By Mary Riley ’19, Political Science Club Co-Chair
You may have heard rumours that the stock market will crash in 2018 and you might be wondering how, and why? Although nobody really knows exactly when or how it will happen, some economists have come up with some alarmingly compelling arguments.
The first thought that comes to my head when I think about the stock market is the stock exchange. I imagine people yelling at each other in a room with paper and numbers on monitors plastering the walls. I am not alone; this is a common conception of the stock market for most people. Discussions surrounding the stock market and Wall Street also have the effect of making people feel unintelligent. Common terms like ‘Bull Market’ or ‘margin debt’ tend to make us feel out of our league.
However, when we are able to understand the historical context and structure of a stock market crash, we are able to familiarize ourselves with the topic.
There are many factors that contribute to a stock market crash. For example, the 2008 stock market crash was caused by the mortgage crisis and the fact that banks have always been insolvent because they are not liquid. Translation: the banks never contain and have all of the money that they say they do. Some of these same concepts could still contribute to a stock market crash today. Currently, the stock market is what is called a Bull Market, which is a “financial market of a group of securities in which prices are rising or are expected to rise” (investopedia.com). This bull market, however, has led many people to think that a stock market crash will not happen.
The stock market has always been an entity that is inextricably intertwined with the global economy. For example, the stock market crash of 1930 had a significant effect globally — it helped contribute to Germany’s rising inflation. That is why one possible trigger for a stock market crash is “potential turmoil in Europe” (seekingalpha.com). Another important trigger is inflation. According to the economist, “the New York Fed’s inflation model sees the core rate accelerating this year.” Inflation rates are important to the stock market and the economy because the rise of inflation rates triggers central banks to tighten their monetary policy. This tightening of monetary policy could have a serious effect on the stock market because “central banks have created 37 percent of GDP growth in the last years,” and if “central banks are forced to start tightening because of inflation, the house of cards falls, the S&P 500 goes down the drain” (seekingalpha.com).
Banks are always involved in stock market crashes because of their inherent lack of money. The inflation rate rising and the fact that banks are insolvent are all real phenomena, but what can be frightening is that there could be other unknown factors that spark a market crash.
Besides the spark of a market crash, there are other factors like margin debt that can deepen the severity of damage to the market and economy, once the market crashes. Recently, margin debt has been growing at unprecedented rates. In fact, it is currently at a historical high. Although margin debt may sound confusing, in reality it just means purchasing shares of a stock on credit, meaning if you cannot afford to purchase shares of a stock on your own, your investment bank can pay for a portion of your shares. As you make a profit off of your stocks, you eventually pay the investment bank back for your loan. The problem with margin debt is that technically the investment bank owns part of your stocks until you repay the debt, so at any given time if your stock prices are plummeting, the bank can sell your shares of stock to cut their losses. In the event of a market crash, margin debt could deepen the destruction of the crash because “all of those margin debts will be called upon and if people do not have collateral or liquidity, which is often the case with margins, then there will be forced sales and that will push the market even lower” (seekingalpha.com).
Although people can predict that a stock market crash will happen soon, no one can say for sure when it will happen or what will be the spark. Some people believe that because the market has been doing well and is currently doing well, it will continue on this trajectory and that the damage done in 1930 or 2008 is unlikely to happen again. Again, we fail to learn from our mistakes. The similarities between the stock market crash of 2008 and possibly 2018 seem to be uncanny.