Bubbles last until they feel like fundamentals, and until last week, investors believed that tech stocks could only head up and the Japanese yen could only head down. By Monday’s market opening, investors cowered for shelter as the two bubbles popped in unison.
The Biden administration in Washington and the Kishida government in Tokyo both pursued the same unsustainable policy, ballooning the government balance sheet to push up asset prices.
By July 31, when the Bank of Japan raised its short-term interest rate to 0.25% from zero and announced that it would “taper” its purchases of government bonds, the central bank owned half the outstanding float of Japanese government bonds.
Japan’s debt-buying binge pushed up inflation expectations, weakened the yen and buoyed Japan’s stock market during the past three years.
A lower yen translated foreign earnings into a larger sum of local currency and inflation reduced real wages, causing a transfer of national income to corporations away from households.
As the above chart shows, the yen exchange rate, expected inflation (as reflected in the yield difference between inflation-indexed and ordinary coupon government bonds) and stock prices moved in unison. Japan’s major stock indices lost more than 20% through the August 5 session before rebounding at the August 6 opening.
Meanwhile, in the United States, the Biden administration tried to shovel money into consumers’ pockets by increasing transfer payments, as I explained in an August 2 analysis.
Washington’s choice of weapon was fiscal rather than monetary: Transfer payments (federal checks to individuals) rose nearly 20% above the long-term trend.
Economist Lawrence Summers, who served as president Barack Obama’s Treasury Secretary, calculated that the actual inflation rate including higher interest costs on consumer loans had peaked at 18% in 2023 and remained at 8% in 2024, double the official tally.
American consumers started to pull back on retail purchases in May, and employment growth began to stall by July.
In Japan’s case, a general revolt by voters, who gave Prime Minister Kishida an approval rating of just 15.5%, forced the hand of the Bank of Japan.
Long-suffering Japanese voters were tired of inflation eroding their living standards. In the United States, consumers used credit cards to plug the gap between 8% inflation and average weekly earnings that had risen just 3.3% in July from the same month in 2023.
By June, US consumers had stopped borrowing and stopped spending, and the inflationary bubble driving US growth had begun to deflate. Friday’s unemployment report, which showed the highest jobless rate in three years, was a wake-up call.
Economic weakness called into question the astronomical valuations of Big Tech companies, whose enormous investments in artificial intelligence had no apparent relationship to prospective revenues.
We wrote in Asia Times’ Global Risk-Reward Monitor on July 31: “Since 2017, foreign holdings of US Treasuries have risen to $8 trillion from $6 trillion, while foreign holdings of US equities jumped to $15 trillion from $6 trillion. America’s leadership in artificial intelligence and the chip design that supports it is the main attraction of the dollar. If tech stocks lose their luster, the dollar will be vulnerable as well.”
The trailing P/E ratio of the S&P Information Technology sector was roughly the same as the overall S&P 500 P/E throughout the years 2008-2022. It’s now half again as high. Is that justified?
One widely circulated estimate by Sequoia’s David Cahn on June 20 suggests that revenue from large language models (LLMs) must reach $600 billion a year to justify the massive investment in software, chips and data centers now being devoted to AI.
OpenAI, meanwhile, is earning $3.4 billion a year, and according to The Information, losing $5 billion a year. A mystical leap of faith is required to match the paltry revenues of LLM providers and the massive CapEx required to support them.
Tech took the brunt of the US stock market selloff. Investors worry that the AI bubble may turn out as miserably as the dot-com bubble of the 1990s, which led to a lost decade in returns to tech stock investors.
Follow David P. Goldman on X at @davidpgoldman