Why the bear markets are talking bull
Hysterical coverage of falling share prices rests on the fallacy that they are a good indicator of economic health.
Amid the masses of hysterical news coverage of plunging stockmarkets, no one seems willing to point out the fatal flaw in the commentary. Anyone who follows such matters closely should realise that share prices are a lousy indicator of economic health. Plummeting share prices do not necessarily signal an imminent slump, just as rising prices are not a sure sign of economic strength. Yet the recent collapse of global stockmarkets is widely assumed to show that the world is on the verge of an economic depression.
Anyone who follows the television news will be familiar with the typical pattern of coverage by now. The news anchor will ask an expert what it means that a particular stockmarket index has fallen sharply over the past hour or two. Then the expert will sagely explain that some particular corporate or economic development is responsible for the latest fall.
Yet such an approach has as much validity as reading tea leaves. The ‘expert’ might as well pronounce on the future of the global economy by reading the TV presenter’s palm as by talking about share price movements.
It should not even be necessary to do a thorough study of the world economy to realise this simple fact. There are numerous everyday examples that can be used to illustrate it. For example, the Chinese stockmarket fell by about 30 per cent in the first eight months of this year – that is, before the recent global slump in share prices (1). Yet the latest forecasts from the International Monetary Fund (IMF), published only last week, suggest that China’s economy will grow by 9.7 per cent in 2008 and 9.3 per cent in 2009 (2). There are many other similar examples.
Anyone who follows share prices for any length of time will also recognise that they can move in a counterintuitive way. It is not unusual for a company’s share price to fall straight after announcing large profits. This will be rationalised along the lines that investors were expecting even bigger profits. Conversely it is common for a firm’s share price to surge after announcing large losses. The argument in such a case is that investors were expecting things to be even worse.
These are not isolated examples. A definitive study of over a century of share price movements in the world’s main stockmarkets by professors at the London Business School showed there is no correlation between economic growth and share price movements (3). If anything, there could be a negative correlation between the two.
If stockmarket indices are a poor indicator of economic performance, it begs the question of how is it possible to really understand what is going on. The best starting point when considering the health of an economy, although it is far from perfect, is probably to use conventional economic statistics. So far only a few small countries – Ireland, New Zealand and Singapore – conform to the most common technical definition of a recession: that is, two consecutive quarters of falling gross domestic product (GDP). It is likely that Japan and Western Europe will soon join them, and America might follow them, too.
The latest IMF forecast is for GDP growth in the advanced economies of 1.5 per cent this year and 0.5 per cent in 2009 (4). This is hardly stellar economic performance, but it is also far from the sharp contraction in economic output which is characteristic of a typical downturn. What looks likely is a prolonged period of slow growth in the developed world rather than a severe downturn followed by a recovery.
It is also worth noting that the developing world is likely to fare better. The IMF forecasts GDP growth for developing and emerging economies of 6.9 per cent this year and 6.1 per cent in 2009 (5). Others forecast lower growth in the developing world, but it still looks set to be significantly better than that in the advanced economies.
Rather than a classic recession, let alone the Great Depression of the media imagination, what looks likely is a slow but steady squeeze on consumption in the developed world. There are several reasons for this situation, many of which spiked has previously discussed (see Markets In Crisis). Clearly a financial bubble centred on the American property market has burst from mid-2007 onwards. This has in turn hit financial institutions that are holding debt for which borrowers are facing repayment problems – or debt that has gone ‘toxic’ in the current favoured term.
It is also important to remember that the bubble was itself a consequence of actions taken to counter the effects of an already weak economy. The American authorities engineered a massive consumer boom earlier this decade in a desperate attempt to maintain economic momentum. Low interest rates did the trick in the short term but at the cost of encouraging massive borrowing. Eventually the bubble had to burst. Credit has become more difficult to obtain and several financial institutions have gone bust as a result of the affair.
The current climate of green hostility to innovation has also played a significant, if unsung, role in the squeeze on consumption. A key reason for the upward trend in energy prices is lack of investment in new sources of supply (6). With the strong economic growth of developing economies it is necessary to invest in developing more energy supplies. Yet sufficient investment has not been forthcoming. Given that energy is an important input into agriculture – in the production of fertiliser and the use of farm machinery – higher prices have also played an important role in the surging cost of food.
But the current slump in share prices cannot be explained purely in relation to economics. There is a strong element of panic, too. The seizing up of the inter-bank markets, where banks lend money to each other, is at least partly an expression of intense risk aversion. Rather than try to identify and isolate troubled institutions, the banks have simply stopped lending to each other. The problems also look set to hit the ‘real economy’ as the traditional supplies of credit for companies dry up. Financial institutions are likely to be increasingly reluctant to lend to businesses they consider troubled in any way.
Politicians on both sides of the Atlantic have exacerbated this sense of panic by their prevarication and inconsistency. Alistair Darling, Britain’s finance minister, has declared the British economy resilient, then argued it is facing a crisis, then claimed it is resilient again (7). America’s politicians have had huge battles over a bailout package for their banks. And it should be remembered that last week’s market panic started when European Union countries took unilateral action rather than agreeing on a common approach to the financial turmoil (8).
In this context the frenzied media coverage of falling stockmarkets can also be partly seen as an expression of panic. The media, like financial institutions and politicians, are exaggerating the substance of the threat. In that sense they are like someone hysterically screaming ‘don’t panic’ in the midst of a fire. They are only likely to make matters worse.
But the media discussion cannot be explained by panic alone. There is a deeper reason why they have lost their bearings. In recent years economics has become ever more narrowly defined to focus on consumption and financial markets. The importance of the real economy of production has been increasingly downplayed. As a result of this development, it has become difficult for commentators to explain the significance of economic shifts.
Economics used to be a key terrain for political debate. In its broadest terms, some would favour a capitalist economy while others would advocate some form of socialism. This debate had the advantage of focusing attention on key determinants of economic activity. Both sides would look at such factors as profitability, productivity, levels of investment and industrial activity to determine the strength of an economy.
But since the triumph of TINA – the idea that There Is No Alternative to a market economy – real economic measures have been rarely discussed. Production is largely seen as a natural activity; hardly worthy of examination or discussion. In contrast, huge attention is focused on issues related to consumption such as branding and marketing. To the extent that the real economy is discussed, it is often seen as simply dominated by the financial markets. There is also a related trend to see economics in psychological terms – the rise of so-called ‘behavioural economics’ – rather than in relation to material developments.
This one-sidedness makes it impossible to put recent financial developments into their proper context. Real economies are often seen as simply an offshoot of the financial markets. In reality, there is a relationship between the two, but it is complex and indirect rather than one of financial master and economic servant.
A key step to start dealing with the current problems is to reawaken what could be called the ‘economic imagination’. Unless there is a proper framework of meaning in which significant developments can be understood there will always be a tendency to elevate the trivial and miss what is truly important (9). Rethinking economics may not provide an immediate solution to the world’s financial turmoil but it is a crucial starting point.
Daniel Ben-Ami is a journalist based in London and the author of Cowardly Capitalism (Wiley 2001). Visit his website here. He is speaking in the session Growing pains: the pros and cons of economic dynamism, at the Battle of Ideas festival at the Royal College of Art, London on 1&2 November.
Against austerity, by Brendan O’Neill
There Is (still) No Alternative, by Mick Hume
Congress bales out, by Brendan O’Neill
Scapegoating the spivs, by Tim Black
It’s the politics, stupid, by Phil Mullan
Lehman Brothers: when confidence runs out, by Rob Lyons
Five myths about the Wall Street crisis, by Daniel Ben-Ami
From the politics to the economics of fear, by Mick Hume
Fannie, Freddie and the ‘economics of fear’, by Sean Collins
The truth about the ‘credit crunch’, by Phil Mullan
(1) MSCI China index for year-to-date to 30 August 2008, MSCI Barra
(2) World Economic Outlook, IMF, October 2008, p2
(3) LBS puts no stock in economic growth, Financial Times, 10 March 2008
(4) World Economic Outlook, IMF, October 2008, p2
(5) World Economic Outlook, IMF, October 2008, p2
(6) Over a barrel, Fund Strategy, 25 August 2008
(7) Alistair Darling’s split personality, by Daniel Ben-Ami
(8) Blow EU Jacques, I’m not alright, by Mick Hume
(9) The ‘credit crunch’ and the crisis of meaning, by Frank Furedi
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