22 January 2016

Don’t panic, or not too much anyway


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Ever since the first worried investor sprinted around the corner of Exchange Alley in the City of London in 1720 and said something along the lines of “um, I fear this South Sea Bubble may have burst”, or if he was smart nonchalantly pretended nothing was up and calmly sold his shares (as Thomas Guy, founder of Guy’s Hospital did) mankind has wrestled with the question of how to react when share prices fall or there is an economic panic on. Of course, by now that cycle of boom’n’bust and the herding instinct was supposed to have produced world revolution and the end of capitalism, according to the Marxists. Only it has not.

Why? Well, since the South Sea disaster of 1720 and the simultaneous bursting of an even bigger bubble in Paris, what evolved into the capitalist system has produced the most extraordinary improvement in human fortunes. That economic progress has been interrupted by war and outbreaks of epic stupidity as certain individuals succumb to greed, of course. And along the way there was slavery and cruelty by the barrel load. But the positives far outweigh the negatives. Commerce and capital markets provided the wealth that seeded universities, extended school education, funded medical research, extended life expectancy and drove technological innovation.

Yes, Western government played a role in the technological improvements of the 20th century, but where did politicians get the money to pay for their projects? From taxpayers, and increasingly as the 20th century went on by borrowing from those operating in the financial markets. Every time I hear a Bernie Sanders (Hillary Clinton’s far-left rival for the Democrat nomination) or Jeremy Corbyn (UK Labour’s far-left leader) demand more spending, by which they must mean borrowing alongside more taxes, I marvel at the incongruity. They hate those markets and want to punish or banish them, but where do they think borrowed money actually comes from? They are in the curious position of hating the people in the debt markets they would borrow even more from.

But the Sanders/Corbynites are, it seems, about to have a bit of a moment if this difficult economic start to the year continues and confidence-sapping fear spreads. One can imagine Sanders or Corbyn saying soon that it’s the financial crisis 2008 Part II – déjà vu all over again. The capitalist system, they’ll say, is inherently unstable and destined to fail because it is rooted in the over reliance of greedy people on markets.

That may be nonsense – indeed, it is nonsense – but the modern Marxists will get a hearing if the situation worsens and the fragile recovery in a country such as Britain turns into a recession. For all the boasting by the Conservatives about employment levels in the UK, the Chancellor of the Exchequer looks worried with cause. This may explain why the Tories in Britain are presently throwing absolutely everything at Labour – presenting it as a deadly risk to the nation’s security – in case the economy turns and the opposition gets a chance to go back on the attack.

Indeed, the market rally towards the end of this week cannot disguise that concerns about the global economy are justified. According to China’s government, the country’s growth slowed to 6.9% in 2015, the lowest rate of expansion in a quarter of a century. You can believe whichever figures you want about the Chinese economy, such is the questionable rigour of the official data, but what is undeniable is that the Chinese government’s ability to build itself out of temporary trouble by creating infrastructure is not what it was a few years ago. On that front, they appear to have hit a wall.

In the West the oil glut and falling demand from China is not producing the bonanza that cheap oil is supposed to produce. It is not powering growth. Economists for JP Morgan Chase estimate that this year it will add only 0.1% to US growth. Their rivals at Goldman Sachs say cheap oil will have almost no benefit. Add in a disaster movie’s worth of geopolitical risk – in the Middle East, North Africa, Russia and in the potential disintegration of the European Union – and you might be ready to end it all now. Oh, and we still haven’t worked out how to unscramble the consequences of QE and eight years of stimulus and excessive cheap money.

Note that I haven’t even mention Donald Trump yet. The party of Abraham Lincoln, Teddy Roosevelt and Ronald Reagan may end up with Trump as its nominee. The National Review, the influential conservative American magazine founded by William F Buckley Jr in 1955, is so concerned that it has launched a kamikaze-style attack on Trump, dedicating its latest issue to an attempt to make Republican voters see sense. This is understandable. The Trump agenda is insane. The golf-obsessed hotelier and television personality from hell wants to expel 11 million illegal immigrants, breaking apart families in the process. Then he proposes to build a giant wall and conduct a foreign policy that will be run according to a crazy rule-book written by 1980s Hollywood action heroes.

But fear not. Here are five reasons to moderate the panic. Look on the bright side, for a second:

1) Er…

2) Only joking. I do have four reasons. Someone will stop Donald Trump. America is too great a country to let him become President.

3) Downturns cannot be eliminated and there is no use pretending they can be. They are part of the cycle of innovation and reinvention. They reflect human nature and the tendency for people to go too far when money is cheap and the economy is improving. What is happening now is a necessary shake-out, after a period of crazy valuations in industries such as technology. From the US, to Israel, and in Britain in London, Cambridge and beyond, an entrepreneurial revolution is underway and extraordinary companies are being built.

4) For all that it is worthwhile being sceptical about the claims made for China, its leadership seems to be genuinely committed to economic reform and the country is learning the important lesson that micromanaging the stock market centrally tends not to work very well. China is in transition from investment and exporting cheap goods to domestic consumption and high-end services, which should be a boon for good Western businesses eventually. It will take time but it should be a positive development.

5) This week CapX had a record week for traffic.

Ultimately, I suspect that avoiding a correction in the economy turning into a crash will come down to the US, which for all it has been cast as the fading power in China’s shadow is still the most energetic and powerful engine of technological innovation and wealth creation. Last week in the City I spent an hour talking with one of the sharpest veterans of the Square Mile, someone who has seen a great many crashes but who has also been pivotal in the construction in the last 50 years of an enormous expansion in London’s capabilities and in global capital markets. “If America is ok, the world will be ok. That’s how I always look at it. Let’s hope America is ok.”

Indeed, let’s hope America is ok.

Iain Martin is Editor of CapX