The growing imbalance between, on the one hand, the United States and on the other, Europe and Japan, has attracted widespread attention. The US has indeed remained an oasis of prosperity and high employment, but this has been at the cost of a current account deficit of 3 per cent of GDP. By contrast both the Euro 11 and Japan are notching up ever-larger current account surpluses.
There is, however, another imbalance which has attracted rather less attention. This is the imbalance between the pressure on companies around the world and the expectations of financial markets about their performance. Of course, the position varies from country to country and industry to industry so any generalisations about the business sector have to be taken with some caution. Obviously the pressures on Japanese companies selling mainly into the weak domestic market are utterly different from American ones selling into their strong one. But if you are in the internationally- traded sector there are strong common factors affecting your performance, and it is possible to chart some of these.
In a nutshell, international firms are being hit by a triple-whammy: falling prices, rising costs and falling production. Producer prices - the price that companies receive for their goods - are negative in all the Group of Seven nations. This is not quite a unique experience, for there was a period in the early 1990s when producer prices went negative (see left-hand chart). But it is a sharper and already more prolonged experience, for instead of falling prices being a blip at the bottom of recession, there is now the prospect of prices falling well into the future.
Meanwhile, unit labour costs are rising, not by much to be sure, but at a faster level than for five years. The result of this is to squeeze profits - see middle graph - which as a percentage of GDP are now down close to early 1990s levels. As world industrial production falls (right hand graph), the annual change in profits has gone negative.
This macro-economic view of the world is endorsed by the evidence unfolding on the global company reporting scene: look at BP/Amoco and Deutsche Bank to see two global giants producing disappointing results this week.
So what will happen? In the judgement of the editors of The Bank Credit Analyst group, who pulled together the charts shown here, world economic growth has not yet bottomed and global inflation will continue to drift downwards.
But because US and Euroland growth will both move into recession - in contrast to growth in much of the rest of the world - monetary policy will not be eased. The US Federal Reserve will not ease, according to the BCA, because it regrets its mistake of excessive easing last autumn, which has exacerbated the boom in asset prices. To this one might add that the European Central Bank will not ease (or at least ease much) because it is having to act as a counterweight to the weak fiscal and structural policies of the major European governments.
ONE EFFECT of this intense pressure on global companies is the wave of restructuring currently taking place. The pressures mount, but the markets demand performance. They punish managements that fail to deliver - and if that sounds an aggressive, Anglo-Saxon sentiment, note that BMW, a German family-controlled business, had little compunction in shooting the two top guys when the group under performed.
Thus hardly a day goes by without news of some merger, take-over or strategic alliance. And, of course, every time one is announced you know that the outcome of the deal will be the sacking of lots of workers - mergers are a sign of weakness, not of strength. In the short term this wave of restructuring has buoyed the stock market, but the pressure on profits has also extended the already stretched valuations the market puts on companies.
None of this, in the view of the BCA team, means that there is necessarily a long bear market in equities.
But shareholders will have to look through a dip in profits that could run on until early next year. That might seem an acceptable time-horizon, but even when the improvement comes it may disappoint - in a zero or negative inflation world profits are unlikely to rise by more than 4-5 per cent a year. That cannot long sustain double-digit returns on equities.
Finally, investors cannot assume that next time there is a hint of trouble on the international markets the central bankers will ease rates. It does appear that last autumn the Fed repeated the mistake the central banks made in 1987 when, fearful of the economic impact of Black Monday, they cut rates when they should have held them up. That mistake created the conditions for the boom/bust cycle of the late 1980s and early 1990s. You don't need to believe that we face a rerun of that to be aware that the central banks will be cautious in future.
So much for the global view; how does this translate into the UK situation?
There are two main points here. In one sense we are completely "normal" and therefore will experience exactly the same forces as other developed nations. In another we are abnormal, and may therefore face a rather different outcome.
We are normal in that we are an open economy, with foreign earnings (either from exports or from foreign subsidiaries) representing roughly half the profits of the Footsie 100 companies. We are also open in the sense that London-registered companies and UK gilts are liquid markets. If big money is washing round the world looking for a home, some of it ends up here. If big money is running scared, our markets will take a big hit along with the others.
We are, however, abnormal in that we have had a buoyant economy which has been curbed relatively early in the cycle by a sharp rise in interest rates. You can have a debate as to whether this rise was too sharp, and whether rates are being cut fast enough now. But we are also an economy which will bump up domestic demand in response to rate cuts - a function of the impact of short-term rates on mortgages.
SO IF DEMAND does falter globally, it ought to be possible to stimulate demand here by cutting rates. The government also has leeway to ease fiscal policy, having clearly tightened it by more than it intended. (The switch to self-assessment has resulted in unplanned surpluses, though it is almost certainly a once-and-for-all adjustment because of earlier payments, rather than a lasting rise in revenues.)
So there is considerable leeway here for easing, which may well be needed, but also a prospect of the great British consumer rising to the occasion if and when his or her services are needed. Consumers, not just here, but everywhere have an opportunity that hardly anyone has ever experienced - the possibility of goods in the shops becoming cheaper and cheaper and cheaper.
But that will not help the global squeeze on profits. If it is great to be a consumer, it is tough to be a manager. And to be an investor? I think it is puzzling - and unravelling the puzzle will preoccupy the markets through the rest of this year.Reuse content