The maxim attributed to Napoleon that “in war, morale is to all other factors as three is to one” could be applied just as well to an economy. We talk about consumer or investor “confidence” rather than “morale,” but the idea is the same. Success can depend on whether people expect it or not.
Whether or how long consumers will keep on spending is the $64,000 question right now. If one just reads the numbers – output, inflation, unemployment – the U.S. economy is chugging along. It is far from a boom, but it’s not a recession either. Obvious problems seem concentrated in housing construction and mortgage finance.
The stock market shook off its August swoon and hit new highs in early October. Consumer spending has not fallen. So things are basically OK, right?
The answer, as economists are wont to say, is “that depends.” There are a lot of clouds on the horizon and many are larger than the Biblical “size of a man’s hand.”
The average price of houses for the country as a whole is falling for the first time since 1933. Oil prices are hitting new highs. The number of mortgage foreclosures is rising. Millions of people with adjustable-rate mortgages will see their interest rates re-set upwards in the next six months.
Treasury Secretary Henry Paulson just warned that such housing, mortgage and credit problems are more serious than had been thought. Federal Reserve Chairman Ben Bernanke said these factors will pose challenges for a long time.
And then this week, September data showed Minnesota’s job situation worsened again. Our unemployment rate, at 4.9 percent, is now 0.2 percent above the national average and is up 0.9 percent from this time last year.
Local business is not doing great either. Wells Fargo, Minnesota’s biggest bank, reported third-quarter earnings that missed analysts’ estimates. Medtronic faces big problems because of a product defect. Boston Scientific is likely to lay off many. And look at what happened to poor Fastenal. Its third-quarter earnings were up 15 percent. But that was 41 cents per share rather than the anticipated 42 cents, so its stock got hammered down $5.
Through all this, American consumers seem to stand their ground resolutely, like Wellington’s squares of redcoats at Waterloo, only brandishing credit cards instead of bayonets. The question is, can it last?
Unfortunately, economists are no help in answering that question. For 200 years we based our theories on the assumption that humans are strictly rational in making decisions.
Modern finance theory of “efficient markets” assumes the same, even though anyone with experience knows the two most powerful factors in financial markets are human greed and fear, neither of which is rational.
Yes, economic theory is moving away from assuming strict rationality. People have gotten Nobel prizes for their work in moving away from this old foundation. But no one yet has insights that shed light on how long either consumers or investors will stand their ground in the face of increasing bad news.
History may be a better guide than economics. Studying the past tells us investor sentiment does not swing from optimism to pessimism, or back again, in a smooth steady manner. The same is true for consumers.
They rather are like a line of infantry under attack. The platoon may stand up to great pressure, but if one or two drop their rifles and run, it soon becomes a rout.
But if the platoon has been huddled in foxholes under withering fire, just because one jumps up to charge, it does not mean the rest will follow.
Like adolescents, we are highly influenced by what everyone around us is doing. Unlike adolescents, we have powerful impulses to protect ourselves.
Economic downturns used to be triggered by what were called “panics,” usually centered on fears about the safety of bank deposits. Panic still is an appropriate word.
When people are on edge, something that might produce little reaction under ordinary conditions instead triggers great fear. The unexpected snap of a twig doesn’t bother someone strolling through the woods on a sunny afternoon, but if they are the listening post in a foxhole out in front of the perimeter at 3 a.m., the same snap can provoke terror.
Little bits of information thus can take on inordinate weight. It is not that one single bit of bad news causes people to change their sentiment. It is rather that one piece finally confirms fears that have long been building. But the reaction can appear swift.
Sometimes, information that earlier bad news was even worse than first thought puts flame to the tinder. This week, the Minnesota Department of Employment and Economic Development reported August jobs had dropped by 2,000 instead of increasing by 2,100, as had previously been reported. See you guys, I’m out of here …
© 2007 Edward Lotterman
Chanarambie Consulting, Inc.