Not wonderful, but better than most
The easiest way to understand the links is that each crash is just `one more damn thing'
Tuesday 15 September 1998
The scale and nature of the Japanese recession is discussed in the second section of this paper, but the experience of seeing the concern of the Japanese business community does not just put our quite modest troubles in perspective. It also puts into perspective the rolling recession into which the world seems to be sliding.
Seen from London what has been happening in Japan ought to have been the most serious shock the world economy has experienced. The collapse of the East Asian emerging market economies was both dramatic and painful.
A large chunk of the middle class will have seen their savings wiped out. But without in any way trying to minimise the human and political importance of this catastrophe, from a world economic viewpoint it did not seem to matter very much.
The East Asian emerging economies were dazzling performers, but most of them were tiny. Their weight in terms of world out-put was too small to affect the whole.
Or so it seemed. What few of us spotted was the scale of the link into the Japanese economy - the extent to which Japanese companies used these countries as suppliers, the extent to which they had become competitors, and the extent to which Japanese banks had financed their expansion. But even allowing for all that, the decline ought not to have hit Japan as hard as it has.
So what happened? I think the easiest way to understand both the link between emerging East Asia and Japan, and the links between the collapses in Russia and Brazil and the rest of the world is that each crash is "one more damn thing".
If we do indeed have a full world recession over the next two to three years - as opposed to the partial world recession which is happening now - it will be because each bit of bad news, while unimportant in isolation, takes on seismic importance when piled on top of another.
Last month it was Russia than tipped the US markets from concern into terror. Russia itself does not matter in economic terms, though of course it remains vital in geopolitical and military terms.
But people started adding up the sums and realising that if you wrote off the full debts owed to many international banks you wiped out a large portion of their year's profits. Then they thought, wait a minute, we ought to do the same sort of calculation for other dodgy external debts, like Brazil or Venezuela.
It may be irrational for the currency crisis of Russia to spread to Latin America - the only real parallel is that both regions face explosive political situations - but that is what seems to have happened. Add up the doubtful debts and suddenly the position of perfectly solid banks looked decidedly unpleasant.
Now I am not saying that there is a generalised global banking crisis, as there is in Japan. But banks the world over are going to be very careful in their lending for the next three or four years, maybe longer. This is one indication of a change in the global investment mood, a change that the London economics team of HSBC has called "a new sobriety".
There is nothing wrong with being sober. Indeed, had the world banking and investment community been rather more sober over the past three years the East Asian boom would have been more muted and the scale of the subsequent collapse less grave.
The difficulty is that an excess of sobriety is almost as destructive to the world economy as an excess of excess. If we do experience a rolling world recession, where each bit of bad news is piled on top of the last so that finally even the relatively solid economies of North America and western Europe are ground down, then the financial system will have to take its share of the blame.
How does Britain appear through the prism of these newly sober market operators? Three factors seem to distinguish the UK economy at the moment.
The first is that thanks to the much-reviled surge in interest rates, we may have managed to chip the top off the boom. Sure, manufacturing has had a miserable time, but that was collateral damage in the effort to curb the services' boom. In the past month or so it has seemed the service side is heading down a bit too. We are no longer such a dual economy. The sentiment of retailers (see chart) has now fallen to the same sort of level that it was at during the last recession.
That does not necessarily mean a recession is on the way, although obvious that is a risk. But it does mean that there is beginning to be a domestic case for interest rate cuts.
Second, we still have some inflation so that by cutting nominal interest rates it is possible to cut real rates. In a world of deflation and falling prices, cutting interest rates is pushing on a string, for you may simply find that prices fall even faster, so real rates do not fall at all. Given the close link between short-term interest rates, house prices and domestic demand, we may be better placed to pump up demand should the rolling recession roll over us.
And third, we still retain policy freedom - in fact, we probably have more room for manoeuvre than any other G7 country, including the US. We can cut rates and try and reduce the exchange rate. We have a sound fiscal position and so we could try to boost demand that way. And we have a relatively flexible economy, unlike continental Europe and Japan, which ought to respond to policy changes.
It is not a bad position to be in, if as sadly looks more likely by the week, the world economy does continue to deteriorate. Not wonderful; just better than most.
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