Hamish McRae: Memo to City: if winter comes can spring be far behind?

The time to look for an upturn is just when markets are at their lowest ebb. Like now
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The Independent Online

It is time to start the hunt for that elusive prey, the turning point of the business cycle.

It is time to start the hunt for that elusive prey, the turning point of the business cycle. On Friday saw a particularly resonant bout of the jitters on Wall Street. That magic moment therefore must be approaching – but only if you can keep your head when all about you are losing theirs, but make allowance for their doubting too.

The continued existence of the cycle is one of these intriguing aspects of the economic world. You would imagine that the clever people in banks, finance ministries, corporations and markets would understand enough about economics to see both booms and busts a-coming? Maybe they could not eliminate them altogether but they ought at least to be able to iron out the peaks and the troughs a bit.

But the experience of the last couple of years suggests otherwise. One bit of the world economy, manufacturing, is currently experiencing the sharpest downturn since the early 1970s. One bit of manufacturing, the hi-tech chunk, is experiencing the sharpest downturn that any significant part of the world economy has suffered since the Second World War. Sure, there have been many local commercial collapses; sure, there have been property crashes in many countries. But usually when an industry in one bit of the world is going down, somewhere else there is a bit of the same industry going up. The collapse in demand for hi-tech equipment is global.

Just why there should be an economic cycle has been the stuff of endless analysis since economists first identified cycles more than 100 years ago. The difficulty is that each cycle is different, not just in amplitude and timing but in the apparent cause. The last three downturns, in the early 1970s, 1980s and 1990s were all associated with surges in inflation, the first two triggered by a rise in the oil price, the third by asset prices in general.

This one is different: there was a surge in investment, particularly in telecommunications, with the result that the moment demand eased, companies were left with excess capacity and their cut-backs in investment exacerbated the downturn.

This was the main cause of the economic cycle in the 19th century and there was even a bit of economic theory, called the accelerator, that those of us who learnt our economics in the 1960s were taught. It was that swings in investment accelerated both the upturns and the downturns of the cycle. But then everyone became so mesmerised by swings in inflation that this theory was quietly sidelined. Central banks looked to inflation indicators to tell them that they should start to worry and when those dogs did not bark they assumed all was well.

In one sense, though, it doesn't matter. Unless policy-makers do something silly, economies are self-healing. And now is the time to look for the signs that the healing has begun. Enter Marconi. In every economic cycle there are casualties, and those casualties frequently signal that a turning point is in sight. Marconi has not collapsed but its share price, of course, has. Very often these companies return to health, though sometimes only after a financial reconstruction; witness the revival of Canary Wharf after its collapse in the last cycle.

Marconi of itself is not that important in global terms: miserable for shareholders and employees but not big enough to change the world economy. The symbolic collapse that the world markets should be looking for will probably be a giant American company. But add in the fact that BT's share price on Friday hit a new low, that the price of its German and French counterparts is almost as weak, and that the bad news in the US hi-tech world continues to unroll. Maybe it is just a quirk of human nature but turning points seem to occur when people despair that they will ever happen. We are not yet at that point, for there is still too much bombast. But one can begin to sense that mood of despair that will signal an upturn.

For example, the latest economic commentary by Goldman Sachs, which last year was positive about this one, is forecasting only 1.3 per cent growth in the OECD countries this year and 2 per cent next. Its first headline is "Pessimism rules" and while it thinks the worst may be over it admits the recovery is likely to be slow. You can see its forecasts for industrial production in the graph – a sharper fall this year than in either of the two last slowdowns and actually deeper than in the 1970s one too.

The most interesting positive sign is the slight upturn in the OECD leading indicator, plotted alongside OECD growth in the graph, but advanced six months. If this indicator is right – and as you can see it has been a reasonable fit over the last 20 years – the world GDP growth cycle ought to turn up next year.

These cyclical indicators do not tell us much about the strength of the recovery, and they could easily be six months out in their timing. Worse, there is always a danger of a double-dip. That is what happened in the early 1980s, as you can see, and in my own judgement, that is the most serious danger now. Nevertheless, a signal of a turning point is better than no signal of a turning point. At some stage the markets will start to look across the valley and realise that there are hills beyond.

The trouble is, it is hard to be cheerful if you are about to lose your job. Listening to friends in financial services, the overriding preoccupation is where and when the next cull will take place. There have been some rounds of redundancies already, but by and large, City firms have been holding on to labour in the hope of an upturn. Large job losses paradoxically would be a "buy" signal because they would show that the financial services industry was adjusting its capacity to meet the available demand.

Friday's US unemployment figures, which pushed the rate to a four-year high of 4.9 per cent, were badly received – perhaps because of the fears they will have stimulated in Wall Street's dealing rooms.

So an intriguing possibility may emerge. The professionals will find it tough to believe that a turning point has been reached because their own industry will be faced with a more painful adjustment than most of them will have ever experienced. The further away you are from the markets the easier it is to make a long-term rational judgement about their future.

Rational judgement? Long-term? What's this stuff when markets are a-plunging? Look: I did note you should make allowance for their doubting too.

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