What can one say after a week like that? Dramatic market moves can be
cathartic or a signal of grim times ahead. Dramatic policy moves can either
be desperation or a well-judged response to prevent gloom turning to
disaster. G7 promises of drastic action may be praised or dismissed as a
damp squib.
If I say only time will tell, many will see it as a cop-out, but it is also
the only sensible thing to say. So volatile and destructive are markets that
apparent calm gives way to frenzy at the drop of a hat. Once-in-a-lifetime
events happen almost daily; the unthinkable becomes routine. Huge
stock-market falls become almost matter-of-fact.
The government announced on Wednesday what would have seemed unthinkable a
month earlier - a mass bailout of the UK banking system, including at least
£50 billion of taxpayer-funded capital injections and almost limitless
provision of liquidity and official banking guarantees.
The Bank of England, caught since April between worries about inflation and
the credit crunch - one member of its monetary policy committee voted for a
rate hike in August - was suddenly taking part in a coordinated half-point
rate cut with the Federal Reserve, the European Central Bank and other
central banks. Even after the September 11 attacks on America, central banks
did not cut rates on the same day. The ECB, making hawkish noises until a
few days ago, underwent an even bigger Damascene conversion.
The stability and restructuring plan (Sarp), as Gordon Brown calls it - the
name has not caught on but is better than comprehensive restructuring action
plan - is bold and clever.
It ticks all the boxes of recapitalising the banks, providing them with
another huge slug of liquidity - at least £200 billion under the special
liquidity scheme - and up to £250 billion of government guarantees against
new debt issuance by the banks. It hangs together as a package; the banks do
not get the guarantees unless they agree to the recapitalisation.
It is a reminder that the policy machine can be very good indeed. The British
plan will be a template for other countries and undoes some of the
reputational damage suffered by the Treasury, Bank and Financial Services
Authority over the past year.
Real wars are under the spotlight of 24-hour TV and so are economic wars.
Policymakers, like generals, will have often thought about putting a boot
through the screen in recent days. History is being made. So where does it
leave us?
One quick way of assessing the economic impact of the past three to four weeks
is to look at the International Monetary Fund, holding its annual meeting in
Wash-ington this weekend. On September 18 John Lipsky, its deputy managing
director, gave a speech looking forward to the IMF’s new forecasts.
Global growth, he said, would be 4% in 2008 and somewhat below 4% in 2009. At
that time the IMF’s last assessment for Britain was 1.4% growth this year,
1.1% next.
Now the air is thick with the sound of economists chopping forecasts. Global
growth this year is expected to be 3.9%. “Somewhat below 4%” next year has
turned into 3%. Britain is seen as growing by 1% this year and shrinking
0.1% next.
The IMF’s best guess is that the crisis of the past few weeks has lopped a
percentage point off next year’s economic growth and, as it admits, there
are considerable “down-side risks” to its new projections.
Hank Paulson’s decision to let Lehman Brothers fail – the first domino and a
move attacked by French finance minister Christine Lagarde last week as
“horrendous” – will cost the world about $650 billion (£378 billion) of lost
output next year. Britain loses about £15 billion of GDP.
The shape of the IMF forecast is as it was: not much growth in advanced
economies but a lot in the emerging world. All, however, are expected to be
less strong than previously thought, so advanced economies as a group will
grow 0.5% next year, emerging economies by 6.1%, boosted by China with 9.3%
growth and India with 6.9%. To put this in perspective, 3% global growth
would be stronger than the 2001-2 world recession (which Britain escaped),
and stronger than the recessions of the early 1990s, early 1980s and
mid1970s. For advanced economies taken together, however, this will be worse
than the early 1990s and similar to the two earlier recessions. The world is
being kept afloat by China and India.
In Britain’s last big economic crisis, sterling’s “Black Wednesday” plunge out
of Europe’s exchange-rate mechanism (ERM) in 1992, policy activism worked,
though it took time for the gloom to lift.
This was when, under Norman Lamont, a new policy was built out of the ashes of
the ERM disaster, focused on an inflation target. The policy - including
aggressive rate cuts - led to sustained recovery.
There are big differences. Then we were at the end of a recession, now we are
in the early stages. It was a European problem, rather than a global banking
crisis. And, while the Bank blew Britain’s currency reserves in a vain
attempt to prop up the pound, the cost to the taxpayer was small.
All crises end, and this one will be no exception. The IMF predicts a recovery
will “progressively take hold” next year but recovery will be “unusually
gradual”.
The Bank, in taking part in the coordinated rate cut, noted everything was
weak and appeared to acknowledge recession, pointing out there was no growth
in the economy in the April-June quarter and that surveys suggest a further
weakening in the second half. This must also be the message from its own
regional agents.
Predictions, as I say, are risky, but the “Sarp” looks the right way of
ensuring the stability of the banking system – if it is put into place
quickly. Stabilising the economy, after all the frights of the past month,
will take longer. The kind of forecast the IMF has for Britain next year,
essentially zero growth, is weak but not disastrous. If the Sarp works, and
is bolstered by further bold moves on interest rates, it could be possible
to avoid anything worse.
But if the events of the past month have removed any growth from Britain’s
economy next year, what will the next couple of months bring? Britain has
come up with a good plan but remains at the mercy of the markets. They need
to stabilise, and fast.
PS If there was ever a prime minister made for the Davos World
Economic Forum it was Tony Blair. Some of us have had the privilege of
seeing Klaus Schwab, its president, pouring his own Swiss syrup over him and
probing him with questions of the “How difficult is it to be so wonderful?”
variety. Even Blair blushed.
Gordon Brown is no Davos man, regarding it as something to be done in a day.
The two are unrelated but while the Forum was in love with Blair it was also
in love with the British economy, regularly giving it a high ranking in its
annual World Competitiveness Report.
Now the affair is over. Britain is down from ninth to 12th place, ranking
behind America, the Nordic countries, Singapore, Hong Kong, Japan,
Switzerland, Germany and the Netherlands.
Business leaders like the flexible job market and still think we have
competitive financial markets (though they have slipped from second to fifth
in the world). The real dive is on the macro-economic environment, ranked a
lowly 58th, due to “low national savings, a growing public-sector deficit
and consequential public indebtedness”. Brown needs to do some schmoozing.
david.smith@sunday-times.co.uk
Writing three days after the date of your article David we can now see that perhaps the banks have some stability for the moment it is now evident that unemployment and recession loom as equally large or worse clouds on the horizon, and I fear the worst. I hope not but it feels like the 1980's soon
Chris Stuart, Carentan, France
Well at last something positive, this should work, or are there any more skeletons in the cupboard?
A bargain or should it be Caveat emptor?
Segen oder Fluch?
A Walton, Leicester, England
Zero skips in your street?
Peter Cooper, dubai, United Arab Emirates
Wrinklies know about feed-forward, that amplifies but destabilises radio signals; It's what's messing up stock markets.
Technies, also like me, know how to cope with it. You have to realise that every action reverberates, and accept and allow for this from the start. High-brow but it works!
Noel Falconer, COUIZA, France
Markets have mass, momentum and inertia just like physical objects.
Policy makers can encourage stability by measures which damp the velocity of movements and limit the range of movement.
Nick Wilson, Cambridge, UK
The bank liquidity and capital crisis is getting fixed by state support; shares prices now reflect the sharp recession that has started. Any complex mechanism will overshoot - up or down - and we are now entering overshoot territory. Bargain basement share prices...LSE needs a big red SALE sign!
Paul, Witney,