Share falls will slow growth

DON'T let anyone tell you that the rapid fall in London share prices has nothing to do with the real economy of growth and jobs.

A new analysis by the International Monetary Fund seeks to explode this myth and finds that the British and the American economies are most likely to be hurt by the markets' latest lurch downwards.

But despite the share price effect, which the IMF says could knock 1% off British growth, it remains reasonably optimistic about UK prospects.

Output this year is seen as coming in at 1.7%, which would put us behind the United States and Canada but ahead of euroland. In 2003 growth is expected to pick up to 2.4%.

Both figures are well below those in Gordon Brown's budget projections, which could place additional pressure on the public finances.

The normally cautious IMF economists describe the 20% share price falls between March and September as 'precipitate' and appear surprised by their intensity. They believe it is remarkable at a time of other longer term changes in the global economy in the shape of falls in the dollar and long-term interest rates.

Whereas the earlier fall in share prices in 2000-1 could be put down to the air coming out of the technology bubble, the present downturn is jolting, because it comes when the global economy is emerging from a period of stagnation.

Historically, share markets recover in such circumstances. The IMF suggests the key to the present bear market is the American accounting scandals, which does not quite explain why London-has been so badly hit when its corporate governance standards are thought to be better.

A fall in share prices, particularly in a country with a market-based economy like Britain, affects growth in three different ways. It increases the cost of borrowing for households and companies, because the value of security declines. The cost of raising equity capital goes up, and this in term reduces investment. Lastly, it knocks back household wealth and consumption,

The impact of share falls in Europe and Japan is far less pronounced since so much of the finance raised there comes from the banking system. But with banks in Japan all but bankrupt, and the IMF certain that the debt problem is worse than disclosed in public data, this will be small comfort to investors in the Japanese economy.

As for Europe, the rigidities of the 'stability pact', which controls euroland budgets and the problems of an ageing workforce and highly regulated labour markets, have brought their own traumas.

For the moment at least the UK economy is being largely insulated from the worst effects of stock market falls by the strong housing market.

The Fund notes this is particularly significant in that the stock of housing is larger than that of shares, so it has a disproportionate effect on how wealthy people feel and on their consumption.

In the case of Britain in particular, the IMF surmises that 'the effect of housing prices may have more than offset the adverse effects of equity market declines.' But although thus far the housing market has been a useful offset to falling share prices, it clearly does not want it to go too far, with a housing bubble substituted for the stock market bubble of the last few years.

Not surprisingly, the IMF is in the 'sound money' camp when it comes to British interest rates. At a time when many economists are starting to worry about Japanese style deflation, it is focused on bubbles. It believes that the present UK base interest rate of 4%, the highest among the G7 rich economies, is appropriate for the time being and that the Monetary Policy Committee is right to hold rates and may even have to raise them later.

That is a message which the City and private investors, struggling to understand why share prices are so hard hit, will surely not welcome.

Mantle slips
THE lauding of (Sir) Alan Greenspan in Britain is being looked at with some curiosity in Washington, where his mantle of greatness is seen as slipping.

The Fed chairman is blamed for leaving interest rates too low for too long during the tech bubble and buying into the myth of a 'new economic paradigm.'

Now it has been revealed for the first time that a schism has opened up on the Fed with two out of a dozen members voting for an interest rate cut at the September meeting.

Perhaps the 76-year-old wizard should have retired when his reputation was at its peak.