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Anatole Kaletsky: Economic view
Global stock markets have suffered their worst early-January trading since records began in the 1920s. Conventional wisdom is again overwhelmingly gloomy - about the global economy, the asset markets and even the sustainability of the global financial and trading systems. However, conditions are not nearly as bad as the headlines and market pundits suggest. In Britain, there seems to be almost no chance of economic and financial disasters comparable to those suffered from 1990 to 1992.

In the 17 years that I have been writing these Economic Views, I have devoted my first article in January to challenging, where appropriate, the conventional wisdom about the world economy in the year ahead. Here, then, are five ways in which I think conventional wisdom seems worth challenging in 2008:

1. I believe that the global credit crisis, far from taking a turn for the worse, is now almost over. Since the beginning of this year, credit spreads in the inter-bank market have returned to normal. This is the first sign of the financial system beginning to heal. In the next six weeks all the leading banks will report their year-end results and will announce further big write-offs to cope with the sub-prime crisis. There is a decent chance that investors will recognise these as the final big write-offs. The banks will then recapitalise and return to more or less normal operations.

If, however, this market-based resolution of the credit crisis does not occur and investors continue to question the integrity of bank balance sheets, the world's monetary authorities will, I suspect, come out with a Plan B. At a minimum, there could be some new international agreement on new models for valuing illiquid assets such as the mortgage-backed securities now paralysing the banks.

At the maximum, the US and European governments will announce public backing for their national mortgage and banking systems - similar to the action already taken by Gordon Brown to guarantee the deposits in the entire British banking system. The credit crisis will have to be resolved by the end of February, if not by the markets, then by governments and central banks. The world economy simply cannot afford to wait much longer for normal service by the banking system to be resumed.

2. There will be no US recession. Until a few days ago, this would not have qualified as an unconventional prediction, since almost no serious economic forecasters anywhere in the world were predicting a recession. In the past week, however, Merrill Lynch, Goldman Sachs and Morgan Stanley have all publicly said that a US recession this year was very probable and may well have started already. I still believe it will be avoided because US interest rates are so low that businesses and consumers will go on spending - and, even more importantly, the Federal Reserve Board has now indicated a willingness to cut interest rates aggressively and keep cutting until the economy revives. Having said this, I must admit that a recession now looks much more likely than it did even a month ago. Whether a recession occurs or is narrowly avoided makes a big difference, because any market economy is similar to an aircraft that has to fly at a minimum speed to avoid crashing. History shows that the US economy's "stall speed" is around 1.5 per cent in terms of GDP growth. If it slows any further, it is liable to crash and suffer a period of significantly negative growth. In the remaining predictions, therefore, I will give two variants, depending on whether the US crashes into recession or manages to stay aloft.

3. Stock markets around the world will rise in 2008. Valuations of many companies are now very attractive, even on the assumption of a severe slowdown in global growth and a year of falling profits. Moreover, investor sentiment is more bearish than at any time since 1990 - suggesting that a lot of very bad news has already been discounted in market prices. This means that if there is no recession, shares probably should stabilise at around present levels, but may not make much progress until the second half of the year. If, on the other hand, the United States does sink into recession, Wall Street will suffer a more severe bear market in the next few months, but prices will start to rebound sharply well before the recession ends. This recession rebound should start once US short-term interest rates fall well below long-term bond yields. This should happen by March, assuming that the Fed cuts interest rates from the present 4.5 per cent to around 3.5 per cent.

Either way, equity prices are likely to end 2008 at higher levels than they began. In Britain and Europe, interest rates are also likely to be reduced by at least 1.5 percentage points in the 12 months ahead.

But the rate cuts will happen later and more slowly. This is one reason why the outlook for the US economy and stock market is a lot better than it is for Britain and Europe.

4. The much-discussed "decoupling" between America and the rest of the world economy will happen in the case of Asia, but not Europe. Asia will continue to grow rapidly this year. However, Asian stock markets will not decouple if the US sinks into recession and Wall Street therefore suffers a full-blown bear market. In that case, Asian equities will suffer even bigger falls than US shares.

Europe and Britain, by contrast, will certainly be dragged down if the US sinks into recession and will do relatively poorly even if (as I expect) the US slowdown turns out to be less severe.

The main European economies, apart from Germany, have been powered by exactly the same combination of rising house prices and easy credit as the US economy. They are simply 12 to 18 months behind the US in the same credit cycle. Germany, meanwhile, is very dependent on the strength of consumer demand in the rest of Europe. The best that Europe and Britain can expect, therefore, is a performance in the economy and housing markets similar to America's in 2007. If the US suffers a recession, the housing and consumer slumps in Europe and Britain will be that much more severe.

5. In the currency markets, sterling will continue to fall against every other leading currency, partly because Britain is so vulnerable to a serious setback in housing. By the second half of 2008, however, the euro will take over from the pound as the pariah of the global currency markets, since the eurozone will ultimately suffer more than Britain from the slowdown in the global economy because the European Central Bank will resist making the inevitable interest-rate cuts.

This intransigence by the ECB will cause serious economic and political disruptions in Europe - and could even raise questions about the euro's survival as a reserve currency in the long term.