"Some observers" now believe that the next shift in U.S. interest rates may be down, not up. From what I hear these "some observers" are quite highly placed in the monetary policy-making decision structure. This is a measure of how much the 30% decline in the S and P Composite this year has caused or signalled a likely further fall in business investment.
Grrrr: After sharp falls last week, the world's stockmarkets began another frightening rollercoaster ride this week. The bear market has devastated portfolios and frightened investors. Can confidence be restored?
...Stockmarkets, though, continue to slide, and each recovery in share prices has been reversed with the next piece of bad news. Of that there has been plenty, especially in America's corporate sector, with a series of spectacular accounting scandals which have brought down some of the world's biggest companies. Irregularities at Enron, Andersen, WorldCom and others have shaken international confidence in American capitalism. This is a headache for two groups of policymakers. Those concerned with corporate regulation are having to work fast to come up with convincing proposals to restore confidence in the system. And those whose job it is to maintain economic stability have to judge what action, if any, they need to take.
Some hint of how concerned this latter group is should come from Mr Greenspan this week. Until very recently, most economists reckoned the Fed would start to raise interest rates, now at 1.75%, the lowest level in forty years, sometime during the summer or early autumn. Now the consensus of opinion is shifting towards no move until next year; and some observers think a further cut might even be on the cards if share prices, and confidence, fall further...
THIS is not a good time for those of a nervous disposition. Stockmarkets in London and New York plunged again at the start of another trading week, the losses building on those accumulated in last week’s rout. In London on Monday July 15th the FTSE-100 index fell 5% to below the pyschologically significant level of 4,000 for the first time since December 1996, and later that day in New York the Dow Jones Industrial Average dropped some 440 points at one stage. Share prices later rallied in New York to close only 45.34 points lower at the close, and London prices rallied the following day. But such bouncebacks are normal as a few brave, or foolhardy, investors try to pick up bargains. No one can be certain how much further prices will fall. But one thing seems clear: the markets are close to panic. The Dow Jones Industrial Average has fallen by nearly 30% since its peak in January 2000, and the FTSE-100 index has lost more than 40% of its value over a similar period. There is no sign yet of a sustained recovery.
Efforts to restore confidence among investors seem to have done more damage than harm. The breathtaking market declines of last week accompanied two speeches by President George Bush declaring his determination to crack down on the accounting fiddles that have shaken American business and alarmed investors. The president's remarks seemed to undermine, rather than bolster, sentiment. His proposals were considered too weak and too vague to have much effect, and questions about his own probity became a key issue. The sharp market declines this Monday came as Mr Bush declared that “This economy is coming back. That's the fact.” Investors may be dreading Mr Bush's next speech.
Hopes for some steadying of the markets now focus on someone with a bit more credibility with investors: Alan Greenspan, chairman of the Federal Reserve, America's central bank. Mr Greenspan testifies before a Senate committe on Tuesday, and before a committee of the House of Representatives the following day. Mr Greenspan has limited room for manouevre, and he will speak as cautiously as ever. Nevertheless, fund managers around the world will be scrutinising his every word in the hope of finding some reason to believe the worst is over.
For more disinterested observers—economists, for instance—the current behaviour of the markets is grimly fascinating. Why has the boom turned to bust? And how much further will markets fall before they turn around? These are also the preoccupations of those watching their assets, or their pension funds, shrink at an alarming rate. For anyone coming up to retirement, and whose pension fund is linked to stockmarket performance, the speed and extent of the fall in share prices could mean a radical, and painful, adjustment in their plans.
Policymakers, too, are keeping a close eye on the markets. The economic impact of falling share prices is not wholly understood. This makes the risks difficult to assess precisely, and yet the potential for harm is clear. If, for example, the collapse in equity prices is sufficiently steep and prolonged, consumer confidence could be undermined. Individual shareholders might feel poorer and decide to spend less and save more—the so-called “wealth effect”. Companies would feel squeezed both by falling demand and the greater difficulty they experience in raising funds for investment.
In extreme cases, this could dampen economic activity, and threaten to tip economies into recession, or stifle recovery. The 1929 Wall Street crash, which was followed by the Great Depression of the 1930s, is the episode which concentrates minds when panic hits the markets. In fact, the popular perception is mistaken: the prolonged depression of the 1930s was a result of overly tight monetary policy, a lesson that subsequent generations of policymakers have taken to heart. But that does not mean that judging when, and by how much, to relax policy to accommodate stockmarket shocks is easy.
Indeed, fine tuning, whether of fiscal or monetary policy, is notoriously difficult, partly because the linkages between markets and the real economy are still imperfectly understood. And when long slides in share prices coincide with global economic downturns—themselves rare enough—the risks, and the scope for mistakes, is all the greater.
The world’s big stockmarkets, with the exception of Japan's, peaked in 2000; and the world’s biggest economies slid into, or near, recession the following year. The long bull run of the 1990s, and the unprecedented American economic boom over the same period, ended with a sudden jolt. The Internet bubble burst, high-tech companies watched their share prices and demand for their products slump. The Federal Reserve slashed interest rates as soon as it became clear that real demand in the economy was falling; rates were cut eleven times during 2001. Even the European Central Bank (ECB), not known for its rapid responses, cut interest rates three times.
The big European economies, and Germany in particular, have struggled to pick up momentum this year, though most forecasters reckon the worst is over. America responded more rapidly to the more accommodative monetary-policy medicine, and in the first quarter of the year, bounced back from the mildest recession of record at an unexpectedly strong pace. Nobody expects the annualised growth rate of 6.1% to be matched during the rest of 2002, but for now, at least, the recovery, though sluggish, seems to be just about on track.
Stockmarkets, though, continue to slide, and each recovery in share prices has been reversed with the next piece of bad news. Of that there has been plenty, especially in America’s corporate sector, with a series of spectacular accounting scandals which have brought down some of the world’s biggest companies. Irregularities at Enron, Andersen, WorldCom and others have shaken international confidence in American capitalism.
This is a headache for two groups of policymakers. Those concerned with corporate regulation are having to work fast to come up with convincing proposals to restore confidence in the system. And those whose job it is to maintain economic stability have to judge what action, if any, they need to take.
Some hint of how concerned this latter group is should come from Mr Greenspan this week. Until very recently, most economists reckoned the Fed would start to raise interest rates, now at 1.75%, the lowest level in forty years, sometime during the summer or early autumn. Now the consensus of opinion is shifting towards no move until next year; and some observers think a further cut might even be on the cards if share prices, and confidence, fall further.
The current nightmare haunting policymakers is not so much a repeat of the 1929 crash but the more recent experience of Japan. There share prices peaked in 1989 and have never recovered while the Japanese economy has been crippled by four recessions in a decade. There is no shortage of explanations for what went wrong in Japan, but insufficiently aggressive monetary policy is widely held to be partly to blame.
The Fed has already acted to avoid that mistake. And even in Europe, where the ECB continues to insist that price stability is its only statutory responsibility, what the bank has done does not wholly match what it says: it has shown itself willing in practice to miss its own inflation targets.
Greenspan's eye is on the markets
The share-price bust has given new impetus to a long-running debate among economists about how monetary policy should respond to asset-price bubbles. If in some circumstances it makes sense for the authorities to act to stabilise the economy when asset prices—whether share or property prices, for example—fall, should they take action when prices rise sharply, in what appears to be an unsustainable fashion?
Mr Greenspan himself touched on this when in 1996 he talked about irrational exuberance in stockmarkets—interpreted both as a indication that the bull market of the time could not last and that he was concerned about the consequences of its ending suddenly. Yet the Fed was subsequently criticised for not acting—by raising interest rates—to curb the over-exuberance. If he had acted earlier, the earlier boom would not have been so excessive, and the current bust not so deep or damaging. Of course, no one can be sure of that. And what to do in a boom is no longer the pressing concern of anyone but academic economists. Right now, what everyone wants to hear from Mr Greenspan is reassurance that America's economic recovery has not been derailed by the stockmarket.