There are stock markets around the world. As I write this, the markets are reeling from several days of losses of hundreds of points in their indices. They have lost anywhere from 20% to 60% of their value and who knows what they will do upon opening next week. Yet each day and each week we read or hear that the market has not lost so much in a day or a week or a year since and they give a case when things were even worse. So is it so bad or what?
As you might expect, when the market acts this way things are bad. The basic reason is a number of what one might call "feedback loops." Just what is a "feedback loop"? Well it’s something like what happens with a thermostat. The thermostat on your house (if you are fortunate enough to have one in your house) senses the temperature and turns on or off your heating or cooling system based on what the temperature is. There is also a thermostat in your oven. The measurement of the temperature is feedback from the environment and that controls whether the heat is turned on. But that’s just simple feedback and not a feedback loop.
With a feedback "loop," one has two-way feedback. Information in some form is going in both directions. Because we use a POM (a physical object
money) the ownership of stocks is flowing in one direction while POM is flowing in the other direction. Now both the money and the ownership are in the human mind. In the modern stock market, currency is not changing hands, numbers in accounts are changing instead.
In the case of the stock market, there are many people involved. They know about the flow of money and ownerships and adjust their actions accordingly. So when other traders are mostly selling, each trader begins to experience an expectation that future prices are going to go down and this makes each trader more likely to sell. The emotions of the other traders on the floor of the exchange also affect traders giving them an incentive to do what the others are doing. Note that this works for both a falling (bear) market and a rising (bull) market.
Outside the stock market, people judge the value of their assets based, in part, upon the current prices for stocks being sold. This has affects on the behavior of those stock owners. When the market is falling investors tend to cut back on their spending. This reduces many companies’ sales which in turn reduces their profits and the dividends the stocks of those companies pay. That in turn tends to reduce the prices of those stocks.
Each element in the feedback loop is aligned such that increases in one element generate increases in the other elements.
Therefore, the mere fact that the market is falling, though completely irrelevant at the physical level to the amount of goods and services an economy is physically able to produce has a huge effect on the amount of products actually produced for purely psychological reasons.
One of these feedback loops related to the stock market is the willingness of people to make loans. Banks and other lending institutions will not loan money when they feel that the borrower might not be able to repay the loan and doesn’t have enough assets to cover the amount loaned. When prices are falling, banks see non-money assets as being less valuable (with the value expressed as dollars) and stop loaning. This in turn, reduces the ability of businesses to hire and to produce products. That, in turn, reduces the amount of money they and their employees can spend.
Their reduction in spending reduces the sales of other companies which puts more downward pressure on prices for other products which lowers the value of those products as assets.
To review, the feedback loops in a POM economy exist because while production processes move goods and services in one direction there is a corresponding flow of money in the other direction. This means that at every stage in all production processes, the right amount of money must be available to flow in the other direction just sufficient to balance the perceived value of the goods and services produced. These flows of money and products constitute feedback loops. And because the POM supply is independent of the goods and services for sale, that feedback from the money can easily get out of balance, either too much (inflation) or too little (deflation/depression) and one gets a boom or a bust. When the supply of money is expanding, it tends to expand to excess due to the reinforcing nature of the feedback loops and creates inflation. When the supply of money is contracting, as it is doing these days, it tends to contract to excess due to the feedback loops and suppresses production.
What can be done about it? Nothing, so long as the economy uses a physical object money. A POM is uncontrollable. Therefore, nothing can prevent the markets from being disrupted by events. Sooner or later, given a POM and human nature, events will conspire to produce either destructive inflation or deflation despite even a government’s best efforts.