NASDAQ bubbles, China's economy and more
Sitting down with former IMF deputy managing director Zhu Min
Since the COVID-19 pandemic, the NASDAQ Composite Index has climbed from below 7,000 points (March 2020) to over 16,730 (June 2024). However, major tech shares have plummeted dramatically. Heavyweights like Nvidia, Alphabet, Microsoft, Apple, and Tesla saw their stock values drop sharply, raising concerns among investors about the sustainability of the AI-fueled market boom. The latest bout of "Black Monday" tumbles on Aug. 5 came as a warning of the volatility and fragility of global stock markets.
The University of Hong Kong published a paper "The Detection and Inspection of Bubbles in the NASDAQ" in early August, providing a detection method of an emerging bubble in the NASDAQ Composite Index. To learn more about market trends and China's economic outlook, we had the opportunity to interview one of the authors Zhu Min, former deputy managing director of the IMF and former deputy governor of the People's Bank of China.
This is an edited transcript for clarity and brevity.
Q: What are the findings in your paper? Is the NASDAQ in a bubble, and will it burst?
Zhu Min: Our paper provides evidence for the existence of a bubble in the NASDAQ Composite Index and its primary drivers. The drivers of NASDAQ fluctuations can be aggregated into three factors: decelerating technological breakthroughs or progress, unusual market sentiments, and unexpected credit expansions. The current bubble which has existed since 2020 is most likely a mix of all three factors, making the index easy to expand while also making it more vulnerable to downside risks or shocks.
The timing of the burst depends on whether AI-related technological breakthroughs continuously fulfill market expectations, whether the U.S. economy goes into a recession, and whether the Federal Reserve continues to tighten monetary policy for a substantial period of time.
Q: Multiple stock indexes worldwide including NASDAQ suffered severe losses on August 5, which was called "Black Monday". What's next and will it reoccur?
Zhu Min: We estimated that the U.S. stock market might witness big corrections and volatility in the future due to slowing technological innovation, declining economic growth and restricted liquidity.
The first topic to discuss is the technological hype. The NASDAQ rise was driven by breakthroughs in digital technologies, particularly in AI. However, investors' concerns have been mounting, particularly regarding the high expenditures in AI without immediate applications and revenue benefits. The tech giants stocks surge rapidly to a point far above non-tech stocks. The recent financial results from major tech firms have also raised questions about the sustainability of their growth. I once asked OpenAI CEO Sam Altman "Is ChatGPT-5 coming out?". I joked that if ChatGPT-5 cannot be released this year, the tech stocks may continue to plummet.
“NASDAQ is in a bubble, the timing of the burst depends on whether AI-related tech breakthroughs continuously fulfill market expectations, whether the U.S. economy goes into a recession, and whether the Fed continues to tighten monetary policy for long.”
Additionally, any negative impacts on the U.S. economy can be communicated to the NASDAQ. The drop in the global market was a result of fears of an economic recession following the recent release of a series of economic data such as unemployment in the United States, which fell short of expectations. It is best to stabilize market sentiments via a smooth transition from an overheated economy back to the equilibrium, thereby achieving a "soft landing" of U.S. economy. The geopolitical instability also expanded the risk aversion.
Finally, liquidity matters. For example, facing significant inflation pressure in 2022, the Federal Reserve started a new cycle of interest rate hikes. If the Fed cannot ease the monetary policy at the same rate as the market expects, or worse, there will be significant negative pressure on the NASDAQ. Once the Fed starts cutting interest rates, central banks in many countries may also adopt more accommodative monetary policies, thereby increasing global capital liquidity. However, this does not guarantee that "Black Monday" will not reoccur.
Q: Once the bubble bursts and even causes a financial crisis, is there any way for China to prevent the possible spillover effects?
Zhu Min: A preemptive approach and an effective response are both needed.
The 2008 financial crisis had a serious strike on our confidence. China's domestic demand fell sharply, and the government had to act aggressively to prop up aggregate demand.
Fortunately, the confidence can be built up with the proper measures. The more important thing is to identify specific channels for those possible spillover impacts and identify how strong those potential fallouts could be. Let's say, if the U.S. stock market crashed, trade finance could possibly be the first to bear the brunt. After all, China is a large trading country. During the 2008 financial crisis, many American financial institutions were unable to lend, which made it impossible to access foreign debts any more. Nowadays, trade finance is mainly handled by U.S. banks and Euro banks.
On the other hand, a crisis presents opportunity. If the bubble burst and a crisis did occur in the United States, that was the time for mergers and acquisitions. However, that would be a difficult task, as it demanded funds, technology and all other kinds of necessary resources.
“We estimated that the U.S. stock market might witness big corrections and volatility in the future.”
Q: How do you see China's economic outlook for the rest of 2024?
Zhu Min: From a global perspective, the biggest impact on the Chinese economy comes from trade. The world's economic growth has remained low in recent years. The growth prospect for 2024, calculated using purchasing power parity (PPP), is projected to be around 3 percent, while in U.S. dollar terms, it would be approximately 2.6 percent. This represents a sharp decline from the 3.6-percent growth seen during 2001 and 2007. It was a significant drop, and it is unlikely to see a strong rebound over the next five years.
There are several reasons behind this shift. First of all, the fallouts of the pandemic. That was an estimated permanent loss of approximately 7 trillion U.S. dollars. Then there is geopolitics. Geopolitical disruptions in supply chains have raised costs and reduced efficiency, potentially slowing growth by about 0.3 to 0.4 percentage points. Thirdly, an aging population worldwide reduces both labor productivity and capital productivity.
If we look at the country's key growth drivers, returns on infrastructure investment would be hard to further expand as the existing scale is already fairly huge. Real estate investment is currently in negative territory. Therefore, trade would be a crucial economic driver, and maintaining trade growth would be one of China's key challenges in the second half of this year. With foreign trade growth at over 6 percent in the first half, I think there is still room for trade to grow.
There are also risks from the possible international financial market turbulence and the political uncertainties of the upcoming U.S. presidential election. In particular, uncertainties from U.S. presidential elections could mainly revolve around political risks. There might be some radical policies and measures coming out, and even chaos and turmoil. It is hard to tell. If that was the case, negative spillover effects could be huge. Preparations are necessary.
Q: The CPC plenary meeting last month pledged many new reform measures to promote China's modernization. What do you think of these reforms?
Zhu Min: I think the meeting has set a quite clear development path. According to the meeting, one of the priorities would be developing new-quality productive forces. China's manufacturing sector accounts for 30.3 percent of the global total, and the focus now is to strengthen such core competitiveness via digitalization and technological advancement. A stronger manufacturing sector would in turn boost employment, consumption and finally, residential income.
The digitalization and technical upgrading of manufacturing also create more demand for industrial services like software development. Actually, there is so much to be done in this field. China's technological progress in mobile networks and artificial intelligence, as well as its institutional and market strengths, can all contribute to the development of the service sector and be a strong boost for service consumption.
On the consumer front, there is also ample room for service consumption to expand. In the past, consumer spending on goods was mainly driven by the real estate sector, but now the demand for services like education, entertainment, tourism, and culture is on the rise as China moves towards the high-income stage.
“When China builds itself into a service powerhouse with a world-class and competitive service industry, not just a manufacturing giant, the Chinese economy will sustain steady growth in the future.”
One priority of China's next round of reform is to enhance personal income, and there is a package of support policies concerning income distribution, farmers settling down in cities, institutional improvements to better social insurance, education and medical services. Higher income will in turn boost consumption. When China builds itself into a service powerhouse with a world-class and competitive service industry, not just a manufacturing giant, the Chinese economy will sustain steady growth in the future.
As for fiscal reform, I think the meeting has pointed out the right direction, including a clarification of the administrative and financial power of the central and local governments. It was a significant step forward, but it requires much exploration work. We've seen some local governments undergoing some fiscal difficulties, and we need to build up their financial strength and give them more room for policy maneuver.