For a while this summer, the global economy seemed to have paused its monthslong decline, bucking the prognostications that we were entering a recession and even spurring markets upward during a monthlong retread of last year’s memestonk zaniness. Friday, though, all hell seemed to break loose. Stock markets in the U.S. cratered to their lowest point since 2020 as Wall Street has become all but certain the world is about to enter a grinding slowdown, one that could last years, as the problems stemming from inflation prove more difficult to break. If it all seems very sudden — well, it is. The economy has been fine before, so what happened?
What separates today’s market shock from the past two and a half years of the pandemic economy boils down to credit. Since March 2020, the U.S. has been awash in some $5 trillion in money sent directly to people’s pockets in the form of payments, part of a global program to keep the world from imploding as people were forced to stay home. But there has been another form of monetary support propping up the global markets: rock-bottom interest rates. This allowed people and companies to borrow even more money with corporations borrowing another $2.5 trillion in 2020 and $2.3 trillion the following year — with more of that money going to companies that are at risk of defaulting. And now more and more companies are turning their pockets inside out and saying they are unable to pay the money back.
Credit is about trust. When it’s transformed into a number, such as an interest rate, it tells borrowers how likely it is lenders think the money will get repaid. The higher the rate, the more forbidding it is, and vice versa. And this week was a historic one for the demolition of that trust. On Wednesday, the Federal Reserve hiked interest rates by 0.75 percent for the third time in a row, extending the central bank’s most aggressive plan to crush inflation in more than 40 years. It was a move that appeared to bring the world closer to recession, even deliberately inviting it in order to keep prices from rising any further. Other central banks around the world rushed to follow the Fed’s lead, all in the span of a few days. And just like that, the pool of money in the world started to dry up. Jerome Powell, the Fed chair, had warned that the world would start to feel “pain” in the service of keeping inflation down. In this case, recession isn’t even the worst-case scenario, as the prospect of stagflation — with rising prices and a sputtering economy — starting to become more likely.
But there was another facet of global credit that cracked Friday, and that happened in the U.K. The country’s new prime minister, Liz Truss, unveiled a roughly £190 billion budget package that would slash taxes and increase spending to keep energy costs low. The result was a calamitous slide in the price of the British currency to its lowest point against the U.S. dollar since 1985. The message here from the markets is that the era of stimulus is over. It’s now time to pay up.
So people are selling off stocks. The Dow Jones is in a bear market, down 20 percent from its peak. Oil is below $80, which sounds great — until you realize it’s a sign traders believe the world economy is going to be in recession. Bond traders are demanding the highest interest payments on short-term U.S. government debt since the financial crisis. Credit is at the base of economies around the globe, and when it starts to disintegrate, that’s when the money really starts to dry up. Quincy Krosby, the Chief Global Strategist for LPL Financial, described in a note the mentality on Wall Street right now as “raise cash as uncertainty and volatility climbs,” meaning hold onto that money any way you can while you still have time.