Sharp Decline Raises Fears of Recession

For months, the U.S. economy has been batted about by the contending forces of improvement and decline. Only last week, it showed strength in an area in which many had expected weakness: job growth.

But chalk Monday up for trouble.

By wiping out nearly half a trillion dollars in paper profits, the day’s stock plunge revived fears that a downward spiral of contracting wealth, shrinking investment and sharply slowing consumption could sweep the economy into recession.

That put economic policymakers in a box. Federal Reserve Chairman Alan Greenspan had begun to suggest that the economy and financial markets might not be quite as entwined as previously thought--that the former might be able to recover even if the latter didn’t.

But now “he’s got to be worried that a collapse in market psychology could spill over into the rest of the economy,” said David M. Jones, chairman and chief economist of Aubrey G. Lanston & Co. in New York. “He’ll probably have to cut interest rates more than he otherwise would because of this.”

Greenspan and the central bank are in an even more immediate quandary if stocks keep falling. The Fed chairman has made clear he wants to hold off any further rate cuts until the bank’s policymaking body, the Federal Open Market Committee, meets next Tuesday.

Any cut before then would be widely interpreted as aimed at shoring up share prices, something the Fed does not want to be seen as doing. The central bank’s job is to control inflation and maintain stability, not ensure investors good returns.

So far, the market’s decline has been concentrated in the technology sector: The Nasdaq composite index has fallen 62% from its peak of a year ago. Blue chips have fared better. The Dow Jones industrial average is down only 13% from its recent peak, although Monday’s 436-point plunge was ominous.

But if the market’s slide continues and spreads, analysts said policymakers will have little choice but to act. “At some point, this takes consumer confidence and the economy down with it,” warned Mark Zandi, economist with Philadelphia-based Economy.com.

The link between stocks and growth has been one of the most hotly debated issues of the nation’s decade-long boom. When the economy ballooned in the middle and late 1990s, many analysts said stock gains were a principal cause, providing new capital for business, new wealth for families and a sense of near-boundless hope. As share prices have tumbled in the last year, many have warned of the reverse.

In round numbers, rising stock prices added $10 trillion to investors’ wealth between the start of 1995 and the start of 2000. Falling prices since then have trimmed the gain by about $4 trillion.

But the last few weeks have offered hope that the economy could chug through the losses and resume its upward spiral. Retail sales, which were anemic during the usually brisk holiday buying season, recovered in January and February. Purchases of big-ticket items, such as houses and cars, remained surprisingly strong. And, in contrast to what almost everyone had expected, businesses kept hiring people, 135,000 of them last month alone.

Analysts sought to explain the signs of continued strength by suggesting that the link between stocks and the rest of the economy might not be that strong after all. Perhaps Americans had not factored their newfound wealth into their economic decisions because it had come in restricted forms such as pensions and 401(k) plans.

“The question all along has been whether consumers built the full amount [of their gains] into their planning and how much erosion it would take before they noticed,” said Pierre Ellis, a managing director of Decision Economics Inc. in New York.

Analysts said the problem with Monday’s stock plummet is that it pushed key market indexes into hard-to-overlook terrain. For example, the once-hot Nasdaq composite index closed below 2,000 for the first time in 27 months. Even the broader Standard & Poor’s 500 index is off 23%--more than the 20% that defines a bear market.

In addition, some analysts worry that the new losses are taking on a self-sustaining momentum, with U.S. stock declines spurring foreign stock drops that feed back into further U.S. sell-offs--a development that would probably also attract consumers’ attention and make them more likely to trim their spending in line with their stock losses.

The round-the-world stock trend seemed particularly ominous for Japan, where the benchmark Nikkei 225 stock index fell below 12,000 today for the first time since February 1985. The index has plummeted 40% from its 2000 peak.

Japanese officials and others are concerned that further steep declines could hurt the nation’s major banks, which rely on stock holdings to meet international financial safety requirements and remain solvent.

For economists who have predicted that U.S. stock troubles would catch up with the American economy, Monday’s market tumble seemed to be the evidence they have been looking for.

“The most striking thing coming out of Washington is the attempt to tell a story about the economy that’s silent about what’s happening in the stock market,” said Robert J. Barbera, chief economist of Hoenig & Co., a New York-area brokerage house. “It can’t be done.”