Tue, 18 Sep 2001

After New York: Economic recession?

By Frank Kane

LONDON: All summer the U.S. economy -- upon which depends the economic health of the world -- has been hanging on grimly by its fingertips. The events of last week in New York, most experts now agree, are likely to send it hurtling into recession.

This will mean falling share prices, higher unemployment, pension funding problems and, for Britain at least, the likelihood that house prices will end their 10-year surge. The great bull-run of the 1990s -- which saw the creation of more millionaires than at any other period in history -- is finally at an end.

The signs were there before the attacks in New York and Washington. Share prices had been falling for 18 months as the lunacy of dotcom mania gave way to harsh reality. Television advertising, one of the most reliable of indicators, had fallen dramatically. The big investment banks on Wall Street and in the City of London had begun to lay off employees in their thousands.

At the sharp end of the economy, the metal bashers and widget manufacturers also closed factories and sacked workers -- without the big golden handshakes that relieve the pain in the financial sector. But many economics commentators were still reluctant to cry "recession". In America the great hope was that consumers were still spending money in shopping malls, restaurants and leisure centers, and that this would keep the country's head above the recessionary water.

In residential property-mad Britain, consumers were still buying too, their optimism buoyed up by the fact that many were sitting on huge cash piles. Ten years of rising house prices, in a period of low inflation and high employment, had given many people an unprecedented sense of economic security.

All that has crumbled along with the World Trade Center towers. The full extent of the U.S. recession will become apparent only in the next weeks and months, but it does not take a Cassandra to predict that the economic effects of the attacks will be bad. Take just one fact: the U.S. stock market was closed for the best part of a week. In markets-mad America, where ordinary investors buy stocks and shares the way we British buy bread and milk, that means US$400 billion worth of business was lost while the markets were closed -- roughly equivalent to the gross domestic product of Russia.

Add in the psychological effects of losing many of the best and brightest young stockbrokers and analysts, and the destruction of the center of American capitalism, and the portents are not good.

Nobody can predict what will happen to the New York markets when Wall Street re-opens this week, but none of the City analysts who usually produce such gushingly optimistic research notes is optimistic. One big U.S. investor said on Friday: "The whole thing's already going down. We were in a downward spiral and it's going to be exacerbated. The banks are not going to be lending." This is bad news for the Americans, who borrow money to invest in stocks and shares rather than investing in property as in Britain.

Many analysts believe that there will be a "patriotic surge" in share prices this week, as Americans try to show the world they are back in business. But it will be short-lived. Tony Jackson, director of equity strategy at City investment bank ING Barings, says: "The average fund manager in Milwaukee will do his patriotic duty for a few days, maybe even a couple of weeks, but he won't swim against the tide for ever." Many expect a further 10 per cent fall in share values before any improvement.

The stock markets are not the only indicators of economic health, of course, but there was bad news aplenty elsewhere last week. On Thursday, virtually unnoticed in the acres of media coverage of the destruction of Wall Street, came two pieces of economic news that on their own would have sent shivers through the markets. Consumer confidence -- broadly, the measure of how much shoppers intended to buy -- fell to its lowest level in eight years; and there was another jump in unemployment.

This means that Americans, fearful of losing their jobs, will not go out and spend cash or use their plastic money. In the run- up to Christmas -- and this is the time of year when retailers start to estimate festive season demand -- this could have a further disastrous effect on the overall economy.

Things could get worse. If the U.S. stays true to its pledge to conduct a long campaign against terrorism, that will prolong the slump. Apart from defense and oil stocks, few industries benefit economically from warfare. The 1990 Iraqi invasion of Kuwait knocked 15 per cent off share prices and slowed economic growth dramatically, but as soon as American tanks rolled into Kuwait the markets rebounded quickly in the expectation of a short and successful war. In fact, that laid the foundations for the surging markets of the 1990s.

On the other hand, a long drawn out campaign in the Middle- East would inevitably exacerbate the economic downturn. Oil price rises would be inevitable, adding to industry's energy bill. Fewer people would travel, for business or pleasure, with knock- on effects for airlines and tourism. The worldwide insurance industry, much of it based in Britain and already reeling from Manhattan-related losses as high as US $30 billion, could face a further nightmare: billions of dollars of claims from an undeclared war.

In this scenario, the world economy would be reeling. Japan has been teetering on the brink of collapse for many years -- it would not take much to topple it over. The other export-dependent countries of the Far East would also be vulnerable, while Latin America's recent financial crisis would come back with a vengeance. Aid to, and trade with, sub-Saharan Africa would probably dry up altogether. It is hard to see how the Middle-East could benefit, even with soaring oil prices, if it was a theater of protracted war.

In Europe, Germany's economy is stagnating, while France is beginning to show signs of the same malaise.

Britain is in a comparatively strong position, but already there are indicators of a slowdown. How long could it hold out against worldwide recession? The City of London, the powerhouse of the increasingly important financial services industry, is effectively foreign owned. It is hard to imagine bankers in shell-shocked Manhattan, or depression-hit Frankfurt, maintaining their high- profile presence in London if they are forced to cut jobs at home.

With the service sector following manufacturing down, unemployment would rise, and spending would dry up. All that cash locked away in property would either be hoarded against the inevitable rainy day, when troubled banks begin to call in historically high levels of loans. Result: property market crash, personal bankruptcies soar, the bad old days of negative equity return again.

The old adage is: "When Wall Street sneezes, the rest of the world catches a cold." After the attacks on Manhattan, America's financial powerhouse is stricken, racked with fever and in intensive care.

The prognosis for the rest of the global economy must be equally bad.

The writer is business editor of The Observer.

-- Observer News Service