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Velocity vital to stimulate the economy; WEEKEND VIEW.


THE unusual thing about this bear market is that share prices remain high compared to previous ones.

The reason for this is undoubtedly low inflation. The so-called Rule of 20 says that you can work out how much companies should be worth by taking their earnings and multiplying them by 20 minus the inflation rate.

Also most commentators are predicting a sharp recovery next year. Hugh Priestley, of Rathbones, is particularly optimistic, urging investors to buy now or risk missing the upturn when it comes.

There are some who are more cautious, pointing out that growth in the world economy still depends largely on robust US demand. They argue that the US is a post-bubble economy, prone to deflationary forces, in which demand will remain weak for some time.

This is the position Japan has been in for most of the 1990s, but thanks to the American consumers' love of spending, nobody expects the post-bubble US to be quite that bad.

In Japan interest rates are down to zero and in the US they stand at 1.75pc.

Inflation is higher than this, which means that real interest rates in the US are now negative. In theory, you could borrow money, pay the interest, stick it under the mattress and still make a profit.

Holding on to money and doing nothing with it is exactly what people do during a deflationary period. The power of money to stimulate the economy depends on its velocity - the frequency with which a given pound is spent. If the velocity continues to fall, all the interest rate cuts in the world will not restore growth.

After more than six years this column is relocating to the centre pages of Business Week, our Wednesday supplement for readers in England. My first column there will appear on December 19.
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Copyright 2001 Gale, Cengage Learning. All rights reserved.

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Title Annotation:Business
Publication:Daily Post (Liverpool, England)
Date:Dec 15, 2001
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