Byline: CLAY CHANDLER Washington Post
WASHINGTON -- When Federal Reserve Chairman Alan Greenspan issued his now famous warning that ``irrational exuberance'' had driven U.S. stock prices to dangerously high levels, the bulls on Wall Street scoffed. Why, they demanded, should swings in the stock market have any effect on the economy?
But nearly two years later, with the Dow Jones industrial average wobbling at an altitude thousands of points higher, that question is prompting new debate.
A small but growing number of economists and market experts are beginning to worry about the danger of a ``wealth shock,'' in which a sudden drop in share prices spooks investors, prompting them to sharply rein in spending. Since personal consumption accounts for about two-thirds of the total economy, the theory goes, a pronounced souring of sentiment could drag down growth.
This notion is a departure from traditional thinking that large movements in share prices do not have a significant impact on consumer behavior. But proponents of the wealth shock scenario argue that there are a number of reasons to re-examine the old assumptions:
More Americans than ever now own stock. About one in four households own stocks directly, according to most recently available data from the Federal Reserve.
The value of Americans' stock holdings is larger than ever. In 1998, the value of stocks owned by U.S. households, either directly or through a company retirement program, topped $13 trillion, according to the Fed. That's up from only $4 billion since the end of the last recession in 1991. Stocks have not risen so much in so short an interval at any time since the Fed economists began collecting personal wealth data in the 1940s.
In 1998, the value of stocks held directly or indirectly by U.S. households was more than double that of their annual disposable income. In 1991, stockholdings amounted to only 0.8 percent of disposable income.
Recent advances in information technology -- including the Internet, cell phones, pagers and the advent of round-the-clock financial coverage on television -- have made it possible for even small investors to track minute fluctuations in the value of their stock holdings on almost a real-time basis.
Economists puzzling over the U.S. economy's robust expansion have debated how much these developments have contributed to a so-called ``wealth effect,'' in which American households tracking their expanding stock portfolios have felt freer to spend, and thus generate more economic growth.
Some analysts are beginning to worry that the reverse could be true. The wealth shock argument ``shouldn't be treated as a kooky an idea any more,'' says James Glassman, an economist Chase Securities Inc. in New York. ``When you look at all the euphoria we've had in the consumer sector lately, it doesn't take too much imagination to see how it could happen.''
The run up in the stock market in recent years has probably increased the wealth effect, said Nariman Behravish, chief international economist at Standard & Poors/DRI, an economic forecasting concern based in Lexington, Mass. The conventional view has long been that every $100 increase in the value of stocks held by households would generate about $3 in additional consumer spending. Behravish estimates the amount of new spending at about $10.
During the first half of this year, robust consumer spending helped to cushion the U.S. economy from the sharp drop in exports to slumping Asian economies. But Glassman is one of a number of Wall Street analysts who fear that a major downturn in the U.S. stock market could trigger an unexpectedly large decline in consumption in the remainder of the year.
One reason for his concern is that between January and June consumer spending rose at an annualized rate of 6 percent, even though household incomes rose at a rate of only 3 percent. The household savings rate during the period dropped to near zero.
The implication, says Glassman, is that the recent big gains in the value of consumers' stock portfolios have convinced Americans that they need worry less about putting money away for their retirement and can afford to spend more freely.
``Slowing income growth, the record low saving rate and a flagging stock market are setting the stage for a sustained moderation of consumer spending growth'' in the second half of the year, Chase analysts warned in a recent report to clients. Chase analysts estimate that, ``a 10 percent sustained decline in the stock market would be expected to lower real (economic) growth by about 0.5 percentage points over the course of the year.''
How long would a market downturn have to be sustained before it had an effect on spending? There was no noticeable drop in consumer spending in late 1987, despite the brief market crash in October.
Some experts contend a severe market decline now could reduce spending in a matter of weeks or months. Others argue that stock prices would have to remain at lower levels for at least a year.
Stan Shipley, senior economist at Merrill Lynch, expressed skepticism about the idea that a stock market stumble could trip the rest of the economy. ``Remember, stock prices have risen at an annual rate of 27 percent for last three years running,'' Shipley said. ``A 10 percent drop just offsets some of that increase, but it's not a big drain. We're still above last years' levels.''
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