Jeremy Warner's Outlook: Economic ice age, or nothing to worry about?

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The Independent Online

Well that's a relief. There's a continued need to be vigilant and growth is certainly slowing, but essentially everything's fine in the world economy.

Well that's a relief. There's a continued need to be vigilant and growth is certainly slowing, but essentially everything's fine in the world economy. That was the gist of remarks from Jean-Claude Trichet, President of the European Central Bank, after a meeting of G10 central bankers in Basle yesterday at which bizarrely the renewed bout of weakness in the dollar wasn't even discussed, or so he said, anyway. True, he did say after the meeting that the present correction was "brutal and unwelcome", but he didn't think it had the power to derail a still "dynamic" economy. Is he right to be so sanguine, or is this not another case of European policy makers sleepwalking into economic calamity?

As ever, the biggest unknown is not Europe, where economic stagnation is fully taken root, but the US economy. From the moment President George Bush was re-elected to the White House there has been a renewed outpouring of angst-driven commentary about the urgent need of to get to grips with America's burgeoning current account and budget deficits, which according to some threaten to engulf the world in an economic ice age.

Europe has good reason to fear a further deterioration in the value of the dollar, even if M. Trichet, echoing remarks made last week by the German Chancellor, Gerhard Schröder, seems not to be unduly bothered by it. The euro invariably bears the brunt of any global currency realignment. However, there is as yet very little sign of the US being disadvantaged by it.

The Bush Administration has never formally abandoned the strong dollar policy espoused by its predecessor, but nor has it done anything to support the currency in the nearly four years President Bush has been in power. There is little reason to believe it is about to reverse this stance. If it has a policy at all on the dollar, it seems to be one of benign neglect. The weaker the currency, the more it benefits US industry and job creation, and the more it hurts everyone else.

The difficulty arises when the currency gets so weak that overseas investors and central banks refuse to continue financing the current account and budget deficits with inflows of foreign capital. Europeans are already repatriating capital in substantial quantities. How long before Far Eastern central bankers lose their appetite for the greenback too? If support from the Far East dried up, then the dollar really would be in trouble. In order to keep financing the Budget deficit, long-term interest rates would have to rise sharply, plunging the economy into recession or worse.

Yet so far this hasn't happened, or at least not on the scale which conventional economic modelling suggests it should have done by now.

Abnormally low inflation is the primary cause. The Federal Reserve is this week expected to raise short-term rates for the fourth time this year, yet at just 2 per cent the Fed Funds rate remains almost incredibly low by historic standards. With the dollar depreciation which has already occurred, the high oil price and resurgent economic growth, both inflation and rates ought already to be much higher than they are.

Despite the resumption of relatively strong growth, there is still a large element of slack in the US economy. Industrialisation in China and India has also all but destroyed pricing power in the US market, forcing American corporations further to cut costs and improve productivity to sustain earnings growth. Long-term interest rates in the US have as a consequence remained extraordinarily low, enabling the US Federal government to finance its budget deficit at relatively small cost.

So for the time being, neither of the twin deficits present the newly elected President with too much of a problem. If he leaves them unaddressed, they could both get worse, and cause much more serious problems further down the line. Yet the present policy mix - benign neglect on the dollar in combination with reasonably credible proposals to halve the budget deficit over the next four years - may be about right, for the US at least.

It's Europe and the Far East that need to worry, not least Germany and Japan, which are heavily reliant on exports to sustain their still fragile economic recoveries. The present approach may be the least painful way of dealing with the deficits for the US, but for everyone else, it could prove a good deal less comfortable.

Murdoch poison pill

The history of Rupert Murdoch's News Corp has been instructed by two overriding aims. One is rapid expansion into a global media powerhouse. The other is that at all times the Murdoch family remains firmly in control of the equity. Often the two aims have been powerfully in conflict. In the early 1990s, News Corp nearly went bust after a break-neck period of expansion which because of Mr Murdoch's refusal to contemplate dilution of his equity had to be financed entirely with debt.

Yet by keeping 35 per cent of News Corp's voting rights, Mr Murdoch has bought himself a luxury afforded to few other business leaders with global pretensions - the ability to do exactly what he wants. On the whole, this has been pretty good for all shareholders. Mr Murdoch has taken some high risk, visionary bets which have paid off handsomely but which almost certainly wouldn't have been allowed in an "ordinary" company subject to the checks and balances of accepted corporate governance practice.

Judging by yesterday's corker of an announcement, Mr Murdoch has no intention of changing. Indeed, emboldened by News Corp's recent shift in domicile and listing, he's going a stage further and doing something which almost certainly wouldn't have been allowed were he still in his native Australia. In the process he not only brings himself into potential conflict with his institutional and other outside shareholders, but also with his one-time media ally, John Malone of Liberty Media. Last week, Mr Malone bought an option to acquire a further 8 per cent of News Corp's voting stock, which if exercised would raise his stake to 17.1 per cent. Mr Murdoch said at the time that he wasn't losing any sleep over the matter.

Yet someone has since been burning the midnight oil, for yesterday came news of an elaborate poison pill which would be triggered if Mr Malone dares to buy so much as another single share in News Corp. Any such purchase would activate a rights issue allowing other shareholders to subscribe for $80 worth of half-price stock for every share they own. For Mr Malone, it would mean massive dilution.

If Mssrs Malone and Murdoch were ever allies, they are unlikely to remain so after yesterday's riposte. Nor is it known exactly what brought this on. Was Mr Malone about to propose an unwanted merger? Or perhaps he wanted to greenmail Mr Murdoch into an asset swap of some sort? Whatever the explanation, Mr Murdoch interpreted it as a hostile move. It would be hard to think otherwise given that Mr Malone didn't give Mr Murdoch any prior warning of his stakebuilding. Mr Malone, nearly 10 years Mr Murdoch's junior, was once seen as a possible successor to Mr Murdoch should, heaven forbid, Mr Murdoch ever prove mortal. Mr Murdoch, with two sons in the business, has got other ideas.

As ever with Mr Murdoch, shareholders are left completely in the dark as to what's going on. A rights issue of the type announced yesterday without explanation except as some sort of a device for repelling Mr Malone would be thought unacceptable to the point of being almost laughable in almost any other publicly quoted company, and can only serve to heighten concerns over the manner in which Mr Murdoch exercises control over BSkyB. But then as Mr Murdoch has said on several occasions before, if shareholders don't like what's going on, they can always sell.

If we are about to be treated to a stand-up fight between two of the world's greatest media tycoons, it may be worth hanging around just for the ringside seat. As we speak, Mr Malone will be consulting his lawyers. The ensuing fight won't be pretty.