What to Do When Stocks Tank

A down day.

Photographer: Jerome Favre/Bloomberg

Last week's fall in global stock markets was one of the most widely anticipated corrections of recent memory, but what follows could come as a bigger shock. China's stock market rout accelerated on Monday, and the fall cascaded across Asia. London saw shares slide 2.8 percent in early trading, and Wall Street braced for another brutal day.

Like most such setbacks, this one has more causes than are reasonably required. The main concern is China. Its economy is weakening -- which stalls one of the world's few recent engines of expansion. China accounts for roughly 15 percent of global output but has provided close to half of the world economy's growth in recent years.

Meanwhile, Europe's recovery remains feeble. The U.S. expansion is further advanced, but still more tepid than previous recoveries would have led you to expect. Weak global demand means depressed commodity prices, which are hammering many emerging-market economies. The Fed seems poised to start raising interest rates. And on top of everything else, most stock markets stood at unnervingly rich valuations before the turmoil began.

In short, market corrections were probably overdue. The problem is, once they start, especially with so much bad news hiding in plain sight, they're apt to get carried away.

There's little that governments can do to help -- apart from avoiding measures that would make things worse. China's government, especially, has sent confusing signals about its intentions, alternately intervening in the stock market on a big scale then stepping back, leaving investors unsure whether it intends to set a floor or not.

China's monetary policy has been hard to interpret as well. What did the yuan's recent devaluation mean? Was that an ad hoc effort to spur exports, or the start of new and more market-oriented currency policy? Beijing itself probably hasn't decided, leaving the analysts who follow its decisions understandably perplexed.

The right policy, on stocks and currencies alike, is to curb volatility as far as possible by stating clear intentions and avoiding surprises, and if necessary by undertaking limited market-calming interventions. That's different from defending prices or exchange rates that are fundamentally misaligned. Beijing may be moving in this liberalizing direction -- more quickly, perhaps, than many of China's leaders would have wished. But the sooner this question is resolved, and the better the leadership's thinking is understood, the sooner markets will stabilize.

What does the market turmoil mean for the Fed and interest rates? Exactly the same principles apply. It isn't the U.S. central bank's job to put a floor under the stock market: There must be no "Yellen put." Equally, if the correction worsens to the point where depressed share prices are perceptibly braking demand, thus putting the Fed's inflation and full-employment targets in jeopardy, there should be no inhibition about delaying the move to raise interest rates.

As a factor influencing demand, share prices should be accorded the same weight as any other -- no more and no less.

The interest-rate rise that many analysts expected the Fed to announce in September was a close call in any event. Even before the global stock market reversal, the case for holding U.S. rates at zero a while longer was strong. By the end of this week, it may be stronger.

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net.