From The Times July 28, 2008 Pessimists are basing their gloom on old news Anatole Kaletsky: Economic view
A theme of this column for almost a year has been the contrast between apocalyptic views in the financial markets about the earth-shattering consequences of the credit crunch and the rather more mundane evidence from the real economy of a mild recession, at worst. My view has been - and remains - that this episode is likely to be remembered as one of those extremes of panic or euphoria in financial markets, which tend to reoccur once or twice every decade, when market prices - of bank shares, of oil, of the dollar and of several other assets - turn out to be simply wrong.
In making this argument, I have been accused of ignoring market realities and being blindly contrarian. And I fully agree that contrarian thinking as a general philosophy is often financially dangerous and intellectually self-deluding. Oddly enough, though, it seems that at present the analysts who are doggedly pessimistic are being contrarian and defying economic evidence. Meanwhile relative optimists, especially about the American financial system and housing markets, which are generally believed to be the source of all the world's economy problems, are merely putting forward a straightforward conventional view.
The consensus view among economists, as opposed to financiers, at present is that the United States is experiencing, at worst, a mild recession and perhaps only a typical mid-cycle slowdown. This consensus view is reflected, for example, in new economic forecasts published by the US Federal Reserve Board and the IMF in the past two weeks, both of which were revised significantly higher relative to their expectations of a few months ago. This relatively benign consensus view is also shared by stock market analysts outside the financial sector, who generally expect rising profits in most businesses apart from banking, retailing and real estate.
I would argue, therefore, that the true contrarians at present are the bankers and headline-writers who keep predicting economic Armageddon. And in the past two weeks the markets themselves seemed to be coming round to this viewpoint, taking heart especially from the government guarantees offered to Fannie Mae and Freddie Mac, the US mortgage giants. Hence the 40 per cent gain in financial stocks on Wall Street in the week since the US Government made its mortgage announcements - the biggest weekly gain ever recorded by any market sector monitored by the Standard & Poor's.
So the financial and economic world appeared to be moving towards a fairly benign convergence - until the end of last week, when the world economy was again hit by a flurry of shockingly bad news. Consider some of the announcements made over a few hours last Thursday and Friday: Britain revealed the biggest monthly fall in retail sales on record, combined with an abrupt slowdown in GDP growth. In continental Europe, there were plunging business confidence and industrial order figures in Germany, France and Italy. Japan saw its first monthly fall in exports for five years, while America reported worse than expected figures on home sales and unemployment claims. Does all this mean that the earlier pessimism in financial markets is proving to be right, after all?
Let me begin with the bad news. Conditions in Britain and continental Europe are certainly deteriorating faster than many investors had expected. But the shock about bad figures from Europe - for example, the biggest monthly fall in German business confidence since 9/11 - mainly reflects the refusal of euro-bulls to acknowledge previous evidence of a European slowdown, rather than any genuinely “new” news. It has been obvious for several months that British housing and retailing were on the verge of a breakdown and the continental economy's apparent strength in the first quarter was an illusion.
In Germany, for example, the swing from boom to bust had long been clearly visible in the statistics and government spokesmen had already said that the economy was in a period of negative growth. Retail sales in Germany have been falling almost continuously since the beginning of 2007, when the Government imposed a misguided VAT increase, while the growth of German exports was always dependent mainly on the unsustainable consumption and housing booms in France, Britain and Spain.
Elsewhere in Europe a similar, but perhaps even more alarming story, has also been unfolding for months - and all that occurred last week was a confirmation of evidence that the markets should already have taken on board. Key measures of business activity and confidence fell much more than expected this week in France and Italy, as well as in the eurozone as a whole.
Meanwhile, British retail sales suffered their biggest monthly fall on record, Spanish unemployment jumped to 10.4 per cent- much more than expected - and Danish consumer confidence plunged to a 16-year low and Swedish unemployment suddenly jumped from 5.9 per cent to 8.1 per cent. In Japan, too, the weakness of exports revealed last week should have come as no surprise. It has long been obvious that Japan, like the rest of Asia, was in a transition from export-led to domestic-led growth.
But if Europe or Japan were really the biggest worries for investors, then the main reaction in the markets would have been to sell the euro and the yen against the dollar, rather than trashing equities around the world. Instead, the euro and the yen strengthened, as did the price of oil. Which leaves the other economic disappointments that supposedly hit financial sentiment last Thursday - the apparently terrible American housing and employment news. And here we come to the relatively good news about the state of the world economy today.
Last week's sudden reversal in asset prices was mainly attributed to ever-deeper anxieties about the US real estate market, where home sales fell by more than consensus expectations in June. The impact of these disappointing figures was then aggravated by a paper by Bill Gross, the influential chief executive of the world's biggest bond investor, Pimco, which predicted that US banks would lose at least $1 trillion in the credit crunch, rather than the $400 million to $500 million already discounted in the value of bank shares. To explain these alarming figures, Mr Gross maintained that no end was in sight for the housing slump: US housing, he insisted, is the world's “one asset class that all observers can agree is going down”. Except that it isn't.
The median existing-home sale price surveyed by the National Association of Realtors in June was $215,100. Bloomberg and Reuters reported this as 6.1 per cent lower than a year earlier. But it was 3.5 per cent higher than the median price in May - and that price, in turn, was 3.3 per cent above the price in April. In fact, US house prices, which almost everyone believes to be in freefall, have actually been going up for the past four months, after reaching a trough of $195,600 in February.
Of course, there are strong seasonal factors in house prices and the NAR cautions that its house price index should be used primarily for year-on-year comparisons. But even on this basis, June's 6.1 per cent year-on-year drop was smaller than the 6.4 per cent drop reported in May and a marked improvement on the record declines of 8 per cent plus in each of the previous three months. At the same time, the inventory of homes for sale was steady at 4.49 million homes, which amounted to 11.1 months of supply, down slightly from the supply level in April. In Britain and the rest of Europe, by contrast, house prices have started falling only recently, are still much higher above historical averages than in America and are suffering a rapidly accelerating rate of decline. The oversupply of unsold housing is also growing by the day.
In short, the housing correction - and related credit crunch - appears to be at or near its low point in America, while in Britain and the rest of Europe the trouble has only just started. Of course, it is possible to cite different housing indices, on both sides of the Atlantic, which tell different stories (although the NAR index is the one with the longest statistical history and most timely of all the indicators of house prices). All I want to emphasise at this point is that signs of stabilisation are starting to appear in US housing statistics, while all the economic figures from Europe continue to deteriorate fast. This is a contrast the markets do not seem to have noticed - yet.
(20min delay)