Money & Markets: When markets crash

When markets go up like a rocket they come down like a rock. In the modern era most companies have debt, often lots of debt. I doubt there is one listed engineer that does not have a big lump of debt. In the past debt was considered bad, but for decades now, debt is considered a positive, so long as you do not have too much of it.

Once, the sort of levels that are now considered normal would have been seen as the height of folly, but in today’s world everything is based on one kind of debt obligation or other, so lots of debt is just fine. Cash, after all, is a zero-interest-bearing government debt obligation, even if it is only ever replaced with another decorative promise to pay.

Economics and markets are a confidence game. That confidence ebbs and flows and sometimes the oscillating tide creates a crash, and that crash is usually in response to a boom and bubble and is the flip side of that growth process. No one complains about a boom or much about a bubble; high times rarely ruffle feathers. A crash, however, is a different matter, and everyone is upset by losses of profits they made during the vertical stages of the boom bubble.

Right now we are falling from the vertical market heights of stock markets inflated by the central banks’ response to the impact of government Covid measures. When you stop the world, new money has to be injected into the system to bridge the chasm, and markets boom and bubble, then inflation appears to set the stage for a crash.

You can look at the UK market and see no such boom/bubble, but a casual glance at the US markets shows a very different picture. Since just after the credit crunch, global financial crisis or whatever title is current for the 2007-2009 financial fiasco that saw the global financial system go into meltdown, the US markets have been on an almighty rally. At the low the Dow Jones was under 7,000 and now rides 500 per cent above that level. The FTSE by comparison has merely doubled and it is the US markets that are wobbling on the precipice. The tech-heavy Nasdaq is up 1,000 per cent since that low and it’s hard to look at a chart of that index without seeing the ‘Son of the Dotcom boom’ staring back at you.

If the US markets crash that will pull the whole global financial system down with it, and once more central banks will have to print oceans of money to contain an ephemeral moment from turning into a permanent state of collapse. More inflation follows. Yet if they keep printing, runaway inflation follows, and a collapse follows also. The former scenario is probably preferable to the latter because at least it can be rescued with good news and free money, rather than the latter being fixed with bad news and austerity.

Markets always crash, they always have and always will, and 2022 is lined up to be highly likely a year to remember for wild market action. It will not be a good time to be looking for money if the markets do keel over, and it will be some months before cash rains down on companies such as engineers in the following rescue attempt.

Getting ‘back to 2019’ is going to take a long time and on that road there will be many spills and it will be unlikely that a crash won’t be one of them. It will be remarkable if in this dawning era of QT (liquidity tightening) a crash, especially in the US and Germany, won’t occur in 2022.

If the central banks play a crafty hand, it might just be a very nasty correction, something less than 25 per cent, but it is asking too much of central banks to keep pulling off miracles. Now that inflation is here the game has changed and options are more limited.

The US believes it has $1.7tr to play with, to tighten the money supply. This is approximately the cash banks park with the Federal Reserve that they can’t use. Whether this is passive money unlinked to all the other oceans of money flowing around the global economies is not certainly known, so as it is to be pulled out of the system by central bank tightening, it will soon be apparent from the reaction of the bond and stock markets whether it can be drained or instead it is just the tip of the tail of a beast which should not be pulled.

Ultimately it is not rising interest rates, especially from these non-existent levels, that will cause a crash, but the potential unavailability of money to be borrowed. It is this availability that is about to be tweaked and that is what can cause the cascade of a stock market crash.

In such a crash, a stock market crash just being the visible part of a deeper economic setback, there is only one thing you need to prosper. Cash. With cash you can buy up whatever you want at fire-sale prices. Conversely, woe betide the cashless debtor.