The stock market and currency market both sent a loud warning Wednesday that investors believe the global economy is heading into a deep recession.
The fears drove down currencies and stocks around the world, while the U.S. stock market touched a five-year low.
The declines were broad, including most commodities. Oil dropped 7.5% to its lowest point since June 2007. Copper's price fell to its lowest level since 2005. The British pound is now trading at the same level versus the U.S. dollar as it did in 2003.
The dollar, to which many investors retreat in times of stress, gained. So did the Japanese yen, as traders who had borrowed yen to invest elsewhere unwound those bets and sent the cash back to Japan.
The Dow Jones Industrial Average posted its seventh-biggest point drop in history, tumbling 514.45 points, or 5.7%, to close at 8519.21. It is down nearly 40% from its record about a year ago.
Late in the afternoon, the Dow was trading 100 points below its lowest close of the year earlier this month, before rallying just before the close. The Dow has fallen 746 points in the past two days, reversing a burst of optimism early in the week tied to a modest loosening in the credit markets.
While the lending markets continued to ease on Wednesday, weak corporate earnings combined with worries about the global economy to send U.S. stocks grinding lower in typical bear-market fashion, where gains are soon swamped by heavy selling. Even oil's steep decline, sometimes a boon to stocks, contributed to the damage, as traders focused on the drop as a sign of the global weakness.
Energy companies were among the hardest hit, falling nearly 10%, as the broad Standard & Poor's 500-stock index hit a 5 1/2-year closing low.
"The market continues to ignore anything that even looks like good news," said floor trader Ted Weisberg of Seaport Securities, a New York brokerage firm. Referring to a previous bear market that dragged on for more than a year, he added: "It's basically 1973 or 1974 all over again."
Overseas, the declines were steeper. In Argentina, stocks fell 10%, a day after the government proposed to take over private pensions. Brazil also sank 10%. In Japan, the Nikkei Stock Average dropped nearly 7% on worries that the strengthening yen would crimp exports by making Japanese goods less affordable in other nations. Markets in Asia were down Thursday morning, with the Nikkei off 6% in early trading.
European stocks were down 5% Wednesday. Stocks in emerging markets have lost more than half their value in dollar terms since they peaked in May.
Particularly striking was the action in the currency market, the world's largest, with estimated volume of $3.2 trillion a day. Wednesday saw steep declines in most currencies versus the dollar, as investors continued to flee risk and as some countries seemed to teeter closer to crisis. As volatility in the currency market rises, it's a challenge to investors and companies alike.
In recent weeks, the U.S. dollar has strengthened against nearly all currencies except the yen. On Wednesday, the dollar leapt to a two-year high versus the euro, a five-year high against the British pound and a six-year high against the South African rand.
Many of these currencies already had taken a beating in recent weeks, but it has intensified in recent days. On Wednesday, the rand dropped 9.5% versus the dollar, the Turkish lira fell 6.6%, the Brazilian real 5.7%, and the Polish zloty 4.9%. Hungary's forint weakened 2.9% despite an emergency move that boosted interest rates a huge three percentage points, in a bid to defend the currency.
Before the housing and credit troubles developed, emerging economies were major beneficiaries of a global environment of strong growth and a healthy appetite for risk-taking. Now that has all disappeared, leaving some countries struggling. "An enduring credit crunch and slumping global economy clearly now threatens all emerging market currencies," James Malcolm, a currency strategist at Deutsche Bank in London, wrote last week.
Most vulnerable, he said, are countries that rely on foreign financing to meet their deficits and have relatively low reserves -- among them Hungary, Turkey, Poland, Romania, Indonesia and Czech Republic.
But a broader group of currencies is suffering as investors withdraw money from these markets. Tumbling raw-material prices are weighing on currencies in commodity-producing nations from Latin America to South Africa to Russia.
"To me, we are only in the third inning" of this selloff in emerging-market currencies, predicted Stephen Jen, global head of currency strategy at Morgan Stanley, in a note on Monday. He said the story of economic growth and financial resilience in these countries "that is so widely believed needs to be fundamentally and thoroughly scrutinized."
Nearly all commodities declined, with oil falling $5.43 a barrel to $66.75, its lowest point since June 2007 -- a drop of 54% since July 3. A rise in U.S. petroleum reserves, shown in weekly government data, weighed on the market along with the economic worries. Traders are looking ahead to a likely production cut by the Organization of Petroleum Exporting Countries on Friday, although many participants remain skeptical that demand will hold up in the months ahead.
"Right now the crude market is concentrating on recession fears," said Raymond Carbone, president of brokerage Paramount Options on the Nymex floor.
The dollar's rise since July is part of a reversal in longstanding investment trends that prevailed during years of plentiful borrowing, strong growth and low financial-market volatility. "Essentially, every large trade that built up a head of steam in the go-go years has blown up or is in the process of blowing up," wrote Alan Ruskin, chief international strategist at RBS Greenwich Capital, in a report to clients. "That goes for almost every asset class."
The about-face has been particularly rapid in currencies. As the U.S. dollar and the yen -- both exceedingly weak during better days -- have surged, formerly highflying currencies like the euro, the British pound and the Canadian dollar have fallen hard. All three have weakened more than 10% against the U.S. dollar since the start of September.
"We went up the elevator and we're coming down the lift shaft," said Richard Benson of Millennium Global Investments, a London currency manager.
In part, the yen's strength is coming from the reversal of trades by manufacturers in Korea, India and elsewhere who had borrowed low-yielding yen to cover their business costs in their local currencies. The unwinding of this so-called yen-carry trade could continue to play out a while longer, said Paresh Upadhyaya, a currency-focused portfolio manager at Putnam Investments in Boston.
In the credit markets on Wednesday, conditions continued to improve in bank-to-bank lending -- a key barometer of whether the recent financial crisis is easing. The rate on three-month loans in dollars, known as the London interbank offered rate, fell sharply, by 0.29 percentage point, to 3.54%.