Tuesday, January 22, 2008


Going back to the real thing...

As Tyler tucked into his kedgeree this morning, the wireless brought news of fresh financial disasters from around the world.

The glee of BBC announcers was unconfined. The Day of Judgement is at hand. The Mighty Sword of Destiny is well and truly unsheathed, flashing around the Temple smiting the money changers and their evil Legions of the Damned. Only the righteous not-for-profit green living staffers at tax-funded quangos and NGOs will be spared. And great will be the rejoicing in the land.

So is this really 1929, as the BBC would have us believe?

Er, no.

To start with, there's the question of scale. The current sell-off in financial markets is much smaller than 1929-32. As the chart below shows (taken from the excellent Calculated Risk), by the end of 1932, the US Dow Index was down 90% from its peak: this time it's only down 15% so far (guess 20% by the end of today). That kind of fall quite likely signals a normal recession (denoted by the blue bars on the chart), but hardly a thirties style depression.

Note also that all those humongous bank credit write-offs we hear so much about are big, but not that big in relation to global GDP. The write-offs so far amount to around $100bn, with analysts talking about a final figure of $150bn-$300bn. But global GDP is around $50,000bn- or $50 trn- so even $300bn is still only around half of one percent of world GDP.

Second, as has been well documented, the US Federal Reserve Bank bungled its handling of the 1929 Crash. It failed to cut interest rates as required (cf the Bank of Japan in the early 90s). This time though, the Fed has already indicated it will act if necessary, and with its key official bank rate (Fed Funds) standing at 4.25%, it has plenty of scope to cut.

Third, the US government- mired in debt though it is- has already indicated it wants to reflate by cutting taxes.

And even here in debt balloon Britain, there's still plenty of scope to head off depression. The Bank of England can cut interest rates substantially from its current Base Rate of 5.5%. And while Brown/Darling are theoretically slam bang up against their fiscal rule limits, in practice you and I both know they've already gone beyond them (according to the OECD, Britain has the largest structural fiscal deficit in Europe). And they'll definitely go even further, given the nightmare of fighting an election in the teeth of a recession.

No, the real prospect for us is not a thirties depression, but another jobless joyless dose of seventies style stagflation.

With energy, food and other commodity prices racking up, sterling heading down, the housing bubble deflating, and private companies being bailed out with taxpayers' cash, we're already halfway there. All we need is an energy crisis three day week and panic buying of sugar, and the picture will be complete.

Maybe we could have the real Sweeney back as well.

Update 15.00: the Fed has indeed acted, with a bigger than expected 0.75% cut in Fed Funds.

PS On days like this the BBC always manages to find the most extraodinarily hysterical "City experts" to pontificate. I've just listened to some character from a broker I've never heard of saying "I've been in the market for 44 years and I've never seen anything like it". What never seen anyfink like it? "I've never seen anyfink like it in my life". I'm presuming he was out to a broker's lunch on Monday 19 October 1987, when the Dow fell by 22.6% in a single day(today's post-Fed fall looks like being a trivial 1-2%), or 16 September 1992, when Sterling crashed out of the ERM, interest rates yo-yoed from 10% to 15% and back to 12%, and the FTSE was all over the place.