Most of us probably know what “contagion” means in a biological sense – particularly after 2020 brought it home to us in a very visceral manner. But it’s also a term that crops up in financial markets. And just as “contagion” almost always spells bad news in the real world, it’s also not a term you want to hear in market news.
Global economies and financial markets are arguably more interconnected in the modern era, than at any other point in history. This has lots of benefits. But this interdependence also means that problems which erupt in one corner of the globe can have unexpected consequences elsewhere.
As a result, a financial crisis which at first seems contained in one market or sector, can spread – just like a virus – and potentially overwhelm apparently unrelated markets elsewhere. In other words, there is the risk of “contagion”.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
How does financial market contagion generally spread? Debt is a major source of contagion, and also one of its main vectors.
It’s simple when you think about it. Say a friend owes you £100. You need to get it back so that you can go to the pub that night. But when you go to collect, it turns out that he used it to take a punt on a dodgy cryptocurrency and now has no money. As a result, you can’t go to the pub, and the landlord doesn’t get your £100. That’s contagion.
To take a real-world example, the 2008 financial crisis spread globally because ownership of debt linked to US mortgages was far more widespread than most investors had realised. When US house prices fell and that debt collapsed in value, it caused panic as investors sold indiscriminately, unsure of who they could trust.
But while falling US house prices may have been the trigger for the crisis, the real problem was that financial institutions generally were over-leveraged. In other words, they had borrowed too much money, so it only took a small drop in the value of any assets they owned to render them insolvent.
This then fed into a wider crisis because bankrupt banks sold assets and stopped lending money to anyone else, which in turn caused pain in the wider economy.
To learn more about contagion and financial crises, subscribe to MoneyWeek magazine.
-
Barclays bank caps in-branch cash deposits for personal banking customersNews Barclays has placed a cap on how much you can pay into your bank with cash in a bid to fight financial crime - will you be affected?
-
State pension warning as families opting out of child benefit hits record highUp to one million parents could be losing out on £6,500 in retirement because they have opted out of receiving child benefit.
-
What is an investment trust?Videos “Active” investment funds come in two main varieties, one of which is investment trusts. But what exactly is an investment trust?
-
What is a dividend yield?Videos Learn what a dividend yield is and what it can tell investors about a company's plans to return profits to its investors.
-
High earners to pay nearly £2000 more in tax due to fiscal dragVideos The government froze tax thresholds, which will drag employees into higher tax bands as wages rise with inflation. We explain what fiscal drag is, and how to avoid it.
-
What is a deficit?Videos When we talk about government spending and the public finances, we often hear the word ‘deficit’ being used. But what is a deficit, and why does it matter?
-
Too embarrassed to ask: what is moral hazard?Videos The term “moral hazard” comes from the insurance industry in the 18th century. But what does it mean today?
-
Too embarrassed to ask: what is a marginal tax rate?Videos Your marginal tax rate is simply the tax rate you pay on each extra pound of income you earn. Here's how that works.
-
Too embarrassed to ask: what is stagflation?Videos Traditionally, economists and central bankers worry about inflation or recession. But there is one thing worse than both: stagflation. Here's what it is
-
What is pension drawdown?Videos Pension drawdown is a way of taking cash out of your pension pot and funding your lifestyle in retirement. But how does it work and is it the best option for you?
