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What are the implications to the U.S. economy of major stock market sellouts?

Question submitted by Tamia McCormick, from Saint Peter's University, May 28, 2013

Answered by: James P. Dougherty, Adjunct Senior Fellow for Business and Foreign Policy

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A major stock market sell-off would have grave negative consequences for all parts of the U.S. economy, but specifically for the individual consumer, businesses, and the government.

First, a stock market sellout would reduce consumer savings, causing less spending and more saving. That in turn would reduce the amount of money consumers have to spend, which is the biggest driver of GDP and economic growth. Confidence in the economy would be reduced, causing yet another spending pullback, and beginning a vicious circle.

Second, businesses would not be able to raise money from the stock market, harming their ability to grow, expand, and hire. More specifically, new hiring would decrease and layoffs would increase, adversely impacting actual consumer spending in the present and consumer confidence in the future. Fewer new projects, such as construction and expansion into new areas, would be approved, further negatively impacting economic growth.

Third, a major portion of pension plans place their investments in stocks. A sell-off would reduce the amount of money businesses have to pay current and future retirees.

Finally, foreign funds from America's economic partners around the world for direct investment in entities and in financial instruments would likely fall drastically. These foreign funds are a crucial element of the U.S. economy. If they dry up, many aspects of the U.S. domestic economy will be left without funding.

Sell-offs would only occur if some vary serious event ignited them, such as an attack on Iran, the collapse of the euro, fighting on the Korean peninsula, or a large domestic terrorist attack. Overall, the global economy is holding steady, if not particularly well. Fortunately, the economy is not in a state that would lead to major stock market sellouts.