The first draft of this piece read: “Markets often move faster than the time it takes to produce economic commentary pieces, so there is every chance that by the time you read this, the large fall in the Japanese stock market of about 12 per cent during Monday, and smaller falls in other global stock markets (about 2 per cent in the US), may have gone away.” And it transpired exactly like that, as 10 per cent of Monday’s fall was reversed on Tuesday.
What is the most plausible explanation for the crash? One story goes like this: when the US Federal Reserve surprised everyone – by not cutting interest rates – it triggered a global panic. It seemed, perhaps, that the US economy was headed into recession. The knock-on effect for Japan was potent – its stocks are exposed to the US economy, and all of this coincided with the Bank of Japan raising interest rates to a heady 0.25 per cent (perhaps overkill, in retrospect). And so the fall in Japanese stocks was much more precipitous than elsewhere – the greatest on a single day since the 1987 crash.
The share prices of Japanese banks fell more than the average of all Japanese stocks (about 26 per cent over two days). It seemed investors were anxious that companies (namely, clients of the banks) would struggle to cope with the end of low interest rates – their profits would suffer and this would invariably harm the banks. The logic might be overstretched but it is easy to follow: Japanese authorities are not in a great position to intervene effectively; the scope for quantitative easing or old-fashioned fiscal loosening is more limited there than in other countries, for example. After today’s recovery this explanation looks premature.
The stock market – which is only one way that companies finance themselves – is highly susceptible to what investors believe about the future. Not only that, stock prices depend on what others believe about each other, and so on. These beliefs form a house of cards: it might not take much (such as the Fed behaving in a marginally unexpected way, for example) for the whole thing to collapse. One explanation for the crash in Japan is that it happened simply because people believed it would happen. This naturally has a positive angle too: stocks recovered because people thought they would recover.
The takeaway from this kind of market chaos is a sense of heightened nerves, globally. Investors are troubled by several things at the moment. For one, many tech companies have bet a lot on the transformational benefits of Chat-GPT and its competitors. But progress has slowed; Meta is even giving its model away for free. The optimism of the initial bets may prove unfounded. And we are approaching the 2024 US presidential election and the possibility of another Trump administration. This renews uncertainty about the future of US politics – tariffs, isolationism, the existing conflagration between Russia and Ukraine and the potential one brewing between China and Taiwan.
Japan has its own issues. The burden of an ageing population, sluggish growth for three decades, and – as I mentioned before – limited room for monetary and fiscal policy levers to deal effectively with any financial crisis or recession. Because of its proximity, Japan is more exposed both to China’s belligerence over Taiwan and North Korea’s militarism.
These problems and uncertainties are not new. They are precisely the same as they were last week. So they are not the whole explanation for why the market has just this week got the jitters. But this panic will have consequences: whether for the prospects of the Democrats in November’s presidential election (incumbents receive the blame if the economy suffers); or for the stability of the Japanese banking system writ large. It also means that the hawkish tones struck by the Federal Reserve and Bank of Japan might flip and lead to looser monetary policy from both central banks. From my point of view, I hope that this text clears the editorial process before markets move again and force me to write a third draft. But nerves make markets volatile, and there is plenty to be nervous about at the moment.
[See also: When the AI bubble bursts]
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