Today marks the five year anniversary of the Flash Crash, the day in 2010 when the US stock market fell drastically in a matter of minutes then recovered most of the losses. Unlike sharp declines in the past, the Flash Crash happened for apparently no reason. Since then the government has launched multiple inquiries into what happened and recently charged a trader for alleged market manipulation. Figuring all of this out is considered a priority because the stock market is an important part of the economy and has an important place in economic policy.
But does the stock market really matter? And if it does, should it?
Stock market relevance to policy dates back to the crash of 1987, when Fed Chairman Alan Greenspan decided the Fed should respond boldly to market machinations. That emphasis on the importance of stocks was at the core of the Greenspan Fed and was continued by his successors Ben Bernanke and Janet Yellen. Along the way economists increasingly factored stocks into their theories and the Wealth Effect – the idea that when people feel rich from their investments they spend more – gained prominence.
The 2008 financial crisis cemented the importance of stocks in economic management. Policy makers monitored falling stocks as if they were a good barometer for economic activity and reacted accordingly. In 2010, in an editorial defending the Fed’s then controversial Quantitative Easing program, Chairman Ben Bernanke pointed to rallying stocks as evidence the policy was working. In 2012 Assistant Attorney General Lanny Breuer, the man who presided over the Justice Department’s Criminal division in the aftermath of the financial crisis, said when considering prosecution of a bank executive they took into account the impact on the bank’s shares and financial markets. More recently Fed President Bill Dudley has stated that how the market reacts will play a role in how quickly the Fed raises interest rates back to normal.
The first thing we should recognize about the stock market is that it’s a pretty bad indicator for the economy. Today stocks trade at all time highs, but that’s not the case for any meaningful metric of the economy, like employment, GDP growth or wages. Real median household income, perhaps the purest measure of the vitality of the middle class, has steadily declined while the stock market has rallied during the recovery.
The second thing we should realize is that stocks only matter to a small and peculiar subset of the population: large corporations and the wealthy. The employees of the S&P 500, the index consisting of the 500 largest public companies in America make up only 15% of all employed persons. Most jobs in this country are created by companies that can’t participate in the stock market. As for the minority that do, there is no evidence that higher stock prices lead to hiring. If companies added and subtracted employees based on volatile individual stock prices they would constantly be firing and hiring people in almost random fits that might have little to do with their actual business.
Shareholders also consist of a minority of the population, in this case the highly affluent. Most shares are not owned by average Americans, but rather executives and founders. Think of people like Mark Zuckerberg and Warren Buffet. Some academics estimate the top 10% in terms of wealth own over two-thirds of all stocks. Scan down a list of the world’s richest people and you will see why. Meanwhile, the most recent Gallup survey shows almost half of all Americans don’t own any stocks.
Given this reality, it should come as no surprise that the post-crisis era has seen a surge in the economic disparity between the haves and the have-nots. As policy makers have focused increasingly on stocks, they have committed resources to elevating the market thus improving the lot of the rich and powerful. Most of the Fed’s post-crisis programs for example would have been considered a failure if they weren’t constantly validated by a surging Dow Jones Industrials Index. There is a moral imperative to help the majority that has been left behind by this recovery, and it starts with paying closer attention to economic factors that measure their well being.
There is also a practical benefit to shifting our attention away from the stock market. Any market that can yo-yo 10% within a day for no apparent reason, or undergo multiple booms and busts in a 20 year period should not be given too much credibility. The wealth-effect on the way up always turns into the wealth-destruction effect on the way down.
If we can look away from the daily machinations of the unpredictable market we are more likely to work on the sort of structural reform that pays off in the long run, even if it doesn’t make the market go up today.