982, particularly in the United States and the United Kingdom. On the other side, however, there are still many powerful advocates of punitive taxation, trade warfare, beggar-thyneighbor exchange-rate gyrations, and a return to heavyhanded and unpredictable government regulation. These latter views were the source of disastrous policy experiments from 1969 to 1980, as they were also from 1929 to 1937, and the ideology behind them remains fashionable in the press and academia. What has happened to world stock markets since August 25, and particularly since October 14, is that the forces of darkness have appeared to be gaining the upper hand in the United States, Germany, and Japan. Those who want to restore the policies of the Seventies cannot pretend surprise that following their advice would also restore the depressed stock prices of that era.

Stock markets are quite efficient in evaluating the best available information about future opportunities for profitable production. But risks can change very suddenly with new information, and the biggest surprises are invariably matters of government policy, such as new trade barriers, taxes, or monetary-policy blunders. Investors have no choice but to attempt to guess the ever-changing probabilities of destructive government policy changes before they actually happen, because nobody wants to be the last one to run for cover. To sink all the world’s stock markets requires some extremely bad news. If we can figure out what that bad news was, then the situation can easily be changed by governments’ simply not doing what the markets fear they will do.