Hamish McRae: New year will bring more negative surprises

What surprises might be in store for 2002? Most of the predictions at the moment suggest a nasty first half of the year, followed by a recovery in the second. Shares will reflect these better times by ending up by varying amounts a year from now.

What surprises might be in store for 2002? Most of the predictions at the moment suggest a nasty first half of the year, followed by a recovery in the second. Shares will reflect these better times by ending up by varying amounts a year from now.

That at least is the broad view of the International Monetary Fund, whose new forecasts came out this week, and of most of the private sector forecasters too.

But should we trust 'em? Surely not. After the catastrophic forecasts of a year ago, when no mainstream house forecast what has actually happened – a synchronised recession in the US, Japan and Germany – it is very hard to take these people seriously. Only a handful of private sector houses, of which the most notable was HSBC, openly warned of a US recession, and no official one did. You were better off reading a newspaper like this one, which did at least warn of the dangers of recession, certainly in the US, though at that stage we expected only a mild one there.

Still, you have to start from somewhere and the mainstream forecasts are the best place to do so. The interesting task is to try and spot the possible surprises, both on the positive and negative side. Leaving aside things that are either wildly over-optimistic or so pessimistic that they don't bear thinking about I have come up with four negative surprises and one positive: four funerals and a wedding, you might say.

The wedding first. The nicest surprise, surely, would be for the forecasts to turn out right. It's not impossible. Recessions rarely last more than a year and economies are self-healing. It would be both odd and abnormal were growth not to be resumed in the US some time next year, particularly since interest rates have been driven down to very low levels.

Once the US revives, expect the rest of the world to follow. Many people, including the staff and board of the European Central Bank, were surprised by the speed at which the US downturn spread to Europe. But if the links work on the way down they should also work on the way up. Even Japan could resume growth by the end of next year – a US recovery is a necessary but insufficient condition for it to do so.

Any prospect of an even more favourable outcome than current mainstream predictions? Well, anything is possible but it is not realistic to expect a very strong US recovery next year. A solid and sustained one would be just fine – and be enough to ensure that the UK escapes recession.

The funerals, in order of decreasing probability, start with serious economic disruption in Japan. It is quite hard, writing from London, to grasp just how grave the Japanese economic situation has become. The economy is predicted by the IMF to shrink both this year and next. Industrial production is at a 13-year low. There is a fiscal time bomb. The government's tax revenues are 16 per cent lower than in 1990 and spending is 29 per cent higher. There is a liquidity trap: because prices are falling, even zero interest rates would be too high. And structural reform, despite the worlds of the prime minister, Junichiro Koizumi, is stalled.

For the moment there has been little contagion: the rest of the world has not been particularly seriously damaged. The danger is that some sort of discontinuity, a banking crash perhaps, will suddenly undermine the world economy, spreading the Japanese disease elsewhere. If that were to happen, the best hope would be that the crash would become a healing event, setting in train the mechanism for recovery. The trouble is that you cannot control what might happen: sudden catastrophic events sometimes signal the turning point but sometimes cause serious collateral damage.

Funeral two would be a post-euro collapse of demand on the Continent. European confidence is very fragile at the moment. As the left hand graph shows there has been some bottoming out of the best indicator of US business confidence, the one produced by the National Association of Purchasing Managers. But the nearest European equivalent, the OECD leading indicator for the EU, is falling at the sharpest annual rate for 20 years.

And suddenly this region has to cope with the uncertainty of a new currency. Whatever view you take of the wisdom of introducing the euro, there can be no doubt that this is the worst possible time to launch it during the past 20 years. That was not the fault of the planners, for they could not have known that this would happen. But it is terrible luck.

It is certainly possible that once the currency is operating, people will spend their spare balances of the legacy currencies, the marks, francs and so on, and so give a boost to the Eurozone economies. The danger is that people will be worried about prices, worried about making a mistake when buying, worried about the long-term value of their savings and as a result, spend less. This will hit big-ticket items. They won't buy less toothpaste, but they may hold off buying a car.

Eventually things will adjust themselves, but even a short hiatus in consumer spending would have knock-on effects on confidence. And, as you can see from the right-hand graph, consumers are already losing faith in the future.

Funeral number three would be a double dip in the US. Yes, the economy does start to recover in the second or third quarters of next year, but the recovery is not sustained because of low consumer confidence. The Fed has already driven rates so low that further cuts would have little effect. The US is prepared for a slow pull out of recession but not for a fall back into recession after an aborted recovery. That could lead to a collapse on Wall Street, still highly valued by UK and European standards. I believe this is less likely than funerals one and two, which are both more than evens, but those with long memories may recall that a double dip happened in the last synchronised world recession in the 1970s.

Finally funeral number four. That would be that the UK, despite the optimistic noises made by everybody, does indeed have a recession. I score it low, say a 25 per cent chance. But it is not hard to see how it might happen, particularly if Continental European performance is disappointing.

This is all a little unfestive. Sorry. Don't reject the hopeful mainstream predictions; but do take them with a pinch of salt.