The rapid move of markets from a low of 7,000 DJIA to 12,500 (nearly within 10% of their all-time high of 2007) over the last three years was a remarkable leap of faith.  True, corporate profits were going to recover faster than employment in any event; that has been the pattern of past recoveries as companies use the recession to prune labor, invest in new technology, and take over failing competitors’ markets.

Still, the full recovery in global stock indices presumed the toxic asset problem was behind us, normal growth would soon resume, the Fed would pump up growth, the the prospects of emerging markets were undiminished.

It is hard to overstate how much this was an illusion, defiant of objective realities.  Go down the list — toxic assets were buried on balance sheets and not marked to value, not sold off or written down; ‘normal growth’ has turned out to be ‘no growth’ for all the leading economies; the Fed has emptied its barrels to no effect (yesterday’s ‘twist’ didn’t stop US and European and Asian markets from plunging sharply); and China’s growth has slowed even more sharply than I had expected (see “What if China’s Expansion is about to End?” Washington Post, April 2011).  The IMF has consequently lowered its forecasts of growth almost everywhere.

Sadly, all of the recovery elements — getting past toxic assets, restoring home prices, dealing with US and European debts, emerging markets’ rapid growth — rested on reasonable growth in the major economies.  No growth undermines all the existing policies, which were based on muddling through until 2-3% growth per year resumed in rich countries, providing 6-8% in leading emerging economies.

But as those who recognized the nature of this recession warned from the beginning (mainly Rogoff and Reinhart), we are looking at little or no growth at least until 2014.  Indeed, we may not have written off the overhangs in the housing market in just three years.  Under these conditions, the austerity measures taken by so many governments are like adding a poison pill to the existing mix.

So where are we headed?  A return to DJIA under 10,000 seems logical, as perception gradually converges with realities.  And the risk of a panic drop to prior levels (7,000 or lower) is possible if a Greek default, or the US missing a budget deadline, or a major bank failure, or some other chaotic event should spark a sudden collapse of confidence.