Scroll the film forward a year. It’s January 2007 and time for Davos again. Only one topic of discussion interests the ”fat cats in the snow” (as Bono calls them) — that’s how on earth they missed the glaring signs a year earlier that something big and nasty was about to happen.
Davos 2006 had a low-key, complacent feel about it. The hefty contingent from the United States corporate sector was spectacularly unconcerned about the possibility of a hard landing and airily dismissed talk that the chickens were about to come home to roost.
Many of the world’s leading economists gathered at the World Economic Forum shared this upbeat view. Jim O’Neill, chief global strategist at Goldman Sachs, believes that 2006 could complete a three-year period in which the global economy grows more strongly than at any time since World War II. Even if the US should slow this year, the growing strength of the BRICs — Brazil, Russia, India and China — will take up the slack.
Stuff and nonsense, says the Cassandra of Wall Street, Morgan Stanley’s Stephen Roach. Fairy tales are no basis for sustainable economic growth, he says, and the reality is that US growth is dependent on ”funny money” — the proceeds of a speculative bubble in housing that is about to burst. As it happens, Roach was saying exactly the same thing in Davos last year and probably the year before that. The financial markets certainly don’t share his view; equity prices have been rising and volatility is low. The baseline case is that the US’s import-led growth will be balanced by Asia’s export-led growth and that there will be a soft landing in the US as a result of judicious increases in interest rates.
Larry Summers, a former US treasury secretary, injected a note of caution last weekend. If you’ve been waiting for a bus for a long time, he said, and one hadn’t arrived, there were two possible explanations. One was that the buses were not running; the other was that the buses would all arrive together.
The period of maximum risk, said Summers, was not the moment of maximum alarm, but the time when the maximum alarm had passed. ”That’s when complacency sets in,” he commented.
Historically, Summers is right. As he noted, the markets were more relaxed about the Nasdaq when it was at 4 500 — and close to the point where it crashed — than they were when it was 3 500. Kevan Watts, chairperson of Merrill Lynch International, noted that when the financial markets closed on July 31 1914, they had failed to spot that World War I was about to start the next day.
It is, of course, entirely plausible that the optimists are right. The sheer resilience of the US economy should never be underestimated, and it may be that the imbalances in the world economy are part of the natural process of global integration. Normally, economists would expect interest rates to be pushed up by the US’s appetite for global savings to fund its enormous trade deficit. But that has not happened. Long-term interest rates are unusually low, in large part because markets assume that inflation will stay low. They are not especially concerned about excess demand in the US when there is excess supply from China and other countries reliant on exports for their growth.
This, though, is getting perilously close to saying ”it’s different this time” — traditionally the four most dangerous words in financial markets.
It’s what people said in 1999, 1929 and almost certainly in 1720 when the South Sea Bubble was about to pop.
So, if in a year’s time the Davos regulars gather in chastened mood, what signs of danger might they have ignored? Imagine that a decade ago, you had had a crystal ball and could have read today’s news — unspun and uncommented on. The first story is about Iran being at odds with the West over its nuclear programme. The president of Iran, you discover, would like to wipe Israel off the map, as would the new ruling Palestinian party, Hamas.
The next story is about growing concern in the US over the number of military casualties in Afghanistan and Iraq: two countries that neighbour Iran. As a switched-on reader, you wonder what all this is doing to the price of oil. Turning to the financial pages, you find out. Oil prices are no longer $20 a barrel, but touching $70, with expectations that they may go higher.
Staying with the business pages, you find that Alan Greenspan, the grand old man of the Federal Reserve, is about to retire. He will mark his departure by raising US short-term interest rates for the 14th consecutive meeting.
Greenspan, the report says, cut interest rates to 1% in the wake of the terrorist attacks in September 2001 and cheap money has pumped up the US property market, allowing homeowners to borrow money against the rising price of their main asset. The US is now running a current-account deficit of 6% and rising, the cost of military action and clearing up an immense natural disaster blamed on climate change has been to push the budget deficit to 3,5% of the gross domestic product and the savings rate has fallen to zero. You read the figures again because you can’t believe they are true. They are.
What does this mean for the dollar? Surely, you think, it must be dropping like a stone. It isn’t, because, as you discover, central banks in Asia are buying greenbacks in huge quantities so they can keep their own currencies at artificially low levels in order to keep enjoying export-led growth. The ability of American consumers to continue living beyond their means, you find, is now dependent on the actions of the communists still in power in Beijing.
A couple of other stories catch your eye. There is concern about something called avian flu which, according to the World Economic Forum, has the potential — small, admittedly — to turn into the 21st-century equivalent of the Black Death. And Russia is playing hardball with its neighbours over gas supplies.
What’s your response? Yes, there’s a bit of encouraging news from Germany and reports that Japan may have, at last, turned the corner after more than a decade in the doldrums. But that’s not what leaps off the page. The world of 2006, seen from the perspective of 10 years ago, has a profoundly unbalanced economy, high energy prices and a volatile Middle East. It is threatened by climate change, terrorism and a pandemic.
Perhaps you would be sanguine about all this. Perhaps, though, you would be worried sick that any one of these risks could set off a chain reaction that would make 2006 a year to forget. One thing is for sure. You wouldn’t bet too much money on a soft landing. And rightly so. — Â