The Dow Jones Industrial Average has plummeted 504.48 points today. A drop that large has not been seen since the opening days following the September 11th attacks. It is not my intention to compare terrorism to unfortunate management and bad bets on the part of the financial sector. However one must ask what the future holds for the United States and world economic engine.
A strong economy is based on productions of goods by employees with jobs. As a business cycle enters a downturn production is slowed to match consumption. Whether it is the chicken or the egg a downturn in production is usually associated with job losses. Unemployment during the Great Depression exceeded 25%.
One exception may be commodity based economies. In the case of the Russian ruble crisis, the drop in oil prices created exceptional stress on national income based on oil exports. With some world intervention the ruble stabilized, but left the Russian middle class reeling from lost savings deposits and 100% inflation for domestic products and 400% inflation for imported products.
Taking the commodity based economy in another vain would be agrarian economies. Drought or other natural disasters can cripple an economy by failure to produce foodstuffs for national consumption or export. Fortunately major world economies are not as tightly tied to commodities pricing.
An economy whether a state economy or the world economy is still based on the cost of labor and the cost of capital. Globalization sent the world economy soaring. Lower labor rates were created not only by lower cost labor forces, but also by increased productivity. Lower capital costs were the result of historically low commodity prices as well as worldwide access to capital.
The two recent shocks to the US equities markets are a response to the likely increase in cost of capital. This increase whether real or imagined will force a business cycle downward as companies who require capital infusions to grow will not be able to get the capital infusions at attractive rates. This will result in either a lack of investment or a pass through of the increased costs to consumers. In both events a significant strain will be placed on the economy.
Saviors to an economy would include a strong individual, consortium or national monetary policy which can soundly expand the money supply. Soundly is the key term as hyperinflation is all too real a threat which would punish those holding cash deposits in any given currency. A hedge against hyperinflation would be foreign currencies with low correlation to the US economy, which doesn’t really exist. The only true hedge against hyperinflation is commodities, the easiest of which to stock pile is gold. Unfortunately you cannot eat gold like you can corn or heat your home with gold as you can oil products.