Sunday, April 13, 2008
Gloom reigns, but the world is not about to go pop
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


Gloom, gloom and more gloom. Gloom from Washington and the International Monetary Fund (IMF). Gloom from Halifax, West Yorkshire, on the housing market, of which more below.

Even the Bank of England's quarter-point cut in interest rates was gloomy, given it was forced into this by what it described as "worsening" credit conditions. Seldom has a rate cut been greeted with more of a shrug, or such a widespread perception that it will make no difference.

Can I say anything to lift the gloom? Let me start with the IMF. Its latest world economic outlook, published to coincide with the spring meetings it co-hosts with the World Bank, did indeed have some scary language.

"The financial market crisis that erupted in August 2007 has developed into the largest financial shock since the Great Depression," it said, and there was now a one-in-four chance of a global recession, something it had dismissed last year as barely worth mentioning. It calculates that global losses from the credit crisis will hit $945 billion (480 billion).

This is enough to give anybody nightmares. The losses, equivalent to more than a third of Britain's annual gross domestic product, are significantly up on earlier estimates. Talk of the Great Depression is, if not alarmist, certainly alarming.

Let us be clear, however, that the IMF is not predicting such an outcome for the world economy. America's economy shrank by some 32% over the 1929-32 period. In contrast, its prediction for the next couple of years is growth of 0.5% and 0.6% respectively. That is uncomfortably weak for Americans, but implies only a mild recession.

This is also true of the IMF's global forecast. Five years ago, when the Iraq invasion appeared to have gone well, its world economic outlook was upbeat. The global economy, it suggested, would grow by about 4% a year over the following three to four years.

It was not a bad forecast but it was too cautious. In the event, the world economy managed 5% annual growth over the 2004-7 period, the best for three-and-a- half decades.

But keep that 4% in mind it's close to what the IMF predicts for the next couple of years (3.7% and 3.8% respectively).

What was strong a few years ago looks weak in the context of the global economy's recent performance. But 3.5% to 4% growth is still pretty good, and far stronger than during recent world recessions, around the turn of the millennium and in the early 1990s.

It feels gloomy because the balance of global growth has shifted away from the advanced economies. Divergence rather than decoupling is the new buzz word and it is also the new reality.

While advanced economies will grow by 1.3% this year and next, emerging and developing economies will expand by 6.7% and 6.6% respectively.

The fact is that the credit crisis is hitting the West hard, while China, India, Russia, sub-Saharan Africa and the Middle East are all booming.

If you are in America, with barely any growth, or Italy, with today's election being fought in an economy predicted to grow by only 0.3%, things feel grim. In China, 9.3% growth, or Russia, 6.8%, policymakers are more worried about inflation than recession.

As for Britain, the IMF's forecast of 1.6% growth for this year and next is stronger than America, plainly, but also outstrips Germany, France, Italy and Japan. It may not be a great prize to win, but over the next two years Britain will vie with Canada to be the strongest-growing economy in the G7. That does not fit the description of a country acutely vulnerable to the credit crisis. The fact that Britain is seen to be growing more strongly than Europe is also hard to square with sterling's slide against the euro, though the single currency's strength will be a constraint on euroland growth.

It could be, of course, that the IMF is still too upbeat on the global economy. Simon Johnson, its chief economist, conceded last week that it had been last year but maintained that the organisation had learnt a lot about the effect of the crisis.

Certainly there is no indication in its report that it has tried to minimise the impact. And there is no evidence that the world economy, while damaged by the crisis, is about to go pop.

Here, the Bank's monetary policy committee, when it sat down to consider its rate verdict on Thursday, was caught between a rock and a hard place.

Had it not cut, any mild satisfaction it could have obtained by not bowing to some obvious political pressure from Gordon Brown would have been lost in the criticism it would have had from all quarters for sitting on its hands. Had it cut by half a point, people would have interpreted it as capitulation and panic. Its task remains that of preventing a downward spiral.

Credit crises, when you are in them, appear both permanent and terminal. But they do pass. The IMF usefully lists past examples. In Britain, the last time there was a credit squeeze associated with a banking crisis was in 1975-76, and it lasted about six months.

Other credit squeezes happened in 1966-67, lasting nine months; 1991-92, 15 months; and 1993-94, 18 months. This one, dated from the moment it broke into the open, is about seven months old. If it runs on until the end of next year, as some predict, it will be very long by past standards.

By then, of course, the Bank should have cut rates a lot more. It may even do so again next month.

PS: If it's not yet time to throw in the towel on the world economy, what about Britain's housing market? Surely Halifax's shocker a 2.5% drop in house prices last month alone was confirmation we are in an almighty crash?

Since the credit crisis broke there has been a respectable position, now taken by most economists, that this would be the trigger for a significant house-price correction. I certainly considered that in August-September. We should distinguish that, of course, from the obsessives you can find in the internet's darker corners, who have been wrongly predicting an imminent crash for years.

But, without shooting the messenger, it seems to me that Halifax's figure gave us an object lesson in how not to interpret statistics. When a number is so far away from the norm, we should treat it as odd. Yet the figures were reported slavishly and the markets took them at face value.

The lenders' statistics have been behaving slightly strangely in recent months. Halifax fell early, then recovered, then fell again. The statistics may have been distorted by home information packs (Hips), smaller samples than usual, or by the lenders' own valuation policies.

Since summer the Halifax index is down 4% and the Nationwide nearly 3%. In contrast, the government's measure based on a larger sample was up 1% (to January), while the Land Registry shows a rise of nearly 2% (to February) and the FT-Acadametrics index, to March, is also up nearly 2%. This may simply reflect different stages in the buying process but the contrasts are significant.

What is the true picture? Housing activity is down sharply and prices, I think, are slipping, but the lenders' indexes seem to be overstating it. It may be this is just a stay of execution and soon every measure will be going the way of the Halifax. But let's wait a while before declaring that the crash has started.

From The Sunday Times, April 13 2008