Markets unlikely to learn lessons from meltdown

The world's financial markets are acting like Corporal Jones from the British sitcom Dad's Army - rushing around in alarm while shouting "don't panic". The question is whether there is any need to panic. It is tempting to suggest that, unless you have stuffed a fortune into the Russian bond market or put your life savings into one of the country's banks, there is little need for the headless chicken routine.

Look ahead in a spirit of modest optimism. Russia is not so plugged into the global economy that its downward spiral should pull the rest of the world with it. Even those countries in the former central and eastern Europe which once relied almost totally on Russia for all forms of foreign trade have managed to diversify.

Some outside investors will have been burnt by the rouble devaluation and the subsequent market collapse but waste no sympathy. Sensible ones will have limited their exposure to such a volatile market; those who took big punts on Moscow's markets deserve all they get for forgetting the most basic of investment rules.

Germany, the biggest lender to its eastern neighbour, will take a hit. But, though taxpayers may come to complain, most of the country's banks have already made big provisions against their exposure. Although Russia remains an important energy supplier to much of eastern Europe and an increasingly important one further west, interruptions in supply are unlikely to send the price of oil rocketing or leave consumers bereft of alternative energy sources.

The Asian crisis is expected to have a more direct impact on the global economic outlook than events in Russia but there are plenty of analysts who reckon the effect will be modest enough.

Even the fallout in the stock markets on both sides of the Atlantic can be argued away as a necessary correction against previous irrational exuberance. It is a serious concern, for example, for anyone in Britain with a money-purchase scheme with a big equity exposure if they are looking to take their pension now. On an even moderately sanguine basis, however, fund managers are likely to tell anxious pension fund trustees that in six months time, maybe a little longer, markets will have righted themselves and the logic of long-term investment will have been re-established.

Fair enough. But do not bank on everything turning out for the best. Market reaction may be either irrational or merely overdone. That does not matter. Loss of confidence means that, for the global economy, the risks are on the downside.

Look at the world through less rose-tinted glasses. Within the space of little more than a year south-east Asia and Russia have run slap-bang into the reality that free markets and deregulation do not guarantee a free ride to economic nirvana.

It is all very well for academic economists to argue that if only the Russians, Thais, Indonesians and South Koreans had applied capitalism's rules properly, they would not be in the mess they are in at the moment. Western commentators have been quick to point out that capitalism relies on a sound banking system not on indiscriminate lending to asset-gobbling "chaebol" in Korea or cronies in Russia. Get that wrong and of course there will be problems. Just get it right next time and all will be well.

Such doctrines have little appeal for those queuing anxiously outside Russia's banks this week or for those in the Far East who are contemplating unemployment in societies which have never had to build-in appropriate safety nets because joblessness just did not happen. They do not appear to cut much ice - even with Tokyo policy-makers battling to restore confidence in the Japanese banking system.

It is hard to measure how deeply capitalism was ingrained in either Russia or the Far East but it is a fair bet that millions will have lost faith in the politicians who told them it was a great idea.

That is not good news. Beleaguered Boris Yeltsin is hardly anyone's idea of the perfect democrat. He may have helped to dig his own political grave through his close links with the powerful business groups which are trying to run Russia in their own interests, whatever the consequences for others. His regime can never be seen as a model of transparency. But there are some worse options on offer at the moment. Economic chaos is bound to spawn a political backlash.

For the United States and western Europe there are big risks, too. Falling stockmarkets dent consumer confidence which, in turn, can mean slower economic growth. For the US there is a real worry that the Russia-Asia contagion will rip through Latin America, underming not just the economic but also the political progress that has characterised the 1990s.

Even the introduction of the euro may be buffeted by the turmoil that has rocked the markets. Favoured havens include the German bond market. Demand has reached the point where the yield on the German bonds is being driven down to record lows.

That, in itself, should not be a worry. But bund yields are not only falling in absolute terms, they are falling faster than the corresponding yield on Spanish and Italian bonds. That means that the spread between German yields and those of other key euro members is widening. Yet - for the single currency - this is the time they should be converging.

There are reports that the authorities are trying to get the genie back into the bottle. Markets are buzzing with rumours that the Federal Reserve's Alan Greenspan is talking to his opposite numbers in Europe over concerted cuts in interest rates - the classic method of pulling markets out of a tail-spin. Even talk of such a move was able to spark a putative recovery.

It looks unlikely but if it did happen it might help western markets and, maybe, do something to aid Asia but it would do little to get Russia out of its morass. Nor will it provide an alternative for those who now see capitalism as a god that failed. Least of all, will it inoculate the world economic system against future attacks of new variant mad markets.