Transcription
Stocks have reached a permanently high plateau. House prices never fall. This time is different. These are the confident claims that time and again have been made shortly before markets collapsed.
Booms and busts are nothing new. From Dutch tulip mania to the railway bubble, from a dot frenzy to meme coins, the story is the same. Human psychology is just vulnerable. We want to believe that there is such a thing as easy money. And yet right now, Wall Street says crash. What crash? Since the April tariff shock, US stock prices have surged 25%, pushing the total value of a market compared to the economy, market capitalization to GDP to its highest level ever. If there are economic difficulties out there, Wall Street hasn't noticed.
But here's a warning. Warren Buffett once said a ratio of 70% was a good time to buy. Anything close to 200% was flashing red. The kind of signal we saw in 1999 before the dotcom crash and again in 2007 before the financial crisis. 221% is really quite high. The question is are we about to repeat history?
And it has been a strange year. Gold has hit record highs. The dollar has tumbled 10%. Bonds are in turmoil. There are real fears of stagflation and worries about the long-term decline of the dollar. And yet, stocks keep soaring. Why? Well, some argue the rally reflects a much higher money supply in recent years, unprecedented wealth at the top, and rising inequality. Others say it's all about the new wonder technology, artificial intelligence. Silicon Valley profits tell us that AI will transform productivity and boost GDP. But is this a bubble set to burst?
What happens before a crash? One thing that often happens before a crash is often people get really excited about a new technology. A new technology can cause a wave of speculation and speculative investment which pushes values up to unbelievable levels. Back in the late '90s, people said the internet had rewritten the rules of business. So this time was different. Companies with no profits, sometimes even no products, were valued in the billions. By 2000, the NASDAQ had lost almost 80% of its value. But of course, it did come bouncing back.
And it's not just about new technology. In 2005-2006, mortgage salesmen and bankers assured everybody that housing prices could only rise. In the US, mortgage brokers gave out loans to pretty much anyone with a pulse. And to drive that credit surge, a new wave of instruments were created. Credit default swaps, collateralized debt obligations. If you didn't understand them, that was partly the point. They managed to fool credit rating agencies, and banks around the world completely missed all the bad credit hidden in these new instruments they were buying. Two years later, the entire global financial system was on the brink of collapse.
Another feature of the credit crisis was regulatory blind spots. The new wave of complex financial instruments which resulted from financial liberalization in the '80s and '90s. In 2005, Alan Greenspan was patting himself on the back for creating low inflation and high economic growth. In hushed tones, people spoke of a semi-divine figure. Inflation is whatever Alan Greenspan wants it to be. But it was a question of missing the woods for the trees.
And you might think that that kind of regulatory failure couldn't possibly happen again because after the 2008 crash, regulators brought in new regulations on mortgages and bank lending. And when interest rates went up in 2022, most homeowners in the US were on 30-year fixed mortgages, and there was no crash in house prices. But regulators do tend to be fighting the last battle.
Since 2008, we've seen a whole new range of leverage. Margin trading apps, complex derivatives, crypto lending platforms, meme coins, the perfect symbol of bubble psychology. They often start as jokes with no value or purpose. Yet, coins like Dogecoin hit billions in market capitalization. Prices soar not on fundamentals, but on hype. Memes and the fear of missing out. And when the hype fades, there's nothing underneath. Meme coins can rise 1,000% in weeks and collapse just as fast. And by the way, regulators are already looking to reduce many of those post-crash regulations.
Another interesting feature pre-crash is that from tulip mania to housing, when prices rise rapidly, it can create a fear of missing out. You could even argue that the rapid rise in the price of gold this year is making people think, "I don't want to miss out on this," encouraging people to want to get a part of the action. Another important factor is that when prices are rising and a majority are buying into it, we tend to assume, either unconsciously, the majority must be right. And this is known as the herding effect, safety in numbers. One of the greatest scientific minds of all time, Sir Isaac Newton, may have discovered the laws of motion and gravity, but he lost his fortune buying into the South Sea bubble. He actually sold after making a small fortune but then saw his friends making even more money and he couldn't resist getting back in, buying again before the big crash where he lost everything.
A big feature of boom-bust is the role of debt in fueling excessive growth. If you look at, say, the Southeast Asia crisis of 1997, it was preceded by Asian economies borrowing heavily in US dollars. But this meant that any devaluation in their currency would make their debt repayments much more expensive, and eventually speculators attacked the baht, and the currency was forced to devalue, spreading contagion across the region. Now, these days, the biggest growth in debt is really coming from federal governments who have issued debt to fund an aging population. And if you assume that politicians are incapable of changing tax and spending rates, which is not altogether fanciful, debt projections do look pretty grim.
Now, a government borrowing in its own currency is not subject to speculative attacks like a developing economy. It's got a lot of capacity to borrow more than many might expect. But even so, the scale of borrowing across the developed world is starting to make borrowing a little bit more expensive. The fear that somewhere down the line, inflationary pressures could start to rise, especially if politicians make good on their threat to set interest rates themselves. "The economy is booming. We must cut interest rates." Interesting take on economics 101. Now, this is behind at least part of the greater attraction for gold. However, whilst we talk about the role of debt, it is worth pointing out that private household debt is nothing like the pre-2008 crisis.
Now, to go back to the question, what do we see before a crash? Overvaluation of assets, excessive credit growth, a new wonder technology, confusing innovation in financial instruments, irrational exuberance of investors, some kind of economic shock, regulatory failure. So, do we have these now? Well, certainly many are present to some extent. But it is worth bearing in mind one thing. The stock market is not the economy. And before a crash, you always have several years of people predicting a crash before it actually happens. If you are a long-term investor who holds for many years, it doesn't really matter if you do buy before a crash because historically, stock markets have more than recovered.
However, some things really are quite different in 2025. Global economic growth is slowing down. The miracle of AI may prove more of a mirage. Governments are definitely facing a very real challenge from a rapidly aging population, ballooning budget deficits, shrinking of a workforce. Also, the shutdown of a US government is potentially really quite serious. It portends to the prospect of a political divide which makes it really impossible to bring debt trajectory under control. Also, the global economy has always relied on the dollar and the US Treasury as a safe haven. Fears that this could be even slowly unwinding could increase the cost of borrowing all around the world and introduce new financial instability.
What about black swan events? There's definitely the potential for some kind of shock that pushes up, say, oil prices, feeding inflation further. Also, economic activity does show signs of slowing down. Leading indicators of economic activity have been in decline for three years and are falling into negative territory. The US labor market is slowing down with new jobs decreasing. Although this is skewed a bit by much lower immigration figures, it's still a sharp decline on hiring from past years. Oil prices falling in 2025 also suggests weak global economic growth.
Yet, despite the disinflationary benefit of lower oil prices, inflation is actually picking up, driven by a rise in food prices and the impact of record tariffs feeding through into higher prices. In fact, it is worth bearing in mind that when high tariffs were introduced in April, the market really did crash. Since then, the market has kind of shrugged off this new reality. But it is worth bearing in mind tariffs are still historically very high. Have markets really priced in the new era of trade restrictions? Suddenly, stock prices to earnings are near record levels in the US. This is part related to the promise of a technological revolution. But is AI all it's cracked up to be? It's a pretty interesting question, and I'm not convinced that it is.
Anyway, this video goes into more detail. Thanks for watching. Do subscribe. See you soon.