Why Wall Street is a Key Player in the World Economy

The most important financial center in the world? A legendary place of silver spoons and golden parachutes? A center of fierce capitalism? Or all of the above. Wall Street is many things to many people, and your perception of what it really is depends on who you ask. Although people’s opinions on Wall Street can differ widely, what is out of the question is its lasting impact not only on the American economy, but also on the global one.

What is Wall Street anyway?

Wall Street physically occupies only a few blocks that are equivalent to less than a mile in the borough of Manhattan in New York City; however, its influence extends throughout the world. The term “Wall Street” was initially used to refer to the select group of large independent brokerage firms that dominated the US investment industry. But since the lines between investment banks and commercial banks have blurred since 2008, Wall Street in today’s financial parlance is the collective term for the many parties involved in America’s investment and finance industry. This includes the largest investment banks, commercial banks, hedge funds, mutual funds, asset management companies, insurance companies, stock brokers, currency and commodity traders, financial institutions, etc.

Although many of these entities may be based in other cities such as Chicago, Boston, and San Francisco, the US financial and investment industry is still referred to in the media as Wall Street or simply “The Street.” Interestingly, the popularity of the term “Wall Street” as a surrogate for the US investment industry has led to similar “streets” being used in certain cities where the investment industry is clustered to refer to the financial sector of that US. nation, such as Bay Street in Canada and Dalal Street in India.

Why Wall Street Has Such An Impact

The United States is the world’s largest economy, with a gross domestic product (GDP) of $ 22.67 trillion in 2021, comprising 6.9%. of world economic production. It is almost one and a half times the size of the second largest economy, China (2021 GDP = $ 16.64 trillion). In terms of market capitalization, the US is the largest in the world by some distance, comprising 205.97% of the national market capitalization (as of June 2021). Canada ranks second with 152.92% and Japan’s market is a distant third, with just over 124% of the market capitalization.

Wall Street has such a significant impact on the global economy because it is the commercial center of the largest financial markets in the richest nation in the world. Wall Street is home to the venerable New York Stock Exchange, which is the undisputed world leader in terms of average daily stock trading volume and total market capitalization of its publicly traded companies. The Nasdaq Stock Exchange, the world’s second largest exchange, is also based on Wall Street.

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How does Wall Street have such an impact?

Wall Street affects the US economy in a number of ways, the most important of which are:

  • Wealth effectBuoyant stock markets induce a “wealth effect” in consumers, although some leading economists say this is more pronounced during a housing boom than during a bull market in stocks. But it seems logical that consumers are more inclined to splurge on expensive items when equity markets are hot and their portfolios have racked up considerable profits.
  • Consumer confidence: Bull markets generally exist when economic conditions are conducive to growth and consumers and businesses are confident about the prospects for the future. When your confidence is high, consumers tend to spend more, which boosts the US economy, with consumer spending accounting for almost 70% of it.
  • Business investment: During bull markets, companies can use their valuable stocks to raise capital, which can then be deployed to acquire assets or competitors. Increased business investment leads to higher economic production and creates more employment.

Global bellwether

The stock market and the economy have a symbiotic relationship, and during good times, one drives the other in a positive feedback loop. But in times of uncertainty, the interdependence of the stock market and the broader economy can have a very negative effect. A substantial recession in the stock market is considered a harbinger of a recession, but this is by no means a foolproof indicator.

For example, the Wall Street crash of 1929 led to the Great Depression of the 1930s, but the 1987 crash did not trigger a recession. This inconsistency led Nobel laureate Paul Samuelson to comment that the stock market had predicted nine of the last five recessions.

Wall Street drives the US stock market, which in turn is a benchmark for the global economy. The global recessions of 2000-02 and 2008-09 had their genesis in the US, with the bursting of the tech bubble and the housing collapse, respectively. But Wall Street can also be the catalyst for global expansion, as can be seen from two examples from the current millennium. The 2003-07 global economic expansion began with a huge rebound on Wall Street in March 2003. Six years later, amid the biggest recession since the depression of the 1930s, the recovery from the economic abyss began with a massive rebound. Wall Street in March 2009.

Why Wall Street Reacts to Economic Indicators

The prices of stocks and other financial assets are based on current information, which is used to make certain assumptions about the future that in turn form the basis for estimating the fair value of an asset. When an economic indicator is released, it would normally have little impact on Wall Street if it matches expectations (or what is called a “consensus forecast” or “average analyst estimate”). But if it turns out much better than expected, it could have a positive impact on Wall Street; conversely, if it is worse than expected, it would have a negative impact on Wall Street. This positive or negative impact can be measured by changes in equity indices such as the Dow Jones Industrial Average or the S&P 500, for example.

For example, let’s say the US economy is moving forward and payroll figures to be released on the first Friday of next month are expected to show that the economy created 250,000 jobs. But when the payroll report is released, it shows that the economy only created 100,000 jobs. Although one piece of data is not trending, weak payroll numbers may lead some economists and Wall Street market watchers to reconsider their assumptions about US economic growth going forward. Some Street firms may lower their growth forecasts in the US, and strategists at these firms may also lower their targets for the S&P 500. Large institutional investors who are clients of these Street firms may choose to exit some long positions upon receiving your reduced forecasts. This cascade of Wall Street sales can result in stock indices closing significantly lower on the day.

Why Wall Street Reacts to Company Results

Most medium and large companies are covered by various research analysts employed by Wall Street companies. These analysts have in-depth knowledge of the companies they cover and are sought out by buy-side institutional investors (pension funds, mutual funds, etc.) for their analysis and insights. Part of the analysts’ research efforts are dedicated to developing financial models of the companies they cover and using these models to generate quarterly (and annual) revenue and earnings-per-share forecasts for each company. The average of analysts’ quarterly earnings and earnings per share (EPS) forecasts for a specific company is called “Street Estimate” or “Street Expectations.”

Therefore, when a business reports its quarterly results, if its reported earnings and earnings per share (EPS) figures match Street’s estimate, the business is said to have met Street’s estimates or expectations. But if the company exceeds or falls short of Street’s expectations, the reaction in its stock price can be substantial. A company that exceeds Street’s expectations will generally see its share price rise, and one that disappoints may see its share price plummet.

Wall Street criticism

Some criticisms of Wall Street include:

  • It is a rigged market: Although Wall Street operates fairly and on a level playing field most of the time, the convictions of Galleon Group co-founder Raj Rajaratnam and several SAC Capital Advisors about insider trading charges reinforce the perception held by some areas where the market is manipulated. .
  • Encourage biased risk taking: The Wall Street business model encourages biased risk-taking, as traders can make windfall profits if their leveraged bets are right, but they don’t have to bear the huge losses that would result if they were wrong. Excessive risk-taking is believed to have contributed to the collapse of mortgage-backed securities in 2008-09.
  • Wall Street derivatives are weapons of mass destruction: Warren Buffett warned in 2002 that derivatives developed by Wall Street were financial weapons of mass destruction. And this turned out to be the case during the US housing collapse when mortgage-backed securities went into free fall.
  • Wall Street can bring the economy to its knees: As discussed above and as seen in the Great Recession of 2008-09.
  • Too-big-to-fail bailouts need taxpayer funding: The giant Wall Street banks and companies that are deemed “too big to fail” would need taxpayer funds if they need a bailout.
  • Disconnect from Main Street: Many see Wall Street as a place where unnecessary intermediaries abound, who are very well paid despite not generating value for the real economy as Main Street does.
  • Wall Street arouses envy in some and anger in many: The million dollar payments that are quite common on Wall Street arouse envy in some and anger in many, especially after the recession of 2008-09. For example, “Occupy Wall Street” stated in its manifesto that it “is fighting the corrosive power of major banks and multinational corporations over the democratic process, and the role of Wall Street in creating an economic collapse that has caused the greatest recession”. in generations “.

The bottom line

Wall Street is made up of the largest stock exchanges, the largest financial firms, and employs thousands of people. As the commercial center of the world’s largest economy, Wall Street has a lasting impact not only on the American economy, but also on the global one.


About the author

Mark Holland

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