Outlook: It's crunch time for liquidity

RECESSION, DEFLATION, even depression and slump - these are the words on everyone's lips. This is understandable enough: when stock markets are plunging, it's all too easy to get caught up in the rhetoric of meltdown, panic and crash.

The truth of the matter is, however, that we are not yet in a recession, nor, on the balance of probability, does it appear likely there is going to be one, either in Europe or the US. Recession is defined as two successive quarters of negative growth, and hardly anyone is predicting that for Europe and the US, even after the traumas of the last month.

That does not mean it won't happen, or that things aren't going to be anything but extremely tough over the next few years. Right now events are alarming enough to suggest a number of very ugly outcomes, each of them capable of tipping the world into outright recession.

The most compelling of these is the possibility that the bear market we are now witnessing on Wall Street will turn into something similar to the Tokyo rout of the early 1990s. Japan is the nightmare precedent for what happens when a big asset price bubble bursts. Don't try and call the bottom, just sell into the rallies and stick your money in bonds, is the doomsday lesson of the Tokyo collapse.

The parallels with Wall Street are uncanny. Like Japan, valuations were driven sky high by the belief that the US had discovered economic nirvana, that strong, low-inflation growth could go on for ever. Like Japan, the bull market in equities has itself helped sustain US economic growth by making Americans feel richer and thereby encouraging them to spend more. In Japan in the late 1980s companies thought themselves so overweight in capital that they bought stakes in one another. In the US in the late 1990s, companies buy shares in themselves.

Despite these alarming similarities, there are also some key differences. The most important of these is that as far as we know, Western banks are not up to their necks in dodgy and unsuspected property loans of the type that sank the Japanese banking system. Russian and other bad-debt problems are mounting, but on the whole Western banks appear well capitalised enough to withstand a very considerable shock without going under.

We know this, because unlike their Japanese counterparts in the late 1980s, Western banks have reasonably transparent accounts. Furthermore, the US and European economies are much more flexible than that of Japan and are therefore capable of adapting quite quickly to changed circumstances.

None of this means we should all breathe a sigh of relief and plunge back into equities. As Martin Taylor, chief executive of Barclays, argues, we may, after the latest traumatic events in Russia, be looking at a considerable, worldwide credit crunch. If nobody will lend, economic activity dries up.

So, although we may not be heading for outright recession, we've probably got two or three very rocky years ahead of us. As a consequence, the fall on Wall Street could have a good deal further to go, notwithstanding its numerous attempts at a rally yesterday. The downswing may not be as deep or prolonged as Tokyo, and its consequences are unlikely to be as cataclysmic, but when a liquidity bubble deflates, the effects are always bad. It's just a question of degree.

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksAn introduction to the ground rules of British democracy
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

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

iJobs Job Widget
iJobs Money & Business

SThree: Talent Acquisition Consultant

£22500 - £27000 per annum + OTE £45K: SThree: Since our inception in 1986, STh...

Recruitment Genius: Experienced Financial Advisers and Paraplanners

Negotiable: Recruitment Genius: This extremely successful and well-established...

Guru Careers: FX Trader / Risk Manager

Competitive with monthly bonus: Guru Careers: We are seeking an experienced FX...

Guru Careers: Investment Writer / Stock Picker

Competitive (Freelance) : Guru Careers: An Investment Writer / Stock Picker is...

Day In a Page

How to stop an asteroid hitting Earth: Would people co-operate to face down a global peril?

How to stop an asteroid hitting Earth

Would people cooperate to face a global peril?
Just one day to find €1.6bn: Greece edges nearer euro exit

One day to find €1.6bn

Greece is edging inexorably towards an exit from the euro
New 'Iron Man' augmented reality technology could help surgeons and firefighters, say scientists

'Iron Man' augmented reality technology could become reality

Holographic projections would provide extra information on objects in a person's visual field in real time
Sugary drinks 'are killing 184,000 adults around the world every year'

Sugary drinks are killing 184,000 adults around the world every year

The drinks that should be eliminated from people's diets
Pride of Place: Historians map out untold LGBT histories of locations throughout UK

Historians map out untold LGBT histories

Public are being asked to help improve the map
Lionel, Patti, Burt and The Who rock Glasto

Lionel, Patti, Burt and The Who rock Glasto

This was the year of 24-carat Golden Oldies
Paris Fashion Week

Paris Fashion Week

Thom Browne's scarecrows offer a rare beacon in commercial offerings
A year of the caliphate:

Isis, a year of the caliphate

Who can defeat the so-called 'Islamic State' – and how?
Marks and Spencer: Can a new team of designers put the spark back into the high-street brand?

Marks and Spencer

Can a new team of designers put the spark back into the high-street brand?
'We haven't invaded France': Italy's Prime Minister 'reclaims' Europe's highest peak

'We haven't invaded France'

Italy's Prime Minister 'reclaims' Europe's highest peak
Isis in Kobani: Why we ignore the worst of the massacres

Why do we ignore the worst of the massacres?

The West’s determination not to offend its Sunni allies helps Isis and puts us all at risk, says Patrick Cockburn
7/7 bombings 10 years on: Four emergency workers who saved lives recall the shocking day that 52 people were killed

Remembering 7/7 ten years on

Four emergency workers recall their memories of that day – and reveal how it's affected them ever since
Humans: Are the scientists developing robots in danger of replicating the hit Channel 4 drama?

They’re here to help

We want robots to do our drudge work, and to look enough like us for comfort. But are the scientists developing artificial intelligence in danger of replicating the TV drama Humans?
Time to lay these myths about the Deep South to rest

Time to lay these myths about the Deep South to rest

'Heritage' is a loaded word in the Dixie, but the Charleston killings show how dangerous it is to cling to a deadly past, says Rupert Cornwell
What exactly does 'one' mean? Court of Appeal passes judgement on thorny mathematical issue

What exactly does 'one' mean?

Court of Appeal passes judgement on thorny mathematical issue