Will everything change while we're away?

IS IT SAFE to go off on holiday? That little shiver on the markets last week drew attention to the underlying sense of unease that many people harbour about the world economy - a nagging feeling that if you go off for three weeks and don't pick up the news, you might suddenly find the world is very different on your return.

There are, of course, perfectly rational reasons for such unease. The economic situation in East Asia deteriorates by the day; in Japan things are clearly going to get worse before they get better; something eventually is going to end the long boom in the US; and here there has been a slump in confidence among our manufacturers under pressure from interest rates and sterling.

But then there always are rational reasons for being concerned about the world economy. At almost any moment in time there are several problems bubbling away, any one of which might suddenly erupt and cause a lot of collateral damage. World inflation, Latin American debts, commodity prices, the oil price - all these at various times have threatened the world economy, and all of these were overcome eventually.

In terms of the "danger factor", the present identifiable threats may incline toward the top end of the scale, but they are at the top by any means.

So why the worry? I was struck by the comments last week by Bernd Pischetsrieder, the normally supremely confident chairman of BMW. A couple of weeks ago he was purring with pleasure at the purchase of the Rolls-Royce name, snatched from under the nose of VW. On Thursday, he issued a warning that the German car market had peaked.

Commenting on the speculation about more mergers in the motor industry, he said that the best time to buy was when the market was in "crisis". And when, he was asked, would that be? "Within the next two years, first in the USA," he replied. "If we are lucky, it will not hit Europe before 2000."

His comments were industry-specific, for the motor industry world-wide is suffering from serious over-capacity. Nevertheless, they struck a chord because his assumption that there would be a crisis in the industry, that it would come first in the US and then hit Europe, too, squares with what many other people in the business community feel.

It represents well the "sensible sceptic" view of the world, which many of us feel has been a touch under-represented in the financial markets of late. How then should the sensible sceptic view the medium-term outlook as he or she heads off on hols?

I don't think anything radical is going to happen in the next month (famous last words), but I do think that when people come back in September, they will begin to take action ahead of what seems likely to be a more difficult period.

The idea of a rolling recession, implicit in Mr Pischetsrieder's remarks, seems the single most plausible outcome. Japan is already down, and the US will turn down within the next two years. There is still quite a lot of fizz in the US, as anyone who goes there this summer will notice. Growth in the second quarter managed to stay positive in spite of the General Motors strike and a fall-off in exports.

In the months ahead, fixing the Millennium Bug will add a measurable amount to global GNP. Within continental Europe, preparing for the euro will add to economic activity. And in Britain, the economy overall is still growing now and that momentum will also take time to wear off.

Then comes the flop. I have no evidence to support this and the parallel may seem a bit absurd, but I think the experience of Hong Kong up to and immediately after its return to Chinese rule may be a model for Western economies pre and post-Millennium.

The idea of the transfer of power stimulated the economy in the run-up; far from losing momentum because of fear of the future (which many had predicted), the prospect of the changeover actually stimulated it. People went to Hong Kong to catch a glimpse of something that would be gone for ever. So travel and tourism boomed. That stimulated the economy. Mainland money flooded in. That gave it a further boost.

Then, quite suddenly, it was all over. The tourists departed, partly because they felt that they had been overcharged because Hong Kong had become just another bit of China. Then a combination of bad luck and bad management made a difficult situation much worse. Last Friday was the anniversary of the Hang Seng index hitting its peak. Since then it has lost more than half its value.

Now look at the parallel. There are several non-recurring things stimulating the world economy. The Millennium Bug could add about half a percentage point to world GNP in 1999, and the euro about the same for continental Europe. Buoyant markets have themselves stimulated consumption, and that will take some months to wear off, even if markets move downward this autumn.

The Millennium will surely stimulate some additional consumption (most of us will have to have some sort of party, won't we?). All this makes me think that the problem year is not 1999 but 2000, and beyond. If this is right, how might this smallish and unusually open economy be affected? A snapshot of the mood of the moment is shown in the graphs, drawn from the latest AMN-AMRO chart book.

First, earnings. We are paying ourselves more, with a sudden surge in the year-on-year earnings starting at the beginning of this year. This is entirely a private-sector phenomenon. As you can see, public-sector earnings are completely flat.

The sharpest rise of all is in the private-sector services, the top line. So this rise in not a cost-push form of wage inflation, driven by public sector unions, nor an industrial one, driven by private-sector unions. It is happening in the area where unions are weakest, which suggests that it is the product of a willing trade between buyers and sellers of labour.

Why are companies paying people more? Because they want to get good people and feel they can afford to do so. That is somewhat confirmed in the middle graph, showing confidence in profits. Manufacturers are becoming much more glum and service industry confidence has deteriorated, too. But look at the levels as well as the direction. Confidence in profitability is vastly higher than in the early 1990s recession, and for services at least is still pretty much the same level as it has been in the subsequent boom.

The reason is that services are largely unaffected by the level of sterling (right-hand graph). Here the interesting thing is that the surge in sterling is largely a European phenomenon in the sense that against non-EU currencies it has not risen very much. If confidence returns to European currencies and sterling ceases to be such a safe haven - a perfectly reasonable expectation - then much of the present pressure on manufacturing exporters would recede. Our manufactured exports are particularly dependent on European markets.

If this line of argument is right, we go into the run-up to the Millennium with continuing growth; maybe not as strong growth as in the last four or five years, but some growth, say, a bit over 2 per cent this year and something close to 2 per cent next.

And then? Well, the sensible sceptic would say that we have a few months to prepare. Companies are able to take the practical steps to make sure they are strong enough to weather more difficult times. They do not over- hire; they do not over-invest; they build up their financial strength; and they diversify.

There is no magic wand, just common sense - and a little of Mr Pischetsrieder's scepticism, too.