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Stock Market Plunge Renews Fears of Oncoming Recession

By Peter G. Gosselin
LOS ANGELES TIMES -- WASHINGTON

For months, the U.S. economy has been batted about by the contending forces of improvement and decline. Only last week, it showed strength in an area where many had expected weakness -- job growth.

But chalk Monday up for trouble.

By wiping out more than a half trillion dollars of paper profits, the day’s stock plunge revived fears that a downward spiral of contracting wealth, shrinking investment and sharply slowing consumption could sweep the economy into recession.

That put economic policy-makers in a box. Federal Reserve Chairman Alan Greenspan had begun to suggest that the economy and financial markets might not be quite as entwined as previously thought -- that the former might be able to recover even if the latter didn’t.

But now, “he’s got to be worried that a collapse in market psychology could spill over into the rest of the economy,” said David M. Jones, chairman and chief economist of Aubrey G. Lanston & Co. in New York. “He’ll probably have to cut interest rates more than he otherwise would because of this.”

Greenspan and the central bank are in an even more immediate quandary if stocks keep falling. The Fed chairman has made clear he wants to hold off any further rate cuts until the bank’s policy-making body, the Federal Open Market Committee, meets next Tuesday.

Any cut before then would be widely interpreted as aimed at shoring up share prices, something the Fed does not want to be seen as doing. The central bank’s job is to control inflation and maintain stability, not ensure investors good returns.

But if the market continues to slide, analysts said policy-makers will have little choice but to act. “At some point, this takes consumer confidence and the economy down with it,” warned Mark Zandi, economist with Philadelphia-based Economy.com.

The link between stocks and growth has been one of the most hotly debated issues of the nation’s decade-long boom. When the economy ballooned in the mid- and late 1990s, many analysts said stock gains were a principal cause, providing new capital for business, new wealth for families and a sense of near-boundless hope. As share prices have tumbled in the last year, many have warned of the reverse.

In round numbers, rising stock prices added $14 trillion to Americans’ wealth between the start of 1995 and the start of 2000, according to Pierre Ellis, a managing director of Decision Economics Inc. in New York. Falling prices since then have trimmed the gain by between $4 trillion to $5 trillion, Ellis said.

Analysts said that the problem with Monday’s stock plunge is that it pushed key market indexes into hard-to-overlook terrain. For example, the once-hot NASDAQ Composite Index has now lost 62 percent of its peak value. The broader Standard & Poor’s 500 Index is off 23 percent -- more than the 20 percent that defines a bear market.