Alarmists

The sky did not fall this week.

A few days ago, there was alarm in the financial markets. The Tokyo Stock Exchange fell the most ever in a single day. Markets across the region followed suit. Shortly after, the New York Stock Exchange lost over a thousand points in one trading day.

Those prone to panic did what they do well: they panicked. As a result, the markets were oversold.

Stock exchanges operate on two primal emotions: greed and fear. For a day, fear presided.

But the very next day, greed regained its bearings. Investors began buying bargain shares. The stock exchanges recovered much of what they lost in a day when panic ruled.

The sharply erratic behavior of the markets was aggravated by alarmists.

Donald Trump, for one, announced that a great depression has begun and blamed it on the Biden-Harris administration. In the same breath, he announced that World War III was about to commence as everyone waited with bated breath for Iran to mount yet another missile bombardment of Israel as retribution for the assassination of the Hamas political chief right in the heart of Tehran.

Those who had paid critical attention to the things Trump says should have understood that this man knows nothing about how economies work. In the previous week, he announced that he would pay down America’s burgeoning debt using Bitcoin. He has since kept quiet about that. Someone must have told him that one needed real currency to buy cryptocurrency.

For years, Trump has been threatening to impose crippling tariff rates on America’s imports. He did not realize, like most of our protectionists, that it is the domestic consumer that ultimately pays for whatever tariffs are imposed.

To be sure, there is much for the markets to be anxious about. The biggest economies are not recovering from the COVID slump strongly enough. The situation in the Middle East has become extremely tense after Israel took out Hamas and Hezbollah leaders in quick succession. The war in Ukraine seems headed for a long and bitter (and costly) struggle. The US Fed is perceived to be behind the curve in lowering the interest rate regime, putting economic expansion on hold.

Two things mainly caused the extreme volatility in the markets we saw this week.

The first is a report showing job creation in the US was slowing. Many jumped to the conclusion that the American economy was going into a recession. That was unwarranted. A subsequent report, released a few days later, showed that while the US was not creating as many jobs as expected, it was not losing jobs either. That calmed some of the panic.

The second, probably more determinant, factor was the recent decision of Japan’s monetary authorities to allow domestic interest rates to climb.

While most economies had jacked up interest rates the past few years, Japan stubbornly maintained a very low interest rate regime. They did this in the hope of reviving the industrial giant’s stagnant economy.

As the rest of the world jacked up interest rates while Japan maintained low interest rates, “carry trades” were encouraged. Investors took out yen loans at low interest rates and invested the money in economies with higher interest rates. This was a no-brainer way to make money.

“Carry trades” amounted to a huge sum eventually. When Tokyo began raising rates, those doing “carry trades” panicked. The rate differential was narrowing. Exchange rate risks were rising. Greed dictated they pay down their yen borrowing and shift to other investments.

The thinning of “carry trade” involving yen loans created instability in the financial markets. The yen began behaving erratically in the exchange markets. Suddenly, no one seemed to want the Japanese currency.

With the yen being dumped, the Tokyo market was more anxious than anywhere else. This set the stage for the great Tokyo selldown we saw at the start of this week. The severity of the selldown turned into a contagion, infecting stock markets everywhere.

It did not take more than a day, however, for investors to recover their bearings. As soon as people realized they had oversold, they began buying up the same shares. This calmed the markets across the globe. The sky was not about to fall.

Even the situation in the Middle East, which has the potential for upsetting oil pricing, appears to be relaxing as well.

Everyone should have realized that the crazy rulers of Tehran and their militia proxies are long on threats and short on delivery. I pointed this out in this space earlier this week.

The mullahs somehow think they need retaliatory action of some scale to cure the utter embarrassment of having a senior Hamas leader killed right in their capital city. The constantly outraged fanatics of the Hamas and Hezbollah cry for blood to be shed at every opportunity.

While the world anxiously awaited Tehran’s retaliatory strike against Israel, the Hezbollah intensified their missile attacks on northern Israel. Moscow was frantically delivering advanced air defense systems to Iran to minimize damage from a counter-strike.

The last word coming out of Tehran, however, indicated that Iran might not launch a massive strike after all. With the Islamic and Western nations engaged in urgent diplomacy, Tehran now seems willing to forego a massive air strike in exchange for a ceasefire in Gaza.

This is eminently doable.