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The Nasdaq has fallen 34 percent since March, and the Dow Jones Industrial Average is following suit. The decline might be only a technical correction, but the world economy may be hit because the inflow of capital into the United States may decline and restrict that country’s ability to import goods from across the world.

Currently, global economic growth is based on the flow of world capital into the U.S. stock markets and the willingness of the American people to increase their consumption on the basis of this perceived wealth. Even if stock markets stabilize after a technical correction, it is still possible that the world economy could melt down, since capital flows to the U.S. are unlikely to be sustainable if markets are calm.

The East Asian crisis occurred because global demand was weak. Large-scale withdrawals of foreign capital occurred in those countries. That money then found an alternative investment opportunity in information-technology stocks in the U.S. The wealth of U.S. stockholders has risen not because the profits of companies justified such high prices the price-earnings ratios do not make sense but because too much capital was running after too few dollar-denominated IT stocks.

Millions of U.S. stockholders became very wealthy on paper. They borrowed heavily and consumed. This led to higher U.S. imports and the U.S. became the “importer of last resort.” U.S. stock prices, therefore, have become the foundation upon which the world economy now rests.

This was recognized more than a year ago by Federal Reserve Board Chairman Alan Greenspan. In testimony last year before the U.S. Senate Committee on Banking, Housing and Urban Affairs he said, “Foreigners presumably will not want to raise indefinitely the share of their portfolios in claims on the United States. Should the sustainability of the buildup of our foreign indebtedness come into question, the exchange value of the dollar may well decline …” If the flow of global capital into the U.S. ebbs, then the value of the dollar has to decline, U.S. imports will suffer and the world economy could come to a grinding halt.

A decline in U.S. stock prices will erode the confidence of U.S. consumers, leading to a decline in U.S. demand and lower exports from developing countries. That will set off a chain of competitive devaluations as developing countries try to sell goods more cheaply in ever-shrinking U.S. markets. Worse, a decline in the dollar may well set off a stampede to get out of the U.S. stock markets. Declining stock prices and the value of the dollar will pull each other down.

It is argued that the dollars pulled out of the U.S. economy by, say, the Hong Kong Chinese and invested in Hong Kong will create demand there. The decline in demand in the U.S. will then be compensated by an increase in demand from Hong Kong. That is not necessarily true. While Americans are willing to borrow and consume on the basis of paper wealth, this is not true of the Chinese.

Second, a large amount of stock capitalization will simply disappear into thin air it will not be transferred to Hong Kong. Say a selloff occurs, 10 percent of the shares of Microsoft are sold, and the money is taken out of the U.S. What happens to the remaining 90 percent? The price of that 90 percent declines, and that wealth simply evaporates.

It is not necessary for the stock market to burst for there to be a crash. “Stability” can have the same impact. Say Nasdaq stabilizes after a 34 percent fall. That may be sufficient to shake up the expectations of global investors. If fresh foreign capital then stops coming into the U.S. stock markets, the U.S. will not be able to pay for its burgeoning trade deficit and U.S. demand will still collapse.

The only escape from such a global meltdown is a boom in other stocks. It is possible that investment opportunities in planetary exploration or genetic technologies may arise. If this happens, then the collapse of IT stocks may be offset, and the inflow of capital into the U.S. will continue.

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