Even allowing for the long-standing tendency towards excess on the part of stock investors – which has all too often resulted in boom-and-bust cycles – the apparent inability of markets to see more than one step ahead is alarming. The latest manifestation of this is a failure to hear or heed the warning that price signals are flashing, such as the news that US consumer price inflation unexpectedly rose by 3.2 per cent last month.
Likewise, the danger of another supply chain shock as global conflicts and trade disputes intensify and as business’ logistics costs rise is being overlooked. There will be no dramatic entry by China this time to counter global inflation with a new wave of cheap goods.
Inflation rates naturally vary from month to month. However, with trillions of US dollars in portfolio investment hanging on every word uttered by the US Federal Reserve nowadays, a market failure to comprehend the fundamental causes of rising costs could spell financial disaster.
Set aside the fact that parts of the world are already at war – see Russia’s invasion of Ukraine and Israel’s war in Gaza – and that the major powers also seem to be edging towards conflict. Economic problems are growing, often unheeded once they drop out of the news.
One good example is the fact that the past few months have seen global trade disrupted by developments affecting two critical shipping routes: Houthi assaults on ships in the Red Sea and a severe drought in the Panama Canal. These developments, according to the International Monetary Fund (IMF), could serve as an early warning of additional shocks in the global supply chain.
A handout photo, made available on November 21 last year by the Houthi Military Media Centre, depicts a Houthi helicopter flying over the cargo ship Galaxy Leader as they seize it in the Red Sea off the coast of Hodeidah on November 19. Photo: dpa
The conflict in the Middle East has disrupted trade routes, resulting in delays, re-routing of ships and increased transport costs. Continuing and expanded conflict could exacerbate this, posing the risk of another supply chain shock. That would create another uptick in inflation, slow the pace of much-anticipated interest rate cuts and provide the trigger needed to bring about a reversal of market euphoria over equities in general and tech stocks in particular.
This is a much more clear and present danger than many realise. Investors, fund managers and market analysts have appeared in recent times to be desperate to put bad news behind them on the slightest hint of improvement in the global economy.
Stock investment is being driven by surplus liquidity in financial markets rather than by market “magic” or economic fundamentals, and this will come to an end because of either resurgent inflation or a resulting tightening from central banks draining money from the system.
Steve Hanke of Johns Hopkins University and John Greenwood, former chief economist at investment company Invesco and architect of Hong Kong’s monetary peg to the US dollar, say that markets are headed for another 1987-style Black Monday crash.
In an op-ed in The Wall Street Journal last October, they argue that “because of the sustained decline in the money supply, the US economy is in real danger”. Only the excess money the Fed created in 2020 and 2021 has sustained business hiring and consumer spending, they write, “but that extra fuel is almost exhausted”. “The first effect of monetary contraction will be higher market interest rates for a brief period. Then comes an economic slump.”
A major correction in stock prices would reverberate deep into the global financial system, with knock-on effects on financial institutions – perhaps to the point of spectacular failures, as on past occasions. A stock market correction or even crash would harm the real economy.
Given the extreme focus of markets on the tech sector and also the fact that large sectors of economic activity do not receive stock market attention, however, the direct impact would not be so great and might even prove salutary if it pushes investors towards a more holistic view of global investment needs.
Princeton University emeritus professor and 2015 Nobel Memorial Prize in Economic Sciences winner Angus Deaton wrote recently in the IMF’s Finance & Development publication that economists are in “disarray” over the causes of financial crises.
“We did not collectively predict the financial crisis and, worse still, we may have contributed to it through an overenthusiastic belief in the efficacy of markets, especially financial markets whose structure and implications we understood less well than we thought,” Deaton wrote. “Economists, who have prospered mightily over the past half-century, might fairly be accused of having a vested interest in capitalism as it currently operates.”
Maybe it is time now to review and revise our notions of what form of capitalism we want in the future and to abandon blind faith in marketplace “magic”.
Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs
