Growth Check: The Economic Cost of the Market's Decline

A communications consultant I know tells me that two of her clients decided this week to take a break from her services. Why? Because both have suffered losses in the stock market and are suddenly worried about money.

I don't buy the talk that a double-dip recession may lie just around the corner, but if there's one development this economy doesn't need right now it is a few trillion dollars in wealth going poof. The gyrations of the stock market can seem unrelated to the real economy, but they aren't. Big market losses can derail all sorts of plans by both individuals and institutions to spend money.

Just look at the tech world. A few months ago, it was easier to raise venture capital for start-ups than at any time since the dotcom heyday. Now investors are moving more cautiously and it's gotten harder to raise money. In particular, angel and seed funders -- who are often individuals with lots of spare cash lying around -- are said to be pulling back. Meanwhile, the market's plunge has put to an end to the high-profile IPOs that were helping to whet the appetites of investors.

Or look at the world of philanthropy and higher education. Rich people and foundations give out more money to nonprofits when they are flush with stock market winnings, and so expect to see fewer big gifts from the donor crowd if the market continues to tank. Likewise, universities up their spending when their endowments are doing well -- and cut back when the opposite is true.

Finally, consider the individual consumer. People spend less freely when their net worth goes down not only because they have less money, but because they may get nervous about the future and decide it's better to save for the lean times that lie ahead. Paul Dales, a senior economist at Capital Economics, estimates that the stock market fall could cut consumer spending by $140 billion, or 1.3 percent, over the coming year.

Even worse, the stock market decline is occurring as housing prices continue to slump downward. As I wrote here a few weeks ago, the continuing fall in housing prices is bad for the economy because people worry about spending too much money when their homes decline in value. Now, after the market decline, we're in double-whammy land again (as we were during the Great Recession) with both stock and home nest eggs shrinking at once. Not surprisingly, polls show a steep decline in consumer confidence.

These trends underscore that the federal government can't get out of the stimulus business anytime soon -- contrary to the direction of official policy in Washington. Just maybe the stock market's fall will deliver a jolt to Republicans in Washington who have stood fast against any further stimulus.

Obama is gearing up to give a big speech right after Labor Day on jobs and the economy. That seems like a great opportunity to again make a fresh and forceful case for more stimulus.