On January 14, 2000, the Dow Jones Industrial Average, the most commonly quoted index of stock market performance, reached its all-time record high of 11,700. By early October of this year, it had fallen to 7,200, a drop of 38.5% in a 32 month period. This is not the worst stock market crash in history – that honour still rests with the collapse of 1929, when the Dow Jones lost almost 25% of its value in just 2 days.

While many in the media blamed the terrorist attack of September 11, 2001 for the market downturn, the true picture isn’t that simple. The index had fallen from its peak a year-and-a-half before the attack and had been stagnating since the second quarter of 2000. After "9-11" the Dow Jones fell to 8200, then rebounded back above 10000 in the last quarter of 2001. Since last January, however, markets have continued to decline. In July of this year, before the latest slump, the New York Times estimated that losses to that point had removed about $7 trillion dollars worth of value from global stock markets.

The basic reason the market has fallen so far, is that it was grossly overvalued in the first place. Back in December of 1996, when the Dow Jones was at just 6,000, American Federal Reserve Chair Alan Greenspan warned of "irrational exuberance" that was driving up stock prices beyond reasonable levels. Since then, the market has been driven by pure speculation – people bought stocks not to invest in profitable companies, but to ride a wave of rising stock prices they assumed would go on forever.

It may well be that equity markets have bottomed out, and that prices will now begin to recover lost ground. It is unlikely, however, that we will see the Dow return to its previous high levels any time soon – the value to support those prices just isn’t there.

What does this mean for the larger economy? Will a depressed stock market cause the US economy to sink back into negative growth, creating a "double dip" recession?

Economists have argued for some time that modern capitalism is more-or-less immune to the kind of scenario that led to the Great Depression of the 1930s. These days, they contend, the "real economy" is insulated from the effects of stock market fluctuations. For one thing, modern corporations don’t rely exclusively on the stock market to raise funds for new investment. With a highly developed financial industry providing access to debt financing, companies can expand their operations and create new jobs even when the stock market is depressed.

But there is another way that stagnant equity markets can have an impact on the larger economy. The US economy seemed to be enjoying a modest recovery for the first half of this year. That recovery was based almost entirely on consumer spending – investment grew hardly at all during the same period. At the time, some economists worried about the ability of consumers to remain confident and willing to spend in the face of further bad economic news.

Well, that bad news has arrived, in the form a stock market crash that wiped out a large chunk of many people’s retirement savings.

Consumer confidence is always a difficult thing to predict, but people who have just seen a third of their savings evaporate aren’t likely to plan purchases of consumer durables such as automobiles or household appliances.

If consumers stop spending, the US economy could rapidly sink back into recession, one which might well be deeper and longer-lasting than the relatively mild recession of 2001.