Another, much needed, adjustment may be under way.The great question is, how will people behave in this low-interest world? In Japan, very low rates completely failed to boost demand. The ability to borrow very cheaply to buy a home did not encourage people to do so, because house prices were falling. Another mildly encouraging note came from the US tax receipts, which were up sharply in the first part of this year, cutting estimates of the fiscal deficit for the future. If you want to take the cheerful one, as do most of the mainstream City economists and the Treasury, some of the adjustments are already taking place and it will be possible to engineer a "soft landing".Thus, while the Federal Reserve will almost certainly increase US interest rates on 9 August, that may be the last rise of this cycle. In the past that has led to higher current inflation, but that was before the world economy became so global. This time it has led to more demand, but that demand has been supplied, at very low prices, by China.
So in the case of both the UK and US, it has resulted in larger trade deficits instead.This is not going to go on. If you take the gloomy view, articulated among others by Andrew Smithers, who runs a boutique advisory service in London, we are now in a calm before the storm. We tend to forget that because the UK came through the last cycle without any serious interruption to growth.The third is that if the world's central banks set very low interest rates, some people are going to borrow money and spend it That is what they are meant to do. You can see one starting to take place in the energy market, where there is evidence that the high price may be pushing down consumption. That happened in the 1970s and 1980s and will happen again.Another is that there is a global economic cycle, and while we cannot see clearly the shape or timing of the next downturn, it is out there somewhere in the future. Sure, house prices in Germany and Japan are stagnant; true, the Shanghai stock market has performed badly in marked contrast to the economy. We may not quite be facing Rumsfeld's "unknown unknowns" but it does feel a bit like it.At a time like this, it is perhaps best to hang on to a few basics One is that there are natural self-correcting mechanisms.
True, too, that some of the asset bubbles have already burst (Australian housing), while others have yet to do so (US housing). But the differences are less remarkable than the similarities, and this leads us into a world that is different from anything we have experienced in our lifetimes. You have to go back to before the First World War to see real similarities with the present - huge international investment flows, near-stable prices, very low bond yields, etc. Asset prices have been strong just about everywhere; current inflation is low or non-existent just about everywhere.
