Market instability has affected the three time zones in different ways

Hamish McRae On The Agenda For The Next Few Months

Markets can only manage to keep excited for a few days, so it should be no surprise if they now flop for a while. What last week has done, among other things, is to bring into focus the fact that the three different time zones have very different concerns. Everyone was worried - that much was common - but people in different time zones were worried for completely different reasons.

In the East Asian time zone, last week was the week of reassessment: the week when people realised that the whole region faced an inevitably long struggle to rebuild confidence. At best there may be just a pause in economic growth lasting a few months; at worst there is going to an 18-month recession. No one knows which way the coin will flop, but they are now aware that it is spinning. My hunch is that there is quite a lot of bad news still to come, largely because it will take more than a year for the excesses of bank lending and investment in non-productive assets to unwind. But more important, it would be wrong to see the time zone as a single economic entity. Some parts will brush off the market upheavals; others will be severely damaged by them for several years.

In the European time zone two rather different things have happened. There have been, quite independently of the market turmoil, some signs of perkiness in both the German and the French economies. There is nothing substantial happening - nothing that is going to make a serious dent in unemployment - but consumers in both countries seem a little less gloomy and export demand has continued to be quite solid.

Alongside this modest cyclical uplift has been an "EMU effect": the act of preparing for EMU seems to be starting to stimulate economic activity in a number of ways. Practical preparation for it costs businesses money: large companies are already having to invest in new systems for the exercise has now gone beyond the planning stage. To some extent this has come out of existing IT budgets, but in many cases companies are having to spend money they otherwise would not have spent. The result in the short term has been a rise in corporate investment. Meanwhile, companies may have been considering the downside of EMU, the longer-term structural implications for their business, but with a few exceptions (like ASEA-Brown Boveri last week) the employment implications of this have not shown through.

So last week the general market uncertainty stuck, in Europe, an economy which seemed at last to be recovering a little bounce. Will market uncertainty flatten this modest recovery? I don't know the right answer but I know that is the right question.

In North America, in a completely different cyclical position, the issue is whether a market-driven knock to confidence will be the thing which ends the boom. Something was always going to end the boom. The prime candidate would be rising inflation and the associated higher interest rates, but if markets turn down then maybe they will do the job by cutting into consumer confidence.

You can catch a feel for the different economic environment of Europe and North America by glancing at the graph. This comes from the new IMF World Economic Outlook out last month, and is already a bit out of date.

But you can see the contrast between the astonishing self-confidence of US consumers and the gloom of European ones, particular in the "core" countries of France and Germany. (The UK is not shown but would be swinging up towards the US levels.) It may well be that US consumers are so buoyant that they will completely override the market setback.

The likelihood of that is all the greater if sentiment continues to recover as it seemed to be doing yesterday. On the other hand, a sustained recovery would merely postpone the adjustment, and narrow down the margin of error for policy mistakes.

And us? It is difficult because Britain is a European economy which behaves like a North American one.

This is not just a cyclical point, though it is a bit of a relief that the fact that the UK cycle is out of line with the rest of Europe is at last accepted.

It is also a structural point. There are a number of ways in which the US and UK financial structures are different from the core continental ones.

The importance of home ownership is crucial: in the US and UK there is an easy availability of credit both for home purchase and for buying consumer items, a high level of assets in relation to income (a function of home ownership) but also a high level of debt (ditto).

Beyond this there is, of course, the flexible labour markets and the high rate of business start-ups. The result is that it is easier to stimulate domestic demand in the US and UK by a cheap interest rate policy; but both economies are also more vulnerable to a sustained rise in rates.

We may also be more vulnerable to a stock market reversal, though we don't know.

So the events of last week have set an agenda for the next few months. But it is a different agenda for different parts of the world.

We always talk of a single world economy, but actually there isn't one: not only do the three different time zones have completely different preoccupations, but even within those time zones there is differing economic performance.

Understanding this is going to be enormously important in the next few months. It is going to be a worrying time; the markets are going to be ill-tempered; investors are going to be on edge. The optimists are going to grab bits of good news and use this to reinforce their beliefs that all is well, while the pessimists are going to interpret each bit of news to reinforce their view that the long bull market is at an end.

I think things are going to be much more complicated than that. Some parts of the world will pull through in good shape, while others will blunder.