Sell up, the stock market is collapsing after a last-gasp bull run

With monetary easing set to end, it’s a game of chicken as investors see how close they can come to timing the inevitable downturn

Gary Biddle

Published: 1:30am, 8 Mar 2021

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I hope you read my prediction in the Post in February 2020 of a market collapse. It began that day in New York. I further warned that central bankers would “need to raise near-zero interest rates to equip themselves for the next downturn and mitigate distorting effects of low interest rates on real asset values, investments, savings and income equality”.

My second prediction is now set to come true. If you need convincing, please consider that I also warned Post readers in July 2007 of a market collapse we now call the global financial crisis.

My reasoning is simple. Recent bull markets reflect nothing more than monetary easing now set to end. As my professor at the University of Chicago, Milton Friedman, rightly said, monetary policy is very powerful but also very blunt. Whereas it can stimulate capital investment by lowering nominal interest rates, it flows readily into speculation and beyond shores.

The 25 per cent increase in the US M2 money supply this year and similar stimulus by other central bankers (10 per cent in China and 11 per cent in the EU) have caused investor euphoria to levitate share and real estate values far above levels we would have seen in their absence. It’s a game of chicken, to see how close one can come to timing a downturn whose inevitability looms.

Worryingly, the new Biden administration is pushing a US$1.9 billion stimulus package that will raise the risk of a countervailing Federal Reserve response. Even left-liberal economist Larry Summers deems it too big.

Federal Reserve chair Jerome Powell testifies before the Senate Banking Committee hearing on Capitol Hill in Washington, on December 1, 2020. Powell’s law background contrasts with the economics pedigrees of his immediate predecessors. Photo: Reuters

Stimulus already applied and pent-up Covid-19 demand portend a new roaring 1920s like the one following the Spanish flu pandemic a century ago. In the presence of easy money, it would mean roaring inflation.

Former Fed chairwoman Janet Yellen’s recent job hop from chief inflation watchdog to head fiscal stimulator as Treasury secretary has left her Fed successor Jerome Powell holding a hot potato. A consensus builder by reputation, Powell’s law background contrasts with the economics pedigrees of his immediate predecessors, notably Ben Bernanke, a recognised expert in Depression-era monetary economics.

The fundamental problem that Powell faces is easily illustrated. Imagine that every dollar was instantly worth two. Ignoring mechanics for a moment, this money-doubling helicopter drop, as Friedman termed it, would immediately double the nominal prices of real assets such as shares and real estate.

Since the onset of the global financial crisis, the Fed’s balance sheet, which roughly reflects cumulative money growth, has soared 8.7 times. The myth of no-downside modern monetary theory (MMT) is instantly seen in the income inequality and generational wealth transfer consequences.

Magic money is blinding us to the dangerous reality of inflation

MMT further cynically ignores its implicit taxation of dollars held globally, thereby endangering the privilege. Powell recently said: “The kind of troubling inflation that people like me grew up with seems far away and unlikely.” Rather than wistful soothing, pointed economic countermeasures are more the order of the day.

Even China is worried. Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission and the Communist Party secretary of the central bank, called the recent market rallies “bubbles”, including in China’s real estate which he described as “very dangerous”. No wonder. China’s 200-million-plus migrant workers who lack hukou residency benefits are ever less likely to start families, thus exacerbating China’s ticking demographic time bomb.

Back in the US, an explosive divergence between disposable personal income and gross domestic product growth due to Covid-19 payouts adds more stimulus fuel to the fire, even without the blatantly regressive student loan forgiveness promised on the campaign trail.

In Europe, historic disunity prevails with Brexit, Eastern flank dissension, a structurally untenable euro, and with German Chancellor Angela Merkel and French President Emmanuel Macron fading. Even Italy’s Mario Draghi can’t buck Fed easing.

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One might predict that shares, bonds and real estate will tumble, but this is too simplistic. More broadly, comparative advantage will shift from real to financial assets, debtors to lenders, and from young to old, given demographic-risk-preference profiles.

Deft central bank braking that gently nudges yield curves upwards could rein in rampant investment in overvalued assets and the phantom profits they have been generating. Braking too hard risks yet another market collapse.

Has a collapse begun already? Perhaps, but new market highs could come first if investors divine ongoing monetary largesse. It is inevitable that central bankers will abandon the Covid-19 fight in their inflation fright. In doing so, they could cause markets to collapse, as they have before. As I rightly warned you last February and in 2007, consider selling soon.

Gary Biddle is Professor of Financial Accounting at the University of Melbourne and Visiting Professor at Columbia University, London Business School and the University of Hong Kong, where he served as dean