Stock Market Reacts Violently to a Bad Debt Deal

It’s quite common to hear a Republican politician to use the phrase that “the market knows best”. They should be alarmed then to see the reaction that the market has had to their manufactured debt ceiling crisis and the deal that came out of it. We are coming off the worst day for the Dow since 2008, a drop of over 500 points. Only barely did the Dow manage to avoid a nine day losing streak, which would have been the worst performance since 1978. The stock market is now down 10 percent from its April highs.

For a party that loves to effusively talk about the wisdom of the market, the past month’s stock slide should be a wakeup call. The Hoover economics that Republicans in Washington have subscribed to, cutting spending at a time when job growth is at best anemic, is putting the country at risk of a double-dip recession. Don’t take my word for it though. I am only a Political Science major. Take the word of economist and Nobel Prize winner Paul Krugman.

He warned in July that the debt ceiling deal envisioned by Republicans would “damage an already depressed economy; it will probably make America’s long-run deficit problem worse, not better; and most important, by demonstrating that raw extortion works and carries no political cost, it will take America a long way down the road to banana-republic status.”

Krugman warns that focusing on reduced deficits during a period of slow economic growth is essentially like throwing water on a fire that’s barely burning anyway (the economy). He writes:

The worst thing you can do in these circumstances is slash government spending, since that will depress the economy even further. Pay no attention to those who invoke the confidence fairy, claiming that tough action on the budget will reassure businesses and consumers, leading them to spend more. It doesn’t work that way, a fact confirmed by many studies of the historical record.

Indeed, slashing spending while the economy is depressed won’t even help the budget situation much, and might well make it worse. On one side, interest rates on federal borrowing are currently very low, so spending cuts now will do little to reduce future interest costs. On the other side, making the economy weaker now will also hurt its long-run prospects, which will in turn reduce future revenue. So those demanding spending cuts now are like medieval doctors who treated the sick by bleeding them, and thereby made them even sicker.

The bottom line is that the economy is in rough shape. Instead of treating the problem and attempting to stimulate growth, Republicans are the medieval doctors treating the sick by bleeding them. The stock market has reacted by contracting. At first stocks dove on fears that the United States might default due to Tea Party extremists holding the debt ceiling hostage. Now the stock market is tanking because of an uncertain economy that the debt ceiling deal did nothing to solve. In fact it only made matters worse.

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