Global downturn is sharp, but not permanent

"If the world as a whole was to move now into any kind of prolonged downturn, it would be quite a surprise. The normal precipitating forces for a recession are not around"

At times, there can be a huge gap between the perceptions and obsessions of the financial markets, and those of the political and business communities. In fact, it is almost as if the financial markets are inhabiting a self-contained planet, entirely cut off from the rest of humanity. A case in point is the fear in the markets that we might be about to enter a global "recession" - a fear that has been reflected in the dramatic drop in bond yields around the world in recent months. As far as I can tell, this recession fear has barely surfaced in the business or political communities, which continue to assume that the world is in the middle of a rather comfortable and prolonged economic upswing. So who is right?

Clearly, the world economy has slowed down very abruptly since the strong surge in growth in the middle of last year. At that stage, gross domestic product in the major economies was growing at a rate of 3.6 per cent (quarter on previous quarter annualised), with each of the major blocs - the US, Japan and Europe - expanding at very similar rates. Industrial production was even more robust, rising at an annualised rate of 7.2% in the middle of last year.

By the end of the year, though, the annualised GDP growth rate in the major economies had roughly halved to around 2%, with Japan and Europe slowing particularly sharply. So far in 1995, there has also been a marked drop in US growth, which fell to 2.7 per cent in the first quarter, but the situation elsewhere is very hard to read. There has been no GDP data yet in Japan or Germany, and in the latter case there may be no sensible activity figures for many months because of a botched change in the method of collecting statistics from January onwards. Furthermore, in the UK, the wide discrepancy between official government statistics and business survey data has created great uncertainty.

Economists cannot afford to wait until the official statisticians around the world get their act together and produce reliable GDP figures for the first half of 1995. If we wait that long, the world may have emerged from a recession long before the statisticians announce that we were in one to start with. Instead, we need to make the most of what evidence we can get from business surveys, leading indicator models and the like.

The graph shows the results of an exercise just conducted by Philippe Gudin de Vallerin, my colleague at Goldman Sachs. It attempts to make the best possible statistical guesstimate of recent changes in manufacturing production in the major economies, using past relationships between business survey data, other leading indicators and the level of output in each case. The following conclusions can be drawn from this analysis.

First, there has undoubtedly been a very sharp slowdown in the global growth rate in the first half of this year. In fact, for the major five economies taken together, manufacturing growth in the second quarter seems to have turned negative, and it is quite possible that real GDP will also prove negative for the quarter. Second, the slowdown has been most pronounced in Japan and the US, both of which could end up with zero or negative growth in the current quarter. Third, there seems to have been much less of a slowdown in Europe, with Germany and the UK apparently remaining fairly robust. Among the major European economies, France seems to have slowed the most, while anecdotal evidence suggests the devaluing countries on the fringes of Europe have hardly slowed at all. Thus while there is some contrast between the core and periphery in Europe, and while the entire continent may have slowed a little, the situation in Europe is not yet too bad.

Nevertheless, a negative quarter for GDP in the bloc of major developed economies cannot be dismissed lightly. This does not often happen in the midst of a recovery phase in activity, so it demands an explanation. Two events, I believe, explain what has happened.

The first is the currency "shock" of 1995, which actually has been more of a yen shock than anything else. (Measured by trade-weighted exchange rate indices, the dollar is down by 7.4 per cent this year, the mark is up by 3.2 per cent and the yen is up by a massive 14.2 per cent.) Because Japanese exporters have absorbed the main impact of the yen shock in their profit margins without making large changes in the foreign currency export prices, the net effect on activity has been adverse in Japan, but not very beneficial elsewhere. Exchange rate changes normally do nothing more than redistribute output around the world. However, because Japan is currently acting as a "sink" for world activity, the net effect of the yen shock for the world as a whole has been negative. This shock will continue to reverberate around the Japanese economy for quite a while, but will shortly begin to be offset by the monetary and fiscal easing that is now under way. The second quarter should therefore be the low point for Japanese activity.

Elsewhere, and especially in the US, activity has been hit by last year's monetary tightening, and by the rise in bond yields, which has hit the housing sector, and may have had negative "wealth" effects on consumption in some economies. But these effects should soon be wearing off. Short rates in the major economies have been eased, notably in Japan and Germany. Furthermore, bond yields are down by an average of 1.5 per cent around the world. Overall, global monetary conditions certainly cannot be classified as "tight". Monetary "tightness" measures have not yet returned even to mid-cycle readings, and in the next few months, the recent declines in short and long rates should boost world activity.

If the world as a whole was to move now into any kind of prolonged downturn, it would be quite a surprise. The normal precipitating forces for a recession are not around - a sharp monetary tightening to head off rising inflation pressure, and/or a downturn in the investment cycle. With the exception of Japan, company balance sheets are extremely strong, as evidenced by the recent extraordinary boom in corporate merger activity, which has been mostly internally financed by the companies themselves. Consumer activity is still quite subdued, not least in Europe, but it should gain from reduced fiscal tightening next year. Consumers, like companies, have little financial reason suddenly to retrench further.

There are already a few straws in the wind that activity may be passing the worst - better consumer activity in the US, the stronger than expected "Tankan" business survey in Japan, huge upgrades to UK export data, gains in consumer confidence in France, etc. Although there will be plenty of bad activity data to come as the second quarter is fully revealed to the world by statisticians, global activity should in fact be improving by the time this official news belatedly hits the tapes.

Overall, then, there has been more of a dent to the world upswing than the politicians seem ready to concede, but this should certainly not be as deep, nor last as long, as the bond markets currently imply.

Arts & Entertainment
Madonna in her music video for 'Like A Virgin'
music... and other misheard song lyrics
News
Waitrose will be bringing in more manned tills
newsOverheard in Waitrose: documenting the chatter in 'Britain's poshest supermarket'
News
The energy drink MosKa was banned for containing a heavy dose of the popular erectile dysfunction Levitra
news
News
Much of the colleges’ land is off-limits to locals in Cambridge, with tight security
educationAnd has the Cambridge I knew turned its back on me?
VIDEO
Sport
Australia's Dylan Tombides competes for the ball with Adal Matar of Kuwait during the AFC U-22 Championship Group C match in January
sportDylan Tombides was diagnosed with testicular cancer in 2011
News
Ida Beate Loken has been living at the foot of a mountain since May
newsNorwegian gives up home comforts for a cave
Extras
indybest10 best gardening gloves
News
Russia's President Vladimir Putin gives his annual televised question-and-answer session
peopleBizarre TV claim
Arts & Entertainment
tvIt might all be getting a bit much, but this is still the some of the finest TV ever made, says Grace Dent
Arts & Entertainment
Comedian Lenny Henry is calling for more regulation to support ethnic actors on TV
tvActor and comedian leads campaign against 'lack of diversity' in British television
News
Posted at the end of March, this tweeted photo was a week off the end of their Broadway shows
people
News
peopleStar to remain in hospital for up to 27 days to get over allergic reaction
Arts & Entertainment
The Honesty Policy is a group of anonymous Muslims who believe that the community needs a space to express itself without shame or judgement
music
News
Who makes you happy?
happy listSend your nominations now for the Independent on Sunday Happy List
Life & Style
life
Have you tried new the Independent Digital Edition iPad app?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

1st Line Helpdesk Engineer Apprentice

£150.00 per week: QA Apprenticeships: This company has been providing on site ...

Telesales & Sales Support Apprentice

£221.25 per week: QA Apprenticeships: This company is a well established Inter...

Client Relationship Manager - SQL, Python

£40000 - £50000 per annum: Harrington Starr: Client Relationship Manager - SQL...

**Financial Services Tax**

£35000 - £50000 per annum: Pro-Recruitment Group: Take your chance to join the...

Day In a Page

How I brokered a peace deal with Robert Mugabe: Roy Agyemang reveals the delicate diplomacy needed to get Zimbabwe’s President to sit down with the BBC

How I brokered a peace deal with Robert Mugabe

Roy Agyemang reveals the delicate diplomacy needed to get Zimbabwe’s President to sit down with the BBC
Video of British Muslims dancing to Pharrell Williams's hit Happy attacked as 'sinful'

British Muslims's Happy video attacked as 'sinful'

The four-minute clip by Honesty Policy has had more than 300,000 hits on YouTube
Church of England-raised Michael Williams describes the unexpected joys in learning about his family's Jewish faith

Michael Williams: Do as I do, not as I pray

Church of England-raised Williams describes the unexpected joys in learning about his family's Jewish faith
A History of the First World War in 100 moments: A visit to the Front Line by the Prime Minister's wife

A History of the First World War in 100 moments

A visit to the Front Line by the Prime Minister's wife
Comedian Jenny Collier: 'Sexism I experienced on stand-up circuit should be extinct'

Jenny Collier: 'Sexism on stand-up circuit should be extinct'

The comedian's appearance at a show on the eve of International Women's Day was cancelled because they had "too many women" on the bill
Cannes Film Festival: Ken Loach and Mike Leigh to fight it out for the Palme d'Or

Cannes Film Festival

Ken Loach and Mike Leigh to fight it out for the Palme d'Or
The concept album makes surprise top ten return with neolithic opus from Jethro Tull's Ian Anderson

The concept album makes surprise top ten return

Neolithic opus from Jethro Tull's Ian Anderson is unexpected success
Lichen is the surprise new ingredient on fine-dining menus, thanks to our love of Scandinavian and Indian cuisines

Lichen is surprise new ingredient on fine-dining menus

Emily Jupp discovers how it can give a unique, smoky flavour to our cooking
10 best baking books

10 best baking books

Planning a spot of baking this bank holiday weekend? From old favourites to new releases, here’s ten cookbooks for you
Jury still out on Manchester City boss Manuel Pellegrini

Jury still out on Pellegrini

Draw with Sunderland raises questions over Manchester City manager's ability to motivate and unify his players
Ben Stokes: 'Punching lockers isn't way forward'

Ben Stokes: 'Punching lockers isn't way forward'

The all-rounder has been hailed as future star after Ashes debut but incident in Caribbean added to doubts about discipline. Jon Culley meets a man looking to control his emotions
Mark Johnston: First £1 million jackpot spurs him on

Mark Johnston: First £1 million jackpot spurs him on

The most prize money ever at an All-Weather race day is up for grabs at Lingfield on Friday, and the record-breaking trainer tells Jon Freeman how times have changed
Ricky Gervais: 'People are waiting for me to fail. If you think it's awful, then just don't watch it'

Ricky Gervais: 'People are waiting for me to fail'

As the second series of his divisive sitcom 'Derek' hits screens, the comedian tells James Rampton why he'll never bow to the critics who habitually circle his work
Mad Men series 7, TV review: The suits are still sharp, but Don Draper has lost his edge

Mad Men returns for a final fling

The suits are still sharp, but Don Draper has lost his edge
Google finds a lift into space will never get off the ground as there is no material strong enough for a cable from Earth into orbit

Google finds a lift into space will never get off the ground

Technology giant’s scientists say there is no material strong enough for a cable from Earth into orbit