As the world’s financial markets have shown with startling clarity, the long term has ceased to exist. The short term is the next nanosecond, the medium term is the next minute and the long term is what might be happening on the other side of lunchtime.
The antics of dealers could keep the psychoanalysts in learned articles for many a year, with abundant evidence of all the classic textbook disorders: manic depressive mood swings, denial, id impulses, more denial, the lot.
Forecasting what the world will look like after the war is, therefore, nigh on impossible. To the extent that anybody has given it thought, the feeling is that an overwhelming military campaign will be followed by a longer and more expensive period of reconstruction, but that the costs will be worth it as the threat of Baghdad-sponsored terrorism will have been diminished and the boil on the face of the global economy will have been lanced.
This may well be the outcome. Yet contingency planning would suggest that policy-makers had best be prepared for a less-than-perfect scenario, in which the gyrations of the stock market are not just the result of war jitters — although they obviously are to an extent — but are symptomatic of a more serious problem that will be exacerbated by the sundering of the global community over Iraq.
United States President George W Bush is making positive noises about the need for a comprehensive peace settlement in the Middle East, which raises hope that the US has not given up on multilateralism, but the insults that have been flying across the Atlantic and the English Channel in recent weeks suggest that multilateralism may have been holed below the waterline. The sour mood threatens everything from coordinated action on debt relief to expansion of the European Union to the east, taking in the global trade talks and Britain’s relationship with Europe en route.
This would be serious stuff even if the immediate economic outlook were bright, but it does not take a great feat of imagination to envisage a scenario in which the markets enjoy a Saddam rally only to wake up at the beginning of May to a world that has not fundamentally changed. Recent data have suggested that weaker consumer sentiment in the US is affecting spending. Likewise, there appears to be evidence that the boom in retail sales in Britain is waning. Europe’s domestic demand has been poor and so has Japan’s.
John Llewellyn of Lehman Brothers concludes: ”At root, people are less confident that the economy will be performing satisfactorily a year or two ahead. Consumers, uncertain that they will have a job, spend a bit less and save a bit more. Firms, expecting reduced sales, do likewise. Private sector savings rates rise. The result: a self-fulfilling slowdown with a crashing stock market.”
Consumer caution is justified, given the destruction of wealth caused by the equity bear market. Take Britain. Simon Rubinsohn, chief economist at City firm Gerrard, estimates the net wealth of the household sector stood at £3,397-billion in the first quarter of 2003, down from £4,019-billion in the fourth quarter of 2002 and a peak of close to £4,4-trillion in 2000.
The size of the fall is modest in relation to the halving of share prices, but is explained by the simultaneous increase in house prices. Over the past three years, the bear market in shares has almost — but not quite — been balanced by the bubble in property.
Why then has consumer spending been so strong? Largely because rises in house prices are much more visible and, in a sense, more visceral than the decline in value of their financial assets. It is the feeling that bricks and mortar are rising in value that has made people willing to take on more debt, or perhaps forget what is happening to their pension funds and endowment policies. A large chunk of the debt that has been taken on by consumers has been to service existing debts, which is just about sustainable so long as interest rates are falling, real incomes are growing, unemployment is coming down and house prices are going up.
However, as Rubinsohn says: ”The expectation that property inflation is set to slow sharply means that any meaningful increase in household wealth is unlikely over the course of this year. Second, the lagged impact of previous reductions in the value of wealth will continue to affect consumer behaviour at the same time as all the other key drivers of spending are also turning down.
”Real income gains are already being squeezed (a crude calculation would put the current increase at a mere 1%), taxes are set to rise by around this amount, unemployment could begin to edge upwards and dividends will struggle to post a positive increase in real terms.”
Now, of course, the death of the consumer on both sides of the Atlantic has been much exaggerated. Every downward blip in spending has been hailed as the long-awaited arrival of a more prudent approach, and each has been a false dawn. One reason central banks have shown a degree of reluctance to ease monetary policy is that they fear that this could be another case of the boy who cried wolf, and that cutting rates could merely add to inflationary pressure from higher energy costs.
In the end, though, the point about the story of the boy who cried wolf was that there was a wolf. It seems far more probable that the big post-Iraq threat to the global economy will be deficiency of demand, and that policy-makers will be under pressure to come up with coordinated measures to underpin activity.
The meeting of Group of Seven finance ministers and central bank governors in Washington on April 11 would be an ideal time for a show of international unity, which would see the US, Europe and Japan agreeing on a common slate of reflationary measures, including not just cheaper borrowing but steps to prevent the dollar’s fall leading to a rout.
For the developing world it would help were the meeting of Group of Eight leaders in Evian in June to endorse Gordon Brown’s plan for an international financing facility that would double aid budgets to $100-billion a year. Jacques Chirac wants the summit’s successes to be agreement on cheaper water and affordable drugs. In the circumstances, it looks wholly unrealistic to expect Bush to offer any concessions to Chirac that might affect the profitability of the US drugs industry.
Likewise, the split in the European Union between hawks and doves is now leading to speculation that Chirac may attempt to stymie expansion, something France — and French farmers in particular — has never been keen on. Blair’s European policy is obviously in tatters. Holding a euro referendum in this parliament was always going to be a challenge; holding one when you are involved in a slanging match with France is a non-starter.
Looming in the background is another vexed issue, the moribund negotiations at the World Trade Organisation, which will culminate in a meeting in Cancun in September. Officials in Geneva have failed to break the logjam, and it will be up to trade ministers to prevent the talks from collapsing.
The schism in the global community over Iraq makes this much less likely, and illustrates the potential damage that the rift between the West’s leading countries could do to the prospects for the global economy.
One reason Bush and Blair were willing to go the extra mile to try to secure consensus over a second United Nations Security Council resolution is that their domestic agendas could be put in serious jeopardy not just by a botched attempt at toppling Saddam but also by one that went according to plan but left Group of Seven members seething with mutual hatred and distrust. ”The world once again is rent into two blocs,” said Stephen Lewis of Monument Securities, ”with a third world where these blocs contend for hegemony. It is not a cold war exactly, but there is no cooperative basis for carrying on international relations.”
How Chirac responds to this potential crisis is largely irrelevant. How the US responds is crucial — after all, it has provided the money and the muscle that has held the West together over the past 50 years or so. But there has always been a tension between those committed to multilateralism and those who see no reason for the US’s power to be circumscribed by international bodies.
With Bush having gone it alone militarily, there will be those who argue that the logic of his position is that the White House should also go it alone economically, conducting a beggar-my-neighbour dollar devaluation policy that would cause real damage to Europe and Japan, and cutting its own trade deals. If the US goes isolationist, the rest of the world may quickly get nostalgic for the bad old days of the Washington consensus. — Â