The economic effects will linger long after the panic has petered out

[Cyberman]

Hehehehe.... some people are going to get a huge wake-up call.

[BrilloPad]

http://www.telegraph.co.uk/finance/c...tered-out.html

Collapse? What collapse? Investors appear to have concluded that it's all over. Since the start of March, the FTSE 100 has increased by about 20pc, and the American S&P and German Dax have risen by about 30pc. Are investors right to be so optimistic?

For all our sakes, I hope so. But I am unconvinced about the economics, even if investors are right about stock prices. As I have told you before, stock markets have forecast 10 of the last four recoveries. Stock markets did not go into this crisis significantly overvalued, if overvalued at all.

Yet they were hit hard by the collapse in confidence following the bankruptcy of Lehman Brothers last September. It is not surprising that share prices have reversed some of these falls.

And there are some real positives. The first phase of the financial crisis may be over. Confidence in the banking system has gradually been restored and interbank lending spreads have come down considerably. So far, so good.

Moreover, the economic indicators have started to improve. At least in terms of the rate of decline, it now looks as though the UK economy is past the worst. For parts of the world, it may be better than that. The inventory cycle appears to be turning – meaning that the drag on production from manufacturers running down their stocks should be easing.

The slump in world trade should ease as the flow of trade finance is at least partially restored. The Chinese economy may well be experiencing a bounce. And in the US, it looks as though, by the end of the year, the economy may start to recover modestly.

Yet this shouldn't be altogether surprising. We have entered something of a "sweet spot". Outside the UK, inflation has fallen markedly, boosting consumers' spending power. And in most countries this hasn't yet been accompanied by a sharp fall in the rate of increase of pay. Meanwhile, the global economy is enjoying some benefit from the powerful monetary and fiscal stimulus that has been enacted across the world.

Even so, the financial aspect of the crisis is still far from over. The banks still have a raft of losses on plain vanilla loans to firms and households ahead of them, as a result of rising unemployment and falling corporate profits, not to mention potentially huge losses – which, intriguingly, have not yet shown up on balance sheets – on lending to commercial property. And who knows what troubles might yet await us in the insurance sector. Meanwhile, some European countries, such as Austria and Sweden, have frightening exposures to emerging economies.

Moreover, many of the economic fundamentals still look pretty dire. For a start, in many countries, although probably not the US, house prices have much further to fall. Furthermore, the labour market downturn has only just begun. The 1.9pc drop in the UK's output in the first quarter of this year is yet to have its full impact on firms' hiring and firing decisions.

It also looks as though GDP will fall again in this quarter, and quite possibly for the rest of the year. Unemployment has reached 2.1m from a low point of 1.6m, but I think it will be close to 3m by the end of the year. So consumers will remain under heavy pressure.

Furthermore, in the British case most obviously, but also in many other countries, a tightening of policy is looming on the horizon. The Budget contained a small net giveaway this fiscal year, but that is projected to disappear in 2010/11 and to turn into a net tightening by 2011/12. After the election, whoever wins, there will almost certainly be a further tightening to bring the deficit down. If the Conservatives win, they will probably announce a draconian policy on public spending which will see public sector employment and pay severely squeezed. Initially at least, these cuts will be used not to reduce taxes but cut the deficit.

Now you might well think that public spending cuts would be "a good thing". But there's no getting over the fact that in the short term at least they would reduce aggregate demand. The armies of "ethnic awareness
co-ordinators" typically spend the money they are paid and hence create demand in the economy.

Accordingly, even if the global economy does continue to improve a bit in the next few months, leading to apparently improved prospects here, I suspect that the UK recovery could stall.

We must not forget that this is not a normal recession. It is a balance sheet/banking crisis. And there is plenty of evidence that the aftermath of such crises can last for many years. Households still need to raise their saving rates. Banks still need to build up their capital. House prices still need to fall further. At best, western economies are facing a long period of sluggish economic growth. At worst...