The contrast has become even sharper. On one hand, share prices are rising strongly, not just here but in all the major markets. Yet, on the other, growth forecasts are being downgraded, not just for the UK but for the eurozone and the US. This contrast leads to two debates.
The first – which perception of our economic condition is more valid? – has been discussed here and elsewhere. A middle-of-the-road conclusion would be that share markets, while partly driven by the switch from bonds that has begun in earnest, also judge that despite present troubles the world economic recovery will gather pace this year and beyond. There will be bumps, but share values are not stretched on a long-term view and if the recovery is indeed secure, then there will be further rises.
The other debate stems from this. If shares sustain their recovery, does this strengthen the economic recovery? The relationship is two-way. Equity prices reflect financial and economic confidence but they also contribute to that confidence. Most of the time, the former is the more important relationship, but right now a rise in share values might be particularly helpful in boosting the world economy. After all, it is not driven by an investment mania, as was the dotcom boom of 1999; nor is it fuelled by a surge in bank-lending, as to some extent was the boom that ended in 2007. Both those came at the end of booms; this recovery is much earlier in the economic cycle.
So what are the links? I have not been able to find a comprehensive computer model of how rising share prices contribute to increased demand, and I am not sure I would trust the results if I could. But common sense points to several ways in which higher share prices must be positive.
There is one specific mechanism here in the UK: what higher share prices do to cut pension fund deficits. In actuarial terms, these have been greatly increased by the Bank of England’s quantitative easing programme, because the lower bond yields have meant that, for any given level of benefits, the pension pot has to be larger. Mercifully, bond yields are now climbing, which will help a bit, and any rise in the equity portion of the pot will help even more.
We don’t know to what extent companies have postponed investment because they have had to set aside cash to top up their pension funds, but we do know that investment has recovered exceptionally slowly this cycle. Put at its lowest, any narrowing of the pension deficit will take pressure off company finances and that makes a company feel more able to commit to new investment.
This relationship will apply in other countries, such as the US and the Netherlands, which have similar corporate pensions, but everywhere a rise in a company’s shares gives it freedom to invest. If you have a weak share price, you have to rely on your bankers – and given recent experience, few finance directors want to do that. If you have a strong one, you have options: if push comes to shove, you can at least go back to the shareholders with a rights issue.
So what is the direct impact at a personal level? I suspect marginal, but helpful none the less. European Central Bank staffers did some work suggesting that higher eurozone share prices did lead through to a rise in consumption, but we would need a lot of evidence over a long period before being really confident about that. Even if the effect is marginal, though, it must be positive – higher share prices cannot reduce consumption – and in a tricky time that is a blessing.
Let’s wait and see. This surge in prices is very recent. But if sustained, then it could become more than a sign of renewed confidence in stronger growth, and turn into an engine of that growth. Either way, it is encouraging.
Easy money for some – but not for others
If people feel better off because their shares have gone up, they won’t feel it if they go on holiday to the Continent. Sterling has held up reasonably against the dollar but has fallen to the lowest level for a year against the euro, for one of the side-effects of the recovery in confidence in the future of the eurozone has been a rise in the euro.
The threat by the European Central Bank of buying unlimited quantities of distressed government stock has cut yields sharply. But it has had the side-effect of boosting the euro, an unwelcome development for eurozone exporters, and indeed for eurozone jobs. A further rise in unemployment, to 11.9 per cent, is expected to be revealed on Friday.
These movements have led to fears of “currency warfare”, where in a time of high unemployment countries devalue their currencies to try to gain competitive advantage. But it is more accurate to see the present situation as different countries seeking to boost demand by exceptionally easy money and accepting that some currency depreciation is the side effect of that. The moves so far are quite limited; if we start getting violent currency swings, then we should worry.