Hamish McRae: Happy daze is here again

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The Independent Online

Spring has sprung. Or so it would seem from the burst of stories and figures in the past few days.

Spring has sprung. Or so it would seem from the burst of stories and figures in the past few days. Suddenly the green shoots of economic recovery are being spotted all around the world. The numbers seem to be turning up and the mood has certainly lightened. A few more weeks of this and the talk will be of higher interest rates to curb the incipient boom.

This is a global story. Last week Alan Greenspan, chairman of the Federal Reserve Board, said US expansion was "already well under way". Here in Britain, the sector that has been holding the economy back, manufacturing, has started to recover. In Germany, the Ifo index, which measures the mood of the country's industry, is also rising. This is important, for it has consistently given the best indication of the whole eurozone's economic prospects. In Asia the "tigers" – Singapore, Taiwan and the like – seem to be recovering from what, for some, has been the worst recession for 50 years. And in Japan, the commentators have started to argue that the economy has at last bottomed out.

You can catch a feel for this optimism in the graphs. The global leading indicator gives a rough-and-ready forecast of the world economic cycle six to 12 months ahead. As you can see, it turned sharply up in the last part of last year. This optimism is reflected in emerging market share prices: companies with quotes on these markets are very dependent on exports to the US.

Actual industrial production, as shown in the middle graph, has not yet started to rise. But a financial indicator of the stage of the economic cycle, the yield curve – the gap between short-term and long-term interest rates – is also pointing strongly to more growth. Short-term money, thanks to the cuts in interest rates by the central banks, is much cheaper than longer-term. You would expect this to close the global output gap, also shown in this graph. (This last indicator is calculated by the Montreal-based Bank Credit Analyst team, which has a good record of calling turning points in the world economy.)

If all this proves right, company profits that have been battered by the downturn should start to recover. There has been a bit of a recovery already in the profits of the largest US companies, as the right-hand graph shows, and a rather sharper improvement in profit margins.

So it's all OK then? Don't, the bull case runs, think of the past few months as recession, instead think of them as the start of the next boom.

Well, not quite. The fact there is a turning point merely tells us that the global economic cycle is intact: the tempo goes up, it goes down, then it goes up again. We knew that anyway. What it does not do is tell us whether this is the final turning point or whether this cycle will have a double bottom, as many do. Nor does it tell us anything about the characteristics or strength of the upswing.

There are several disturbing features. Here it is really a case of "round up the usual suspects". At the top of that list must come the imbalances in the US economy, in particular the high level of consumer debt and the current account deficit. Just behind would be the extent to which the US financial establishment has stopped worrying about these imbalances; the fact that Dr Greenspan seems pretty confident should make the rest of us less so.

Within Europe, prime worries include the lack of competitiveness of the main continental economies and the social tensions that will come as the voters are made increasingly aware of tougher times ahead. (We are having a bit of that here with the present concern over pensions.) In Japan, people have been worrying for so long that "worry fatigue" seems to be the order of the day. There is a limited amount of hand-wringing you can do without feeling the need to take a break and slip out for a beer. Still, the situation remains extremely fragile and the possibility of another serious policy error remains high.

And from a UK standpoint I suppose the most obvious worry must be the vulnerability of the economy to a rise in interest rates, something that is bound to happen in the coming months as the global interest rate cycle turns up again. Most obviously, how will house buyers cope if the present low rates pile up a couple of points? The answer will be not very well.

But in a way I am less concerned about obvious worries, if only because they are obvious. All the experience of past cycles is that it is the surprises that do the most damage.

Surprises, by definition, cannot be predicted. But it is hard not to feel uncomfortable about the prospect of greater conflict in the Middle East, conflict that may be hard to control. There remains the gravest danger of another terrorist attack or attacks. And there is the possibility that the present run of success achieved by the US military will not be sustained.

My guess, looking ahead, is that barring some unforeseeable catastrophe, we will have a few months of relative cheer. But by the end of the year, people will focus on the fact that this coming period of economic expansion will not be straight-line at all. There will be shocks and setbacks. Yes, there is every prospect that we are either starting, or will quite soon be starting, a seven- to 10-year period of general economic growth. But it will be quite slow growth. People will not get richer quickly and certainly not as quickly as many expect. We are still too influenced by the experience of the Nineties boom. It won't be a rerun of that.

So celebrate the upturn. It is real. But don't celebrate too wildly for clear heads will be needed in the months ahead.

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