Insights from Outside the Finance World
Beginning on Friday, August 2, 2024, global financial markets took a dramatic turn that has impacted both the high-flying US tech stocks and markets in countries around the world, particularly in Japan. Many people—avid market watchers, lay investors, and collapse-attuned folks scanning the horizon for signs of worsening instability—are wondering what is happening here. I’m someone who falls into all of those categories, having been concerned about collapse before the Global Financial Crisis of 2007-2008 and watching the markets quite closely ever since, but only in a non-professional capacity. I became a member of the Sterling EcoGather community through the “Surviving the Future” courses, and have been coming here regularly to connect with others who are similarly concerned.
While I claim no insight into the future, I have been able to identify a number of factors at play here that are worth noting and connecting. Additionally, while I may not be privy to the kinds of inside information available only to those who organize their entire lives and careers around finance, I am well-read on this topic, practiced in seeing the connections in complex systems, and capable of bringing a collapse aware perspective to current events—something that most financial commentators lack.
During their July 30-31 meeting, the Bank of Japan (BOJ) made the decision to increase the "target rate" of Japanese government bonds. Because Japan has been experiencing deflation or stagnation for decades, bond rates were lowered to zero ("borrow as much money as you want without paying interest!") to try to stimulate the economy. On the whole, Japan’s strategy hasn't worked, but the recent global trend of inflation has finally started to appear in Japan, and this allowed the BOJ to start raising target rates, which are still at a shockingly low 0.25%. Around the world, large investors have used the difference in Japanese rates and higher rates in other countries to execute a so called "carry trade" or "interest arbitrage" where they borrow Japanese yen for nothing, convert it to something else (like the Mexican peso) and then lend it (buy bonds) at the higher rate in another country. As long as rates remain the same, this is a way to get a guaranteed rate of return.
Problems arise though, when the rates change. Bonds are weird beasts. Think of it this way: if you buy a $1000 bond that earns 5% interest, but then the rates drop and new bonds are offering 4% interest, your bond is actually more valuable than the ones that are now available. In other words, the value of a bond moves in reverse to the current interest rate. Making matters more complicated, a country's interest rate impacts the value of the country's currency, particularly in relative terms to other countries' currencies. This variance underpins the "foreign exchange market." Other things being equal (which they never are) a higher interest rate is associated with a "stronger" currency—one that can buy more around the world, because people around the world want that currency, and the increased demand makes it more valuable. Between all these changes, traders can be "caught out" with short positions (bets on the value of something being lower in the future) and suddenly need to "cover" these shorts by buying up the thing before the price rises further. All of this is happening to some degree in the current environment.
So a lot of people think that the current market fluctuations might be due to the BOJ. It certainly set the stage... but it's more complicated than that. If you look at an hour-by-hour chart of Japanese Government Bonds (JGBs) between July 30 and Aug 5, you'll see that there was only a small change with the BOJ announcement, but then a huge change when the markets opened for trading on Monday August 5th. Two things happened between these points: the US central bank (Federal Open Markets Committee, or FOMC) decided not to change rates, and then the latest US unemployment data was released. The biggest selloff began after the unemployment data. In other words, it appears that the actions in Japan are having less of an effect on US markets than expectations about and signals regarding the health of the US economy that are \rippling through the whole financial system.
Recent Events Affecting Japan 10 Year Government Bond... Or Not… Chart created by the author based on data from Marketwatch and Bloomberg.
You may have heard (by implication, if not by name) of the Philips Curve, a piece of classic economic theorizing which underpins the widespread belief that inflation and unemployment behave like the two opposite ends of a see-saw. When there are many jobs available for every job seeker (as we've had for some of the time post-pandemic), unemployment will be low and job seekers can be choosy, including demanding higher wages. Worker’s demands for higher wages, in turn, impact what companies charge for their products, and you get inflation. Conversely, when inflation is low, companies are easily keeping up with demand (so prices don't rise) and so they don't need more workers, and unemployment rises. Unlike most central banks, the FOMC has a "dual mandate" to both keep prices stable (low inflation) and maximize employment (low unemployment). It has to weigh these against each other. This means that if the economy is doing well, it raises rates to keep inflation in check; if it's doing badly it lowers them to goose the economy and keep unemployment down.
Since the COVID-19 pandemic began, the economy has behaved in ways that don't fit prior models—or at least not current economic thought patterns. While a 5% interest rate was pretty normal—or sometimes, comparatively quite low—from 1960 to 1999, things changed radically first with the "Dot-com Bubble" and then the "Global Financial Crisis"; as a result markets have come to expect extremely low interest rates. When the first throes of pandemic-induced supply shortages occurred, they led to inflation, which rapidly got out of hand in a way not seen since the 1980s. At that time, there was much hand-wringing as people blamed the FOMC for not raising rates sooner to keep it in check. But when the FOMC eventually did raise rates, the economy kept booming, to the surprise of many economists. So the hand-wringers started ruminating about the high interest rates, worrying that high rates would cause a major economic crash. The economy continued to bear high (though, “non-trivial” might be a better description) interest rates and continued to grow… until very recently we started to see employment slowing down.
The latest employment numbers (which aren't bad by any historical standards—more jobs are still being created than lost, for example) had three negative aspects. First, they were a surprise: economists expected a little slowdown, but were not ready for a larger slowdown, and markets react sharply to surprises. Second, the employment data came out after the FOMC had already decided not to lower interest rates, leading to a new round of hand-wringing about whether they were now again behind the curve and had made a mistake in waiting to lower rates. And third (subtly, but possibly relevant to those who follow the markets closely) the employment results triggered another economic theory known as the "Sahm Rule," which posits that when the three-month moving average of the national unemployment rate is 0.5 percentage point or more above its low over the prior twelve months, the economy is in the early months of recession. The Sahm formulation is considered a “rule” because it has been a historically accurate predictor of a recession.
It's probably fair to say that by the middle of this year, more-or-less everyone agreed that things like the "Magnificent Seven" technology stocks—Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla—had become "overvalued," meaning that people were buying them because they felt they had to, and not because they thought the companies were actually worth what they were paying. By their peak these seven companies accounted for 29% of the S&P 500, meaning that the other roughly two-thirds of the value was spread across 493 other companies. Just about everyone saw this as problematic, but the tech stocks kept growing while other companies largely stagnated. Then, on August 3rd, news of shifts in esteemed investor Warren Buffet positions came out: over the course of 3 months, Buffet had sold off roughly half of his enormous stake in Apple Inc., one of the bellwether tech stocks. The combined signals of "recession coming", "Buffet has backed off tech", and "FOMC has made a mistake" was widely received as an indicator that something was changing.
Is this change bad or good? Well, our current economic system critically depends on continued growth as a way of paying off centuries of accumulated debt... as if the only way you could keep up with your credit card bills was to keep getting raises at work and asking the credit card company to increase your credit limit. But we live on a finite planet, and that growth itself is the cause of so many of the world’s present ills, whether you're thinking about climate change, species loss, resource depletion, oppression, inequality, pollution... and on and on. The Degrowth Movement focuses on the idea that we can't keep doing that, but recognizes (and is also criticized over) the fact that there will be a lot of suffering if the economy actually shrinks.
It's impossible to say at this point whether the stock market's "biggest daily drop in two years" will be a major turning point or just a blip. Indeed, it may not matter much which it is, because it is fair to say that a major turning will happen in the lifetime of many reading this – and the prudent are preparing for that eventuality. The planet truly cannot forever accommodate exponential growth (which is what you get even with a small percentage increase each year), and there are strong indications that we are now making changes that are destabilizing the planet in ways that go far outside the norms that humans evolved in, and even further outside the stable conditions our economy depends on. When homes become uninsurable, cities or countries become unlivable, and food supplies dwindle, it's hard to believe predictions that "only" a fifth of economic productivity will be impacted. And each problem that arises makes other problems harder to solve, a phenomenon sometimes described as "catabolic collapse."
Welcome back my friends, to the show that never ends,
a polycrisis to attend,
come inside,
you cannot hide.
But… I would encourage you to work through the frustration, anger, and grief at the situation, because there are still actions you can take to make the world a better place. I’ve come to believe that “community is the new currency” and that connecting with and (if possibly) surrounding yourself geographically with people who think and care about these issues is a far better investment than the advice you will get from the talking heads on financial networks. Learning about the Wellbeing Economy can help understand that there are choices, from alternative currencies to alternative economic systems, that can help escape the trap of broken economic models. Or you could think about where your food is coming from, and learn to build your own food security. Or you could do as I’ve done, and spearhead building your own community that practices some of these new ways of living in harmony with other people, beings, and the planet. It only takes a small minority to start a major change. There’s no time like the present.
About the Guest Author
Greg Nelson is a recently-retired computer scientist who has been working on the construction of highly efficient homes and has recently been taking up regenerative farming. He has been a member of White Hawk Ecovillage since 2006, anticipating a future in which community was more reliable than money. During the pandemic, he began following The Great Simplification and the Breaking Down: Collapse podcasts, which led him to find and join the EcoGather community in December 2023.