HOW ROBOTS SPARKED PANIC
There is no more brutal sight in the world of finance than stock markets in full retreat. and when this happens, everyone – from US Presidents to the most junior employee of a Wolverhampton widgets firm – must prepare for the worst. For although history tells us that stock markets are not necessarily the most reliable of economic indicators, they can signal a change of direction in the fortunes of the world economy.
The dramatic fall in share values was sparked by panic selling as traders, investment professionals and savers dumped their holdings with a velocity not seen since the great financial crisis of a decade ago. The speed of the falls is partly because share- dealing is increasingly driven by automated trading systems – or ‘robot traders’ – which can over-react and begin a selling binge at the slightest sign of turbulence. More than half of all trades on the US Standard & Poor’s index are done by machines.
But whereas the rush to sell shares in the US is understandable because the value of stocks there has risen 25 per cent in the past year, it is less so in the UK where the FTSE 100 index has gone up only 8 per cent, and there has been only one small interest rate rise since the cut immediately after the Brexit vote. Dividend yields here, too, are significantly less than in america.
Inevitably, any panic on the markets has a knock-on effect. Nervous consumers and businesses are less willing to spend and invest. This shock to confidence then hits output. The panic by investors came just after the smug financial elites had been toasting themselves with champagne at the World economic Forum in Davos. hubristically, the International Monetary Fund had spoken of what it called the first ‘synchronised recovery’ (meaning all parts of the world expanding their economies in unison) since the great recession of 200809. however, the plummeting share prices suggest such arrogance was unjustified. What has happened is that the central bankers who run the US Federal reserve, the Bank of england and the european Central Bank have realised they must stop pumping more money into the world economies via so- called ‘quantitative easing’, which they have been doing with abandon since the last recession.
The aim was to stimulate economies by boosting spending and thus maintain growth and prevent deflation.
But this flawed strategy saw the pendulum swing too far the other way. With an excess of money in circulation, rising prices and interest rates kept low, the risk is inflation. and so, ahead of the central banks ceasing the creation of yet more extra money, the stock markets have panicked.
What they fear above all is that the era of super-low interest rates will soon be over.
The truth is that we are entering a new phase for the world economy. What we are bound to see next is that the global financial markets will continue to adjust swiftly to a tightening in the supply of money.
The Bank of england will show its hand on interest rates this week, with predictions of at least two more quarter point rises in the base rate to 1 per cent this year. So, with wages rising, the spectre of inflation and hikes in interest rates, different stimuli are required.
as for these stock market falls, we must not be too spooked by the sense of panic. Nobel Prizewinning economist Paul Samuelson famously quipped that the stock market had predicted nine out of the last five recessions – in other words, it is notoriously unreliable.
Investors should be comforted in the knowledge that most major stock markets around the world reached new peaks in January, rising by 10 per cent, and that the ‘correction’, if that is what it is, over the past few days has only meant that prices are back to where they were in mid-December.
In Britain, this week’s events simply demonstrate that in the context of such great movements on the world economy, the effect of Brexit will, I believe, be no more than a minor earth tremor. as an open economy, Britain’s output and prosperity will be determined by far more powerful international forces – and they are out of our control.