Alex Brummer

By DAILY MAIL REPORTER
Updated:

 

It would be nice to think that the rollercoaster ride seen on equity markets in recent months is now over following last week's rally. But do not bet on it.

The Basle-based Bank for International Settlements, the secretive central bankers' club, is putting us all on alert. Its annual report points to a series of potential difficulties for the global economy. Since the report is written with an input from the big hitters of international finance - including Federal Reserve chief Alan Greenspan, Bank of England Governor Eddie George and European Central Bank president Wim Duisenberg - its warnings must be given weight.

Among the looming problems, it identifies the high valuations put on technology shares, the suspicious speed of recovery in the emerging market economies of Asia and Latin America and, most critical of all, the value of the dollar on the foreign exchanges. The BIS focuses sharply on the widening US current account deficit. Though this could reach up to 4% of the nation's wealth this year, the dollar, except for one or two wobbles, has remained firm.

This is largely because of the US stock market boom with inflows of capital which financed 40% of the external deficit. But while cash has been flowing into the US at a record rate on the back of the tech stocks boom, it has been moving in the opposite direction as far as Europe is concerned. This has been one of the critical causes of the weak euro.

There is a view that the weakening of the American economy, brought on by higher interest rates, means that the danger has passed and that share prices will continue to rise again, chased by capital inflows. But the BIS puts forward a different and more destabilising thesis. As the US economy slows, so will the inflow of capital, so that the external deficit will no longer be partly covered. This will lead to a sharp reversal for the dollar.

That would be disastrous for Japan which is only just recovering from a decade-long recession. 'Too rapid an appreciation of the yen could threaten to undermine a fragile recovery,' the BIS says. It could also lead to the long awaited recovery in the euro, which has been in almost continuous retreat since its launch 18 months ago.

The risk is that too speedy a fall in the dollar could destabilise the whole financial system. Cash would flow out of US investment funds, hitting nervous equity markets. Confidence would be hit as banks and other lenders tighten up credit and the soft landing could become bumpy.

Britain would be caught in the whirlwind. The Chancellor and the Bank of England could be looking for ways to smooth a falling pound as it moves down in tandem with the dollar. That would almost certainly mean raising our interest rates to steady the fall and to keep out imported inflation.

Poorer pensions
A nation scarred by a series of scandals in pensions and endowment mortgages may still have more nasty surprises to come. There has been a general assumption that whatever may have gone wrong with personal pension selling, our occupational pensions are safe. But a new study commissioned for the BBC's Panorama programme suggests there may be new problems on the horizon.

It shows that 39% of FTSE 500 companies have already stopped offering their employees schemes based on final salaries (defined benefit schemes). A further 25% say they plan to switch to the alternative money purchase schemes within the next five years.

The defined benefit schemes, traditionally, were hugely advantageous to those who spent many years with one employer. So companies have been able to argue to their workforces that a switch to money purchase is a good thing in modern labour markets because of its flexibility.

The difficulty is that in making the switch, companies and pension fund trustees often take the opportunity to lower their own contributions to the fund or prolong a pensions holiday, living off the surpluses already in the fund.

This, together with some of the new prudential rules, put in place after the Maxwell scandal, means that pensions that people had hoped to receive on retirement will be far lower than expected - like the returns on their mortgage endowments. This may well require future retirees to act quickly to save extra funds, or to work longer if they are to enjoy a less penny-pinching retirement.

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