John Rapley - Foreign FocusTHE EROSION of the global stock of wealth continues, with no immediate end in sight.
In the US and western Europe, stock market indices have sunk to where they were five years ago. Furthermore, most indications suggest the rout is not yet finished, with some market analysts predicting the Dow Jones Industrial Average could decline to 5,000 or less, whereas the NASDAQ index will wipe out wealth at a rate last seen in the Great Depression.
But if that seems bad, it is worse elsewhere. In Japan, for instance, stock market indices are now at levels last seen nearly a generation ago. In many countries, including the US, at least some of these losses have been offset by gains in housing markets. As stock markets have imploded, investors have poured money into fixed-income instruments like bonds. The effect has been to send interest rates plunging. Ordinary investors have then taken advantage of cheap loans to buy or improve their homes, driving up property values. Equally, low interest rates have reduced the cost of debt, freeing up money for consumers to spend. This is why the declining wealth of consumers in First-World countries has not yet translated into a prolonged recession.
At least, not yet.
The fact remains that even factoring in rising property values, several trillion dollars have been wiped off the accounts of the world, much of it in the US. And income savings from reduced credit costs have only partially offset the income losses caused by the disappearance of the capital gains that were swelling pockets in the 1990s.
So, in the absence of a prolonged and sustained rebound in the world's stock markets, it seems likely that consumers will rein in their spending somewhat. Currently, there are few grounds for hope of a rebound in stock-market indices. Valuation levels remain at historically high levels.
Meanwhile, the American productivity gains of the 1990s, which were used to justify higher levels of valuation, are now being revised downwards, making stock prices look even more precarious. To top it all off, the flow into American mutual funds, which set the pace for global markets, and which was roaring in the late 1990s, has all but dried up.
The prudent assessment, I believe, is that things will get worse and possibly much worse before they get better.
Therefore, some cutbacks in consumer spending seem more or less inevitable. This effect is likely to be most pronounced in the US, given that share-ownership there is more widespread than in western Europe. There are, in fact, some recent signs that this has already started happening. If consumers cut back on spending, the world economy is likely to continue slowing, and possibly tip into recession.
That is the best-case scenario. The worst-case scenario adds a decline in real estate values to this bitter mix. Some analysts maintain that by transferring their assets from the stock market to their homes, ordinary investors have simply inflated one bubble as another deflated. There is a great deal of debate as to whether or not the property markets of the First World are currently in a bubble. But if property markets were to collapse, then the real problems would begin.
For then the global economy wound sink into a depression, compounded by deflation. As asset prices fall, so too will prices on most other goods. If that sounds good to hard-pressed consumers, it is worth bearing in mind that prices on labour are likely to also fall. Moreover, deflation tends to create a vicious cycle in which consumers postpone spending, anticipating price declines. This force sellers to further cut prices. This, by constraining revenue, leads to further cuts in spending, and so on. Reversing deflation is extremely difficult.
Where might there be safe havens in such storms? It is probably reasonable to assume that the fallout of this decade will mirror the boom of the last. So countries like the US, where asset prices rose the highest, will suffer harshly. Countries like our own, which shipped capital to New York and took on debt, will reap savings in debt costs while under-priced assets pull money back. It is probably telling that as global stock markets have slid, the Jamaican market has actually advanced.
Still, that may provide only partial consolation for the costs of a global recession.
John Rapley is a Senior Lecturer in the Department of Government, UWI, Mona.
