Stocks crashed, and then rebounded, Ukraine invades Russia, Italy tricks the rich, a revolution in Bangladesh, and Western companies lose confidence in China.
These are, in my opinion, the most important economic stories that we need to talk about in this economic update.
So, let’s dive into our first story right away, which is about
1 The stock market crash & rebound
Roughly two weeks ago most stock markets, and especially tech and Asian indices focused markets crashed.
This obviously led to a lot of commotion, talk about broken stock markets, and fears for a further fall in stock prices, which could eventually cause a recession.
It also led to a lot of speculation about what was causing the stock market to fall so fast.
Luckily, now that the dust has settled, and, stocks have recovered some of their losses, that is… at the time of recording, it is the perfect time to ask ourselves.
What happened?
Well, scouring the internet for answers, I essentially found 4 main explanations.
The first is that it was caused by the release of unexpectedly weak job market figures from the United States, which could signal that a U.S. recession is immanent, which would in turn be bad for companies everywhere.
The second explanation is that this all started in Japan, where the Bank of Japan raised interest rates to stop the Yen from falling. Higher interest rates then caused Japanese stocks to crash because they mean that stocks are suddenly a less attractive investment compared to having money in the bank. On top of that, ultra low rates in Japan compared to the rest of the word, especially after Covid, had made it super attractive for people to borrow in Japan and invest that in the rest of the world. This investment strategy, of profiting from ultra low rates in Japan, by borrowing in Yen and investing in Mexico is known as the carry trade. A lucrative strategy as long as rates remained low in Japan and the Yen was falling.
However, when the Bank of Japan raised interest rates, this strategy suddenly became far less attractive for two reasons. First, it made borrowing in Japan much more costly. Second, increased rates caused the Yen to go up. As a consequence Yen debt taken out by carry traders… suddenly got much bigger compared to their investments in the rest of the world. Ironically, when these carry traders then sold their foreign investments to buy Yen to repay their debts, they caused the Yen to go up even more, making the carry trade even less attractive, and so forth. A positive feedback loop. Therefore, according to this narrative, a Bank of Japan rate hike, not only caused stocks in Japan to go down by a lot, but all over the world as well
The third narrative I found is that the market crash was caused by a dawning realization that while A.I. technology is promising, it is perhaps not promising enough to justify the billions of Dollars invested by American tech companies, and semiconductor producers in Asia. This could explain why especially tech and Asian stocks suffered from this particular stock market crash.
Finally, the fourth narrative is that stock markets these days are simply more volatile for technical reasons that have nothing to do with the state of the economy. Instead, crises like the 2011 Eurozone crisis, 2013 taper tantrum, and this latest market panic tend to happen in the summer because this is when many traders are on vacation leaving even more trading up to potentially volatile trading algorithms. If this story is true, this latest collapse & partial recovery is likely just another blip in a long list of irrational market panics.
So, as is so often the case, there are multiple convincing well-thought out narratives that can explain what we have seen. But, which one is correct?
Well, despite newspapers often pretending to know the answer, the sadly complicated reality is that nobody really knows why markets go up and down.
That being said, I personally was not convinced by the U.S. jobs data story because this data wasn’t so bad and because a potential recession might these days actually be good for stocks because it would encourage the Fed to lower interest rates faster.
So, I’d put my money on this downfall being a consequence of the other three stories, plus perhaps a consequence of central banks all over the world reversing their quantitative easing programs and having higher interest rates, a situation that markets just haven’t been used to. If that is true, we should prepare for more volatility.
A troubling message. But, if we want to put our minds at ease it is always helpful to zoom out, by for example looking at the SP500 index over a year, which as you can see still did really well this year, despite the crash.
Zooming out may also explain why I think that
Ukraine’s remarkable invasion of Russian territory
matters for the global economy.
The biggest geopolitical story last week was that Russia invaded Ukraine, and that, in contrast to earlier incursions, Ukraine has now committed its own elite troops and has taken a sizeable chunk of Russian territory. In doing so, it likely hoped to draw Russian forces away from the frontline in Ukraine, where Russian troops had been steadily advancing.
But, okay, why does this matter for the global economy? Two reasons.
First, Ukraine is not just getting desperate because it is again steadily losing territory, it is also running out of Dollars fast. After all, a lot of those Billions of Dollars in aid you hear about don’t come in the form of money, they come in the form of weapons, and, given that Russia’s invasion made Ukrainian industry far less competitive, Ukraine’s trade deficit has exploded which means that it is bleeding foreign currency.
So, much so, that the country was estimated to be less than a month away from a default.
But, to convince foreign investors to provide it with much needed relief, the Ukrainians need to at least appear to be either winning or heading towards a stalemate or ceasefire. So, it could be that Ukraine’s worsening financial situation is actually making it so desperate that it now chose to divert troops away from its own territory to Russia.
The second reason why I think economists need to track Ukraine’s invasion is that the Ukrainians recently captured the last operational gas transit point from Russia to Europe via Ukraine. And, while this gas route is no longer very important for Europe as a whole, Austria still actually gets a lot of gas through this pipeline, and would need to import gas from Italy and Germany to replace that, putting pressure on energy prices in Austria and the rest of Europe.
But, while there is currently no indications the Ukrainians or Russians will stop this flow to Austria, the risk of it happening has just increased, which could explain why European benchmark gas prices jumped as much as 5.7% early august.
So, keep an eye on European and in particular Austrian gas prices, and a potential Ukrainian financial default or bailout in the near future.
Another interesting story that I have been keeping an eye out on lately, is that
Italy seemed to have tricked the rich
who, on the run from higher taxes in Britain, and potentially Switzerland, were increasingly moving to Milan, after promises of a juicy tax incentive, in which no matter your income you’d only need to pay the Italian state 100k euros every year. A tax structure that is not very attractive to most. But, if you have a high six figure income, 100k in taxes is potentially a great deal.
However, after a popular backlash, Italy’s prime minister Meloni recently announced this tax would double to 200k euros, making Italy much less attractive for many millionaires, all of the sudden.
This is relevant for the global economy because it is part of a larger trend, where while small countries like Dubai, Singapore, and Greece increasingly try to attract the global wealthy, traditional tax havens like Britain and Switzerland are becoming less attractive.
So, what can we expect from Millionaire migration in the near future?
Recent research projections by Henly and Partners seem to indicate that Millionaire migration is driven by three main factors: economic opportunities, personal safety + convenience, and the tax burden.
So, countries that have all of this like Singapore and the UAE are increasingly attracting millionaires. At the same time, countries that are not necessarily tax havens but still great places to live with a lot of opportunities, like the US and Australia also still attract a lot of Billionaires. On the flipside, the most millionaires are projected to flee China, which is perceived as less safe, for Millionaires at least. Right after that Britain follows after it made clear its intention to scrap the long standing ‘nom-dom’ tax incentive which allowed wealthy UK based foreigners to consider themselves domiciled overseas to avoid paying UK taxes on overseas income and wealth.
But, while Italy’s increased flat tax only applies to rich people moving there after the law goes into effect, I think the move to double the flat tax shows that countries face a really difficult balancing act, both economically and ethically. On the one hand, governments want to maximize tax revenue to maintain investments or the welfare state. Giving millionaires a tax break can increase overall taxes collected if you attract enough of them. But, if other countries respond with their own tax breaks, it could lead to a race to the bottom. On top of that, most voters find it is deeply unfair that the richest in society get the most tax relief, meaning that the more millionaires you attract via tax breaks, the bigger the political backlash you can expect.
A tricky balancing act as Britain’s case demonstrates removing tax incentives can quickly lead to a millionaire exodus.
A government that has bigger problems on its mind though is
Bangladesh, which just went through a revolution
where prime minister Sheikh Hasina recently resigned and fled the country following weeks of student protests about a quota system that reserved 30% of government jobs to loyalists. A big deal in an economy that relied increasingly on the state to keep it going.
After violent repression by state forces had failed to quash the unrest, the army refused to kill more students, causing the prime minister to flee. After this, the army invited a nobel prize winning ‘banker to the poor’, dr. Mohammad Yunus to head of Bangladesh’s army-backed interim government.
The revolution in Bangladesh is crucial for the global economy for two reasons. The first is simply that Bangladesh has a lot of potential, given that it is the 8th most populous country in the world, and was until recently considered an economic success story, as the country was lifted from absolutely poverty. The second reason is that Bangladesh plays a crucial geopolitical role, being completely surrounded by India, while importing mostly from China and exporting to the West.
So, what does this revolution mean for Bangladesh’s economy?.
The Economist argues that the fact that the military refused to kill more students and then invited Dr. Yunus is a hopeful sign that this is a genuine chance for Bangladesh to become a more open society. That is, if dr. Yunus takes the time to reform Bangladeshes dysfunction government institutions. In this scenario, Bangladesh might continues to grow to become the next Asian growth miracle.
However, slow and difficult reforms will be really difficult given that Bangladesh’s main opposition party —the BNP— does not have a great track record and weak leadership right now, leaving a lot of political space for radical Islamist parties.
This is an outcome that India tried to prevent by supporting Sheik Hasina to the bitter end. But, that support has of course made a lot of Bangladeshis really mistrust India. But, mistrust or not, Bangladesh’s dependence on India, China and the West simply means that it easily could become a victim of a great power struggle.
Is that really an environment in which Dr. Yunus can reform Bangladeshes government, or will a plunge into anarchy be inevitable?
We will have to see. But, to the north, one thing is for sure and that is
Multinationals are struggling in China
Specifically, the Financial Times reports that the CEOs of companies ranging from L’Oreal to AB Inbev report falling sales growth, while car maker CEO’s like those of Porsche and Mercedes Benz even report rapidly falling sales.
This is the reversal of one the big trends dominating the global economy the past decades, which was characterized by more and more Western companies moving production to China in the hope of big profits.
Most Western CEO’s blame the slowdown on weak Chinese consumer demand. But, let’s be honest, that would mean that they are not to blame. A convenient excuse. So, are they right?
Well, on the one hand, their fears about reduced demand are in line with most reporting on China which indicates that house prices continue to drop. This continued drop in household wealth this could explain why analysts from Fitch report that Chinese consumers are moving away from premium and luxury good and back to cheaper goods.
On the other hand, I already reported on this channel over a year ago that German car makers had simply acted to late as their Chinese competitors rapidly switched to electric engines.
So, while China’s consumer slowdown is real, Western companies are also genuinely outcompeted in many booming sectors like electric vehicles and solar panels.
Something that may seem like a contradiction to anyone who has not seen my video about China’s failing growth miracle.
Which brings us to the end of this economic update, a format that yes I’m continuing to experiment with while also aiming to make as many deep dive videos as I did before. An ambitious goal that is not possible with the resources I have now. So if you want to make it happen, please consider supporting the channel on patreon.com/moneymacro or by becoming a member using the button below.