Suddenly, the malaise in the financial markets has left the business pages and become front-page news. Share prices have been weak for three years – we have just had two years when the FT index ended the year down instead of up, the first time that has happened since the early 1970s. Yet until recently most of us brushed this off as a narrow worry for people directly involved in finance. Sure, shares were off a bit, but compared with the performance of the real economy, it didn't really matter, did it?
Now something has changed. Viewed rationally, the UK economic news is still astoundingly good. Underlying inflation is 1.8 per cent, the lowest since the 1960s. Unemployment on the claimant count is 3.2 per cent, the lowest since the 1970s. Growth this year should be a bit under 2 per cent, and we have just come through a world recession without a single quarter when our economy declined. So what is up?
Three things are up. First, we have a pretty robust financial system, but if two years of falling prices have created problems, a third would be very serious. Second, the ageing of our population puts a burden on markets to provide reasonable pensions as never before. And there is a wider sense of concern on both sides of the Atlantic, post-Andersen, about the integrity of our core private sector institutions. You will always get companies run by crooks but if you cannot trust the auditors or the accounts then there is a problem indeed. A word about each.
Recessions always show up weaknesses in the economy. Weak companies go bust, or at least get taken over as part of that Darwinian process that defines market capitalism. More worrying is weaknesses in the banking system for that might inhibit the ability of an economy to recover. It happened in the US in the 1930s and again in Japan in the 1990s, where banks have so many bad debts that they cannot lend money even to potentially good borrowers. In Britain in the 1970s our own banking system was similarly threatened and the Bank of England set up a rescue, where good banks helped support weak ones.
But now the world banking system, Japan apart, seems reasonably secure. It was excesses on the stock markets that have undermined confidence: the rise of the dot.coms and I think particularly the length of the bull market in stocks created a sense of invulnerability. If shares went down one year, well, you just waited a few months and next year they would go up again.
Now we have had the once-in-a-generation earthquake of two years' decline, with the once-in-a-lifetime possibility of a third year down. So, here in Britain, pensioners find their pensions are likely to be cut, companies may have to top up their pension funds (as happened in the 1970s), and home-buyers who relied on the capital growth of low-cost endowment policies to pay off their mortgages are disappointed.
But though this for many people is a serious disappointment – that is why the markets are on the front pages – you have to see this in context. This sort of decline in shares happens very rarely; even people who will have to top up their mortgages will have made huge profits on their houses; and the destruction of wealth is far less than earlier generations experienced as a result of war and runaway inflation. So let's hear less wingeing.
What would be serious would be if people believed the fall in the markets meant there was less point in saving for retirement. Weak markets make that more important, not less. The inexorable mathematics of people living longer and having fewer children is that people have to save more for old age and probably work longer too. But surely again we should not moan about that: in any rational sense greater longevity must be good. Hands up everyone who wants to die younger. And we should realise too that if we chose to have smaller families then we are also choosing to have a smaller workforce to support us in old age. Meanwhile, we should hope for a market upturn.
The greatest concern, then, is not so much that stock markets should be down, nor that a growing proportion of our society will rely on those markets for its pensions. Rather it is the evaporation of trust that has followed the Enron affair.
Markets depend crucially on trust: trust that governments will repay their debts; trust that central banks will preserve the value of the currency; trust that companies will be reasonably competently run (or at least that shareholders can heave out the duff managers); trust that company accounts give a true and fair picture of the company's performance.
Here in Britain it is hard to see any systemic crisis of confidence in our companies or in the financial services industry. Yes, there are substantial concerns that some large companies seem to have been managed for the benefit of their directors rather than customers or staff. There are concerns that savings packages have been sold in an unethical manner. There have clearly been huge errors of judgement in company management, particularly in telecoms, witness the catastrophe at Marconi. But even if you add all this up you don't have a level of distrust that might undermine the ability of the economy to continue to function effectively. For all its faults, the economy has come through a difficult couple of years in pretty good shape.
I'm not sure that is quite so true of the States. In one sense the performance of the US economy has been impressive: a rapid rebound from an awful period last year and very sharp increases in productivity despite falls in demand. They are a resilient lot. But the trust deficit is wider there than here. Quite aside from the implosion of Andersen, there has been a string of cases of what is at best unethical and at worst illegal corporate behaviour.
The US system will of course reform itself. It always does after financial scandals. That process has already begun. For example, new rules are being prepared to make sure that investment banks offer more independent advice on shares, rather than puffing the companies for which, surprise, they happen to be making a share issue. As for policing accounting standards, well, there will be changes there too but actually there is no greater punishment than killing a top firm. The Andersen lesson will keep the rest sweet for a while.
But the level to which US markets had been driven was such that on long historical comparisons, their markets may still be too high. Markets won't recover till trust comes back, but they may not do very well even when it does. My guess is that by the end of this year there will have been a gradual rebuilding of confidence and that any second leg to the US recession (if it comes) will be over. But do not expect the next bull market to have begun.
What happens to Wall Street will affect us here, as it will affect financial markets just about everywhere. The excesses both here and in Europe may be less dramatic than those of the States but it would be naïve to think that we could buck what happens to the US economy or to US markets. The tail does not wag the dog.Reuse content