The Crashing Stock Market -- A Predictable Disaster
For Immediate Release: March 13, 2001
The sharp fall in the stock market in the last year has caused tens of millions of families to lose a large portion of their lifetime savings. In some cases, the stock decline could delay retirement for years or deny children the opportunity to get a college education. While most of the discussion of the market's decline treats it as an unforeseeable tragedy -- like a hurricane or earthquake -- in fact, it was entirely predictable. Due to the negligence of the nation's political leaders, who chose to ignore the evidence of a stock market bubble, tens of millions of families will have to suffer severe consequences from the crash.
The basic logic of the bubble was easy to detect. The ratio of stock prices to corporate earnings reached twice its historic average in 1999. The only way that these stock prices could be sustained is if corporate profits grew far faster (e.g. 4-5 percent above the rate of inflation) than they had historically. In fact, the government's projections of profit growth showed the opposite. The implicit profit projections in the Social Security trustees report (profit growth is implicitly projected by the GDP and wage growth projections) showed real profit growth of less than 1.6 percent annually. The projections from the Congressional Budget Office showed an even slower rate of profit growth. If these projections were taken seriously -- as they apparently were for other purposes -- then there is no possible way that the stock market levels of 1999 or early 2000 could have been sustained.
However, the Clinton Administration and Congress chose to ignore the obvious dangers posed by the stock market. Instead they chose to focus the nation's attention on long-term and questionable problems, such as possible budget deficits in twenty or thirty years, or projected shortfalls in the Social Security trust fund. The potential impact that these possible problems could have on the life of American families is dwarfed by the immediate impact of a sixty percent decline in the NASDAQ and a twenty percent drop in the larger S&P500 index. Tens of millions of American families have ample grounds to be angry at politicians who chose to ignore the most important problem facing the nation thereby contributing to a situation that may have destroyed their plans for a comfortable retirement or a college education for their children.
Dr. Dean Baker is a macroeconomist and Co-Director of the Center for Economic and Policy Research in Washington, D.C. He has warned of the over-valuation in the stock market for several years, beginning with "Saving Social Security With Stocks: The Promises Don't Add Up," Century Foundation, 1997. More recently, he is the author of "Double Bubble: The Over-Valuation of the Stock Market and the Dollar," CEPR 2000; "The Cost of the Stock Market Bubble," CEPR, 2000, and "After the Fall: The Supply-Side Effects of a Stock Market Crash", The American Prospect, August 13, 2000.
Comments and interviews are available by Dean Baker at 252-995-7869 and Mark Weisbrot at 202-423-6762.