Horrible year of hangover and misplaced hope

The big three – the US, Germany and Japan – were in recession well before 11 September
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The Independent Online

Given my surname, I suppose I could reasonably refer to 2001 as an annus horribilis. It started off badly. The Federal Reserve came back from its holidays with a nasty economic hangover and immediately took a strong dose of interest rate medicine. Hopes began to rise in the spring – indeed, there was a spring in the step of the world's equity markets – but this all ultimately came to nothing. Dr Greenspan upped the dosage but, for the most part, the patient's health got worse, not better. Hopes of a soft landing began to fade and, by the middle of the year, recession was already in place.

The bad news was not just confined to America. Japan was beginning to think that the worst was over. There had been some kind of recovery in 2000, partly built on strong global demand for technology products. Moreover, with the arrival of Junichiro Koizumi as Prime Minister, it looked as though political reform was finally beginning to come through. Once again, however, Japan has proved to be a disappointment. The political reforms have not materialised, high debt levels are forcing the government to tighten fiscal policy and there is no real consensus on what to do about deflation. Meanwhile, the technology-led export recovery of 1999 and 2000 has turned into a technology-led export collapse.

And then there's Germany. Once the locomotive of European economic growth, Germany has proved to be more of a shunting engine, crawling along with no real hope of getting very far. At the beginning of the year, the generally held view was that a combination of low interest rates and tax cuts would keep the German economy going, even if the rest of the world was in a little bit of trouble. German consumers, however, have chosen to increase their savings, forgoing this year's Christmas pudding and mince pies in an attempt to put themselves on an economic health drive. This new-found austerity is all very well but it's had the unfortunate side effect of sending the German economy into recession.

The Scrooge-like spirit to this last year's proceedings has not just been confined to the world's biggest three economies. From Canada to Korea, from Argentina to Afghanistan, things have not been great (admittedly for a variety of different reasons). What is clear, however, is that the global economy has been through a much more synchronised slowdown than anyone expected. At this stage, we still do not fully know the key ingredients in this complete pudding of an economic performance. Nevertheless, here are some ideas.

The global economy overdosed on technology. Investors drank up technology stories in the same way that some of us will over-indulge over the Christmas break. As they drank, they seemed to lose their sense of reason. New paradigms and extraordinary profits began to dominate, leaving rationality far behind. But, as profits disappointed, the party came to an end and the world woke up with the most enormous hangover.

Like reformed alcoholics, some of these investors will never touch a drop of technology again. Capacity utilisation in technology around the world has collapsed, suggesting that it will be a long time before we see anything like a return to the boom years of the late 1990s.

The global economy has proved to be more "connected". A year ago, a lot of people were thinking that the world was no longer a synchronised place. After all, Japan had been in recession for years and yet the United States had boomed. Europe had, for the most part, plodded along even in the light of nasty shocks from, for example, Russia. The formation of regional trade areas – whether it be the European Union, Nafta or Mercosur – seemingly implied regional immunity from developments elsewhere in the world. After all, the Asean crisis supposedly hadn't led to any lasting problems for the global economy in 1998 and 1999.

Yet, these assumptions have proved to be incorrect. Countries around the world have been hit hard by common factors. More Europeans own US assets than ever before. US companies have invested in production facilities abroad more aggressively than ever before. Profit flows from one country to another are bigger than ever before. So, when the US, Germany and Japan all hit a brick wall at the same time, they brought other parts of the world down with them.

Some crises are worse than others. The Asian crisis was bad enough but the trade losses for other parts of the world were partly offset by gains in the form of higher capital inflows. This was particularly true for the US, where a rapidly widening current account deficit in the late 1990s was accompanied by a major appreciation in the US dollar's value against a basket of other currencies. The US provided a willing home for capital that was fast exiting Asian markets, built on the belief in a technology miracle.

This time, investors may have pulled out of US equities or, indeed, equities elsewhere but they have not been able to find a high returning alternative. It is increasingly looking as though we have finally said goodbye to the high returning world of the late 1990s, when investing in any idea, no matter how daft, was as easy as pulling a Christmas cracker.

Then there were the tragic events of 11 September. A lot of people have suggested that the destruction of the twin towers, the attack on the Pentagon and the war in Afghanistan threw the global economy into recession. Certainly, these awful events were not helpful for either business or consumer confidence. But to suggest that they were the root cause of recession just looks plain wrong. The big three – the US, Germany and Japan – were in recession well before 11 September and the excesses which led to recession had already been around for a very long time.

This is, however, a festive time of year and some people will be looking to celebrate. Perhaps Gordon Brown and Sir Edward George will meet up for a wee dram over the next few days, looking back with a degree of satisfaction at their navigational abilities over the last year or so. Certainly, the UK economy has shown a remarkable performance over the last 12 months given the scale of economic distress elsewhere in the world. It has not been good news for everyone – consumers may be eating off a nicely fattened goose but manufacturers are more likely to be chewing on a few turkey drummers. Nevertheless, the performance of the UK economy during 2001 looks to have been truly impressive.

As always, though, there is a residual worry. As Gordon and Eddie emerge in the New Year, they may find themselves – along with UK consumers at large – with a rather large credit card bill. So far, the consumer has bailed us out. The UK has avoided the recession seen in other parts of the world. Yet, ultimately, this has been a gamble. The hope must be that the world economy picks up before the British consumer stalls. If that does not happen, it is going to be turkey drummers all round next year.

 

Stephen King is managing director of economics at HSBC.

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