analysis

5 hours agoMon 3 Nov 2025 at 6:58pm

Michele Bullock will face tough questions about why the RBA didn’t see higher inflation coming. (ABC News: John Gunn)

If Charles Dickens were around today and contemplating a novel on the state of world affairs, he may well begin thus:

“It was the best of times, it was the worst of times.”

For rarely have we seen such a stark contrast in the collective moods of our leaders.

Talk to political observers and there’s almost unanimous agreement that things haven’t been quite this dire for the best part of a century.

War has been raging across a wide front in Eastern Europe as Russia doggedly pushes on with its brutal, never-ending one-week war against Ukraine, while Israel has only just halted its two-year obliteration of Gaza.

China continues to flex its military might with neighbours, Japan, Vietnam and the Philippines over disputed territory in the South China Sea, all while eyeing off a potential invasion of Taiwan.

Meanwhile, America has troops on the streets of its cities, is ramping up a trade war with friend and foe alike, and issuing menacing overtures that hint at military action in Central and South America.

Compare that to the world of finance, where, if the markets are correct, there’s absolutely nothing to worry about. In fact, things couldn’t be peachier.

Wall Street is sitting a whisker below record highs, having surged an incredible 37 per cent since it cratered in early April on fears US President Donald Trump’s Liberation Day tariffs would tip the globe into recession.

Last week, the world’s biggest company, chipmaker Nvidia, became the first corporation ever to top $US5 trillion in market value. Apple joined Microsoft with a value north of $US4 trillion.

Last week, Nvidia became the first corporation ever to top $US5 trillion in market value. (Reuters: Dado Ruvic)

Even more incredible is the action on global debt markets.

The normally large interest rate penalty for ultra-risky borrowers has been whittled right down. There’s now barely any gap between safe and dangerously risky loans, and is the narrowest it’s been in almost three decades.

Lenders see almost no risk at all.

This has been a boom for everyone. Even those convinced that financial Armageddon is just around the corner have done well. Gold prices have rocketed in the past two years.

Heads in the sand?

There’s an old saying that stock markets are built on a “wall of worry”. Every boom brings forth the doomsayers. Some economists, it is often joked, are noted for calling eight of the last three recessions.

But as stock markets continue to unshackle themselves from traditional valuation methods, there are plenty of cool heads getting nervous.

Last week, Reserve Bank of Australia governor Michele Bullock issued a blunt warning on the state of financial markets.

“People are thinking, well, you know, could it all end up very badly?” she told an annual dinner of senior economists.

“There’s sort of no answers there, but people are just a little bit flummoxed about why credit spreads are really low, the risk premiums are really low.

“What is it that the markets are so comfortable about? They just think that there’s going to be no bad outcomes here. I think some people are worried that that might all end in tears.”

She’s in good company.

The heads of two of the world’s biggest investment banks, Jamie Dimon of JP Morgan Chase and David Solomon of Goldman Sachs talked of “bubble territory” and “investor exuberance”, while the Bank of England and the International Monetary Fund echoed the very same fears.

And still, stocks soldier on. For the past few years, Wall Street and the rest of the world’s equity markets have been dragged along by a mere handful of technology stocks known as the Magnificent Seven.

For the past two years, those gains have been driven by growing expectations about Artificial Intelligence and the extent to which it will reshape our lives.

Wall Street has been dragged along by a handful of technology stocks known as the Magnificent Seven. (Reuters: Mike Segar)

A few months ago, Microsoft expected to spend an astonishing $US100 billion this year on AI development but last week revealed it had shelled out $US35 billion in just the first quarter.

Meanwhile, Google, Meta, Tesla, Apple and Amazon all have promised similarly huge lifts in AI expenditure.

Until now, Wall Street investors have been happy to let them rip when it comes to spending. But at some point, that spending has to generate returns. And if Silicon Valley’s streets aren’t paved with gold by the end, it seems almost inevitable there will be some kind of reckoning.

This time it’s different

Of course it is. It’s always different. Until it isn’t.

It’s difficult to avoid comparisons with the last great tech boom, around the turn of the century, when the internet was just taking off.

When the crash finally came, it ran a wrecking ball through Wall Street and the legions of companies that had hitched their wagon to the train to glory.

The US Federal Reserve was forced to slash interest rates and embarked upon a long campaign of propping up financial markets, an addiction it has yet to wean itself off.

A key measure of market health is now flashing red, just as it did back then.

If you want to buy a stake in America’s top 500 companies, via an Exchange Traded Fund, you’ll be paying 41 times their underlying, cyclically adjusted earnings.

That’s exceptionally expensive. In fact, the only time it has ever been higher is during the dotcom bubble and, even then, it was only marginally higher.

But there are some mitigating factors.

The difference now is that many of those companies leading the charge today are extremely profitable, whereas back in the dotcom boom, many were start-ups that merely burnt through investor cash. When things turned pear-shaped, they went belly-up.

There are other differences too.

The phenomenal rise in asset prices this century is a direct result of the amount of cash that has been injected into the system.

The graph shows that the supply of money is now almost six times greater than during the 2000 tech meltdown in the US. (US Federal Reserve of St Louis)

The supply of money usually expands as an economy grows. But as the graph above shows, it is now almost six times greater than during the 2000 tech meltdown, when the US Fed decided to pump up the cash volume.

The curve steepened again after the Global Financial Crisis and then went vertical during the pandemic.

That tiny little downturn at the top? That’s when the Fed turned off the tap. But the Trump administration is now running ever bigger deficits with its tax cuts, pumping more into the system, and last week, the Fed gave up on trying to claw cash back.

So, the spigot is about to open again.

Why is this important? Wall Street’s performance has almost exactly mirrored the growth in money supply this century.

All that money sloshing around needs to find a home. That’s why, during the pandemic, and in the chaotic Liberation Day tantrum in April, the correction barely lasted a few weeks before resuming its logic-defying rise.

It’s possible that any correction, no matter how severe, may only be short-lived.

Just a touch more vodka to the punchbowl

Michele Bullock will endure some tough questions today on why the RBA didn’t see the higher inflation numbers coming.

But she will be secretly counting her blessings that she isn’t cutting rates during a stock-market boom, and with Australian real estate prices in record territory and once again gathering pace.

Central bankers like to tell you they don’t take asset prices into consideration when deciding on rate movements, that they concentrate on their two mandates: inflation and unemployment.

But they understand better than anyone the link between financial markets and the real-world economy.

Australian real estate prices are in record territory and are once again gathering pace. (AAP: James Ross)

A market crash strips wealth from households. That leads to lower spending and, before long, a spike in unemployment that can quickly blow up into a prolonged recession.

None of them wants to bear the responsibility for that. That’s why they have continually pumped up markets — stocks, bonds and property — for the past quarter of a century.

But for how long can they keep the edifice intact?

As Dickens once wrote: “We forge the chains we wear in life.”