Peter Jones: Don't get too excited: it may be chilly for a while yet

Published on Thursday 28 May 2009 21:45

BITTER east winds that made spring more than a trifle frigid have gone, the temperature is rising towards a positively hot weekend according to the weather people, and there are not so much green shoots on my lawn as a verdant thicket.

According to some, the economy is turning up just as fast. Good news? Not really, and, indeed, there are more sober assessments that, here in Scotland, the recession has a long way to go before it ends.

Yet the signs of the economic mercury rising seem to be all around. Yesterday, The Scotsman reported that three-quarters of American economists believe the US economy will be out of recession in the July-September period this year.

This month, the International Monetary Fund praised the UK government's response to the financial crisis as "bold and wide-ranging", prompting Chancellor Alistair Darling to express his confidence that "we will see a return to growth by the end of the year".

The Organisation for Economic Co-operation and Development also issued indicator data that implied Britain may be one of the countries to come fastest out of the recession.

The financial markets seem to agree, for the pound has been regaining value against both the dollar and the euro.

Then there are the stock markets. The FTSE-100 has bounced up about 27 per cent since hitting a low at the beginning of March. The US markets are up by similar amounts. And oil prices have risen sharply to above $60 a barrel, often taken as a bellwether of rising economic activity. Interesting word bellwether. It comes not from meteorology, but from agriculture. It originally meant the lead sheep in a flock, with a bell around its neck, whose lead, says my dictionary, is "followed blindly by others".

I have a dreadful feeling there may be a bit of blind following going on here.

Stock market prices are set by clever people whose job is not to follow what is happening to companies in the real economy, but to anticipate what is about to happen to them.

So, right now, the rising prices indicate merely an expectation that company profits are about to increase.

The problem is that when all this collective wisdom is added up into stock market indicators, they turn out to be lousy forecasts. Paul Samuelson, a renowned economist, famously quipped in 1966: "Wall Street indices predicted nine of the last five recessions."

One analysis of US recessions since 1960 found the S&P-500 index missed nearly all of them. Using a fall of 10 per cent as a reasonable indicator of bad times ahead, the analysis found no such fall before the 1960 or 2001 recessions, rises before the 1980, 1982 and 1991 recessions, and two falls of about 20 per cent in 1987 and 2003 when no recessions subsequently occurred.

So forgive me, but I am highly sceptical that the current market rally indicates anything much.

For one thing, family firms and small businesses – just as important a part of the economy as quoted companies – do not feature in these indices. And, as I've written in previous columns, I strongly suspect oil price increases are driven more by speculative trading than by real changes in supply and demand.

Where the indices do have some importance is indicating not much more than a return of some confidence that things are going to get better. That's a good thing, but when statisticians and economists at the Scottish Government look for evidence from the real world that things actually are getting better, they can't find it. Worryingly, their data tells them this recession is already worse than most for which they have numbers.

So far, the steepness of the decline in output is matching that of the 1930 recession, which turned into the Great Depression with mass unemployment.

Their view is this recession is not going to hit bottom until much later this year and that recovery will come only in 2010, rather later than is being forecast by the Chancellor.

The real problem is that this recession began with a financial crisis and that tends to cause much longer lasting and deeper recession than those caused by, for example, a hike in oil prices, as was the case in the 1970s.

That is because a financial crisis causes banks to reduce their lending to companies and individuals because they have to keep their stocks of capital at higher than usual levels. And although the government has done much to reduce the banks' exposure to toxic debt, there is still a lot left which hampers their abilities to lend.

Lending so companies can hire people, buy materials and invest in plant is critical to recovery. But, so far, the Scottish Government's economists note, there is little sign that lending is expanding and next to no chance of it returning to the kind of levels seen in 2007 before the crisis broke.

The message, I fear, is to ignore heating-up markets, keep the warm clothes handy and hunker down for a while longer.

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