Jeremy Warner's Outlook: Cocktail of negatives closes on markets

Click to follow
The Independent Online

It's all starting to look distinctly grim out there, with the credit crunch now into a second, possibly more dangerous, phase, the oil price testing the $100 a barrel mark, the dollar in apparent freefall and the pound at its highest level against the greenback since 1981. To cap it all, the Dow was again tanking last night. Yet at the same time, the economic data continues to look robust. Admittedly, much of this data is quite backward-looking, but with mainstream pundits now talking about the possibility of recession or worse, it's a curiosity none the less.

How might this confluence of influences play out? The oil price first. Traditionally, a high oil price has spelt doom for the world economy. By taking money out of the pockets of US consumers which otherwise would have been spent on other things, high oil prices have played a powerfully deflationary and, on occasions, quite devastating role in past cycles.

Yet there is good reason for thinking it might be a bit different this time around. For some years now, both producers and market analysts have consistently underestimated the strength of the oil price, which time and again on confounding expectations has been blamed on the activities of speculators or tension in the Middle East. It is now plain as a pike staff that there are more fundamental forces at work here.

In part, it's just a factor of dollar weakness. The Americans are paying more for their oil, but, with oil priced in dollars, the Europeans are not feeling the pain as acutely. But the more important reason is growing demand from the emerging economies of China and India.

Obviously, Middle Eastern tensions, and in particular worries over Iran's nuclear ambitions and what the US might do about them, remain a contributory factor. In the round, however, the high oil price seems to be demand-led. Unlike in previous cycles, the increased demand is not coming from the US, but from high-growth emerging market economies.

What's more, future development plans in these economies are virtually all highly energy-intensive – infrastructure, heavy industry and factories. This seems to underpin a relatively high oil price well into the future. If you believe that the world is already at peak oil production, and that it's all downhill from here on in, then the oil price may never return to more normal levels. This is going to have a depressing effect on Western economies, where interest rates will consequentially have to be higher than otherwise. Yet as long as Chinese and Indian demand keeps growing, so will the world economy. Nor is it all entirely bad news for the West, where business is sharing in the Eastern bonanza.

The same distinction between Western and emerging-market economies can nonetheless be made with regard to the consequences of the credit crunch. This is very much a Western phenomenon whose impact on the East has so far been zero or even mildly positive, in the sense that monies which would once have been ploughed into Western debt markets are being diverted into these high-growth economies.

The financial sector has already been very seriously damaged by its own past excesses. That's going to have a big impact on the UK, where financial services are a disproportionately large part of the economy. Credit conditions are also going to tighten markedly over the months ahead to help pay for the losses.

A recent Federal Reserve survey showed credit conditions, as you might expect, already tightening sharply for mortgages and commercial property. More worrying, there is now evidence of these harsher conditions affecting the industrial and corporate world. Corporate America will be benefiting from the weak dollar, which, because it makes imports more expensive and exports more competitive, is already beginning to correct the current account deficit problem.

The positive way of looking at all these developments is that it is a good thing they have occurred now, with emerging markets still growing exceptionally strongly, rather than at the end of the cycle, when the consequences would have been far more serious. The credit crisis is seen in this context as a necessary and even welcome corrective of excesses which if allowed to build any further could have had truly devastating consequences further down the line.

I'll be condemned for being Panglossian in my view, but I continue to think this take on events is the correct one. That doesn't mean I think the credit crisis is going to ease from here on in. In fact, it is almost certainly going to get worse, with the Northern Rock debacle possibly just the hors d'oeuvre for something more serious.

It is in the nature of financial crises that the eventual catharsis needs a really big calamity to happen first. The only question is, who's it going to be? Northern Rock may not have been it. The fear that has spooked banking stocks over the past week is that the losses so far acknowledged in the banking industry are just the tip of the iceberg. Mercifully for Mervyn King, Governor of the Bank of England, any further calamity is more likely to occur in the US or Europe than in Britain. Perhaps unwise to bank on it, though.

BA makes case for airline consolidation

British Airways was widely thought to have been the biggest loser in the Open Skies agreement hammered out between Europe and the US earlier this year. In practice, the agreement looks like turning out mildly positive for the airline, with the growth opportunities provided by being able to fly to more US cities expected to more than counteract any enhanced competition at Heathrow.

The reason BA was so opposed to Open Skies was not so much that it had a position to protect and was therefore bound to object to liberalisation as that it thought the agreement didn't go far enough. To have genuine open skies between Europe and the US, European carriers have to have the right to fly passengers between US cities as well as between European and US ones. There also needs to be the freedom for airlines in the different trading blocs to bid for each other.

As Willie Walsh, chief executive of BA, pointed out in a speech to the Washington International Aviation Club last night, these are both prizes still worth fighting for. What's more, there is every opportunity of winning them. The Open Skies agreement allows any member state to nullify the treaty if by 2010 progress has not been made towards achieving these goals. British Airways fully intends to hold the UK Government to its word.

Indeed, it is duty bound to do so, if only because the industry urgently needs further liberalisation. Mr Walsh makes the point not simply for altruistic reasons, though there would obviously be major consumer benefits. But it is also necessary to allow consolidation among Western airlines so that they can drive efficiency and be in a better position to compete with what Mr Walsh calls "the emerging force of lower-cost long-haul carriers in the Middle East and Asia".

Without the protections offered by the flag-carrier rights enshrined in international treaty, the likes of British Airways, American Airlines and US Airways would already be toast. The newer airlines of the emerging markets don't have the same crippling legacy cost bases, so they are a lot more efficient. They have also been able to invest more effectively in the latest, most fuel-efficient, aircraft. It is vital that the established industry be allowed to consolidate at a more aggressive pace and on a transatlantic basis if it is to meet this challenge.

British Airways first started to dream of pulling off a transatlantic merger more than 10 years ago. The endeavour eventually foundered on regulatory objection. Governments allowing, it looks as if Mr Walsh will be attempting to dust off these plans at some stage in the next three to four years.