One of the most important things to remember in an emergency is to remain calm. Panic tends to cloud a person’s rational thinking and judgment. In every situation, panic can create more problems than it solves. It does two things: 1) It causes us to misunderstand the ramifications of the problem we are trying to solve; 2) It causes us to act in ways that defy logic and make us worse off.
First a misstatement of the ramifications of the problem, as somebody quoted yesterday:
“The stock market lost $1 trillion! It will never recover.”
This statement is an attempt to explain the consequences of the change of events that has occurred this week, but it is far from correct. What is really going on here?
First, the problem: It is not the downgraded bond rating by Standard & Poor’s. The problem is government debt, growing deficits and a lack of political will to rein in spending. One could make the argument that more tax revenue is needed, but with or without tax hikes, unless spending is slashed, additional tax revenues will not cover the fiscal path we’re on now.
So the United States has been downgraded from AAA to AA by one of three credit agencies. There does not appear to be a mass exodus from the bond market, and the Federal Reserve operated under that assumption as well yesterday when it decided to keep interest rates low. Under the former circumstance, interest rates would have to rise to attract more investors to U.S. bonds. In other words, the cost of borrowing for the federal government would increase. This is not any different from a consumer with shaky credit having to pay a higher interest rate in order to borrow. But this has not happened yet. To put it in perspective, our rating is below Austria, Australia, Germany and Canada, but on par with Belgium and the United Kingdom, and better than China and Japan.
Second, let’s look at what the market did and didn’t do. Obviously, it reacted to a new position that the United States is in for the first time in history. For a third day, it has been “bipolar,” as one headline put it. So getting back to the statement about the market: It did not lose $1 trillion. Yes, stock prices fell and there was a global sell-off, but an investor can only lose money in the market once he or she sells stocks. As I have mentioned in many other blogs, selling any type of bond, equity fund, stock or any other type of investment when the price has fallen ensures a loss. Unfortunately, there were probably more than a few people who sold stocks Tuesday morning only to find them bounding back by the close of the trading day and regretting their hasty decision.
And for anybody to say that the market will never recover is simply fear or ignorance at best, gross negligence at worst. It is bad enough that people always feel the need to “do something” and do it quickly during a financial upheaval, which may correct itself a short time later. To take a loss during such a time as this is akin to jumping off of a train that is about to derail in order to avoid injury. It is a hasty and illogical reaction that puts people in more danger. Sometimes the best thing to do is nothing. Just hang on for the ride. It is not going to go on forever. If any retirement savers feel the need to exit the market, it should be done calmly and methodically over time and for good reason. AAA credit rating is not reason enough.