Friday, June 26, 2009

Greenspan Says Stock Market Recovery Could Lift Economy

Alan Greenspan, writing in the Financial Times, argues that a continued recovery by the stock market could lift up the economy. A healthy stock market helps supply banks with capital for lending, increases household spending, and spurs new capital investment, he argues. See below for more on Greenspan's thinking.

Maybe there was a Greenspan put after all?:
Inflation - the real threat to sustained recovery, by Alan Greenspan, Commentary, Financial Times: The rise in global stock prices from early March to mid-June is arguably the primary cause of the surprising positive turn in the economic environment. The $12,000bn of newly created corporate equity value has added significantly to the capital buffer that supports the debt issued by financial and non-financial companies. Corporate debt, as a consequence, has been upgraded and yields have fallen. Previously capital-strapped companies have been able to raise considerable debt and equity in recent months. Market fears of bank insolvency, particularly, have been assuaged.

Is this the beginning of a prolonged economic recovery or a false dawn? There are credible arguments on both sides of the issue. ...[T]he crisis will end when ...[there is] a stabilisation of home prices or a further rise in newly created equity value available to US financial intermediaries...

Global stock markets have rallied so far and so fast this year that it is difficult to imagine they can proceed further at anywhere near their recent pace. But what if, after a correction, they proceeded inexorably higher? That would bolster global balance sheets with large amounts of new equity value and supply banks with the new capital that would allow them to step up lending. Higher share prices would also lead to increased household wealth and spending, and the rising market value of existing corporate assets (proxied by stock prices) relative to their replacement cost would spur new capital investment. Leverage would be materially reduced. A prolonged recovery in global equity prices would thus assist in the lifting of the deflationary forces that still hover over the global economy.
I recognise that I accord a much larger economic role to equity prices than is the conventional wisdom. From my perspective, they are not merely an important leading indicator of global business activity, but a major contributor to that activity, operating primarily through balance sheets. ...

Stock prices, to be sure, are affected by the usual economic gyrations. But ... a significant driver of stock prices is the innate human propensity to swing between euphoria and fear, which, while heavily influenced by economic events, has a life of its own. In my experience, such episodes are often not mere forecasts of future business activity, but major causes of it. ...

He also gives his view of the future inflation threat. I'll just note that I quite agree with Greenspan's assertion that he accords "a much larger economic role to equity prices than is the conventional wisdom."

This was reposted from Mark Thoma's blog, Economist's View.

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