Global Financial Crisis Imminent?

U.S. and China Form Unexpected Crisis Task Force

I’m seeing storm clouds gathering on the horizon.

I don't have a crystal ball for the timing or what will be the lightning strike that sets it off. It could be another pandemic, a systemic financial crisis overwhelming our fragile system, or something else entirely. But whatever it is, it’ll cause a huge panic event in the markets.

Last month, while traveling from Buenos Aires, Argentina, back to our green refuge in Asuncion, Paraguay, I stumbled upon some news from Bloomberg that added weight to these apprehensions. It highlighted a recent meeting between senior officials from the U.S. Department of the Treasury and the People’s Bank of China (PBOC) during their two-day discussions in Shanghai, China. Here’s a snippet:

China’s central bank said a meeting in Shanghai produced an agreement with the U.S. Treasury to appoint contact people to deal with any future “financial stress events,” a rare example of the world’s two biggest economies seeking common ground.

“Appoint contact people to deal with any future financial stress events”? This is just a fancy way of saying they're setting up a panic room for when the financial disaster hits the fan.

Storm Warning

But is this good news? "Seeking common ground" definitely has a positive ring to it, after all.

Definitely not.

Remember, we’re talking about two global superpowers that have been at each other's throats for the past 6-7 years. Here’s a quick rundown of some notable run-ins between them (and this is far from an exhaustive list):

• Trade wars. Trump slapped 25% tariffs on $34 billion of Chinese goods in July 2018. China retaliated. By 2019, average U.S. tariffs on Chinese goods hit 21%.

• TikTok drama. Trump tried to ban TikTok in 2020. Feds banned it on government devices in 2022. By 2023, over 30 states followed suit, and in 2024, Congress pushed for a nationwide ban.

• Spy Balloon incident. A Chinese "weather balloon" was spotted over Montana on February 1, 2023. The U.S. shot it down off the coast of South Carolina on February 4. In response, China accused the U.S. of overreacting.

• De-dollarization. Since 2009, China has been the main driver behind de-dollarization, from making deals that bypass the dollar to starting oil trades in yuan, promoting its digital yuan (e-CNY) globally, and dumping U.S. debt.

• South China Sea tensions. China claimed about 90% of the South China Sea in 2009 and constructed around 3,200 acres of artificial islands by 2021. The U.S. started its first "freedom of navigation" operation (FONOP) in 2015, with over 50 operations conducted by 2023 to challenge China's excessive maritime claims.

• Human rights. The U.S. sanctioned 28 Chinese entities over human rights abuses involving Uighurs in 2019. Trump signed the Hong Kong Autonomy Act in 2020. Biden expanded sanctions to 59 Chinese companies in 2021.

• Cyber wars. A major hack of the Office of Personnel Management (OPM) was blamed on China in 2015. In 2018, the U.S. charged Chinese hackers with stealing technology secrets. In 2020, the U.S. accused China of hacking COVID-19 research.

• Arms race. China's defense budget grew 7.2% in 2023. U.S. passed $858 billion defense bill for 2023, citing China as primary challenge.

• Diplomatic tensions. The U.S. closed the Chinese consulate in Houston in July 2020. China retaliated by closing the U.S. consulate in Chengdu. More tit-for-tat expulsions followed in 2021.

• Taiwan tensions. There were a record 380 Chinese warplane incursions in 2022. Pelosi visited Taiwan in August 2022, triggering major Chinese military drills. In September 2022, the U.S. approved a $1.1 billion arms sale to Taiwan.

• Sanction threats. U.S. warned of sanctions if China helped Russia evade Ukraine war sanctions in 2022. Threatened more over potential Taiwan conflict in 2023.

• Yellen's 2023 visit to China. Treasury Secretary Janet Yellen traveled to China in July 2023, warning of "severe consequences" if China aided Russia in Ukraine.

The bottom line is that when rival powers with such a track record of strained relations team up to weather "financial stress events," it's not a kumbaya moment—it's a storm warning.

Here’s a snippet from the U.S. Treasury readout released after the meeting in Shanghai:

The meetings concluded with Treasury and the PBOC exchanging letters in support for coordination during times of financial stress to strengthen appropriate information sharing and reduce overall uncertainty between Treasury and the PBOC regarding crisis management and recovery and resolution frameworks.

In layman's terms, this means that the financial power players in Washington and Beijing are getting serious about preparing for a financial tsunami. When the two economically most important nations on the planet start making contingency plans like this, it's definitely time to pay attention.

Canary in the Coal Mine?

Now, what I found particularly interesting about this move is the timing.

The meeting in Shanghai between the U.S. Treasury and the PBOC took place just days after global markets crashed, triggered by the unwinding of the Japanese yen carry trade I told you about in an essay last month.

You may recall that on August 5, Japan’s Nikkei index plummeted an astonishing 12.4%—the largest drop since the infamous Black Monday crash of 1987.

As panic spread through international markets, the Dow Jones fell over 1,000 points, dropping 3%. The S&P 500 lost nearly $2.1 trillion in hours, ending down 3.1%, while the NASDAQ Composite slid 3.6%.

In total, the global stock market wiped out over $5 trillion in a single day.

I went into some detail unpacking what the “yen carry trade” is and what happened in this particular instance (click here if you want to catch up).

The point is, there’s reason to be worried about these carry crashes because history shows they often lead to major crises.

The yen-dollar carry trade, for instance, also played a role in contributing to the global financial crisis of 2007-08. A 2009 report by the Bank for International Settlements (BIS), often called "the central bank for central banks," tied the yen carry trade unwinding to the 2007 credit crunch. It was this crunch that caused lending to suddenly dry up across the financial system. The rest is history.

Note: The crisis worsened in the latter half of 2007 and continued into 2008, transforming from a credit squeeze into a full-blown global financial meltdown.

Is this why the U.S. and China are suddenly eager to team up on dealing with future "financial stress events"? I can't say for sure. But one thing's clear: when two global superpowers - locked in geopolitical, technological, and economic rivalry - start prepping for crisis together, it's a glaring warning sign that a mother of all financial storms might be just around the corner.

Regards,

Lau Vegys

P.S. While an impending financial crisis and market crash might seem terrifying, they often harbor hidden opportunities. That's exactly what our Crisis Investing newsletter is all about. Doug, Matt, and I have recently prepared a special issue that reveals how to potentially turn market mayhem into money-making opportunities.