Bill Emmott - International Author & Adviser


Ceci n’est pas une Economic Forecast, but . . .
The Times - January 21, 2013

Ceci n’est pas une pipe, runs the title of one of Rene Magritte’s most famous paintings, underneath an image that looks, well, rather like a smoking device. Honest economists, which isn’t all of them, need to take a cue from the great surrealist. The arguments in this column may look like predictions. But I assure you that they are not. They represent hopes and possibilities.

Rather, in a way, like financial-market prices. These have begun the year in strikingly bullish mode, with investors switching their money out of safe havens and into riskier assets such as equities and junk bonds—sufficiently so, indeed, to pluck a warning about over-exuberance from the cautious lips of Sir Mervyn King, governor of the Bank of England. Share prices are a bet on the future. They seem to be betting that the future will feel a lot rosier than the present.

Could it really be? It doesn’t feel probable out here in the real world, with the eurozone in recession, America crawling along, and dear old Blighty lying flat on its back and thinking of Little England. To repeat, this is not a forecast. But the market bet that 2013 is actually going to be much better than that is based on hopes that some good things might happen. And they actually could.

The hoped-for goodies fall into three main boxes. The first, and most plausible, hope rests on America. That economy has been doing well by European standards, at roughly a 2% annual rate of growth, but poor by its own past standards during recoveries. It has been boosted by its own famed flexibility and technological innovation, especially now in oil and natural gas production. But it has been held back by the reluctance of most corporate boards outside the energy sector to invest their cash.

No one can know for sure what it is that will change managers’ minds. They have been reducing debt and building up cash for several years now. In every business cycle between slump and recovery they do change their minds, for reasons that John Maynard Keynes described in the 1930s as their “animal spirits”. But quite why and when is a mystery, which is why that usually very precise economist used that vague but vivid phrase.

The most plausible reason to sit on cash is fear of the future, whether about government policies or financial stability or, in Japan since the late 1990s, about a switch from inflation which makes debt gradually cheaper to deflation which makes debt costlier and cash more valuable.

European companies afraid of a collapse of the euro could very reasonably worry about all three. But American ones have reason to become more sanguine.

The “fiscal cliff” of automatic and drastic tax rises and spending cuts this month that preoccupied them last year was averted, even if narrowly and messily. Again messily, the signs in Washington are that the political mood favours further compromise over fiscal policy, both on raising the legal ceiling on US public debt and on longer-term fiscal reforms. And the Federal Reserve’s pledge to continue highly expansionary monetary policy indefinitely makes deflation a pretty remote danger. If the fog of policy uncertainty does clear, so those animal spirits could turn steadily greedier.

That boost to business investment would be helped further by the second box: falling energy prices. World oil prices last year looked like they were falling, as they did drop well below their peak, but actually they remained remarkably stable at a little more than $100 a barrel, making the average oil price for the year the highest ever.

For this to change, and to boost all oil-consuming countries, production needs to rise, consumption needs to grow only moderately, and politics needs to be favourable. The first is happening, spectacularly in America, haltingly in Iraq, slowly in Brazil and parts of Africa. The second is happening too. It is only the third that be counted as truly unpredictable, depending as it does on the Arab uprising, Iran-Israel tensions and risks so far unknown. A resolution to the Syrian civil war would help, greatly.

The third potential goody also depends on politics. That is a stabilizing of the euro crisis and, more critically, a change of German minds away from universal hair-shirt austerity and towards selective reflation. The stabilizing has happened already, though of course a bizarre pro-Berlusconi outcome in Italy’s February 24 election, or a new political crisis in Greece, could rock the boat again.

The change of German minds depends on neither of those things happening—Italy’s much likelier outcome is a centre-left coalition government dedicated to austerity and modest reform—and could not anyway occur, really, until after Germany’s own election in September. But then, if politics are calm and the German economy in or near recession? Even politicians’ animal spirits can change eventually.

These are hopes, not pipes. They could of course become pipe-dreams, especially if all sorts of potential political surprises occur, such as a military clash between China and Japan over their islands dispute, or a revolution in the Arab Gulf. But there are also further potential positive surprises, including a reflation-led recovery in Japan thanks to its new government, or better-than expected growth in China, where the economy already looks to be perking up. Forecasts are foolish. But so is the assumption that the bad times will last forever. For that is also a forecast.


Bill Emmott is Group Economic Adviser for Fleming Family & Partners



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