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A Crash Course for Central Bankers

A collapse in U.S. stock prices certainly would cause a lot of white knuckles on Wall Street. But what effect would it have on the broader U.S. economy? If Wall Street crashes, does Main Street follow? Not necessarily. Consider three famous episodes: the U.S. stock market crash of 1929, Japan's crash of 1990-1991, and the U.S. crash of 1987.

The 1929 U.S. crash and the sharp decline in Japanese stock prices were both followed by decade-long economic slumps in each country. (The Japanese depression, despite much whistling in the dark by the country's policymakers, still lingers.) By contrast, the macroeconomic fallout from the 1987 tumble on Wall Street was minimal. Why the difference?

A closer look reveals that the economic repercussions of a stock market crash depend less on the severity of the crash itself than on the response of economic policymakers, particularly central bankers. After the 1929 crash, the Federal Reserve mistakenly focused its policies on preserving the gold value of the dollar rather than on stabilizing the domestic economy. By raising interest rates to protect the dollar, policymakers contributed to soaring unemployment and severe price deflation. The U.S. central bank only compounded its mistake by failing to counter the collapse of the country's banking system in the early 1930s; bank failures both intensified the monetary squeeze (since bank deposits were liquidated) and sparked a credit crunch that hurt consumers and small firms in particular. Without these policy blunders by the Federal Reserve, there is little reason to believe that the 1929 crash would have been followed by more than a moderate dip in U.S. economic activity.

The downturn following the collapse of Japan's so-called bubble economy of the 1980s was not as severe as the Great Depression. However, in some crucial aspects, Japan in the 1990s was a slow-motion replay of the U.S. experience 60 years earlier. After effectively precipitating the crash in stock and real estate prices through sharp increases in interest rates (in much the same way that the Fed triggered the crash of 1929), the Bank of Japan seemed in no hurry to ease monetary policy and did not cut rates significantly until 1994. As a result, prices in Japan have fallen about 1 percent annually since 1992. And much like U.S. officials during the 1930s, Japanese policymakers were unconscionably slow in tackling the severe banking crisis that impaired the economy's ability to function normally.

Central bankers got it right in the United States in 1987 when they avoided deflationary pressures as well as serious trouble in the banking system. In the days immediately following the October 19th crash, Federal Reserve Chairman Alan Greenspan -- in office a mere two months -- focused his efforts on maintaining financial stability. For instance, he persuaded banks to extend credit to struggling brokerage houses, thus ensuring that the stock exchanges and futures markets would continue operating normally. (U.S. banks, which unlike their Japanese counterparts do not own stock, were never in any serious danger from the crash.) Subsequently, the Fed's attention shifted from financial to macroeconomic stability, with the central bank cutting interest rates to offset any deflationary effects of declining stock prices. Reassured by policymakers' determination to protect the economy, the markets calmed and economic growth resumed with barely a blip.

There's no denying that a collapse in stock prices today would pose serious macroeconomic challenges for the United States. Consumer spending would slow, and the U.S. economy would become less of a magnet for foreign investors. Economic growth, which in any case has recently been at unsustainable levels, would decline somewhat. History proves, however, that a smart central bank can protect the economy and the financial sector from the nastier side effects of a stock market collapse.

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Tokyo's Pantry

Tsukiji, Tokyo's massive wholesale seafood market, is the center of the global trade in tuna. Here, 60,000 traders come each day to buy and sell seafood for Tokyo's 27 million mouths, moving more than 2.4 million kilograms of it in less than 12 hours. Boosters encourage the homey view that Tsukiji is Tokyo no daidokoro -- Tokyo's pantry -- but it is a pantry where almost $6 billion worth of fish change hands each year. New York City's Fulton Fish Market, the largest market in North America, handles only about $1 billion worth, and only about 13 percent of the tonnage of Tsukiji's catch.

Tuna are sold at a "moving auction." The auctioneer, flanked by assistants who record prices and fill out invoice slips at lightning speed, strides across the floor just above rows and rows of fish, moving quickly from one footstool to the next without missing a beat, or a bid. In little more than half an hour, teams of auctioneers from five auction houses sell several hundred (some days several thousand) tuna. Successful buyers whip out their cellphones, calling chefs to tell them what they've got. Meanwhile, faxes with critical information on prices and other market conditions alert fishers in distant ports to the results of Tsukiji's morning auctions. In return, Tsukiji is fed a constant supply of information on tuna conditions off Montauk, Cape Cod, Cartagena, Barbate, and scores of other fishing grounds around the world.

Tsukiji is the command post for a global seafood trade. In value, foreign seafood far exceeds domestic Japanese products on the auction block. (Tsukiji traders joke that Japan's leading fishing port is Tokyo's Narita International Airport.) On Tsukiji's slippery auction floor, tuna from Massachusetts may sell at auction for over $30,000 apiece, near octopus from Senegal, eel from Guangzhou, crab from Sakhalin, salmon from British Columbia and Hokkaido, snapper from Kyushu, and abalone from California.

Given the sheer volume of global trade, Tsukiji effectively sets the world's tuna prices. Last time I checked, the record price was over $200,000 for a particularly spectacular fish from Turkey -- a sale noteworthy enough to make the front pages of Tokyo's daily papers. But spectacular prices are just the tip of Tsukiji's influence. The auction system and the commodity chains that flow in and out of the market integrate fishers, firms, and restaurants worldwide in a complex network of local and translocal economies.

As an undisputed hub of the fishing world, Tsukiji creates and deploys enormous amounts of Japanese cultural capital around the world. Its control of information, its enormous role in orchestrating and responding to Japanese culinary tastes, and its almost hegemonic definitions of supply and demand allow it the unassailable privilege of imposing its own standards of quality -- standards that producers worldwide must heed.