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Why Stock Prices Dropped

Stock prices last week fell more than 5% because of specific economic events and policy responses from Congress and the president.

Stocks may recover, but recent events demonstrate how nervous investors are becoming about what they see in primary economic indicators, and President Obama's populist and ill-directed responses.

Troubling Events

Since Jan. 1, signs that the economic recovery may be faltering have emerged -- job losses and new unemployment claims are up again and remain at recession levels; retail sales appear to be flailing; housing prices show signs of falling again; and demand for new homes is declining (fewer visits to new-home showrooms and disappointing sales data); and non-residential construction and jobs in that sector continue to fall.

China's fixed exchange rate policy has destabilized the U.S. and Chinese economies, sending tremors around the globe.

In the United States, China's policy floods markets with products priced at less than their cost of production and throws Americans out of work without creating new jobs in export industries. Falling employment results in poor retail sales and more job losses; it's what economists call the multiplier effect.

In China, the fixed exchange rate for the yuan against the dollar requires Beijing to print lots of yuan to sweep dollars off foreign exchange markets and return to China as payment for exports. This causes inflation, too easy credit and an asset bubble. Instead of fixing the problem by steady and significant revaluation of the yuan dollar peg, the Chinese government is pulling back on credit and that could cause a second crisis on both sides of the Pacific. A Chinese asset crash could be the next big thing, and that won't be a good thing.

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