Market meltdown is all about mood
THE world's financial markets spent most of last year waiting for the American authorities to raise interest rates and celebrated when the move finally came in late December, because it signalled that the US economy had finally shaken off the effects of the 2008 financial crash. But a week can be a long time in stock markets. In January traders decided the world was not clawing its way back to health after all; it was headed into the abyss of another global recession and the Federal Reserve's rate hike was a cataclysmic mistake which could only make things much worse.
This is not irrational. Anyone with a sense of history has to be struck by the similarity in how the global economy has moved since 2008 when compared with its recovery from previous financial disasters brought on by banking failures in the 1890s and the 1930s.
Credit Suisse economist Jonathan Wilmot has plotted the data from these earlier follies and the way the charts fit together is uncanny. What it shows is that while the recovery in the 1890s was plain sailing, the revival in 1930s America was stopped in its tracks for a reason which sounds uncomfortably familiar. Thinking the patient had recovered, the US authorities put up interest rates in 1937, eight years after the initial 1929 Wall Street meltdown. They were too early and too optimistic. The shock brought on another heart attack.
Thus the debate today comes down to a simple difference of view. Will we continue gradually to get better as we did in the 1890s? Or is it 1937 all over again, with inept policymaking eight years on from 2008 set to induce another heart attack in our global economy?
The fear that the defilibrator is in the hands of incompetents explains the speed with which the markets' glass has gone from half full to half empty, but the results are still bizarre. The much admired Chinese economy is no longer so admirable. The slow but obvious recovery in the eurozone is no longer sustainable. The belief that there were more gainers than losers from low oil prices is no longer credible. That is what markets would have us believe but this change of sentiment comes without any shift in the underlying data.
The effect is real enough: markets keep on falling and it is beginning to change behaviour. Chancellor George Osborne has been forced to abandon his plan to sell off the Government's remaining share stake in Lloyds; Deutsche Bank has been forced to issue calming statements about its financial health. Bank of England economist Andy Haldane muses on whether this is the third and final leg of the financial crisis - after America's sub-prime meltdown and the near collapse of the euro, is it now the turn of the developing world to fall apart?
Yet if you don't work in finance it is hard to see what the fuss is about. The British economy may not be as good as Osborne likes to say it is but it is doing reasonably well even if the export performance is dire and manufacturing is suffering from the shutdowns in the North Sea. Companies are not shooting the lights out but outside the energy sector they are still reporting good profits. Unemployment continues to fall and, in London at least, there is no shortage of jobs.
The fall in oil prices is good news - unless you live in Aberdeen - because the money that used to go to filling the car can now be spent on other things. There are hardly any bankruptcies, the shops are full of goods and the customers are full of cheer.
What is odd is not just that markets see it differently but that the divergence is so marked. The market is not just flashing red, it is panicking to an extent seen only three times this century - in 2001 after the dotcom crash, in 2008 after the financial crash, and in 2011 when it looked like the euro would collapse. In each of those earlier times the danger was obvious. This time nothing much has happened, or not yet anyway. However, there is always an explanation, albeit one that does not show the markets in a good light. Finance is a young person's game and a huge number of responsible jobs in the City are held by people in their twenties and early thirties.
The last rate hike was in 2006. So if you want one reason why things have gone so sour look no further than the fact that right around the world a worryingly large number of people controlling billions if not trillions of assets have never before seen interest rates go up. When the Fed finally made its move at Christmas these people had no idea what would happen nor how they should react. This ignorance made them vulnerable, scared and much more susceptible to panic. They have not disappointed. Unfortunately, it matters because if the falls damage business confidence it could create the very recession markets are worried about.