The CounterRevolutionary

Sunday, February 15, 2004


Stop talking down the economy!

First, I’m sorry that I haven’t posted in a while – work has been busy. Second, I’d like to post about something I know a little about (or at least get paid to do) – finance. Last Friday, an economic statistic was released that greatly troubled me. The University of Michigan consumer sentiment plummeted from 103 to 93. An AP survey released a few weeks ago showed a similar decline.

What troubles me is that this deterioration does not appear to have any economic drivers. After all, the economy is doing just fine. The unemployment rate is lower than it has been since the 9/11 attacks and is currently one of the lowest in the developed world. Even the establishment survey is finally registering job growth. Likewise, the economy is growing at a healthy clip and the stock markets have been advancing. Interest rates are at their lowest in 40 years and the Fed has signaled that they intend to keep it that way. Finally, inflation, the scourge of post-WWII economies, is nowhere to be seen.

Furhermore, there were no economic events during the survey period that would cause consumer confidence to thusly dip. No attacks, no major lay-offs, no corporate scandals or world events that would cause the public to take a bleaker look at life. It appears that sentiment dipped despite a healthy real economy.

What, then, could have caused the public to get gloomy? I believe that the answer is election year politics.

To understand why this development is so troubling we have to travel back to September 12th, 2001. Forget for the moment the emotional and the political situations of that day and focus on the economic. A day earlier, a terrorist strike aimed at the financial heart of the US killed almost 3,000 people and took down two skyscrapers (I worked a block away). The stock market was closed indefinitely, obituaries were being written for the airline and the hospitality industries and the economy was in general disarray.

Unfortunately, the 9/11 attacks were the second major economic disaster in as many years to strike the US. The first was the deflation of the Nasdaq technology bubble. By many measures (e.g. P/E) that bubble was larger than the one that toppled in 1929. There was another, less publicly known, bubble in the debt markets as well. There was a real chance that the aftermath of the exuberance would be as extreme as the bubble was frothy. A Great Depression II was not out of the question.

Yet the nation’s economy survived those two events, suffering only a mild recession. The saviors of the economy were the consumers – they continued to spend. Not only did they turn around the US economy, but they kept the European and Japanese economies afloat by buying foreign goods. Business spending, on the other hand was nowhere to be found. Overspending in the 1990s and weak financial positions (see the debt bubble) caused many companies to be shy about building many new products.

The ability of the American consumer to spend was caused by two major influxes of cash, lower interest rates and lower taxes. Lower interest rates allowed homeowners to refinance their homes and to use the extra cash for spending. They allowed manufacturers to offer 0% financing on automobiles and appliances. Lower taxes were more direct – in an atmosphere where few companies were offering raises, lower taxes put more money in people’s pockets.

What does this have to do with consumer sentiment? After all, consumer spending and consumer sentiment do not appear to be related (people spent during the recession despite low sentiment numbers).

The trouble is that the pillars of our recovery are under threat. The interest rates are low and will stay low for a while, but you can only refinance your house once and many people have already taken that advantage. There is little to no chance that the rates will go any lower than they are today. The tax cuts are also under political threat. As in every recovery, there is a real probability of relapse. Just punch up the Nikkei stock index or the Japanese GDP from 1990 on or the Dow from 1929. There were many “false positives” of recovery which proved to be fleeting.

With the American consumer getting “tired”, to continue our recovery businesses must begin to spend. And consumer sentiment and business sentiment are related. Business owners must produce goods in the amount that they believe the marketplace can absorb. They use measures of consumer sentiment to gauge future demand. And if the consumer acts gloomy, the businesses will not spend. Without new business spending we are in danger of relapsing into recession.

That’s why I’m worried.

Now that it’s clear why consumer sentiment is so important right now – what’s causing it to drop despite good economic numbers?

The economy, of course, is not all statistics and figures. More than anything, the economy is about psychology. When in the 1990s we wanted to believe that dot.coms were real companies with real value – we believed it and made it so. Conversely, FDR was right when he said in the middle of the Great Depression that “the only thing to fear was fear itself” – views of a bleak outlook tend to reinforce themselves.

Consumer psychology, today, is driven by the election process. For the past few weeks more and more people have been paying attention to the Democratic primaries. And what they’ve heard from the candidates about the economy is gloom and doom. They have attacked the President for his stewardship of the economy and for his failure to produce more jobs. The American consumer/voter is taking this to heart.

The poll numbers bear this out. In a recent Washinton Post poll, the President’s economic approval ratings dropped from 51 to 44 over a similar stretch of time (question 2a). Again, no bad economic news could have affected the consumer during this period. But, many more have begun to pay attention to the election process (question 3).

To the Democrats, I say, “Stop talking down the economy!”

Criticism of a president’s economic policy is, of course, a legitimate political topic. But at the same time it is possible to do it without threatening the economy. For example, would it be so wrong to acknowledge that 5.6% unemployment is not a bad place to be? The Democrats can easily argue that our economy is not that bad, but it can do much better. Governor Bush took a similar tactic in 2000. While that approach may not be as effective as sowing economic fear, the candidates should not be beyond reproach for the consequences of their rhetoric.

Conservatives, too, are responsible for some economic gloom ‘n doom. Recently they latched on to the growing budget deficits as an excuse to bash the Administration and the economy. This is nonsense. If a country is allowed to run a deficit, then what better time than during wartime and while escaping a recession. Any one of these reasons should be sufficient and both are present today. Nevertheless, the deficit is not that large. When compared to the GDP, it is smaller than the Reagan deficits. Furthermore, deficits are hard to predict – remember Perot circa 1992 holding up graphs showing an ever increasing trajectory?

The conservatives’ complaints about deficits seem to be a mix of muscle-flexing before an election and a proxy complaint against “big government.” Complaining about deficits has become more politically correct than being a “small government” conservative. But if that is their cause, they should stop bad-mouthing the economy lest the deficit becomes a minor afterthought of a recession.

Finally, the White House deserves some blame for the spreading economic gloom. They have failed to laud themselves for steer this country through a minor economic miracle. How else do you describe a state of affairs when the result of a major terrorist attack and a massive financial bubble is 5.6% unemployment and 4% GDP growth (the French figures are 9.7% and 0.5%; and German are 10.2% and 0.2% respectively)? The Administration should be shouting this from every rooftop. Do they actually expect a hostile press corps to carry their water?

The economy is a legitimate election year topic, but in their zeal to get elected, politicians should avoid causing irreparable harm to the economy. If the Democrats cannot find a way to criticize Bush without spreading economic doom and gloom they do not deserve to be elected. So,

Stop talking down the economy!


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