The lead article in the New Year's Day edition of the Washington Post bemoaned the loss of $6.9 trillion in value in U.S. stock market last year. While those who own large amounts of stock have reason to shed tears, this may end being good news for the rest of us. The loss of stock wealth means that stockholders have less claim to value of the country's output. The U.S. economy can produce just as much in 2009 as it did in 2008 (in fact somewhat more, because of labor force and productivity growth). If stockholders can demand less because of the reduced value of their stock, then this leaves more for the rest of us. The most visible evidence of how the loss of stockholder wealth can benefit the rest of us was the sharp decline in consumer prices over the last three months. As a result, real wages rose at almost a 15 percent annual rate in the three months from September through November. Of course, insofar as the demand generated by stockholders (and homeowners, who have also seen their wealth plummet) is not replaced by other sources, then workers are losing jobs. Eventually weakness in the labor market will put more downward pressure on real wages. However, if the loss of demand from stockholders is effectively replaced by demand from the government or foreign sector, then the vast majority of the country will be made better off by this plunge in stock prices. The Post should have reporters who understand this fact.
--Dean Baker Addendum: Since the question has been asked repeatedly, I will try to quickly explain how the fall in stock prices can make non-stockholders wealthier. There are two components to the wealth that people have in stock. One component is the flow of income in dividends, which is turned based loosely on the growth of corporate profits. If, for the moment we make the unrealistic assumption that the growth in profits is unaffected by the crash (there will be feedback effects as we are seeing -- the plunge in demand that resulted from the stock and housing crash is also leading to declines in profits), then this future flow of dividend income will not be affected. The second component of wealth is that value of the stock itself. How much can I get for selling my 100 shares of Verizon today. This second component is obviously directly affected by the fall in stock prices. Stockholders will consume based in part on the value of their stock wealth. The logic is that they try to more or less balance their consumption over their lifetime. If they have more wealth, then they can consume more over their lifetime. To take a simple example, imagine a person is 75 and can expect to live another 10 years, and had $200,000 in stock. Then we might expect this person to spend roughly 10 percent of her wealth or $20,000 a year. Now suppose the market has crashed and her stock is only worth $100,000. Then we would expect her spend just $10,000 a year. This is what is happening as a result of the stock crash. Stockholders have less wealth and therefore are spending less money on cars, vacations and everything else. The reduction in demand places downward pressure on the price of these goods, making them cheaper for everyone. Those folks who did not have a lot of stock gain in this story, assuming that they hold onto their jobs.
