Markets, pundits and bears: How much should you care?

Over the past 18 months, I have been warning readers about the ongoing economic problems and the possibility of another world financial crisis. Now, along with economic woes, financial markets are in full panic mode. But does this matter?

Financial market meltdown 'not a huge calamity,' says economist

Traders work on the floor of the New York Stock Exchange. So far in 2016, the TSX has continued a downward tumble as the price of oil dipped below $29 US a barrel and the loonie hit a 13-year low. (Spencer Platt/Getty)

Over the past 18 months, I have been warning readers about the ongoing economic problems and the possibility of another world financial crisis. Now, along with economic woes, financial markets are in full panic mode. But does this matter?

My pessimistic tone on the economy reflects a sense that economic policy is somehow not recognizing the severity of the situation. Our overreliance on monetary policy in the absence of any real fiscal stimulus amounted to a crisis in the making.

Here we are now, with the world's biggest economies faltering, prompting IMF managing director Christine Lagarde to call this 'The New Mediocre', although mediocre may turn out to be too optimistic a word. It took most pundits, however, a long time to catch up to this sad realization.

In fact, until a few months ago, some were still denying a recession took place in 2015. But now, all of a sudden, everyone is sounding pessimistic. It was neither the constant depressing economic news that alarmed market observers, nor the persistent high unemployment rate.

Talking economics suddenly in vogue

Pundits also largely ignored the low economic growth, the increasing income inequalities, our declining wages, or the inability of so many Canadians to make ends meet every month. These worries were met largely with yawns from financial markets (and governments) and treated as the price we all had to pay.

As long as financial markets were doing well, speculators simply shrugged; there was no reason to be concerned. Economists like myself who were raising our voices were ignored. But it was the recent financial market nosedive and the loss of more than 20 per cent of financial wealth that suddenly woke the sleeping economic giant.

Now, all of a sudden, with billions of dollars in wealth evaporating, the economy matters, and pundits of all political persuasion, those who once would never have suggested it, are demanding action on the part of the government. Panic has set in. But so what? Is this latest financial meltdown a big deal? On the latest financial worries, I can only offer a big great sigh.

For me, this is not a huge calamity, and here's why: 

  • First, financial markets are driven in large part by exuberance and speculation. There is no rationale to them. Economists describe this as herd behavior: when something bad (or good) happens, others tend to jump on that bandwagon, and a small effect can turn into something much bigger, even though the underlying cause is small. It is clear that what is happening now is simply panic. But we know from similar episodes in the past that financial markets eventually recuperate. Granted it may take a few years, but they rally back. Keynes talks about "animal spirits" and the bursts of optimism and pessimism. So the pessimism will eventually be replaced with optimism, and a new bubble will begin. 
  • Second, the loss of wealth overwhelmingly affects the one per centers. Granted, some retirement funds will be affected, but in large part, it is the financial movers and shakers who see their wealth disappearing. I am less concerned with the financial losses of the über-rich than I am about the working plight of most Canadians. From a pure macroeconomic perspective, it matters less, despite what they will tell you ad nauseam. They will tell you that it matters a great deal, but in reality, it does not.
  • Third, the reality is that financial markets have only a very indirect relationship with the real economy. Take, for instance, their respectful performances since the 2007 crisis. While the real economy was underperforming, financial markets were flying high, completely out of touch with the difficulties of the real economy. In fact, the economy has yet to attain its pre-crisis performance with respect to many variables, yet the financial markets have achieved this and more.

In the last two years, as Canada's economy was slowing down, the financial market was on a roll. So the recent financial turmoil will have only a limited impact on the economy, if at all. In the end, financial markets are like the wizard in the Wizard of Oz: all smoke and screen.

So don't pay attention to the man behind the curtain, and neither should governments, whose primary task is to put Canadians to work. The economic impact of creating jobs far outweighs the gyrations of the financial market.

Louis-Philippe Rochon is an associate professor at Laurentian University and co-editor of the Review of Keynesian Economics.


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