Dark shadows

 

The mayhem that broke out in financial markets last week.  

As stock markets plunged, there was a mad rush to explain the correction by way of the “fundamentals”, and in particular the possibility that the US economy is not as strong as previously assumed and may even be slipping into recession.

It’s all the fault of the Federal Reserve, many pundits said. In attempting to quell inflationary pressures, policymakers had held interest rates too high for too long and are now about to reap the whirlwind by tipping the US and world economies into recession. 

The hoped-for “soft landing” was transmogrified into the hardest of crashes.

In the event, the whole thing was over almost before it had begun. 

There’s plenty of evidence of a slowing economy, but not much of an outright recession.

No immediate need, then, for the Fed to come riding to the rescue, even if it is now under the strictest of instructions to urgently start cutting rates at the next available opportunity.

The selloff in markets already looks like just another outbreak of algorithmically driven mid-summer madness.

Even today, after the correction of the last few weeks, Apple still commands a stock market value which at £2.5 trillion is bigger than the annual GDP of the entire UK economy.

Years of quantitative easing has fed an asset price bubble of monumental proportions. When money is cheap and plentiful, it promotes risk-taking and misallocation of capital; that’s precisely what we have seen.

Central banks have sought to dampen these effects through macro-prudential regulation, but their reach doesn’t stretch to the “shadow banking” sector, which has grown like Topsy in recent times, feeding such nonsense as the “Japanese carry trade”, where money is borrowed cheap in Japan for investment in tech and other higher-risk assets.

Taken together, leveraged lending and private credit have roughly doubled in size over the past decade. The regulatory crackdown on the banks has simply pushed credit expansion out to the less well-regulated fringes.

Since the banking system went belly up in the financial crisis of 2008-10, non-bank forms of finance have ballooned, and today account for around half of all UK and global financial sector assets.

Jeremy Warner Telegraph 11 August 2024

https://www.telegraph.co.uk/business/2024/08/11/stock-market-tremors-early-warning-financial-crisis/

Shadow Banks

Global supervisors at the Financial Stability Board call these non-bank financial intermediaries.

https://englundmacro.blogspot.com/2022/11/banks-need-to-worry-about-shadow-banks.html

 

Pushing risk from banks into what’s often called shadow banks, hasn’t necessarily made the system as a whole safer, nor has it reduced the Fed’s role in lending support when times get tough.

https://englundmacro.blogspot.com/2023/08/fed-drawn-into-shadows.html