The American stock market, fuelled by “enthusiasm around artificial intelligence”, is hovering near an all-time high, despite volatility triggered by renewed trade tensions following President Donald Trump’s series of tariffs on key trading partners.
This trend has drawn comparisons to the late 1990s tech boom that ended with the dotcom crash in 2000, Gita Gopinath, the former chief economist of the International Monetary Fund (IMF) wrote for The Economist.
While technological innovation continues to reshape industries and increase productivity, Gopinath warns that the current rally is likely “setting the stage for another painful market correction,” with consequences that could be far more severe and global in scope than those felt a quarter-century ago.
Should the investors be worried?
The primary concern is the massive domestic and international exposure to American equities. Over the past 15 years, both American households and foreign investors have poured capital into the market, encouraged by strong returns and the dominance of US tech firms.
Gopinath predicts that a market correction of the same magnitude as the dotcom crash could wipe out over $20 trillion in wealth for American households, an amount equivalent to roughly 70% of American GDP in 2024, surpassing the losses incurred during the crash of the early 2000s.
This could threaten to cut consumption growth by 3.5 percentage points, translating into a two-percentage-point hit to overall GDP growth, even before accounting for declines in investment, she noted in the news article.
Whereas, foreign investors could face wealth losses exceeding $15 trillion, or about 20% of the rest of the world’s GDP, the former IMF economist predicts.
The dollar’s fading ‘flight to safety’ cushion
Historically, foreign economies has found a cushion in the dollar’s tendency to rise during crises. This “flight to safety” has helped mitigate the impact of lost dollar-denominated wealth. However, this dynamic may not hold in the next crisis.
Despite expectations that tariffs and expansionary fiscal policy would strengthen the dollar, it has instead fallen against most major currencies. This, alongside foreign investors “hedging against dollar risk,” reflects “waning confidence,” she said.
Doubts cast on the strength and independence of American institutions, particularly the Federal Reserve could further erode trust in the dollar and American financial assets, Gopinath noted.
Headwinds in the policy space
Unlike the year 2000, the current global economic order is more uncertain, with fewer policy tools available to soften a blow.
Serious headwinds to growth are being whipped up by America’s tariffs, Chinese critical-mineral export controls and general geopolitical uncertainty. Further tit-for-tat tariffs between America and China would damage global trade as almost all countries are exposed to the world’s two largest economies via complex supply chains.
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, she explained.
What is the solution?
More generally, avoiding chaotic or unpredictable policy decisions, including those that threaten central-bank independence, is critical to prevent a market collapse.
Gopinath argues that the underlying issue is “unbalanced growth,” rather than unbalanced trade as “productivity growth and strong returns have been concentrated in a few regions, primarily America,” she wrote in The Economist. As a result, the foundations of asset prices and capital flows have become increasingly narrow and fragile.
The solution lies in the rest of the world generating growth to redress the imbalance and put global markets on a firmer footing. There are encouraging signs that capital is beginning to flow back into emerging markets and other regions. In the meantime, avoiding chaotic or unpredictable policy decisions, especially those threatening central-bank independence, remains “critical to prevent a market collapse,” she noted.
