From boom to bust?

Recessions inevitably follow booms, are we living on borrowed time?
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The Independent Online

If you asked an economist where the Dow will be in a year, you'd probably get a number between 5,000 and 15,000. Some card-carrying economists even assert that the Dow's true home should be 35,000. Reliant on different analytical tools, economists vary widely in their predilections, as well as their predictions.

If you asked an economist where the Dow will be in a year, you'd probably get a number between 5,000 and 15,000. Some card-carrying economists even assert that the Dow's true home should be 35,000. Reliant on different analytical tools, economists vary widely in their predilections, as well as their predictions.

Unfortunately, we can't know in advance who these clever or lucky individuals are, and consequently, we can't base our investment decisions on their analyses and predictions.

Economics is not an exact science. In addition, even if the economic apple cart were smooth, there's plenty of uncertainty to upset it. Wars, rogue traders and other wayward unquantifiable forces tend to occur with unsettling frequency and spoil the forecasts.

Instead of indulging in the mug's game of Dow predicting, it might be more informative and profitable to ponder the next recession, whether global or restricted to the UK. One will surely be coming along. We just don't know when it will arrive, how long it will stick around, and how bad its bite will be.

"After this long expansion, you would normally expect the US economy to turn down," says Schroders chief economist Keith Wade. "That is why people are saying that this can't go on, and some even predict a recession."

For most British economists, questions about the home economy lead to thoughts of abroad: "The UK has benefited from expansion in the US," Wade notes, "and if the American stock market fell back, it would have a knock-on effect everywhere. About 12 per cent of UK exports go to the US, so there is a direct impact there. A large part of overseas earnings from the UK, perhaps a quarter, come from their subsidiaries in the US. A slowdown or recession in the US would have a knock-on effect on UK company earnings."

But perish memories of the deep and painful recession of a decade ago. The next one "probably won't be as severe", Wade believes. "Ten years ago the economy was very overheated, inflation had risen, interest rates had to go upsharply and the bubble in the UK housing market had to unwind."

Different economic factors are now operative, which will impact most on different sectors of the economy. "The UK recession of the early 90s was very much a domestic-driven downturn. A recession now would be more global in origin and would obviously hit the trading rather than the domestic sector, and manufacturers, exporters, people like that would be the most affected," says Wade. "While the US economy is showing signs of a bubble, many changes in its economy have been positive."

Jeremy Batstone, chief economist of NatWest Stockbrokers, concurs that "when America sneezes, the rest of the world catches cold. Look at UK and European technology stocks. They are very close watchers of Nasdaq, and when Nasdaq has a good day, our technology stocks have a great day".

Like Wade, Batstone is mostly unruffled at present: "The very worst - case scenario is a deep recession caused by a very sharp hike in short-term interest rates to stop high octane growth. Recession and inflation would happen at the same time 'stagflation'. It's harder to see this occurring in the UK, but it's quite easy to see in the US, with its twin deficit." Still, he rates this probability at only 10 per cent.

Much of his optimism is based on the continuous success of one person, and this is both good and bad news. "I don't foresee a recession in the near future if you mean the next three to four years. Growth expectations are continuing to rise. Our central projection is that Alan Greenspan will engineer a soft economic landing. He can achieve the slowdown because the global financial system believes in his ability."

It is not all smooth sailing: "There is little sign that, globally, growth expectations are being revised down, or even showing any sign of peaking out. But if economic activity doesn't slow, the authorities are going to have to tighten short interest rates in order to create the soft landing," says Batstone.

Here, too, nothing's precise: "Because monetary policy is such a blunt instrument, you could very easily overtighten short term interest rates, and that, has been what has happened in response to a strong growth and inflation surge. Short interest rates have had to be raised aggressively and that has been the end of the cycle. We've moved back into a hard landing and recession."

Mr Greenspan notwithstanding,"some sort of exogenous shock could come along and derail everything," Batstone notes. "Were Mr Greenspan to be run over by a bus or anything happen to him, I think it would cause a very severe tremor to go through the financial markets," says Batstone, whose greatest gloom seems to be reserved for his sense of Greenspan's successor. "If you look back at the financial record of past Fed' chairmen, they haven't had anything like the same kind of success that Mr Greenspan has had. And he's not in his first youth, of course."

We can only hope, then, that Mr Greenspan has the good sense to looking both ways before crossing the road.

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