Market misery: a storm before the calm
Sunday 17 March 1996
It is miserable but it also seems a bit humiliating. One set of American figures, which may even turn out to be wrong when they are revised and re-revised, ought not to have such an effect here. It is nothing to do with us. The US is not our largest export market, so the fact that it is growing fast ought to have less impact than the fact that the French and German economies are flat on their backs.
There is no link, formal or informal, between the dollar and sterling and, in theory, you might expect continental European interest rates to have just as large an impact on our own as US ones. Of course you would expect US markets to be hit by anything that suggests that interest rates will not fall further, but the link here seems more emotional than rational. We are the tail, wagged by the dog.
But if we appear to be simply slaves to transatlantic sentiment, there is one justification for this. The UK economy does seem to be more closely synchronised to the US than it does to the rest of Europe. Why this should be is something of a puzzle, but it is observably the case. Thus the lowest points of the last recessions in those two countries were within a couple of months of each other and some 18 months before the bottom of the cycle on the European continent.
Step aside for the moment from the implications of this for the financial markets - there has been plenty of analysis of that already, and if they head on downwards there will be much more - and look instead at some implications for the real world. There seems to me to be two grand questions worth trying to answer. One is: in what way have the seismic structural changes that have taken place in the US economy during the last decade altered the way it responds to changes in demand? The other is: are there are lessons here for us?
To explain: 10 or more years ago, if an economy experienced a long period of growth, it would start to run into capacity constraints, which would show in a rise in imports and wage costs. So growth would be choked off, usually by higher interest rates.
Now have a look at the graphs. The US has just experienced a long expansion. Sure, there was a pause in the second half of last year, but now, if these new figures mean anything, that pause is over and the economy is zipping along again. But what is surelyremarkable is the way in which this long expansion has taken place with very few signs of strain.
On the left is export performance, showing the way in which the US now consistently leads both Japan and Europe in export growth. At the beginning of the 1980s the positions were reversed. That is in part a function of the cheap dollar, but clearly the US has been able to take advantage of this competitiveness without frittering it away in higher wages. On the right are employment costs, which show absolutely no sign of perking up. There has been positive demand for labour (that is, payrolls have been rising) since the autumn of 1991, but, as you can see, that seems to have coincided with a fall in employment costs. The US has been very good at job creation, even if it has done so in a climate of insecurity, and that insecurity has helped hold down labour costs.
It is fairly easy to see what has been happening in the labour market. Large firms have continued to shed labour, as has manufacturing, while small firms and service industries have picked up the slack.
You can even pick this up in those latest employment figures, the ones that caused all the fuss. Taking January and February together, total jobs rose by 520,000. Yet manufacturing jobs fell by 50,000. So even in a time of rapidly rising employment, a lot of people are being "let go". No wonder workers are disinclined to up their wage demands.
But this insecurity, however uncomfortable it may be for employees, does mean that the economy can run closer to capacity without leading to inflation; what economists call "the natural rate of unemployment" has come down.
As for the other principal indicator of strain, the balance of payments, while the US has continued in substantial current account deficit, at least that deficit has not been rising as a percentage of Gross Domestic Product. Some thanks for that go to the growing strength in private-sector service exports, including intellectual property, but also those regular exports noted above.
I think the broad answer to the first question I posed is that the structural changes in the US economy may well have enabled it to sustain a longer expansion than one might have expected 10 or 20 years ago. A predominantly service economy does not hit the clear capacity restraints that a predominantly manufacturing one does. If you run out of capacity in your car plants, you tend to import more cars; but if you run out of capacity in your restaurants, or among your lawyers, you cannot import either of them. And while lawyers may be adept at bidding up their charges, waiters and cooks seem to be less so.
Turning to the second question, I think there is indeed a parallel to be struck here. We were told by the economic forecasters that devaluation of sterling would push up prices. We were told that rapidly falling unemployment would push up wage settlements. We were told that strong growth would push us back into serious balance of payments difficulties. None of that happened, or at least not to any great extent. Now that we are having slower growth, all those pressures have eased further.
Looking ahead, it is equally possible that we, too, can sustain continued decent growth without hitting the barriers. The US figures on the two successive Fridays suggest that it is most unlikely that there will be a US recession this year. However hard it is to see strong direct links between the two economies, if past performance this cycle is a guide to the future, then it would be reasonable to expect a perfectly decent growth performance here, despite weakness in our principal export markets. The Treasury, which back in November reckoned that rising UK consumption would rise through this year, may well prove to be right.
So these two days of misery for the markets may carry a more positive message for the real economy: that growth this year will surprise on the upside. Expect the various brokers' forecasts, which have been revised downwards in recent months, to start being revised back upwards again.
As so often in the crazy logic of the financial markets, bad news for shares and bonds is good news for the real world of jobs, trade and output. Maybe we need more misery Fridays, but perhaps not this week; three in a row would be a bit over the top.
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