Nick Beams
The current turmoil in financial markets was set off by the Trump administration’s threat to impose tariffs on an additional $300 billion worth of Chinese goods and its decision to label China a “currency manipulator,” following Beijing’s move to allow the renminbi to fall. The extreme volatility has prompted questions about the stability of the global financial system.
But the latest round in the US-China conflict was only the catalyst for the emergence of these issues. Under conditions where the world economy is clearly on a recessionary trend—the euro zone is slowing and the UK economy contracted in the second quarter—the deeper question now coming to the surface is how long central banks can continue to pump money into the financial system without setting off a systemic crisis?
Having cut interest rates to record lows in response to the global financial crisis of 2008, the world’s major central banks have reversed their policy of trying to “normalise” monetary policy and are moving to provide further stimulus.
The US Fed cut interest rates last month and is set to do so again in September, with the prospect that more cuts may follow. The European Central Bank has signaled it is looking to further ease monetary policy at its meeting next September, and the central banks of Australia, New Zealand, India and Thailand have already moved and cut their rates.
The results so far have created a historically unprecedented situation in bond markets. It is estimated that some $15 trillion worth of government bonds are trading at negative yields, meaning an investor who purchased the bond and held it to maturity would make a loss.
This phenomenon may spread still further. Over the weekend, the Wall Street Journal published a lead article with the headline “Investors Ponder Negative Bond Yields in the US.” It quoted one financial analyst who noted that if you had raised the prospect of negative rates 10 years ago you would have been “laughed out of the room,” but now “people are getting on board the negative-rate idea very quickly.”
The fall in long-term interest rates is essentially a vote of no confidence in the prospects for global growth, as investors seek safe havens for the cash that has been injected into the system. If there were opportunities for profitable investments in the real economy, money would move in that direction. Instead it is being pushed into financial assets.
In the market for equities, this leads to higher stock prices. It also brings higher bond prices, pushing down their yield, since the two factors move in the opposite direction.
In an expression of the growing concern, the Journal article cited another analyst who said he was “perplexed” over yield levels and it was as if “Armageddon is being priced in.”
Across the Atlantic, similar concerns have been voiced in the pages of the Financial Times. As a column by Rana Foroohar noted, the market volatility was “ostensibly triggered by the US-China conflict turning into a full-blown currency war.”
But, she continued, at its heart it was about the “inability of the Federal Reserve to convince us that the July rate cut was merely ‘insurance’ to protect against a future downturn,” when, “as any number of indicators now show… the global downturn has already begun.”
However, stock markets have in general continued to rise. But this is not an indication of health, as stocks are rated at their most expensive levels in more than a century. “I don’t think it’s a question of whether we’ll see a crash—the question is why we haven’t seen one yet,” she wrote.
There were “plenty of worried market participants,” as evidenced by the record levels of negative-yielding bonds around the world. When many are prepared to pay for the “security” of losing a little bit of money as a hedge against losing a lot, “you know there’s something deeply wrong in the world.”
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