A meltdown like no other?
Gita Gopinath on the crash that could torch $35trn of wealth
The world has become dangerously dependent on American stocks, writes the former IMF chief economist
THE AMERICAN stockmarket has see-sawed lately amid a flare-up in trade tensions, but remains near its all-time high.
The surge, fuelled by enthusiasm around artificial intelligence, has drawn comparisons to the exuberance of the late 1990s that culminated in the dotcom crash of 2000.
Though technological innovation is undeniably reshaping industries and increasing productivity, there are good reasons to worry that the current rally may be setting the stage for another painful market correction.
The consequences of such a crash, however, could be far more severe and global in scope than those felt a quarter of a century ago.
At the heart of this concern is the sheer scale of exposure, both domestic and international, to American equities.
Over the past decade and a half, American households have significantly increased their holdings in the stockmarket, encouraged by strong returns and the dominance of American tech firms.
Foreign investors, particularly from Europe, have for the same reasons poured capital into American stocks, while simultaneously benefiting from the dollar’s strength.
This growing interconnectedness means that any sharp downturn in American markets will reverberate around the world.
To put the potential impact in perspective, I calculate that a market correction of the same magnitude as the dotcom crash could wipe out over $20trn in wealth for American households, equivalent to roughly 70% of American GDP in 2024.
This is several times larger than the losses incurred during the crash of the early 2000s.
The implications for consumption would be grave.
Consumption growth is already weaker than it was preceding the dotcom crash.
A shock of this magnitude could cut it by 3.5 percentage points, translating into a two-percentage-point hit to overall GDP growth, even before accounting for declines in investment.
The global fallout would be similarly severe.
Foreign investors could face wealth losses exceeding $15trn, or about 20% of the rest of the world’s GDP.
For comparison, the dotcom crash resulted in foreign losses of around $2trn, roughly $4trn in today’s money and less than 10% of rest-of-world GDP at the time.
This stark increase in spillovers underscores how vulnerable global demand is to shocks originating in America.
Historically, the rest of the world has found some cushion in the dollar’s tendency to rise during crises.
This “flight to safety” has helped mitigate the impact of lost dollar-denominated wealth on foreign consumption.
The greenback’s strength has long provided global insurance, often appreciating even when the crisis originates in America, as investors seek refuge in dollar assets.
There are, though, reasons to believe that this dynamic may not hold in the next crisis.
Despite well-founded expectations that American tariffs and expansionary fiscal policy would bolster the dollar, it has instead fallen against most major currencies.
Although this does not mark the end of the dollar’s dominance, it does reflect growing unease among foreign investors about the currency’s trajectory.
Increasingly, they are hedging against dollar risk—a sign of waning confidence.
This nervousness is not unfounded.
Perceptions of the strength and independence of American institutions, particularly the Federal Reserve, play a crucial role in maintaining investor confidence.
Yet recent legal and political challenges have cast doubt on the Fed’s ability to operate free from external pressures.
If these concerns deepen, they could further erode trust in the dollar and American financial assets more broadly.
Moreover, unlike in 2000, there are serious headwinds to growth, whipped up by America’s tariffs, Chinese critical-mineral export controls and growing uncertainty about where the global economic order is heading.
With government debt levels at record highs the ability to use fiscal stimulus, as was done in 2000 to support the economy, would be limited.
Compounding the situation, and adding to the overall risk, is the escalation of the tariff wars.
Further tit-for-tat tariffs between America and China would damage not just their bilateral trade but global trade too, as almost all countries are exposed to the world’s two largest economies via complex supply chains.
More generally, avoiding chaotic or unpredictable policy decisions, including those that threaten central-bank independence, is critical to prevent a market collapse.
Meanwhile, it is important for the rest of the world to generate growth.
The problem is not so much unbalanced trade as unbalanced growth.
Over the past 15 years productivity growth and strong returns have been concentrated in a few regions, primarily America.
As a result, the foundations of asset prices and capital flows have become increasingly narrow and fragile.
If other countries were able to strengthen growth, that would help redress the imbalance—and place global markets on a firmer footing.
In Europe, for instance, completing the single market and deepening integration could unlock new opportunities and attract investment.
This year’s Nobel laureates in economics provide a valuable recipe for innovation-led growth.
There are encouraging signs that capital is beginning to flow back into emerging markets and other regions.
However, this trend may stall unless those economies can show they are able to generate consistent growth.
In sum, a market crash today is unlikely to result in the brief and relatively benign economic downturn that followed the dotcom bust.
There is a lot more wealth on the line now—and much less policy space to soften the blow of a correction.
The structural vulnerabilities and macroeconomic context are more perilous.
We should prepare for more severe global consequences.
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