The relationship between wall Street and Washington is like a bad marriage. They fight, promise to change, try to believe each other and go back to their old ways. The government shutdown is only the latest of these tiffs. Stocks were down before the shutdown, up after, and they are likely to be volatile if politicians continue to duke it out over spending limits and the debt ceiling. None of it has been surprising. After all, we've seen this movie several times over the past three years. Congress squabbles, markets fall; Congress makes up, stocks rise. Even if this particular remake ends happily, one thing is for sure--the endless cycle of Beltway shenanigans is damaging our economy.
You can see it in the divide between the S&P 500 and Gallup's consumer-confidence numbers. As behavioral economist Peter Atwater recently pointed out to me, these two numbers have historically almost always moved in step with each other. But while markets are higher today than they were in their precrisis peak in 2007, confidence, which reflects perceptions about the strength of the real economy, is lower.
No wonder both consumer and business spending are down. Government could be doing so many things to help the economy, from properly reregulating the banking sector to revamping education to funding the R&D that fuels job creation. But instead of leading the way to growth, some politicians remain obsessed with defunding Obamacare. While they complain that the law has created punishing uncertainty for businesses, their brinkmanship creates far worse uncertainty about bigger things--like whether we'll have jobs. With or without shutdowns that shave 0.2 percentage points off GDP growth per week, we'll be lucky to maintain 2% growth, let alone achieve the 3% we need for true economic health.
The divide between stocks and the real economy tells us some important things. For starters, the foundations of our recovery are weak. Equities have remained relatively strong because the Federal Reserve is artificially propping them up with $85 billion a month of asset buying. The tactic is understandable--the Fed has kept the money spigots open, risking market bubbles, in part because of "fiscal headwinds"--that is, growth-destroying partisan politics. Ben Bernanke can't make Congress agree to fund the government or raise the debt ceiling, but he figures he can at least shore up stock and home prices.
The problem is that this monetary cycle is breaking down. People simply aren't buying into the sugar high of this kind of policy anymore. For proof, look at how the Fed's decision a couple of weeks ago not to taper off its massive spending spree boosted stocks for only a day. Each new round of quantitative easing does less to goose the market than the round before. "It all shows what a weak and narrow recovery we are in," says Atwater.