Hamish McRae: It may look painful, but sometimes stock markets need a shock to purify the system

The puzzle is not the event; it is the reaction to it. Everyone knew that WorldCom was a company in grave trouble. Its shares had already collapsed; its bonds were junk; its leader had recently quit. Now the only additional information has been that it had been fudging its figures. Surprise, surprise.

Yet to judge by their reaction, the world's markets have been surprised. This thing happened in the US. It is nothing to do with us. It was a disaster that you would have thought was already reflected in the markets. Yet, self-evidently, it wasn't. Japanese, European and UK equities all slid by between 3 and 4 per cent, with the high-tech sectors falling more. The US markets, on the other hand, took things rather more in their stride, at least in early trading, falling less sharply. What is happening?

There is a simple answer to that question that is correct but unhelpful. That is that the world's share markets are facing a crisis of confidence and that crisis is contagious, hitting companies that have nothing to do with WorldCom. The rider that should be attached to that explanation is that people are worried that there will be other similar mis-statements of accounts – that this is a systemic problem rather than an isolated one.

But this is unhelpful because it fails to answer two key questions. First, why should the markets have suddenly become more worried about the systemic dangers? If an absolutely blue-chip firm in a completely different corner of the commercial forest had been discovered cooking the books then, sure, this collapse of confidence would be justified. But not because of this. And second, why is the rest of the world apparently more scared than the US?

We won't have a good answer to these questions for many months but there are some things that can sensibly be said now. Let's try.

The starting point is that share markets have now experienced a double-dip, in most cases falling back roughly to the trough in late-September last year. Might this be signalling that the US economy will also experience a double dip? If so, that would validate both the collapse of confidence in US corporate performance and the worries elsewhere in the world. A double-dip in the US would be dreadful for Germany and Japan, both of which have weak domestic demand and so depend on the States for demand from their exports.

The double-dip worry has been around for many months. It seemed to have gone away in the early part of this year, when the US economy bounced back. Now it is back. The obvious linkage would be US markets underlining consumer confidence, which in turn would cut demand and hence profits, which in turn would hit US markets and so on. Is the danger real?

There are three graphs, all, it should be said, prepared ahead of the WorldCom débâcle, which suggest that the danger is small. Goldman Sachs has drawn up a new leading indicator for the world economy and this is signalling an upturn in industrial production. The US manufacturing scene has improved, with stocks, employment and production all turning the corner. And payrolls in the US – particularly for temporary workers – have also zipped round.

None of this makes it certain that there will be no double-dip. The Goldman indicator in particular needs to be watched because that tries to look forward while the other graphs are only giving us photographs of the recent past. But it is silly not to be encouraged by encouraging data.

What about the possibility of a flight of capital from the US and a plunge of the dollar? Well, the dollar has certainly weakened, as it should. Earlier this year it was up more than 40 per cent on its value in 1995. That was too much. You can be a long-term bull of the dollar and still believe it had overshot.

Direct investment into the US has stopped on a net basis – i.e. outflows are as large as inflows – and portfolio inflows have come back quite a bit. Inflows during the first two months of this year were running at only $14.5bn (£10.4bn) a month, against $41bn a month in 2001. Obviously little matters like this won't encourage the punters to go into equities, though, actually, US shares are becoming much better value. But there is little sign of any loss of confidence in US government bonds. There are legitimate concerns about the speed at which the Federal budget of the States is moving from surplus to deficit, but the US Treasury numbers are still about the best of the G7 nations. France, Germany and Italy are all struggling to contain their deficits and Japan seems to have given up on containing its one. Rationally, US credit should be better than that of other nations, with the possible exception of the UK – and we are heading fast back into deficit too.

In any case, if the dollar continues to fall, it becomes a world problem as much as a US one. If you think the US recovery is fragile, try Europe's. The largest economy, Germany, has unemployment rising still, and very flat domestic demand. German exporters could live with a higher euro but will not relish the effect that has on profits. Europe's cost base remains high compared with America's and as yet European companies have failed to achieve the increases in productivity that US firms have managed to crank out right through the downturn.

So in a sense there is a justification for European and Japanese fears: if the US sneezes, as it did yesterday, the rest of us risk catching a cold.

And Britain? Well, sterling is following its usual mid-Atlantic course, moving half way between the dollar and the Euro. We have the advantage that we don't need to raise interest rates just yet, whatever the Chancellor thinks. It is just possible that the whole global interest rate cycle will not turn up this winter as seemed inevitable even three weeks ago. And under the extreme scenario of worldwide deflation, with the next move in US rates being down rather than up, then the Bank of England would have the scope to cut rates significantly in a way that the US Fed does not have.

The two things I find most encouraging are that this explosion has happened exactly where you might have expected it to occur and, paradoxically, that it has indeed shaken everyone up. Had the disaster occurred in some sector other than telecoms, then it would have carried a dire message for it would have said that the US economic malaise affected the whole economy, rather than the bit where the excesses were greatest.

As for the shock – well, we have lots of experience that shocks mark turning points. The East Asian countries' debt problems of five years ago re-established better practice in their financial markets. Russia's default has created a platform for its present economic boom. You could even argue that Britain being kicked out of the European exchange rate mechanism was the basis for the country's superior economic performance over the past decade. The WorldCom shock may not be the turning point, but it will certainly deflate US corporate self-aggrandisement and that can't be bad.