continued from previous page 10 the economy to others

Lead indicators

The extent to which the combined effects of the housing market crash and the resultant credit crunch will lead to a recession is currently hotly debated by analysts, though it clearly has the potential to be very serious indeed. Hard data in the coming months should prove conclusive one way or the other as, in truth, there are few genuine ‘lead indicators’ of a slump that can tell us definitively that one is about to happen, or how deep it will be. For example, production tends to fall most noticeably once the slump is already underway and unemployment is another lagging indicator, only rising when companies have started cutting back on staffing levels in response to difficult trading conditions.

Falling stock markets are better lead indicators of a recession; this is because at the level of individual companies it is their interim and preliminary company results along with quarterly trading statements that typically give advance clues as to what is happening on the ground, and stock markets are usually quick to react, as they have been this time. Nearly all major stock markets have at some point fallen 20 per cent or more from their peaks since the credit crunch started, technically entering ‘bear market’ territory. The problem with stock markets, however, is that they can fall in the short-term for all sorts of other reasons too and also have a tendency to over-react to events. When UK shares lost about 50 per cent of their value in the 2000-3 bear market (and US shares almost as much) this reflected little that was happening in the real world of the underlying capitalist economy of production and trade.

Some economists and analysts have argued that the best indicator of an impending recession is what is called an ‘inverted yield curve’ on the money markets. This means a situation whereby short-term interest rates are above long-term rates (the inverse of the usual relationship) and in these circumstances banks have little incentive to lend long-term to industry when selective short-term lending is both safer and more profitable. In practice, an inverted yield curve is indeed almost always a precursor of recessions. Unfortunately, like falling stock markets, inverted yield curves can happen at other times too (the US had a significantly inverted yield curve in 2000 and had a curve that flattened and threatened to invert in 1998, yet there was no recession on either occasion). This time around, the US yield curve inverted in 2006-7 and has since switched to being positive; the UK yield curve inverted in the wake of the credit crunch starting last summer, and has recently started to flatten out again.

Mine’s A Baltic Dry

Arguably the best lead indicator of a recession exists as a measurement of what is happening in the ‘real’ economy of production and trade in capitalism rather than its financial superstructure. This is a curious and little known gauge of economic activity called the Baltic Dry Index. It covers dry bulk shipping rates and is managed by the Baltic Exchange in the City of London.

Each day the Baltic Exchange establishes average prices for shipping various cargoes around the world, whether it be 100,000 tones of iron ore from Brazil to the UK or 100,000 tons of soybeans from the US to India. Essentially, the index is a barometer of activity amongst shipbrokers involved in shipping those raw materials that are typically the precursors to production around the world, and it measures the demand for shipping capacity versus the supply of bulk carriers. It is a useful index because dry bulk mainly consists of commodities that act as raw material inputs into the production of other goods such as electricity, steel and food. Also, demand for these is variable and elastic whereas the supply of dry bulk shipping is inelastic, changing little in the short-term because of the length of time needed to build new tankers. This means changes in the index tend to principally reflect changes in demand. Fluctuations in the index have historically proved to be amongst the best lead indicators of economic activity in the market economy there is.

This has been demonstrated over the last few years, when the Baltic Dry Index surged on the back of the booming global economy and the demand for industrial and agricultural commodities led by China, India, Brazil and other emerging markets. Interestingly, despite a continuation of much of this activity, the index has in more recent times faltered. >From the beginning of 2005 until the start of 2008 the index more than doubled, but after some volatile movement has since fallen from a peak of nearly 11,800 reached in May to around 7,000 at the time of writing, a fall of around 40 per cent. If this fall continues into the autumn and beyond, then a widespread, serious recession is more than likely as it will be reflective of a massive decline in the demand for raw materials required for the world economy.

Quite how severe the economic downturn proves to be is no small matter of interest as it will affect the lives of hundreds if millions across the globe, leading to falling production, falling property prices, rising unemployment and acute financial distress for many. And this is far more significant than the distress that is being caused for a Prime Minster in Britain who swore that this would never happen and who thought he could hold back the tide of capitalism’s business cycle through his financial management skills – a man who has been left looking ever more like King Canute instead, staring out to sea with the waves already lapping well above his ankles.

DAP