Stephen King: Today's economic problems cannot be compared with 1991

To suggest that all the world's economic problems can be placed at the door of Saddam Hussein is ridiculous

I was thinking of writing this week about the London Congestion Charge but I'd read so many articles on this issue already that I was beginning to think that a congestion charge should be imposed on articles about the Congestion Charge. Instead, I'm going to return to the thorny issue of war. I last wrote about this back in November when I argued that the main uncertainties related to business and consumer confidence, oil prices and the likely response from policy makers. Since then, things have indeed become a lot more uncertain: consumer confidence in the US is now at a nine-year low, oil prices are now approaching levels last seen in the 1990-91 Gulf War and policy makers have started to spring a few surprises, most notably in the UK.

This week, however, I want to tackle a more specific issue, namely the mixed message from Alan Greenspan, the chairman of the Federal Reserve, in his Congressional testimony last week. In his testimony, he said "the intensification of geopolitical risks makes discerning the economic path ahead especially difficult. If these uncertainties diminish considerably in the near term, we should be able to tell far better whether we are dealing with a business sector and an economy poised to grow more rapidly – our more probable expectation – or one that is still labouring under persisting strains and imbalances that have been misidentified as transitory".

Many people appear to have been reassured by these comments. Mr Greenspan seems to be arguing that, on the most likely scenario, the recent run of bad economic news has been simply the result of uncertainties associated with the Gulf, with al-Qa'ida, with North Korea and assorted other "geopolitical risks". These should, in time, go away, leaving economies well placed to respond favourably to the current low level of interest rates and accommodating fiscal policy.

Being a bit of a cynic, I do not fall into this camp. The markets might want a quick resolution to events in Iraq – whether peaceful or not – but it seems unlikely that geopolitical risks will completely disappear as a result. Dangers of terrorism will presumably not go away and nor will uncertainties with regard to North Korea. Moreover, if the constant debates within the UN on Iraq are not resolved, we may be faced with a world community that is fatally split, with new faultlines emerging between America and, to use Donald Rumsfeld's phrase, "Old Europe". The certainties that seemed to stem from the collapse of the Berlin Wall will be over. In this new world disorder, geopolitical risk could simply end up higher on a permanent basis.

Perhaps of more short-term concern is Mr Greenspan's willingness to admit to prevarication and uncertainty within the Federal Reserve itself. America's central bank may be hoping for lasting recovery but it seems to me that the Fed simply does not know how the American economy will respond over the coming months. After all, Mr Greenspan was unable to rule out the more worrying possibility that, despite all the interest rate cuts and despite all the tax cuts, sustained recovery may still not be safely in the bag.

To his credit, Mr Greenspan did provide a list of factors that have shifted in the right direction in recent months. Bond yields have fallen, credit spreads have narrowed and liquidity conditions have apparently improved in financial markets. But is any of this enough to suggest that a decent economic is just around the corner? I fear not.

The belief in a quick post-war recovery appears to be based on the 1991 experience, when the Gulf War coincided with the end of the US recession. A lot of investors hope we're playing the same game again. There are, however, two problems with this argument. First, although the Gulf War coincided with the end of recession, there was no decent recovery in US economy activity until 1994, three years after the Gulf War came to an end. Second, the economic and financial conditions facing the US economy today are very different than those that were seen in the early 1990s.

This is not just a case of bold assertion. Take a look at the left-hand chart. This shows the performance of the US equity market in the three years before the start of the 1991 Gulf War and the three years to the present day. Before the Gulf War, the equity market had shown an overall gain of about 45 per cent. Before today, the equity market had shown an overall loss of about 40 per cent. These differences matter. A rising stock market lowers the cost of capital to companies, it makes it easy for companies to meet their pension obligations and it makes consumers feel wealthy. A falling stock market – as we're now beginning to discover – does exactly the reverse.

I suspect that the Fed would respond to this observation by saying that there are other differences which show the latest period in a more positive light. In 1990 and 1991, the US was having to deal with the credit crunch, whereby banks and other financial institutions were unable or unwilling to lend reasonable amounts of money at given interest rates. In response to that difficulty, the Fed delivered very low short-term interest rates over a remarkably long period of time. The steep yield curve that resulted from this policy in effect widened the margins on bank lending, thereby gradually increasing the ability of banks to supply the appropriate amount of credit.

No such problems today. But this argument really rather misses the point. A credit crunch is all about willing borrowers who simply are unable to get hold of the relevant funds. A post-bubble environment is all about unwilling borrowers who regret the debts they've already built up and who have no intention of raising funds, no matter how willing banks might be to lend to them. The absence of a credit crunch is completely irrelevant to today's problems – it's debt that matters and there's too much of it.

This financial theme also has resonance for the real economy. If companies have borrowed too much, they've also probably spent too much. Bubbles are all about excessive accumulation of real assets, typically in the form of excessive investment spending. A likely sign of post-bubble malaise, therefore, may be low levels of capacity utilisation. And, as the right-hand chart shows, that's exactly what we see today. Industrial production in the US economy did pick up through much of 2002 but, unusually, capacity utilisation did not. It seems that there's too much capacity sloshing around the system which, in turn, implies that profits are lower than normal and debt repayment is just one big collective headache.

My point is simple. Comparing the current economic position with the 1990-91 experience is rather futile. Yes, both periods involved Iraq and at least one period will have involved war. Other than that, however, the underlying challenges facing policy makers today are radically different from those that came through 12 years ago. Policy makers have been trying to deal with a post-bubble hangover for a good three years now with only limited success. To suggest that the world's economic problems can all be placed at the door of Saddam Hussein, the cave of Osama bin Laden and the palace gates of Kim-Jong Il is, quite frankly, ridiculous.

Stephen King is managing director of economics at HSBC.

stephen.king@hsbcib.com