The Stalled Recovery, Smoke and Mirrors, and the Carnage on the Street

The Dow ended the week below 12,000 for the first time since March. This is the sixth straight week of downs for the Dow. It’s almost as bad over at the Nasdaq. All the gains racked up in 2011 have now been erased.

What’s going on?

The real economy is catching up with the financial economy, as it always does eventually. Wall Street is built on smoke and mirrors, while the real economy is based on jobs and wages. Smoke and mirrors can only take you so far – as we learned so painfully three years ago.

Jobs and wages stink, if you haven’t noticed. They’ve been bad for months, even before this week’s data made it fairly clear the recovery has stalled.

Stock prices had been rising nonetheless. That was partly because big corporations were enjoying big sales and fat profits from their foreign operations. But foreign sales are slowing. Chalk that up to the European debt crisis, Europe’s insane austerity measures, Japan’s tragedy, and China’s concerns about inflation.

Meanwhile, other companies have been busy restocking inventories in the hope American consumers will be in a mood to buy. But that hope is coming to an end, as the reality dawns that American consumers can’t and won’t buy very much, given their shrinking home values, high debts, and job worries.

Stock prices were also rising because of Wall Street’s certitude that it can make loads of money from the gullibility of millions of small investors. Here’s where the smoke and mirrors come in.

Over the past year, the Street lured small investors back into the market on the smokey promises that the worst is over and stock prices are bound to rise. The lure became a self-fulfilling prophesy. As investors re-entered the market, they bid up stock prices. Hence, the mirror.

Insiders on the Street are always the first to bail when they sense they’ve been overselling, as they started to do a few weeks ago. This gives them a second opportunity to make money off small investors — by selling short.

The nation’s second-largest financial redistribution in history (the largest, on a percentage basis, occurred in 1929) came in 2007 and 2008 – from small investors and their pension funds to the Street’s savvy traders who shorted them. Now it’s been repeated, although on a smaller scale.

And Washington? Completely clueless. Our representatives in the nation’s capital continue to obsess about future budget deficits and games of chicken over raising the debt ceiling — neither of which has anything at all to do with the stalled recovery and the carnage on the Street.

Otherwise, the airwaves are filled with Weiner’s tweets, Gingrich’s implosion, and Pallin’s emails. When times are tough we look for entertainment.

Robert Reich

This is from Robert Reich’s blog, www.robertreich.org. He is professor of public policy at Berkeley, former U.S. Secretary of Labor, and author of 13 books, the most recent of which is “Aftershock: The Next Economy and America’s Future.”

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