In the face of a flue like economy, the Dow Jones passed 14000. Why is that? Consider this: real estate is a way of storing wealth, but when signs point to a devaluation of said wealth, any economic agents would try to move that wealth to something better, in most cases, it is either money, or stocks and securities. So, which would it be?
With a weaken economy, holder of US currency, formerly a great way of storing wealth, might not want to hold US dollars. With over 50-70% of held currency being held by people outside of the US, an expectation of losing value would lead many to run for better harbor. This would creates a shift in demand for money downward, creating the lose of value that was expected, which would then creates a vicious cycle. The intensity of the lose is dependent on how people adjust their expectation as they read the market and compare it to their own experience. This is good for the US because the US economy is big, and it had preformed admirably in the past, which would greatly dampen the intensity of expectation. Nevertheless, people will see that money value is dropping, and money demand should still shift downward. In other word, having to choice between storing one’s wealth in stock or in money in this situation, it seem obvious which is the the better choice. Adding to that the rate cut be the Fed help in providing more credit to the market as a stimulus, the stock market seem a good place to move to.
This situation then would help to provide some positives to our ailing economy. For starter, to any observer, it is clear that the US has benefit much from global trades as it allows the US to live way beyond its mean; however, in doing so, the US had built up a huge trade deficit that would someday become unsustainable. The drop in the value of the dollar relative to other currencies should helps to increase US export and decrease US import, a first step toward balancing the trade imbalance.
Secondly, our stock market had be a little more than volatile in recent months, and it need stabilities for our economy to recover to good health. The credit influx into the market, because there really is no where else to store it, should help our market recover. Added to that is the descrease in financial confidences due to the subprime mortgages and increasing rate of default, a strong Wall Street should help in restoring some confidences.
Thirdly, the current turmoil will help to teach lenders to be less complacence and to be more responsible with their lending, and to rely on more than just the market to tell if someone is going to be a good borrower. It is true that as lender, one must lend money with incomplete information of the borrower; hence collateral help to make the lending less worrisome. However, as real estate value increase, more collateral become available, which lead to more lending, which will help to increase demand on real estate; resulting in a vicious cycle that lead to a bubble. This is why lenders must not become complacence and to learn to step back from the market to see what is developing, and sometime to slow down lending before it actually become a problem like it already have.
From my point of view, I think the US economy is in a good position to recovers before any real recession take root, and at the same time it will become a stronger economy. However, the key to recovery still remain in restoring confidence in the market, especially the financial market. But, this is not a new path that America now faces as the story is very similar to the 1990s, and again, the US will recover.