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Andrew Sheng

Danish philosopher Soren Kierkegaard said that life is understood backwards and lived forward. We look at history to guide us, but the only way to truly know the future is to live our lives. If our perception of reality is subjective, then what we experience is based on beliefs or judgments that can be detached from reality.
As financial markets become increasingly bubbly, Financial Times columnist Gillian Tett has described financial bubbles as a “candyfloss economy”.
This term describes a market or system that looks big, sweet and attractive from the outside but is entirely hollow on the inside. Tett cites an Islamic finance scholar as the originator of the term: “Real assets – like houses – were being used to secure debt that was then rehypothecated multiple times, partly with derivatives, just as sugar is spun and re-spun into candyfloss.”
Estimates by the McKinsey Global Institute suggest that the global balance sheet grew faster than GDP in the 50 years from 1970 to 2020, with the pace of that growth steadily increasing. Most of this happened after 2000, when asset valuations and credit expansion detached from GDP growth. In other words, finance is like candyfloss, pumped up by credit and the belief that valuations can only keep rising.
In the candyfloss economy, financial engineering is prioritised over real engineering or production. Financial derivatives are created essentially through leverage, based on contractual promises secured on assets such as real estate. Derivatives can be created as long as there are buyers who believe in the product or the issuer.
The real danger in financial candyfloss is that buyers have a false sense of stability in values. Valuations gain momentum: they rise simply because more people believe they will continue to rise. But what goes up must eventually go down.


Mathematically speaking, the candyfloss economy arises from circular reasoning that stems from self-referential logic and positive feedback systems. Evidence from financial markets and beyond shows that self-referential systems can briefly generate massive, unsustainable values before collapsing.
Circular reasoning occurs when an assumption – which could be false – is treated as its own proof. Financial candyfloss has expanded since 2000 because levels of government debt have grown across the globe, being monetised by central banks. The resulting liquidity has lifted both consumption and asset valuations. It all hinges on the promise that governments will repay their debts in the future.
Today, US government debt has grown to the point where interest payments could soon need to be financed by new borrowing. We are seeing circular financing in the current bubble around artificial intelligence (AI), where chipmakers hold equity stakes in AI model developers who then buy chips from those same investors. Both borrow heavily to fund their expanding capital expenditure.
In physical or biological systems, growth continues only as long as new energy flows in; without fresh input, the system contracts. Real systems face clear resource constraints.
In social psychology, the illusory truth effect holds that repeated exposure to a claim increases belief in its truth, regardless of whether evidence supports it. It is commonly believed that if you tell a lie long and big enough, it will eventually be accepted as the truth. Even as AI hallucinates, so do human beings, from mild self-deception to the madness of crowds.


The full faith and credit underpinning the US dollar is now being tested by harsh, arithmetic reality. As the US increasingly uses the dollar for geopolitical advantage, global surplus economies are reducing their holdings of dollar assets. This reduction pushes up US interest rates, which are fiscally intolerable given the scale of US government debt.
In short, no candyfloss economy can remain self-referential forever. Every system ultimately rests on trust. As global trust in US leadership erodes and ordinary people feel that the benefits of the candyfloss economy flow disproportionately to a small elite at the expense of everyone else, a fundamental reset is on the horizon. In the meantime, the smart money wants to push up asset bubbles so they can get out earlier than the dumb money, greedy for more profit.
In complex systems buffeted by overlapping shocks, no one can predict precisely what will trigger the turning point or exactly when it will arrive, but warning signs multiply daily. As a former central banker, the signal to watch is when the US Federal Reserve begins to buy Treasury bonds at scale to keep down interest rates.
That is when investors will realise the borrower is trying to delay the inevitable by buying back their own bonds through monetary creation. The bill is passed to Treasury bond holders through eventual inflation, with negative real interest rates.
When the candyfloss eventually dissolves, someone always foots the bill. Let’s pray it won’t be us.


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Opinion

World Opinion

Economy

Global Economy

Wishful thinking and irresponsible levels of debt are driving a global economy that looks sweet from the outside but is utterly hollow


Wishful thinking and irresponsible levels of debt are driving a global economy that looks sweet from the outside but is utterly hollow.


Artificial intelligence (AI)

United States

Stocks

Expresses the views, ideas and conclusions of the author. (Eg. Enough of Crazy Rich Asians, think of crazy poor Hongkongers.)


Not even the AI candyfloss economy can defy reality forever

.css-1c6uqr6{color:inherit;font-weight:inherit;font-size:inherit;font-family:inherit;line-height:inherit;overflow-wrap:break-word;}Wishful thinking and irresponsible levels of debt are driving a global economy that looks sweet from the outside but is utterly hollow

Wishful thinking and irresponsible levels of debt are driving a global economy that looks sweet from the outside but is utterly hollow