Apocalypse or economic correction? A calming guide for nervous citizens

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The Independent Online
IT NOW looks odds-on that there will be a global recession over the next two to three years. But that does not mean that there will necessarily be a worldwide economic catastrophe. Some countries, including this one, look in pretty good shape to pull through rather better than we came through the early 1990s version that we all remember so well.

At the moment about one third of the world economy is in recession or depression: nearly all of East Asia, patches of Latin America, Russia of course, and even some bits of Europe such as Italy. But until a few weeks ago the financial markets had managed to shrug off these concerns and shares were hitting new highs. Their message was that while one third of the world might be in trouble the other two thirds would be fine.

In the past week two things have happened to change this benign outlook. One is the deteriorating situation in Russia; the other is Wall Street's own loss of nerve.

The Russian crisis ought not to have much direct impact on the West, for it is not a particularly big economy: its output is about the size of Spain's. It does not buy much from us because it does not have the money to do so. But what has happened is alarming because Russia remains a nuclear power and because it is one more bit of bad news on top of others. Banks that have lent to Russian companies have added to their losses on loans to East Asia. It is this cumulative nature of the world's economic troubles that has upset everyone and indirectly led to Wall Street's wobbles.

Wall Street matters because high share prices have been the thing sustaining the long American boom. People in the US, to a far grater extent than here, keep their savings in some form of stock market account - maybe in shares or unit trusts, but more and more in an account that looks like a bank or building society account but is actually invested on the stock exchange. When share prices fall, the balance on the account, which had been steadily rising, suddenly falls. Everyone feels poorer, and may well cut their spending as a result.

Britons worry about share prices, insofar as they do think about them, because they might affect the value of their pension. Americans worry about them because it affects whether they feel they can afford to buy the new car. We all remember that recessions happen, because many of us are still smarting from the effects of the last one. Only in the past couple of months have house prices risen enough to clear most cases of negative equity. In the US the recession was less serious, and the memory correspondingly dimmer.

But markets are different animals from the real economy. What we all want to know is whether the market wobbles are signalling economic wobbles to come. What does all this mean for us?

The best guide to the future is the past. No one can have more than the dimmest outline of the shape of the world economy over the next economic cycle, but we do know that a cycle exists. It would be nicer if it didn't - if we somehow knew how to smooth out the humps and the troughs, but we don't. It seems to be embedded in human nature that we get carried away with enthusiasm when things are going well and have a fit of the glooms when they are going badly. So peering into the future entails trying to guess how the next cycle might compare with past ones.

Think world first, then narrow it down to Britain. For some places in the world this one is already the worst in living memory. The present recession is the first serious one in Hong Kong since the Second World War, and looks like being the worst for Japan since then too. But that does not mean it will be the worst for everyone. Both Hong Kong and Japan had mad speculative booms - Hong Kong in the 1990s, Japan in the late 1980s - which were bound to end in tears. North America and Western Europe haven't had anything like that, though anyone who has been in the US much this year will have noticed a sense of the boom.

Think about Britain and compare with, say, the early 1970s when inflation was soaring and house prices could double in a year, or the late 1980s, when again house prices shot up by 25 per cent in a few months. It hasn't been like that now. Apply the simple rule that the bigger they come the harder they fall and the coming fall ought not to be as serious as the previous ones: the boom has not been so big, so the slump should also be more limited. It is possible we may come though the next three or four years with merely a period of very slow growth, not the actual recession that many fear. In previous cycles we have tended to do rather worse than the US or continental Europe; it is perfectly possible that this time we may do better. We cannot, however, assume that. So the wise will prepare. How?

Everyone's situation is different. Some of us are in secure (or at least secure-ish) jobs. Some are not. Some of us are working in growth industries, while others in parts of the economy which always head down when recession hits. Because no downturn is a carbon copy of the previous ones, it is impossible to say that, for example, the housing sector will be the one which is more severely hit. At the moment manufacturing is suffering because of the strong pound; but many manufacturers will come through in decent shape, perhaps because they have some product which is not very price sensitive, or because they just happen to be particularly good at what they are doing.

If there is a general rule, it is that people should try to be particularly cautious about borrowing more than they can afford. That was the prime lesson of the last recession and it holds good now. Recessions have an economic purpose: they weed out the weaker companies and help the stronger ones. As a result, and at the cost of misery for some, the whole economy becomes more efficient. Individuals who have over-borrowed are hit by the same weeding out process that is forcing companies to lift their game. That is particularly true this time, as it seems most unlikely that inflation will run to the rescue of the those who have borrowed big. The reverse may happen: we may be moving into a world where prices, instead of rising, tend to fall.

But there is still time. The economy is still growing, albeit more slowly. The companies whose shares have fallen are still the same companies they were three months ago. We still need and enjoy the goods and services a modern economy produces. Some ordinary people have time to sort out their finances. And market economies, for all their shortcomings, have proved time and time again that they are good at adjusting to new and more difficult times.

Caption: LONDON

Investors enjoyed a strong run in the post-election euphoria but shares have fallen 11 per cent this summer

TOKYO

The Japanese stock market, down 15 percent since July, has suffered from the fall-out from the Asian crisis

FRANKFURT

German shares fell yesterday, adding to woes on a market that has lost 20 per cent since July

NEW YORK

Monday's plunge wiped out all the year's gains

RIO DE JANEIRO

Brazil, the hope of Latin America, has fallen 35 per cent in two months

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