Our economy's crisis of confidence

By Robert J. Samuelson
Monday, June 14, 2010

It's psychology, stupid. Not since World War II has an economic recovery been so hobbled by poor confidence. Every recession leaves a legacy of anxiety and uncertainty. But the present residue is exceptional because the recession was savage and -- more important -- its origins (housing bubble, financial crisis) were unfamiliar. People are super-sensitive to the latest news, for good or ill, because their vision of the future is blurred and their bias is gloomy. Having underrated economic risk during the boom, Americans may be overrating it now. Unfortunately, perceptions can become self-fulfilling.

The Obama administration is grappling uneasily with this reality. It can rightly claim that its economic policies quelled the near-hysteria of late 2008 and early 2009. But the success was partial, and the administration isn't getting much credit even for that. Only 23 percent of the public say President Obama's policies have improved the economy, reports a new Pew survey. By contrast, 29 percent think his policies made matters worse and 38 percent believe they made no difference. For or against, those policies haven't restored faith in the economy's underlying strength.

Decisions by people and companies to spend or hoard, hire or fire reflect fickle hopes and fears. These fluctuate, but today's common starting point is pessimism. In May, 56 percent of American families expected flat or declining incomes over the next year, reports the University of Michigan's Surveys of Consumers. Before the recession in early 2007, 89 percent of families expected higher or level incomes in the year ahead.

The weak labor market is clearly a powerful psychological poison. Almost everyone knows someone who is or was unemployed -- a jobless recent college grad, an idle construction worker, a fired manager. True, the unemployment rate (9.7 percent in May) is below the post-World War II high (10.8 percent in late 1982), but underemployment and prolonged joblessness hover near postwar peaks. Once lost, a job is hard to find. Almost half (46 percent) of the 15 million unemployed have been jobless six months or longer. Nearly a fifth of the labor force is unemployed, working part time involuntarily or so discouraged they've stopped looking for work.

The stock market also shapes psychology. "Our economy has become very sensitive to the stock market," says Mark Zandi of Moody's Economy.com. The wealthiest 20 percent of Americans represent about 60 percent of consumer spending, says Zandi. These same people are most heavily invested in the market. When the market rises, they feel wealthier, save less and spend more -- and vice versa. In mid-2007, their savings rate plunged to 1 percent of disposable income; but when the market dropped, savings jumped to 16 percent and spending suffered.

Consider the present implications. The market's rebound beginning in March 2009 prompted another reversal. Feeling richer, the well-off spent more. By year-end 2009, their savings rate had dropped to 3.5 percent. Similarly, the market's latest decline could weaken the recovery. (At this writing, the Standard & Poor's index of 500 stocks is down about 11 percent from its recent peak.)

The danger is that pessimism feeds on itself and leads to a dreaded "double-dip" recession. Companies won't hire because they fear customers won't spend; and customers don't spend because they fear companies won't hire -- or may fire. For the moment, a double-dip seems a long shot. Private hiring has restarted; inventories have been depleted; strong growth in China, Brazil and India has boosted U.S. exports; psychology could turn for the better. Still, the fact that some knowledgeable observers fear a renewed recession attests to the low state of confidence.

The truth is that economists aren't especially adept at relating popular moods to economic outcomes; that's one reason most missed the housing bubble and why today's forecasts seem tentative. It's also a further cause of depleted optimism. People have lost faith in economic seers, who often miss the latest turn in local or global developments. Was the present euro crisis widely predicted? Nope. People seem conditioned to think that surprises will be unpleasant.

What's missing are "animal spirits," in the famous phrase of economist John Maynard Keynes. In the boom, surplus animal spirits spurred speculation. Scarce animal spirits now hinder recovery. Given the magnitude of the housing and financial carnage, most of today's cautiousness and risk aversion -- by both businesses and households -- were unavoidable. But the Obama administration's anti-business rhetoric and controversial health "reform" may have compounded the effect. These policies created uncertainties and fanned partisan rancor. In the case of health "reform," they raised the cost of future full-time employees.

The administration believes these various policies don't hamper economic recovery. It ignores contradictions and inconsistencies. Historians, more detached and better informed, may conclude otherwise.

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