The stock market may seem like an important way to measure the economy, but it matters less than we think

It’s true that financial volatility can damage a normal business, perhaps even ruin it, but it’s necessary to separate out the micro from the macro

Ben Chu
Sunday 30 December 2018 11:36
Comments
A currency plunge certainly harms living standards by pushing up inflation. But the impact of a revaluation on prices is temporary
A currency plunge certainly harms living standards by pushing up inflation. But the impact of a revaluation on prices is temporary

Stock markets have been up and down like Santa in the world’s chimneys this Christmas.

After taking a record unfestive pummelling on 24 December, American shares experienced a record one-day gain on Boxing Day.

It’s a fitting way to end a year that has been characterised by an unusual level of financial volatility.

The MSCI World Index covers most of the rich world’s largest listed companies. It raced up in January to a record high. But since then the index has shed around a fifth of that value.

And consider some of the constituents of such indexes. Apple crossed the $1 trillion (£790bn) valuation threshold in August, becoming the first listed company ever to do so. But four months on and the iPhone-maker is worth “just” $740bn.

On 26 July Facebook’s shares dropped by 20 per cent. That translated into a paper loss of $120bn – the worst day of value destruction suffered by a single company in US corporate history.

The global oil price has bounced around wildly too this year. In October it hit a four-year high of $86 a barrel, prompting concerns about a potential surge of global inflation. But now, within a few months, the black stuff is back down to $54 a barrel.

Sterling peaked at $1.43 in April, up from $1.34 in January. Now the pound languishes at a measly $1.26, beaten down by fears of a no-deal Brexit.

An honorary mention is due to bitcoin. The original cryptocurrency shot up at the start of the year to $17,500. Now one unit trades for only $3,600.

Why does this kind of financial volatility – these surges and slumps in prices – matter?

Perhaps it seems obvious. If you own something and it halves in value that’s likely to be alarming, not to mention expensive. If you’re going abroad on holiday you obviously don’t relish discovering that the value of the currency in which you are paid has fallen by a tenth.

Perhaps it might even be ruinous if you were planning on selling a financial asset to realise the cash for something important such as paying off a debt that’s falling due. Those who have borrowed in dollars and invested in bitcoin are unlikely to have had an enjoyable year.

If you were planning to retire in 2019 and your pension has collapsed in value over the past 12 months you can also see the problem.

But all these examples assume the investor needs to realise the cash imminently. If you’re saving for retirement several decades hence, even a 5 per cent daily swing, like the one we saw in US stocks on Boxing Day, is really neither here nor there.

What about the real economy? It’s true that financial volatility can damage a normal business, perhaps even ruin it. Think of a goods importer that sees its import costs go up due to a currency slide. Think of a small oil driller that watches the value of the black stuff suddenly plummet.

When those companies expire their workers can lose their jobs and livelihoods.

But it’s necessary to separate out the micro from the macro. At an economy-wide level, idiosyncratic shocks will tend to balance out in the medium term. Sharply lower energy prices are bad for energy producers but good for energy consumers. A cheaper currency can be bad for importers but can be beneficial to exporters.

Support free-thinking journalism and attend Independent events

A currency plunge certainly harms living standards by pushing up inflation. But the impact of a revaluation on prices is temporary if it’s a one-off, as we’ve seen since the Brexit vote.

Some economists, such as Roger Farmer, think stock market crashes lead to domestic recessions. But the causality of that relationship is disputed. And as the Nobel economics laureate Paul Samuelson caustically observed, “The stock market has predicted nine of the past five recessions.”

It would be fatuous to argue that financial market volatility doesn’t matter at all for ordinary people. Yet it matters rather less than we’re sometimes led to believe by the noise of excited speculators and the dramatic media headlines. Sometimes it’s better not to pay too much attention to the puffs of smoke emitted by the chimney of markets.

Register for free to continue reading

Registration is a free and easy way to support our truly independent journalism

By registering, you will also enjoy limited access to Premium articles, exclusive newsletters, commenting, and virtual events with our leading journalists

Please enter a valid email
Please enter a valid email
Must be at least 6 characters, include an upper and lower case character and a number
Must be at least 6 characters, include an upper and lower case character and a number
Must be at least 6 characters, include an upper and lower case character and a number
Please enter your first name
Special characters aren’t allowed
Please enter a name between 1 and 40 characters
Please enter your last name
Special characters aren’t allowed
Please enter a name between 1 and 40 characters
You must be over 18 years old to register
You must be over 18 years old to register
Opt-out-policy
You can opt-out at any time by signing in to your account to manage your preferences. Each email has a link to unsubscribe.

By clicking ‘Create my account’ you confirm that your data has been entered correctly and you have read and agree to our Terms of use, Cookie policy and Privacy notice.

This site is protected by reCAPTCHA and the Google Privacy policy and Terms of service apply.

Already have an account? sign in

By clicking ‘Register’ you confirm that your data has been entered correctly and you have read and agree to our Terms of use, Cookie policy and Privacy notice.

This site is protected by reCAPTCHA and the Google Privacy policy and Terms of service apply.

Register for free to continue reading

Registration is a free and easy way to support our truly independent journalism

By registering, you will also enjoy limited access to Premium articles, exclusive newsletters, commenting, and virtual events with our leading journalists

Already have an account? sign in

By clicking ‘Register’ you confirm that your data has been entered correctly and you have read and agree to our Terms of use, Cookie policy and Privacy notice.

This site is protected by reCAPTCHA and the Google Privacy policy and Terms of service apply.

Join our new commenting forum

Join thought-provoking conversations, follow other Independent readers and see their replies

Comments

Thank you for registering

Please refresh the page or navigate to another page on the site to be automatically logged inPlease refresh your browser to be logged in