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Bang Bang -You're Dead!
Stuart Macdonald

The long anticipated sound of overinflated Internet, Communications and Technology (ICT) bubbles finally bursting can be heard across all of the world's major stock exchanges. The resultant stockmarket crashes have indeed been something to behold. Initial falls of over sixty percent in the ICT dominated NASDAQ exchange, since its giddy heights of 6,000 plus just two years ago, have led to a domino effect throughout other technology bourses, such as the UK's techMARK.

This copycat exchange was launched in order to capitalise on the success of the NASDAQ and as a result briefly touched highs of 5,700 points. However, as it is warned in the small print of financial advertisements, the value of stocks and shares can go down as well as up. This rather important point seems to have been forgotten by many over zealous investors over recent years, who have been eager to join the party so as not to miss out on the promised profits. They have had to learn the hard way. Rising stars such as the techMARK and many others have been dragged back to Earth with a bump, by the collapse of share prices in the NASDAQ.

This sharp decline in the value of shares has affected many of the larger so-called blue chip firms such as Abbey National, British Airways and Railtrack. These falls have been triggered as a consequence of decreased investor confidence in the performance of fragile markets. Investors want a way out, preferably with as much of their initial stake as possible. It seems that largely as a result of these stockmarket losses, Economists and Bankers are talking of a massive global recession.

Yet the UK economy is still growing strongly with inflation and unemployment levels both at their lowest levels for decades. There have been industrial problems in the past which have affected the general population of the UK to a far worse extent than fluctuation in the value of shares. The mass utilities strikes of the 1970s and early 1980s are just one example. Surely the scaremongering of central bankers Alan Greenspan and Eddie George is merely the actions of dull men in dull suits trying to justify their expensive existence. Or is it? If the past has taught us anything it is that the events of the stockmarkets, particularly in America are a reliable measure in attempting to gauge the health of the global economy. As the saying goes, if America sneezes, the whole world catches a cold.

Raging American Bull

It's all very well to make cryptic statements such as these, but what does all of this actually mean? Will earnings fall in Europe as jobs are lost in America? Is that holiday to the Caribbean going to have to be put on hold for another year? The world economy has been enjoying one of its longest and most prosperous periods of growth in a generation. Last year the rate of growth was almost five percent according to the World Bank - a figure equivalent to several trillion dollars. A large proportion of this growth has been due to the American economic juggernaut, which has led world demand and whose companies have been only too eager to create world supply. As companies have prospered, so have their employees, who continue to feed the monster with their fatter pay packets. Americans have also bought into the (rather misguided) belief that their companies will continue to grow at a rapid and sustainable rate for the foreseeable future, by purchasing company shares as a form of savings.

This high level of consumer demand in the USA for both domestic and imported goods and services has led to the economic growth of other major suppliers such as Europe and parts of Asia. Higher levels of business investment continue the global ripple effect, so that European and Asian demand has grown in line with that of their American counterparts. There have been a number of significant developments, however, which have recently altered this rosy picture and led to the gloomy predictions of worldwide recession.

What is going wrong?

Firstly, saturation point has been reached in many areas of formerly strong consumer demand. For example the global market for computer and telephone hardware has dramatically shrunk over the last year, causing international behemoths such as Motorola, Cisco and Intel to announce profits warnings and subsequent job cuts.

Secondly, much of the consumer spending which has driven the Economic boom in America has been as a result of credit spending i.e. people spending money which they simply do not have using their credit cards, in the expectation that future earnings growth will cover their profligacy. This has not proven the case, as US earnings growth has risen slowly in spite of tightening labour market conditions (i.e. less skilled workers available due to higher levels of employment). As a consequence, consumer spending has been gradually dropping. This has led to large firms such as Ericsson and Proctor and Gamble to announce profits warnings and job losses.

Both of these points have contributed to the fall in share prices. This has proven doubly damaging for the US economy, however, as roughly half of the adult population have invested in shares over the last ten years. The sudden drop in the value of these hitherto strong assets has meant that spending confidence has suffered. Also, many US bank loans, both to businesses and individuals, have been based on the guarantee of stocks and shares. Now that these have fallen in value, the banks are increasingly demanding new collateral or their money back. All of this has the cumulative effect of America's 100 million small investors selling their holdings and causing the panic selling which has gripped the world's stockmarkets over the last week.

What can be done?

According to Economists, the solution to stockmarket malaise is to cut interest rates. The idea is that if the cost of borrowing is made cheaper both for investors and businesses, then investment will become more attractive and so shares will stop plummeting in value. Interest rates have been repeatedly cut in America over the last month and still the stockmarkets have suffered.

A further solution to a crisis of confidence in the economy is to cut taxes. This is intended to stimulate consumer spending, as they feel as though they have more money in their collective pockets. This course of action is currently being debated in America as one of President Bush's principal policies. Whether it has the desired effect is another matter, as people may well feel that there are tough times ahead and begin to save rather than spend.

In 1997, when the world's economies were reeling following the financial collapse in Asia, the strength of the American economy dragged us back from the brink of recession, despite the best attempts of the global media to convince us otherwise. This time, however, America is the crippled patient and it is questionable whether the European economy is a large enough crutch to support it and the rest of the world.

Foot and Mouth

It is possible that we may just have managed to maintain a high enough level of consumer spending and business investment to stave off a recession, had foot and mouth disease not reared its ugly head. The disease has spread from Britain to the Netherlands, France and Ireland and will surely grip the whole of Europe before summer, such is its infectiousness. We have already seen the devastation which has been caused in rural communities as livestock is culled and more importantly, as tourists are discouraged from visiting. In the three weeks of the foot and mouth outbreak in the UK, it is estimated that the economy has lost over £1 billion. This figure is set to rise as businesses cancel orders for new goods and machinery and the ripple effects of a fall in income spread to towns and cities. It has been mooted in North America that restrictions on the movement of people from Europe, nevermind livestock, are being given serious consideration. The effects of such a ban would be horrendous.

Unless the world's financiers can pull something quite dramatic from their briefcases, than there is no way of avoiding the economic slowdown which has been precipitated by stockmarket crashes. J.M. Keynes once said that: "In the long run, we're all dead". It would certainly seem that, in view of the evidence, the world economy is up against a firing squad from which there is no escape.

© Stuart Macdonald 2001

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