Why has the stock market fallen sharply over the past week?
Because the widely discredited S&P lowered the rating on Treasury bonds one notch?
Because the economy slowed to essentially zero in the last few months?
Because the European Union is under extreme stress?
The stock market fell because last Tuesday night Congress approved, and President Obama signed, an agreement to cut public expenditures by $2.5 trillion over the next decade. That is the only significant change in the real world.
Those expenditures, which would have been financed entirely by borrowing money, would have put money in the pockets of defense contractors, road builders, home health care providers, school districts, and thousands of other companies, nonprofits, and individuals.
Those expenditures would have boosted the economy, expanded GNP, and, most importantly from the point of view of the stock market, expanded profits. Now they will not, and the process works in reverse. Now the economy will be smaller and profits will be less.
The stock market is a wild and crazy market, but at the end of the day, it combines the perspective of thousands of investors -- massive and tiny -- about the current value of a future stream of profits for companies whose stock is publicly traded.
When an economy is operating well below capacity, which is undoubtedly the case for the United States, borrowing money in order to buy guns, butter, schools, houses, and roads boosts the profits of those companies over time. Interest rates have been low and remain low because there is a great deal of unused capacity in the economy, and not a single reputable economist believes that this will go away soon.
There are some -- usually not economists -- who magically believe that when unemployment is over 9% and interest rates are very low -- that the government borrowing a dollar means that dollar is not invested in something productive in the private sector. The stock market just rebuked them big time.
It did not have to be that way. The U.S. economy needs to grow, not be subject to austerity. We are all paying the price for the new economic lunacy in Washington -- that a recession can be avoided by sharply cutting spending. This has never been true and is not now.
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