Economic View: Green shoots mired in sludge

These times are the mirror image of the mad months at the end of 1999 when they said the boom would never end. They were wrong

It has been a rough old week. Financial markets are glum. The news about the world economy is glum. The international political scene is glum. And there is a general perception, probably correct, that things will get worse on all those three fronts.

It has been a rough old week. Financial markets are glum. The news about the world economy is glum. The international political scene is glum. And there is a general perception, probably correct, that things will get worse on all those three fronts.

On the other hand, the trough of a market or economic downswing – or indeed the run-up to a probable military conflict – always feels like this. These times are the mirror image of the mad months towards the end of 1999, when markets were booming and people suggested the long boom would never stop. "It is different this time," they said – and they were wrong.

I suppose the nearest time to this was towards the end of the early 1990s recession, when the then Chancellor Norman Lamont was derided for supposedly spotting "green shoots" in the economy. He was actually quite right to call the end of the downswing but it took many months before the recovery really gathered pace.

It is worth saying all this because there is going to be more gloom in the coming weeks. Just as it took several months for people to realise that the party was over during the first half of 2000, so it will be a long time before this crop of green shoots will be recognised as such.

Still, recoveries are never mechanical, straight-line phenomena and each one is different in its timing, detail and quirks. The thing to do now is to distinguish between the typical, bottom-of-the-market sludge – the opposite of the top-of-the-market froth – and the real concerns that will inhibit recovery.

At the top of those real concerns must surely be the general threat of deflation combined with a large overhang of debt – a global epidemic of the Japanese disease. But it is really too early to make much of a judgement on whether the world is slithering into that trap, or indeed whether gently falling prices combined with very low interest rates could be circumstances for decent, if unspectacular, growth.

Three more specific concerns are shown in the three graphs: the continued gradual downgrading of growth expectations for this year; the danger that US and UK households may be over-consuming, while the opposite danger is evident in Germany; and the extent to which European consumers distrust their new currency.

The downgrading of growth has been steady as far as the UK and eurozone are concerned, disturbing in the case of Japan, and bumpy in the case of the US. Note that these lines are not actual growth month by month; they are the consensus expectations each month, starting in January 2001, for what overall growth would be be this year.

The worrying thing is partly that everyone was so hopelessly wrong last year about prospects for 2002: the downgrades of between 0.9 and 2.3 per cent make forecasting economies two years ahead look a mug's game. Equally worrying is the recent evaporation of hopes. In the spring there was a sudden surge in expectations for the US, reflecting the strong first quarter this year. That is going now. Prospects for the US, UK and eurozone are all being cut, and I would expect cuts in Japan's figure soon.

The implicit risk is that the experts can get economies as wrong as markets. (In the case of Japan they even got the sign wrong, not just the figure.) The forecasts for next year are quite strong – but we cannot trust them, particularly as forecasts for this year are still being cut.

We also see the remarkable way in which consumption in the US and UK has soared relative to that in the eurozone in general and Germany in particular. But Americans and ourselves have done so by borrowing. Yes, we have had faster growth than the eurozone but not that much faster. In Germany the problem is quite the reverse. The Germans won't spend. Living standards are currently falling, which is rough for consumers but also rough for producers. Car sales in the eurozone are down 11 per cent on last year; both here and in the US they are up.

This is worrying because if you ask the question – where will growth come from next year? – the answer ought to be continental Europe. But until consumers spend more, that won't happen. Demand has to be domestic; it cannot be external because neither the US nor the UK can expect to sustain that stunning rate of growth of consumption much longer.

The third graph may give a partial explanation for flat eurozone demand. People feel they are being ripped off by the perceived surge in prices since the euro was introduced. On the left scale is a balance of perceptions about price rises; on the right, the official figures. HSBC, which plotted the relationship, suggests that European consumers think they are facing 5 per cent inflation when actually it is only 2 per cent. So they spend less. You could almost say that consumers have protested at the new currency by refusing to spend it.

The question is how long will they stay on strike? If they choose to save rather than spend, that is a perfectly rational choice given the uncertainties ahead. But the immediate effect is to cut tax revenues on VAT, so it worsens the already serious budgetary problems, particularly of Germany, France and Italy. My guess is that spending will gradually recover as familiarity with the euro increases, but there is little sign of that yet.

There, at least, are some things to watch: revisions to private sector forecasts, eurozone consumption, and reaction to the euro. My guess is that all three will look rather better in a couple of months' time. In the meantime, expect more bottom-of-the-cycle sludge.