John Rapley - Foreign FocusTHIS NEW year may be a make-or-break time for us. Having run up the country's debt to lay the foundations for future economic growth, the government like those of many developing countries is counting on a rebound in the world economy to swell tax revenues and thereby restore balance to the nation's finances. Can we hope for better days ahead?
Economic forecasting is risky at best, but the current omens give cause for pessimism. While the monetary officials of the industrialised countries maintain that the world economy is recovering from recession, the risks of a slide backwards appear to be growing.
First, there is the problem of global asset values. The great bull market of the 1980s and 1990s has clearly ended, as the world's major stock markets have now finished their third losing year in a row. So far, the impact of the stock market slide on the 'real' economy has not been drastic, but that may well change. If, for example, the New York market falls back again this year, it will mark the first time in history it has done so for four straight years. The last time it performed so badly was in the Great Depression.
In some countries, the fall in the stock market has been partially offset by rising house prices. This appears to have sustained consumer spending. But house prices are now showing signs of moderating, and debt levels are reaching historic levels. Without a rebound in asset values, it seems inevitable that consumer spending will be reined in.
The Christmas shopping season in the US, reportedly the weakest in 30 years, may be an early indicator. And if consumer spending in the US falls back, there are no countries which can take up the slack. Japan is mired in economic gloom and Europe is flirting with recession.
So, might the world's major stock markets rebound? Not likely. Of course, most of the analysts are still bullish. But then they have been for each of the last three years. The fact is that stock markets have been kept from plunging further by a drastic loosening of money supply. The world's central banks have pumped hundreds of billions of dollars into the world economy, and some of this has found its way back into the markets.
However, prices remain high. Moreover, earnings are likely to drop. In the US, many firms have counted on pension surpluses to swell their earnings. During the 1990s, the booming stock market left them with a lot of paper wealth, which they transferred to their bottom lines. Over the last three years, they have continued to bank on these earnings.
However, pension funds have actually bled as their investments have lost value. There is now a huge gap between expected and actual earnings. Once financial statements begin to recognise that and they will probably have to do so soon earnings will slide. This, in turn, will put downward pressure on share-prices. The US Federal Reserve Board may well further loosen liquidity to shore up stock prices, even if it is uncomfortable with their lofty levels.
The problem is that there is not much room left to loosen interest rates are already approaching zero while an external inflation shock may yet hit the American economy. Oil prices are rising, as war fears build and the crisis in Venezuela deepens. Meanwhile the dollar is falling, and some economists predict a sharp drop in this year.
Should this happen, this will push up the cost of imports to the US. American firms will likely take advantage of this to raise their own prices. An inflationary shock remains unlikely. But then, so too does a continued slide in inflation of the sort that will permit much more monetary loosening. This, in turn, may also mean that the housing boom has run its course, or is close to doing so.
So the outlook is not so good. If the US economy slides back towards recession, the world economy is sure to follow. Decreased tax revenues in some developing countries are likely to produce financial crises, of the sort last seen in 1997-98. This time around, the financial contagion may be confined to the Third World. Nevertheless, it may mean that we have a rocky road ahead.
John Rapley is a Senior Lecturer in the Department of Government, UWI, Mona.
