John Rapley

LONDON:

It's hard to imagine a United States-style housing bust in London, where rent on a cramped flat in a serviceable neighbourhood can easily put you back the equivalent of J$70,000. London is booming. So much so that the inflation rate is rising, forcing the Bank of England to raise interest rates, which further attracts foreigners to come and put their money in British bank accounts.

That is a big part of what is happening in Britain. Once the world's financial capital, London ceded that place to New York in the last century. As recently as a few years ago, most people would never have expected New York to look back again. But it is.

Today, London is the place where investors from around the globe want to carry out transactions. In part, that has to do with changing geography. The fall of the Berlin Wall and the collapse of the Soviet Union opened up a large new pool of foreign investors who preferred nearby London to distant New York. The British capital is today a haven for Russian billionaires, from legitimate to shady.

New money

So, too, the Chinese expansion and the oil surge have brought new money into London. Governments which formerly banked largely in New York have recently been shifting some of their reserve assets to Europe. For the time being, the dollar is increasingly seen as a weakening reserve currency, and current data suggest that a gradual reallocation is occurring in the reserve portfolios of many of the world's central banks. The U.S. financial scandals of the 1990s, and the subsequent stiffeningof American financial regulation, have hardly helped the cause of U.S. financial markets.

This shift away from U.S. investments has recently led to a rather striking decline in the U.S. dollar's value. In the short term, this is probably good for the U.S. economy. As its housing boom goes bust, cheaper exports may take up the slack in the economy. With Europe and Asia increasingly healthy, they may take over the U.S.'s role as the growth pole for the world economy.

However, a weakening dollar does have risks. First off, a sharp drop in its value could bring on a broader financial crisis. In that situation, the U.S. Federal Reserve Board would have little choice but to defend the currency's value by driving up interest rates, which would likely sink the U.S. economy in recession.

Weakening dollar

At present, that eventuality looks remote. What appears to be a greater risk is that a weakening dollar could raise the inflation rate. Not only will imported goods be more expensive; but the great rush by American firms to outsource production, by taking advantage of cheap Third-World labour and the strong dollar, could slow down.

This would mean more American jobs, which is a good thing. But that would also augment the bargaining power of labour. Already we are seeing signs of this in higher labour costs and declining productivity (since workers cannot be forced to work as hard to keep jobs when labour becomes scarce). Should this trend continue, only a recession would likely bring down inflation.

For now, New York's loss of the pole position to London may be a blow to the city's pride, but it doesn't appear to be hurting the economy. Nevertheless, the complacency which still abounds in US financial markets - where inflation-adjusted returns on assets are at historically low levels - may be a signal that problems lie ahead.

But in London, the party continues. And it may go on even as the Bank of England prepares to remove the punch bowl by raising interest rates.