In confidence, this is what rules the world's markets

Hamish McRae: 'Venture capital for hi-tech seems to have dried up altogether'
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Confidence. That issue will dominate this autumn: consumer confidence, business confidence, market confidence and so on. And there is an autumnal chill in the air.

Confidence. That issue will dominate this autumn: consumer confidence, business confidence, market confidence and so on. And there is an autumnal chill in the air.

Confidence affects everything but shows itself at different levels and varieties all over the world. In Britain, consumer confidence is closely tied to the housing market. Strong house prices are a sign of confidenceand feed through into consumer confidence. People worry less about saving when they feel the value of their property has risen. As a result household savings in the UK have fallen from 11 per cent in 1997 to 3 per cent now, the lowest since the peak of the late 1980s boom.

In the US, consumers are similarly confident. Household savings are actually negative (though there is doubt about the validity of the figures) and consumer confidence is the highest it has been for a decade. The consumer confidence index, based at 100 in 1985, has been around 140 all this year, in contrast to its trough below 50 in 1992. Confident consumers spend money: there has been a bounce in consumer spending in the US through the summer.

So consumers in the US and UK remain confident. Elsewhere there are shivers. Consumer confidence fell sharply in France last month and has been falling in the other big euro-economies since the summer. But it is still at historically high levels. Euro-consumers are still cheerful; just not as cheerful as they were a couple of months ago.

Interestingly, Germany, France, Italy and the Netherlands all plan tax cuts in 2001. Maybe that will counter incipient gloom in the shops; at least it shows the governments are aware of the need to pump things up.

But consumers, confident or otherwise, are not a leading indicator of the world economy. They react - we react - rather than point to the future. So the noise in the pubs and in the shopping malls merely says what is happening now, not what will happen soon. The only hint of concern here should be in the housing market, where some reports suggest a pause or even a fall in prices.

Business confidence is less buoyant. In France, Germany and Italy, it has been falling for months right across the board. Even export orders have fallen in the last couple of months, despite the boost from the weak euro. Here in Britain it has varied enormously between the manufacturing and the service sector, reflecting the different prospects for each: glum manufacturers, cheerful service industries.

But there is evidence of worries in some services: even industries with solid demand for their service, such as banking, find their margins are being squeezed by competitors applying the new technologies to what has been a conventional industry. As in other spheres of business, you can be confident there will be plenty of demand but not confident you will be able to make money out of it.

In the US, business confidence is much less solid than consumer confidence. Weak demand in the biggest traditional industry, automobiles, has been joined by a blip in demand in the new hi-tech ones. This not just a "dot com" or a startup phenomenon, though there is plenty of pain there. Big established companies are damaging confidence more generally, like the PC maker, Dell, or the chip manufacturer, Intel, both of whose shares have crashed. The problem is not any catastrophic fall in demand, at least for the present. It is that previous projections are seen as over-optimistic.

This moves us to market confidence, or rather market over-confidence. The last couple of weeks have been autumnal. The NASDAQ index of high-technologies stocks is back to the lowest level of the year, and the mood in venture capital in the US and here has become sombre. Things are moving so fast one has to rely on anecdotal evidence rather than figures, but I know of instances where venture capital for hi-tech businesses seems to have dried up. It is no longer a question of falling valuations; the money ain't there.

Among the big established companies, this loss of confidence has shown in the US in a widening of differentials on the bond market. A top US company can issue a bond at around half a percentage point higher than comparable government debt. That differential hasn't changed in the last year. A year ago, a less secure company could issue its speculative or junk bonds at three percentage points above the US debt. Now the gap is nearly five percentage points. Why? Loss of confidence in anything other than top names.

So that is the picture now: consumers pretty cheerful; businesses starting to worry; and markets in danger of running really scared. What next?

The obvious area to focus on is market confidence. The issue here is to what extent any market adjustment - and it does look as though we probably are having one - damages the real economy. There are specific links: during the first part of the year, the "dot.coms" spent vast amounts on marketing. That money is no longer around, so any business that relied on it will have a hungrier time.

But that is a narrow example. There is the memory of the crash of 1987, where markets collapsed briefly, but the world economy carried on cheerfully for two more years of expansion. There was an eventual world recession but that was triggered by rising inflation, a beast that has remained in its cage this time around.

True, there are big imbalances in the world, a dollar sustained only by capital inflows into the US, a Japanese economy sustained only by an enormous budget deficit and so on. But I don't believe a decline in market confidence will, of itself, wreck the world economy unless things get out of hand.

Business confidence? Well, if business people can see profitable demand they will retain their confidence, carry on investing and taking on labour. There is no downturn in demand in the developed world's labour markets, rather the reverse.

Consumer confidence? Well, what might upset us here? Higher fuel prices? Maybe. A fall in house prices? Sure, but provided interest rates remain low that isn't going to happen.

But watch the various aspects of global confidence through the next few months, for this will determine the shape of the world economy next year.

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