News ID: 209922
Published: 1019 GMT February 13, 2018

Stock market turmoil may expose flaws in global finance

Stock market turmoil may expose flaws in global finance
deadlinenews.co.uk

Was last week’s global stock market sell-off only a ‘correction’ or does it signify a new period of financial instability, caused by major flaws in the world financial system?

The stock market turmoil has sparked concerns that the relatively good economic times in the past couple of years, at least in the developed countries, could be ending, IPS reported.

It is too early yet to understand what has just taken place or predict what comes next.  It is widely agreed that a ‘correction’ has taken place in the US stock market. But whether this is just a blip, or will progress to a crash, remains to be seen.

Some analysts said there is nothing to worry about as such corrections to over-valued markets are normal and soon there will be business as usual. Others are more pessimistic, with a few even predicting it is the start of the worst bear market ever.

The immediate trigger was the positive news on US jobs, prompting fears of wage increases and higher inflation that would pressurize the Federal Reserve to raise interest rates more rapidly. Higher interest has a negative effect on stock markets as they give an incentive to investors to put their money in alternatives, especially bonds.

In good times, a lot of short-term speculative funds flow from the developed countries to the developing countries in search of higher yield. But in times of global uncertainty, or if interest rates rise in the US thus providing higher returns to investors, the funds can rapidly flow back, often causing significant damage or even devastation to the host developing economies.

But the larger reason for the sell-off is the jump in equity prices to record levels, caused by speculative investments not backed by fundamentals, and fueled by the easy money policy that the US government pursued in the hope of stimulating economic growth.  Some of the trillions of dollars pumped into the banking system by ‘quantitative easing’ contributed to the stock market bubble.

Even though quantitative easing has ended and is being reversed, US stock prices continued to rise rapidly in January. It was a matter of time before a downturn occurred.

The stock market sell-off, if it continues, can have large repercussions on developing countries.

There is the domestic effect. Affected investors feeling they have less wealth will decrease their spending, affecting demand for goods and reducing GDP growth. Those that borrowed to speculate in the stock market may have debt-repayment problems.  Companies may see their market capitalization and asset values reduced as the prices of their shares go down.  If the sell-off becomes more prolonged, banks start worrying about non-performing loans.

Then there is a complex of issues related to the interaction between developing economies with the global financial markets.  The stock-market turbulence could affect global investor confidence in emerging economies, which are seen as riskier than the US.

In good times, a lot of short-term speculative funds flow from the developed countries to the developing countries in search of higher yield. But in times of global uncertainty, or if interest rates rise in the US thus providing higher returns to investors, the funds can rapidly flow back, often causing significant damage or even devastation to the host developing economies.

   
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