If the stock markets of the world all drop 10-20 percent simultaneously, are we as Americans significantly worse off?

BY busadmin  October 15, 2008 at 10:30 AM EST

Man stocking food; AP photo

Question/Comment: Would you please clarify something for me that I am struggling to understand? If the stock markets of the world all drop 10-20 percent simultaneously, are we as Americans, or any other nationality, significantly worse off? If, relatively speaking, investors take an equal hit everywhere and have a roughly equal percent of their wealth evaporated, would it really change wealth? Won’t global prices simply revise themselves downward (i.e. commodities like oil, wages through future stagnation of wage increases) and leave us relatively in the same economic situation — except for investors who would be 10-20 percent closer in wealth to non-investors (mostly poor)? If not, what piece am I missing?

Paul Solman: You’re missing what wealth IS and how it affects economic behavior – of both firms and individuals.

Since you’re emailing from Cote d’Ivoire, say you own a cocoa processing company in Abidjan (cocoa being, as you know, Cote d’Ivoire’s primary export). Your stock price goes down by 20 percent. What happens?

First of all, if your investors feel poorer, research shows that they’ll spend less. (This is known as the “wealth effect” or, in this case, the “lack-of-wealth effect,” I suppose.) As people spend less, businesses are squeezed. They lay off employees, who in turn spend less. Soon enough, your business is hit too. Down and down it goes, round and round it goes in a spin. Not loving the spin we’re in.

Yes, in the long run, prices should come down, as should the price of labor. Then, some day, the economy should begin growing again. But as the famed English economist John Maynard Keynes famously wrote, “in the long run, we’re all dead.”

Meanwhile, in the short run, we can prosper or suffer: suffer if the economy spirals down into recession, and produces less wealth than it otherwise would.

Think of Cote d’Ivoire. It has a per capita annual income of somewhere between $1,000 and $1,500, depending on how you’re counting. Think of your cocoa plant, with fewer customers. Think of having to lay off workers, whose whole families may depend on them for short-term survival.

And if you try to raise more money to keep those workers employed by issuing more stock to investors, say, with a lower stock price, it’ll be harder to do.

Stock prices do not always go up. But when they go down dramatically, a lot of people get hurt. Some get hurt very badly.