Issue:
December 2023 | Deep Dive
FCCJ Deep Dive experts disagree on prospects for a global financial crash
Have we created a monster, in the shape of a financial system that has grown so big and powerful that it threatens to destroy the “real” economy - industry, services, property and other assets?
These were among questions examined by expert panellists at an FCCJ Deep Dive event on November 17, which drew strong, and often divergent, views reflecting uncertainty over the direction of the global economy.
The event’s title, Stock Markets – Another Black Monday?, was prompted by publication of a recent paper suggesting there could be a repeat of the dramatic market crashes of 1987 and 1929.
The lead author of that paper, John Greenwood, former chief economist at investment company Invesco, was unable at the last minute to attend, but other panellists responded to his views.
Greenwood and his co-author, Steve Hanke of Johns Hopkins University, argued that the U.S. Federal Reserve’s policies were “threatening” the country’s financial markets and economy. The policies, he said, were in danger of creating a steep recession and a repeat of Black Monday – the catastrophic stock market crash that occurred on Monday, October 19, 1987. The crash occurred worldwide, starting in Hong Kong and spreading throughout Asia and Europe before reaching the U.S.
Early in the Covid-19 pandemic, the paper noted, the volume of U.S. dollars in circulation soared. Then, in March 2022, the Fed reversed course by tightening the money supply, increasing the federal-funds rate and introducing quantitative tightening in what became the most extreme monetary contraction since 1933.
“Because of the sustained decline in the money supply, the U.S. economy is in real danger,” the paper said. “Only the excess money the Fed created between 2020 and 2021 has sustained businesses hiring and consumers spending. But that extra fuel is almost exhausted. When it dries up, the economy will run on fumes.”
It continued: “The Fed continues to ignore the money supply, and we now face the opposite problem. The money supply has been contracting for 18 months, and soon, after the overhanging extra money from 2020-21 has been used up, spending will plunge and inflation will fall.”
The first effect of a monetary contraction is higher market interest rates for a brief period, the paper suggested. Then comes an economic slump. When the stock market crashes, “higher for longer” will become a thing of the past as the Fed makes an abrupt pivot.
The other two Deep Dive panelists did not subscribe to the theory of an impending market crash, but one of them, Hung Tran, a non-resident fellow at the Atlantic Council in Washington, warned of an even scarier scenario taking shape because of financial system excesses.
Tran, a former executive managing director at the Institute of International Finance in Washington, highlighted the gap that he argued had developed between the real economy and financial activity in the U.S. and other advanced economies.
Transactions in foreign exchange markets have soared to US$7.5 trillion a day, which “far exceeds” what is needed to facilitate trade and investment in goods plus financial market transactions, he said, by way of example.
Meanwhile, equity transactions in the U.S. have rocketed to $85 trillion annually, or seven times the value of U.S. annual GDP.
Nearly three-quarters of equity trading on U.S. stock markets consist of algorithm and high-frequency trading, which takes place within seconds. “It is not clear how this kind of financial activity helps companies to raise funds for their (normal business) activities,” Tran said.
He added: “At the same time, global wealth is increasing big time. It now exceeds $450 trillion, while global debt stands at around $350 trillion. Wealth is very unevenly distributed, with the top one percent of the world’s population owning most of it, while many weaker members of society are heavily indebted.”
The dollar plays a key role in the process of economic “financialization” and the financial sector has come to represent 50% of U.S. GDP compared to just 10% for manufacturing. Many companies now rely on the buying and selling of financial assets for much of their profits. In the case of General Motors, for instance, this reliance amounts to more than one-third.
Tran said the financialization of major economies began under former U.S. President Ronald Reagan and his then British counterpart, Margaret Thatcher, and accelerated sharply after the 2008 global financial crisis, when central banks poured massive amounts of monetary and fiscal aid into economies. Measures taken during the Covid-19 pandemic gave the process another boost.
The financial economy is so big, and the balance sheets of central banks and governments so stretched, that neither can realistically expect to come to the rescue of companies and financial institutions in the event of another financial crisis, Tran argued. Consequently, the “safety net” beneath major economies has been greatly weakened, he added.
With such dire threats seemingly hanging over the global economy and the financial system, the third Deep Dive panellist, Jesper Koll – sometimes referred to as a “Japan optimist” – was characteristically determined to strike a positive note, although he did acknowledge the need to be vigilant over market risks.
“People too often look at the debt side of the balance sheet and not at the asset side,” said Koll, who is one of Japan's leading financial strategists and former chief strategist and head of research for U.S. investment banks JP Morgan and Merrill Lynch. For every one dollar of debt that the world has taken out over the past couple of decades, the global economy has created $2.80 in new savings. Global value creation has expanded enormously, not least in Japan, Koll said. The value of global GDP has nearly tripled in recent decades to over $100 trillion, and “there is still plenty of room for growth in Asia, Africa and elsewhere”.
The Fed has become a capable enough lender of last resort, via the creation of new financial facilities, to successfully support the financial system in the event of renewed financial crises, Koll said. Tran, too, conceded that further Black Monday-type events were unlikely. So perhaps the situation is not as bad as Greenwood and Hanke believe.
Only time will tell.
Anthony Rowley is a columnist and contributor for the South China Morning Post.
