'Financial Crisis' Trigger: What Midterm Elections Will Do To Markets | Steve Hanke

Steve H. Hanke · Johns Hopkins University

Germany's probably heading into recession next year on energy costs and deindustrialization.

Asked about Germany tipping into recession next year, Hanke says by probability yes. Manufacturing is 23% of German GDP versus about 12% in the European average, and energy-intensive, yet German energy prices are now the highest in Europe. He blames the nuclear phase-out and giving up cheap Russian gas, which is driving deindustrialization. He adds that the ruling coalition's popularity has fallen to 20%.

“So France is in the tank, Germany's more or less in the tank”at 36:37

Steve H. Hanke · Johns Hopkins University

France's combined public and private debt near 225% of GDP leaves it cornered, with Japanese selling a risk.

French government debt is just over 100% of GDP and private-sector debt is also above 100%, so combined debt is about 225%. Hanke says France is highly leveraged and has no room to borrow more. The bond-market risk is that Japanese pension funds, drawn to yen-denominated domestic debt, sell foreign holdings including French bonds, which would hurt France. France's last two quarters of GDP data are already weak.

“So if you put them both together, you've got like debt to GDP, private and public, running at about 225%”at 38:27

Steve H. Hanke · Johns Hopkins University

Japanese investors selling French government debt would be a real problem for France.

Hanke says Japanese investors will start selling French government debt, which would be a real problem for France. David Lin agrees that this would push French yields even higher and raise borrowing costs. The excerpt starts mid-discussion, so the supporting case for the Japanese selling is not visible in this part of the transcript.

“the Japanese will start selling that French debt, which will be a real problem for the French.”at 40:05

Steve H. Hanke · Johns Hopkins University

Core CPI excluding energy and food still rising rapidly; inflation is still a problem.

Hanke says that even after stripping out energy and food from the consumer price index, prices are still rising at a very rapid rate. Inflation beyond the war-driven fuel and grocery spikes is therefore part of the affordability picture voters are reacting to.

“if you look at the consumer price index and cut out the energy and food, it's still going up at a very rapid rate.”at 7:39

Steve H. Hanke · Johns Hopkins University

Money supply growing above the 6% golden rate means too much liquidity, keeping inflation elevated.

Hanke judges US liquidity by money supply growth. M4, the broadest major aggregate, is growing 7.4%, above his 'golden growth rate' of 6%, which he says is consistent with hitting a 2% inflation target. He concludes there is not a liquidity shortage but probably too much liquidity. He adds that the inflation genie is still out of the bottle, so money growth is driving inflation that remains very elevated.

“looking at the money supply, it's growing rate that exceeds Hanke's golden growth rate of 6%, a rate consistent with hitting a 2% inflation targets... So there's not a problem with liquidity, there's probably too much liquidity.”at 40:39

Steve H. Hanke · Johns Hopkins University

Expects a clean Democratic sweep; Trump toxic to swing voters over war, prices and tariffs.

Hanke has become more bearish on Republicans keeping the Senate and now expects a clean Democratic sweep, in line with prediction markets. Drivers include blowback from the Iran war through gas and diesel prices, a K-shaped economy with inflation still high excluding food and energy, and public opposition to tariffs. He says Trump has turned from neutral to a negative for swing voters.

“Trump has basically become very toxic to a certain segment of the voters, and that segment happens to be the swing voters.”at 9:13

Steve H. Hanke · Johns Hopkins University

Divided government is optimal: legislation is mostly negative, and it slows Trump's agenda.

Hanke argues that almost all legislation is net negative, adding regulation, red tape and government intervention, so gridlock reduces bad policy. He says the US economy has always performed better under divided government than under unified party control. He flags the risk that a president facing a weak economy and gridlock may turn to foreign policy.

“divided government is, in my view, the optimum thing to happen, to have the presidency in one party and the Congress in another party”at 10:44

Steve H. Hanke · Johns Hopkins University

AI investment faces a 58% revenue shortfall and circular financing; a pop could cut AI stocks 70%.

Projected AI revenue falls 58% short of what is needed for investors to earn a 12% return on the investment. About 55% of AI investment is circular, coming from hyperscalers in a vendor-finance arrangement like a car maker lending to its own buyers. If the bubble popped, Hanke estimates the overall market would fall about 40% and the AI/tech sector about 70%, repeating the 2000–2002 tech bust.

“there's a 58% revenue shortfall, David.”at 21:51

Steve H. Hanke · Johns Hopkins University

Credit-fueled AI asset boom lifts financial crisis odds to about 40%, versus 7% normally.

Hanke argues that rapid credit growth to AI combined with soaring AI asset prices raises crisis risk beyond a mere slowdown. He cites a 2022 Journal of Finance study by Robin Greenwood and colleagues covering 42 countries, which found such credit boom and asset-price surges sharply raise crisis probability. Normal odds are about 7%, rising to about 40% under this combination. He compares it to the 2007 housing bubble collapse.

“the probability of a financial crisis happening, not just a slowdown... It goes up to 40%. ... To have a crisis, normally the percentage is around 7%.”at 23:34

Steve H. Hanke · Johns Hopkins University

K-shaped economy: top 10% wealth rose 31% since 2022 while bottom 10% gained only 6%.

Using the Federal Reserve's Survey of Consumer Finances (released Oct 9), Hanke says median family net worth rose only 2% from 2022 to 2025, versus 37% from 2019 to 2022. Over 2022–2025 the top 10% gained 31% and the bottom 10% gained 6%. Households over 75 gained 37% while those under 35 fell 23%. He links this to the affordability anger driving voters.

“the rich are getting a lot richer, and everybody that's not so rich is not doing very well.”at 5:14

Steve H. Hanke · Johns Hopkins University

Public now opposes tariffs, a historic shift; Trump uses tariffs as threats and has backed off.

Historically the public was positive or indifferent about tariffs, but under Trump's tariff wars it is now against them. Hanke says voters finally connected tariffs to higher prices, as attacks on American consumers, which feeds the affordability backlash. He adds that Trump now mostly uses tariffs as threats and has rolled back the tariff talk, and a divided Congress could roll back some tariffs.

“with his tariff wars, the public is actually against tariffs.”at 8:26

Steve H. Hanke · Johns Hopkins University

If the economy sours under divided government, Trump may escalate abroad, possibly with Iran.

A Democratic Congress would likely restrain Trump on Iran and push a negotiated deal, lowering escalation risk. But if gridlock leaves the economy stalling, the president could turn to foreign policy, and the US is already in two wars (Iran de jure, Russia de facto). Hanke cites a Tucker Carlson article claiming inside information on a planned bomb strike on Iran.

“then the president will turn to foreign policy and he could get us in more trouble with foreign policy than we're already in.”at 12:45

Steve H. Hanke · Johns Hopkins University

No tax cuts on the board; Democrats would likely push tax increases and reverse parts of the big bill.

Hanke says he sees no tax cuts on the legislative agenda, since the big beautiful bill has already passed. If Democrats controlled Congress they would try to reverse part of that bill and raise taxes, which Trump would veto. This creates a standoff in which the market-friendly tax cuts are unlikely.

“I don't see that any tax cuts are on the board”at 14:06

Steve H. Hanke · Johns Hopkins University

Oil won't fall quickly even after a deal; refilling emptied storage keeps demand strong through 2027.

Even if a Democratic Congress pushes Trump toward an Iran deal, Hanke expects oil to come down only slowly. The war emptied storage, which must now be refilled, keeping demand strong through 2027. A midterm outcome would tilt policy toward a deal and reduce major escalations, but would not change oil much.

“all the storage has been emptied due to the war, they'd be refilling storage... So the demand's going to remain pretty strong through 2027.”at 17:20

Steve H. Hanke · Johns Hopkins University

AI investment is unprecedentedly large and drove 96% of Q3 GDP growth, a fragile base for the economy.

Hanke says 96% of the 3.4% annualized Q3 GDP increase came from AI investment, so growth is being driven almost entirely by AI spending. He cites a forecast that AI investment will reach about 3.6% of GDP. Past mega-investments were far smaller: canals about 0.7%, railroads 2.2%, electrification 0.5%, highways 1.1% and telecom 1.1% of GDP. He agrees with the host that hyperscaler capex may slow, which would weaken GDP.

“Now 96% of that increase was all AI investment.”at 18:14

Steve H. Hanke · Johns Hopkins University

Each $100 loss in stock wealth cuts US consumption by about $3, a drag on the economy.

Hanke gives a rule of thumb that every $100 decline in stock wealth reduces consumption by about $3. Consumption is roughly two-thirds of GDP, and the positive wealth effect from stock gains has kept US spending strong, though household wealth growth has slowed. A tech-led stock decline would therefore pull back consumption and could trigger a broader financial crisis.

“for each $100 in wealth decline, you get a decline in consumption of about $3.”at 26:58

Steve H. Hanke · Johns Hopkins University

Taming inflation needs much tighter policy: Fed funds near 6.75%, or money growth cut from 7.4% to 5-6%.

Hanke says money supply growth of 7.4% is too fast to bring inflation back into the bottle, so money growth would need to slow to roughly 5-6%, which means tighter money. In Keynesian terms, he cites an analyst's calculation (Schlock) that the Fed funds rate would need to rise about 275 basis points, from roughly 4% to about 6.75%, to control inflation. Hanke frames this as the Keynesian view and presents the monetarist route, slowing money growth, as the alternative. Both routes point to tighter policy.

“And with me, the money supply is growing too fast to get it back in the bottle, you'd have to slow it down to from 7.4% to something like five or 6% growth rate. So this all means tighter money.”at 42:01

Steve H. Hanke · Johns Hopkins University

Rising money supply and velocity are lifting nominal GDP, which explains recent 3.4% real growth.

Hanke uses the quantity theory of money equation of exchange (MV = PY). He says money supply and velocity are both accelerating, which raises the right-hand side (prices times real activity). Adding those together, nominal GDP is rising. He presents this as the explanation for the 3.4% real growth figure, and notes that inflation is also very elevated. He disputes a declining-liquidity reading, saying the money supply is still accelerating, so the picture is one of nominal expansion.

“If both of those are increasing, that means that the right hand side, P plus Y, price plus real economic activity. Add those two together and you get nominal GDP, it's going up.”at 44:58