Meanwhile, on the stock market…

The Duncan Weldon Economics Matters Column

The last few days have been traumatic. We’ve had scenes of absolute panic, much damage has been done and the authorities have absolutely failed to get a firm grip on the situation.

I’m talking of course about the stock market.

The FTSE 100 index of leading shares has now fallen by triple figures for four trading days in a row – something which has never happened before.

Yesterday morning I tried to sound a note of calm, pointing out that markets rarely fall in a straight line, that the short term sell-off was overdone and that we should expect a bounce soon. I now know how Nick Cohen felt as his Observer ‘there are no riots in the UK’ article went to press on Saturday night.

The global economy is in a mess. The issues in the Eurozone are well known, whilst the UK and USA are both experiencing very slow growth and the renewed prospect of a double-dip recession. Japan is struggling to recover from the blow dealt by March’s earthquake whilst the Chinese government is concerned about ‘over heating’ of its own economy.

Whatever the rights and wrongs of S&P’s call to downgrade US debt last Friday, the timing couldn’t have been worse.

The banks (especially in Europe) are once more at risk – overly exposed to sovereigns which may have to default, causing losses on large bond portfolios.

In Britain our export prospects look increasingly weak given trouble overseas, corporations are reluctant to invest, consumers are over indebted and not spending and the government is embarked on the largest fiscal tightening in post-war history.

What we are seeing in the financial markets now, at least in Britain and the US, is not ‘debt scare’ – it’s a classic ‘growth scare’.

Equities (shares) are plummeting, the yield on government debt (the interest rate the market charges the government to borrow) is falling and commodity prices (other than gold) are sharply heading lower.

If the markets were concerned about government debt in the UK or USA we would expect the yield to be rising – markets would want to be compensated for the increased risk of default.

Lower share prices and lower commodity prices (from oil to copper) represent the markets pricing in lower growth and/or a recession. Lower bond yields reflect reduced risk appetitive and a lower chance of inflation.

George Osborne boasts that lower yields show Britain is a ‘safe haven’. Try telling that the Japanese who experienced extremely low yields through out their two ‘lost decades’ of stagnation.

This is a global growth scare and the government is responding as if it’s a concern about debt. Their solution, rigidly sticking to tough austerity, is actually part of the problem.

There are now numerous flash-points on the economic horizon that could trigger a full blown financial crisis – Italy & Spain being the most pressing. But even if a 2008 style crisis is avoided we’ll be left with the problem of low to no growth and no government plan to deal with it.