Comment: A judgement on the policy-makers

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It was a black Monday on the London markets, but as far as equities were concerned it was an equally black one in Paris and New York.

When share markets around the world move sharply in unison they are usually trying to say something important. Understanding what this might be is the key to understanding the big forces on the world economy in the coming months.

Obviously, the fact that London experienced the worst fall in share prices since that other black Monday in October 1987, and the continued plunge of the pound on the exchanges, focus attention on this country. The timing of the Conservative conference adds a little twist to the story.

But it is important, not to say disturbing, to note that the fall in French share prices was somewhat larger in percentage terms than that in London, and if the pound is close to a new low against the mark so too were the dollar and the lira. Wall Street was not too brilliant either.

The central point here is that, while it obviously matters to us here that our markets are in a tizz, in world terms we are a sideshow. The really important thing that is happening is that other markets are in a tizz too.

It is quite possible to separate the forces on each of the markets and argue that each is responding perfectly rationally to the flow of new information. Thus the pound is falling because the three things that might stop its fall are not available to the Government.

Those three things are words, intervention and interest rates. The first have been completely devalued, for no one will believe a statement in support of sterling after the events of recent weeks.

The second is inoperative because, once allowance is made for the losses incurred on our behalf by other central banks, there are virtually no reserves left. The third is seen as not a credible option for the Government given its political difficulties and the weakness of the economy.


Given this, it is hardly surprising that the pound is falling. It is already below its purchasing power parity against the mark, but it may well continue to fall until it reaches a silly level.

Foreign exchange markets traditionally overshoot. We are into serious overshoot territory now against the mark.

The changing perspective on the probable trend in British interest rates gives a quite rational explanation of the fall of the stock market. What happened yesterday was the result of a reassessment of the pace at which interest rates might come down, together with the still quite small possibility that they might actually have to go up.

Last week, when this column noted the possibility, most people in the market would have put that at less than one in 20. Now it is perhaps one in five, which is high enough to be uncomfortable.

One can carry out the same exercise for French equities. Over the past week the probability rose that money market rates would remain high until the end of the year while export prospects in France's largest market, Germany, weakened sharply.

Exports to three of its other big markets - Britain, Italy, and Spain - will be hit by the currency movements. It is perfectly rational, under these circumstances, to mark down the shares. (The German market went down for much the same reason.)

Relief for French industry would come if there were to be a franc devaluation in the next couple of months, and yesterday the authorities were intervening again to hold the franc up. A forced franc devaluation may yet occur, but French equities are not yet contemplating that.

Or look at the US. There is growing evidence of a triple-bottomed recession. Yet further cuts by the Federal Reserve in short-term interest rates are hardly likely to have much effect, for they will probably trigger a rise in long-term rates.

Share prices have been on a demanding rating based on a solid, if fairly slow, recovery. Now that this appears even further off, prices have to fall.

Meanwhile, the prospect of lower short-term rates pushes down the dollar.

One can, in fact, make a good case that a sustained recovery in the US will be in place by the end of next year. When that is assured, expect share prices to steady and the dollar to recover. But since there have been so many false dawns the markets have become impatient waiting for such a recovery, and this time will want to see evidence before they react.


So it is quite possible to explain the gloom of yesterday in an ordered way. This is not a sudden irrational fit of terror - the gloom is perfectly well- founded. But when markets, for rather different reasons, are hit by bad news there is always a danger that the cumulative total of gloom will be greater than the sum of the parts.

This is worrying. It is as though markets all around the world are saying: 'We do not trust you policy-makers.'

British markets certainly do not trust the Treasury, but then they are hardly alone. The US markets are not great admirers of their present president. The Japanese quite rightly think their authorities have made serious mistakes. The French are divided and worried.

The Germans have the bill for unification still to pay. The Italians are in despair over fiscal policy, and are not sure they have a government. And Canadians are not even sure that they have a country, as Quebec seems increasingly likely to head off on its own.

In every one of the Group of Seven industrial countries there is grave uncertainty. It is hardly surprising that financial markets should react badly.

At a time like this the important thing for investors is to go back to fundamental issues like value. It is possible to say some sensible things here. One is that both the dollar and sterling are now clearly undervalued against the mark.

Another is that by world standards UK shares are undervalued. Of course the dollar and the pound may fall further - so could UK shares. But sharp movements in markets create opportunities.

The big message of the financial markets is that they think the policy-makers are hopeless. But there is a countervailing force to poor policy. The markets should remember that economies are ultimately self-adjusting, provided they are given the time to do so.