The fatal flaws of both bulls and bears

For the bulls, the world is a happy-clappy place: markets are likely to do well, with the world economy set to grow at a three-decade high of 5% this year. A combination of strong US consumption and surging Chinese production has powered global growth. Even if the American consumer falters, the US corporate sector will fill the gap, while China will enjoy a benign “soft landing”. If there are threats to this rosy scenario, they are generally seen as external. Terrorist attacks or war may present problems, but the economy is sound.

Such a rose-tinted view ignores the fact that the current global boom is in many ways artificial. By maintaining negative real interest rates and cutting taxes, the US authorities have massively boosted the world economy. But eventually they will need to repay the debts that have built up as a result.

Nor is the huge subsidy that Asian central banks are giving the US economy sustainable. At some point, when it is no longer in the East’s interests to bail out the West, there could be a painful adjustment.

The doom-mongers’ view, examined by Simon Hildrey in this week’s cover story on page 18, is more credible but also flawed. For a start, it confuses the symptoms of economic weakness with its cause.

Bears claim wrongly that such factors as high levels of household debt and inflated house prices threaten the global economy. But from an economic perspective, these are the outward indications of a more fundamental malaise; for example, house prices were bolstered by low interest rates, which were, in turn, an attempt to shore up a weak economy. The difficulty that contemporary economies have in growing organically, without vast supplies of cheap credit, is at the root of the problem.

But the bears also underestimate the resilience of the global economy. The defeat of organised labour that came with the end of the cold war means that there is far more room to manoeuvre. Economies can be restructured if necessary, without the threat of industrial unrest.

The paradox is that the world looks set for a period of fundamental economic stability punctuated by financial instability. While there are few underlying threats to economic activity, the prospects of turmoil in the financial markets are high.