In the past 24 hours, Japanese stocks suffered their worst collapse since the 1987 crash, other Asian markets cratered, tech stocks plummeted, the Dow plunged, and several additional global markets suffered from various synonyms for “fell a lot.”
What’s going on in global markets? Any attempt at an explanation has to start here: Nobody actually understands how markets work. This is not a cop-out. It’s a boring statement of fact. It is not humanly possible to fully comprehend an equilibrium with tens of thousands of parties and counterparties making decisions based on dynamic and asymmetric information flows. As a result, you should generally distrust almost every article that attempts to explain the causes of stock-market gyrations, just as you should generally distrust people who predict the weather by staring at tea leaves.
But with that massive caveat out of the way, it seems like this historic global market correction is being driven by three major events: recession fears, AI-bubble concerns, and, perhaps most important, the unwinding of a major macro-investor trade involving the Japanese yen.
First, the recession fears. In the past few months, the economy has clearly slowed down, prompting many people to expect the Federal Reserve to cut interest rates for the first time since the inflation crisis began. In its latest meeting, however, the Federal Reserve declined to do so. Last week’s jobs report suggests it might have made a costly mistake. The Bureau of Labor Statistics reported that the official unemployment rate ticked up to 4.3 percent. This is particularly concerning because, in the past year, the jobless rate has increased by 0.8 percentage points, which is historically a worrying indicator of an imminent recession.
Second, while some analysts are worried about a broader economic slowdown, others are alarmed by the amount of money that major tech companies—such as Microsoft, Alphabet, Amazon, and Meta—are investing in AI. In the past few months, analysts at several major banks, including Goldman Sachs, Sequoia Capital, and Barclays, have published notes questioning whether AI will generate enough profits to pay off the hundreds of billions of dollars that tech giants and venture capitalists are committing to the technology, as The Atlantic’s Matteo Wong recently wrote. OpenAI, for its part, is expected to lose $5 billion in 2024, almost 10 times its losses in 2022. Artificial intelligence might be the most important platform technology since the invention of the web. To conflate one day’s sell-off with the future earnings potential of an entire tech category would be a mistake. But just as the internet revolution produced and then recovered from the dot-com bubble, some analysts are starting to worry that current investments in artificial intelligence are out of step with the imminent revenue being generated by AI tools.
Third, and most important, is the yen. In the past few years, the central banks of the U.S. and almost every other industrialized economy raised interest rates to burn off inflation. But in Japan, where economic growth has been feeble for years, the central bank declined to raise rates for fear that it might lead to a deep recession. This kept the yen relatively cheap in a world of rising rates, which helped Japanese multinational corporations sell exports in countries with stronger currencies. As a result, Japan’s stock market exploded upward over the past two years.
Japan’s low rates had another side effect: They created the perfect conditions for a popular trade that may have quietly driven the surge in stocks around the world, including in the United States. It worked something like this: Macro investors could borrow Japanese yen—which, again, pay no interest—then convert it to other currencies that paid a higher interest, and invest in higher-yielding assets, like tech stocks. This “carry trade” looked invincible, as Japan seemed determined to keep its rates low. But in July, the Bank of Japan raised rates for the first time in years. The Japanese yen jumped higher, at the same time that U.S. data weakened the dollar, creating a headache for investors. For example, let’s say a trader had borrowed 1 million yen several months ago and converted that amount to, say, $6,000. Suddenly, those dollars bought only 900,000 yen. To address this 100,000-yen shortfall, the investor would need to sell out of other positions to acquire more yen—say, Microsoft and Meta stock. Thus, a massive carry trade interrupted by a sudden increase in the value of the Japanese yen might have triggered a stock-market sell-off. “You can’t unwind the biggest carry trade the world has ever seen without breaking a few heads,” Kit Juckes, the chief foreign-exchange strategist at Societe Generale, said in a research note.
Every article about a stock meltdown should be legally obligated to end with the same message: Just calm down, okay? In any given year, there is a 64 percent chance of a 10 percent correction in the S&P 500. Meanwhile, there is even more reason for Americans to remain calm in 2024. The stock market is coming off an all-time high, and the U.S. economy continues to grow while inflation continues to decline. Breaking news about market meltdowns is a part of life. So is forgetting about the last one.
