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Preparing for an Age of Austerity in public spending

Chemical companies, Consumer demand, Currencies, Economic growth, Financial Events, Futures trading, Leverage, Oil markets
By Paul Hodges on 22-May-2010

S&P 500 May10.pngThe blog has sometimes despaired of the cheer-leading and wishful thinking of too many leading policy-makers. As I argued in the Financial Times in March 2007, before the Crisis began, “they seem to confuse being market-friendly with being friendly to markets“.

It therefore welcomes the realism being shown by the UK’s new coalition government. Today, David Laws, Chief Secretary in the Treasury, argues that “we are moving from an age of plenty to an age of austerity in the public finances“. And coincidentally, Nobel Prize-winning Paul Krugman suggested yesterday that most Western countries aren’t really like Greece, but “are looking more and more like Japan“.

The blog’s own chart above, showing the relative movements of the US S&P 500 index, and Japan’s Nikkei 225, illustrates Krugman’s point:

• The black line and axes show the % monthly changes (basis September 1985) in the Nikkei 225, to 2004
• The red line and axes show the % monthly changes (basis September 1995) in the S&P 500, to today

The chart shows the parallel market tops in November 1989 for the Nikkei, and in August 2000 for the S&P 500. It highlights a remarkable parallel, first noted by market guru Alan Shaw in Barrons in July 1998, and this continued until early 2003.

The parallel then disappeared, before re-emerging briefly last year. And the recent market falls may well be a first sign that the two lines are reconnecting again. The rationale for the parallel is simple, that Japan and the West both face the problem of an aging population, with Japan’s demographics being some 10 years ahead of the West’s.

The difference since 2003 can also be explained by this “cheer-leading” by Western policy makers, who have tried to maintain perpetual growth in their economies. Every time markets dipped, their response has been to cut interest rates and inflate speculative financial bubbles,.

With a G7 government instead now talking about an expected ‘Age of Austerity’, chemical company Boards will clearly want to revisit their planning Scenarios. They need to ensure their strategies are robust enough for them to be confident of surviving a continuing Downturn.