American consumers key to UK soft landing

The stomach says that if the US goes down sharply it will drag the rest of the world with it

It is one of those periods when the background noise tends to drown out the new signals. Hardly a day passes without some new evidence of a slowdown somewhere in the world. The list is relentless: poor computer sales in the US; a fall in German industrial output; even slower growth in Japan; new fears of bankruptcies in East Asia.

It is one of those periods when the background noise tends to drown out the new signals. Hardly a day passes without some new evidence of a slowdown somewhere in the world. The list is relentless: poor computer sales in the US; a fall in German industrial output; even slower growth in Japan; new fears of bankruptcies in East Asia.

As so often there is too much information of too low a quality. But three things do seem to be quite new. First and most obvious has been the collapse of the New Economy dream. This has led, second, to a marked shift of opinion in the US about the possibility of recession. And third, also to some extent associated with worries about the hi-tech economy, there are growing concerns about the stability of the world banking system.

The US has become the focal point for worries about a hi-tech led slowdown. This sector has been driving the US economy during its recent growth spurt: take out hi-tech and the US would be growing at about 2 per cent a year, not 4 per cent plus. Put another way, all the hi-tech companies have to do is to grow at a normal rate - say 5-10 per cent a year instead of 20-30 per cent - and the US suddenly becomes a slow-growth economy.

The shift would be exacerbated were hi-tech companies forced to make sudden cuts in their own investment, for this would in turn undermine other parts of the hi-tech economy. The market for PCs has reached something close to saturation. Is it possible that the market for, say, servers will do the same in the next couple of years?

Until recently there was reasonable confidence that America could make that transition in an orderly way: in the jargon, to achieve a soft landing rather than a hard one. There still is confidence. A typical view is that of the bank JP Morgan, which has just increased the odds on a hard landing from 35 to 40 per cent. So, that is still a minority possibility but it is an uncomfortably large one. The more talk there is of recession the more likely there is to be one.

The Federal Reserve will meet these concerns by cutting interest rates. Its chairman, Alan Greenspan, said as much earlier this week. So the key question is whether cuts in rates will be sufficient to sustain the economy. Assume a couple of quarter-point cuts, one in the spring, one in the autumn, as Merrill Lynch does, and you can still see the US growing at more than 3 per cent next year. But if there were a more general loss of confidence in the New Year, then growth would ratchet down and US corporate profitability would be savaged. Merrill Lynch sees a squeeze on profitability, rather than a recession, as the key risk.

JP Morgan, by contrast, focuses on the rise in the number of jobless. US household savings are now negative. That is sustainable in the short-run, for there are plenty of historical examples in other countries where household savings have dipped below the waterline for a year or two. But it is only sustainable while people feel they can earn their way out of trouble. The threat is rising unemployment. On the graph, the JP Morgan team has plotted the rise in jobless numbers in the early 1980s and early 1990s recessions. If the 2000 line were to continue the US would be on track for a disagreeable 18 months.

How long before we know?

My guess would be that by about March we should have a very good feel for whether the US is heading into a recession akin to that of the early 1980s or early 1990s. They were different: the former was nasty, the latter pretty mild. For the moment the strong balance of probability is towards the milder end of the spectrum, if indeed recession does come.

If it does come, will it spread? To so extent of course it will. During the last few days the dollar has fallen sharply against the euro, reflecting the market expectation that next year could be the first for a decade when US growth is lower than European. But eurozone growth is slackening too and has in any case been dependent on the strong US market. Consumer confidence is in general still high, though not as high as it was last summer. The fundamental imbalances in Europe (including the UK) are less marked than they are in the US. So the mind says that barring accidents Europe ought to weather recessionary pressures better than the US. Trouble is the stomach says that if the US goes down sharply it will drag the rest of the world with it. The stomach also says that the UK will be in its usual midatlantic position, performing half way between the US and continental Europe - though the mind says that we ought to come through the next global slowdown in pretty good shape.

Recessions are usually associated with financial crises. As is discussed in the News Analysis next to this column, the banking sector is coming under greater pressure at the moment. It is usually financial discontinuities that turn mild downturns into something more corrosive. You can see that in Japan right now, for it has been the weakness of the banks there that has made it virtually impossible for Japan to establish a recovery. The banks have so much bad debt on their books that they are frightened to make the new loans needed to finance growth. There is as yet nothing comparable to that on the horizon in either the US or the eurozone and UK banks, in particular, look in very good shape. But it is a worry.

Meanwhile if there were one single indicator to look at, I suggest those US jobless figures. While the great American consumer keeps consuming the party continues; but they will only party if they feel there is a job for them in the morning.