The New York Stock Exchange is reflected in a puddle on January 4. 2020 was a historic year marking a rapid plunge into bear market territory and a swift recovery into the bull zone. Photo: Bloomberg
by Andy Xie
by Andy Xie

Covid-19 market bubbles, a creation of the distorted global economy, cannot last

  • A global pandemic and the devastation it has wrought on the real economy hasn’t stopped stock and property markets reaching new heights
  • Despite the Fed’s best efforts, such asset bubbles cannot be sustained. Could political instability in the US be the shock that deflates the bubbles?
The year began with lockdowns and varying degrees of restrictions on movements across the world as the Covid-19 pandemic accelerated with new, fast-spreading variants being discovered. Financial markets, however, began with new records.

The pandemic is projected to have caused the global economy to decline by about 5 per cent in 2020. Meanwhile, government deficits are projected to increase above trend, by about the same amount. Despite the combined loss of one-tenth of the global economy, global financial markets ended the year higher than before the pandemic. Could this Covid-19 bubble pop in 2021?

Quantitative easing after the 2008 financial crisis led to an asset bubble across the world. Governments and central banks used more debt to climb out of a debt crisis. When this bubble was teetering on the edge in September 2019, the Fed brought out a second round of quantitative easing to resuscitate it.

It finally collapsed when the global economy seized up under the pandemic in the spring of 2020. What happened after was like magic.
The Fed quickly introduced a third round of quantitative easing, totalling US$2.3 trillion. The US government also committed to about the same amount of cash handouts for households and businesses. Essentially, the Fed monetised the extra government expenditure, making the government spending true helicopter money.

Liquidity, zero interest rates and fiscal stimulus doesn’t always lead to rising asset prices. Japan’s experience shows that. There must also be eager speculators with some capital to make it work. It would seem American millennials who received the helicopter money decided to take a punt by buying call options on tech stocks.

Tesla Motors CEO Elon Musk poses during a television interview after his company's IPO on the Nasdaq market in New York in 2010. Tesla stock has been a favourite with millennial investors. Photo: Reuters

The big banks that sold the options squared their positions by leveraging up their balance sheets to purchase the underlying stocks. It was essentially helicopter money with leverage into the highest-risk stocks. The old hands, who initially refused to believe it, couldn’t resist joining the momentum. The Fed succeeded in creating another bubble.

In this fast-moving bubble, Tesla rose nearly tenfold, bitcoin fivefold, and the Nasdaq nearly doubled. The asset inflation spread from the US stock market into other areas. Stocks and properties rose across the world. Property prices hit new records in lockdown ghost towns. That is stranger than any Fast & Furious movie. But like any movie, this will come to an end. Could it end quickly in 2021, to mirror its meteoric rise?

Hong Kong developers launch luxury projects as surging stocks create wealth

A bubble usually ends with a shock, such as an accounting scandal or rising interest rates. So much helicopter money may indeed lead to inflation and rising interest rates. In addition to these usual suspects, an unusual spectre – armed insurrection in the United States – may pop this bubble.

On the day a rebel army of Donald Trump’s supporters stormed Capitol Hill, the Dow ended on a record high. Apparently, the violence at the Capitol didn’t get the attention of speculators. The elite interpret the event as a small mob of extremists, incited by Trump, who went berserk. Hence, better law enforcement will take care of it.
The reality is much more complicated. As I have written in this page many times, globalisation and financialisation have marginalised and impoverished the working class. Globalisation has increased the profit margins and market for America’s legacy advantages. The people who own such assets have prospered, leading to income polarisation.

Financialisation, engineered by the Fed over the past three decades, has magnified such advantages in asset markets, leading to extreme wealth inequality. Indigenous working men have become a less significant part of the American story. The 2008 bailout of the fat cats that caused the financial crisis showed how political power was used to loot the people for the greedy elite.

The insurrection of the white working class in the US must be viewed in this historical context. In their eyes, the institutions and rules have been rigged against them. Modern history is full of rebellions against oppression under the pretext of law and order.

Are we witnessing the start of the third American revolution?

America’s elite still have not woken up to the fact the system has lost credibility. A wholesale reorganisation of society, as Franklin Roosevelt carried out in the 1930s, is necessary to restore stability. Until then, the spectre of armed insurrection will hang over the US.

Two bubbles – America’s stock market and China’s property market – dominate the global economy. The Covid-19 bubble is the weirdest in history, forming and expanding rapidly in a collapsing global economy. The US dollar’s unique status must be the main factor making this possible. The past trend of one bubble after another inspired the desire to gamble even in a dire situation.

As US instability escalates and seeps into the minds of the masses around the world, self-preservation may replace gambling as the dominant psychology. The loud sounds of gunshots may burst the Covid-19 bubble as quickly as it was formed.

Andy Xie is an independent economist