MacroscopeSeptember could be an important inflection point for global markets

There is an ominous sense of déjà vu about the state of the world economy right now. Global growth looking very tired, buoyant stock markets increasingly divorced from underlying fundamentals and global policymakers struggling to contain burgeoning financial risks. We have seen it all before and it would be a disaster to see the return of a new storm.

We saw a similar build-up in the run-up to the 2008 global financial crash and we are seeing parallel trends once again. In the years leading up to the crash, an explosion of global credit, untamed financial engineering, the proliferation of exotic investment products and excessive exuberance by investors, ended up in a disaster of epic proportions.

The collapse of the subprime mortgage market in 2008, catapulted the global economy into recession, deflation, doom and gloom from which the world is still trying to recover. The consequences are still being felt in the shape of the brave new world of monetary invention the central banks have created with quantitative easing programmes and zero interest rates intended to put the world economy back on the road to recovery.

However, it is becoming increasingly clear these tools for recovery are not without their risks. Global financial markets are becoming far too pumped up by the central banks’ derivative money glut. The subsequent return of excessive speculation, leverage and risk are leaving investors and the global economy seriously exposed to the chances of a new crash. Next time round there may be no more effective policy tools left to deal with any new disorder.

The worry for policymakers is this vast pool of engineered central bank money is becoming less effective on helping the real economy – what economists call diminishing marginal returns. If QE and zero interest rates are doing nothing more than pumping up irrational exuberance and excessive speculation in financial markets, it poses a big dilemma for policymakers. Should they start to put the brake on super-stimulus long before inflation risks begin to break higher and stock market sentiment starts to fold?

Global central banks are trapped between a rock and a hard place. Once they begin the process of withdrawal it will be like waving a red flag at a bull. Stock market zeal could go into very sharp retreat. It is the reason why the US Federal Reserve has been so reluctant to tighten interest rates too dramatically and strenuously avoided downsizing its US$4.7 trillion pile of QE assets.