There’s one certainty: the economy will recover. Eventually

The dip in the economy after 2008 was not nearly as serious as in the 1890s or 1930s, but the bounce-back has been slower

(EPA)

Whenever share prices collapse – as they do from time to time and are pretty much doing right now – there are always three questions. One, why is this happening? A second, what effects will this have on the real economy of output and jobs? And third, are share prices giving a more general warning about economic troubles ahead?

It is impossible to give a truly satisfactory answer to the first. If we could, we could predict market crashes and all become vastly rich. The various factors trotted out now to explain the crash (the collapse of the oil price, slowing growth in China, worries about the limits of easy monetary policies, and so on) were all evident last May when shares hit an all-time high. The facts have not changed, or at least not much, but the perception of those facts has shifted radically. So let’s leave question one aside and focus on numbers two and three.

Asset prices do affect the real economy in a number of ways. For example, buoyant house prices have helped drive the recovery in Britain. People feel richer, and choose to spend more either on their homes or on other things as a result. Economists call this a wealth effect. With share prices, the links are less direct but there nonetheless.

There has, unsurprisingly, been a lot of work trying to estimate wealth effects. They vary from country to country. For example, in 2009 the European Central Bank reckoned that a 10 per cent increase in financial wealth boosted consumption in the eurozone by between 0.6 per cent and 1.5 per cent, but changes in housing wealth in Europe had very little impact.

In 2005, after the popping of the dot-com bubble, the Bank of England looked at a number of developed countries and concluded that a 0.6 per cent effect for financial assets was about right, but found that the impact changes in house prices were harder to estimate. Still another study, in the International Review of Financial Analysis last year, looked at the UK and Italy and found that, while house prices were important in the UK, they were not in Italy. With the price of financial assets it was the other way round.

We don’t, of course, know how far shares will fall or for how long, but my back-of-an-envelope calculation is that the fall so far will cut consumption here by a little, say 0.5 per cent. If the rout were to spread to house prices, the hit would be greater, but so far that does not seem to be happening. Maybe, now that many pensioners have become more aware of the value of their pension pots, share prices matter more than in the past – but we don’t know.

There are, however, effects on companies as well as consumers. Aside from general confidence, they are hit in two ways. One is they may find it harder to raise money if they need to. Note how the government has postponed a sale of the last chink of Lloyds Bank shares. The other is if they have defined benefit pension funds, which will have fallen in value and may need a greater top-up. That knocks profits and hence the ability to pay dividends. This in turn further undermines share prices. Pull all this together and what do you get?

Let’s focus on the UK. The range of estimates for growth this year is from about 2 per cent to 2.7 per cent. The official forecast last November, from the Office for Budget Responsibility, was 2.4 per cent. It is plausible that the share crash, if there isn’t a recovery in the summer, could knock 0.5 per cent off growth. That would mean growth of somewhere between 1.5 per cent (if the pessimists prove right) and 2.2 per cent (if the optimists are right). This would not be a catastrophe, but it would be a marked deterioration from present official expectations. Expect these to be revised down at the time of the Budget, now only five weeks away.

So a hit. A very palpable hit – but not a disaster. Suppose, however, the share crash is warning of something more than a slowdown. This is, after all, a global phenomenon.

Japanese shares were off more than five per cent yesterday. The shares of the Deutsche Bank are down nearly 15 per cent this week, and while the German finance minister Wolfgang Schäuble said yesterday he had no concerns about the bank... well, it is unfair to say so, but you always worry when finance ministers say they are not worried. He did, by the way, say last September that the global economy faced a financial bubble. In particular, he warned against an over-reliance on central bank stimulus to prop up economies, a warning that now seems prescient. Inevitably, the R-word, recession, appears more and more often in economic commentaries, even if only to argue that it would be improbable.

You cannot, given past experience, dismiss it out of hand. Very few mainstream forecasters spotted the danger of the global financial crash of 2008, and nobody wants to be caught out this time. A couple of emails hit my inbox in the past few hours with the word “panic” in the headline. One was from the asset management arm of the Swiss private bank Pictet Group and was clear enough: “There’s no need to panic”. The other from Schroders was: “Time to hit the panic button?” Its chief economist, Keith Wade, thought probably not. There are other reports suggesting a US recession is a 20 per cent possibility.

At a time like this, it is probably most helpful to take a long perspective, and by coincidence the annual study by Credit Suisse Asset Management of markets going back to 1900 is just out. It looks at the three great financial crises of capitalism, the 1890s, the 1930s, and from 2008 onwards. The dip in the economy after the most recent one was not nearly as serious as the others, but the bounce-back has been somewhat slower. But what is fascinating is that, eventually, US share prices recovered in all three periods, with the present experience somewhere between the not-too-bad recovery after 1890 and the more hesitant one in the 1930s. Moral: that share prices eventually bounce back, provided you wait long enough for them to do so.