Dow’s big drop doesn’t warrant intervention

By Freedom Newspapers

Well, Tuesday was certainly a dramatic day on the stock market, wasn’t it? When the Dow industrials fall 416 points in a single day — even though 3.3 percent is not all that precipitous a decline — people tend to notice and ask questions.

Does it signal the end of the Bush tax-cut boom? Does it mean the U.S. market has become the tail wagged by the Chinese dog? Did Alan Greenspan start it by uttering the dreaded R-word at a speaking engagement in Asia? Is a recession in the offing?

The fact that the Dow closed only 52.39 points higher Wednesday, and sustained modest losses again Thursday and Friday, doesn’t alleviate uncertainty.

Esmael Adibi, who supervises Chapman University’s economic forecasting project, said he still believes the university’s Anderson Center forecast that the economy will slow down this year but not drop into recession, published in December, still looks pretty solid.

“Our forecast of 2.1 percent economic growth in 2007 included a forecast of a modest decline in housing prices … and the ripple effects that will cause,” he said. “If the housing market collapses much more dramatically than we expect, a recession (generally defined as two consecutive quarters of no growth or decline) is possible, but the probability is still quite low.”

As for the plunge in the stock market — which is not the same thing as the overall economy — Adibi says he expected something like it. The market has been rising for about three years, and that usually brings on a “correction” of up to 10 percent. The Chapman people wouldn’t be surprised to see it fall a total of perhaps 5 percent before resuming an upward swing.

What happened Tuesday was a confluence of events, something of a “perfect storm,” each of which precipitated pent-up doubts. There was the decline overnight of 9.2 percent in the Chinese stock market, in which U.S. investors purchased $5.2 billion in equities in 2006. Then there was a decline in orders for durable goods and Greenspan’s comments.

The Chinese economy has been growing at about 10 percent a year for a decade, but the growth is export-driven rather than consumer-driven, so there are doubts about how resilient it is. The Chinese market is still less transparent than one would like, the Chinese banking system often funnels money more on the basis of political connections than economic merit, and the central bank reports to the communist party. So hiccups in Shanghai cause shaking worldwide.

Unlike government policies, trends in a relatively free market are subject to reality checks from time to time. Tuesday’s slump is a reminder that economic boom times are unlikely to go on forever. Those who bought more house than they could really afford or who have taken on too much debt might be reminded to take corrective action.

A one-day fall in the stock market, however, should not be an invitation for the government to march in and do something really stupid, like repeal the Bush tax cuts. The economy should muddle along, though at a somewhat slower pace.