It's (Almost) All About Confidence

The present economic recession commenced in December 2007, a year ago. We learned this officially two or so weeks ago. To be sure, the recession is riddled with a host of accompanying economic data that substantiates, or proves, that times are tough. The unemployment rate, GDP, retail sales, capital spending are just a sample of the data we see. 

The depth and length of a recession depends largely on the restoration of confidence. We, as consumers, investors, and businessmen, have little confidence these days. It is clear that we had misplaced confidence prior to December 2007 and even into the first quarter of 2008. The child that ably manages his balance on a bicycle for the first time only to fall when someone interrupts him with a reminder that "he really doesn't know how to ride a bike" comes to mind. Once fallen, and confidence shaken, the newbie bike rider may be stupefied to hear that his future survival depends on his ability to immediately continue riding a bike.  

The point here is the paradox between the sickness and the cure. We are in the problem we are in because we borrowed too much and spent what we borrowed on things whose prices were inflated by a bubble. The macroeconomic antidote to this problem? More debt and spending. It is not unlike a drunk curing a blistering hangover by chugging a fifth of whiskey in the morning. 

Paradoxical or not, that may indeed be the drunk's short-term cure.  The long term cure is just too painful and requires great discipline. A society that pays homage to instant gratification eschews a long term, albeit healthy, remedy. However, this peculiar short-term cure requires the confidence that the morning fifth of whiskey will not cause the already splitting headache to make you feel like you just got hammered by a Joe Frazier left hook. 

Without confidence, no one will want to spend if we think our employment situation is shaky. No one wants to lend if they don't have confidence in a timely repayment. No one will invest without confidence that the investment itself is recoverable. 

When our confidence is shot, human nature, the primitive brain, takes over. We ration. We become rational. Our survival instincts sharpen. We save. We wait. We see. We react. It is irrational to do otherwise in the short term. We are survivors. Our DNA says so. Otherwise, we would not exist. Extinction is the fate of those species that do not promptly adapt to danger signals.

A manufactured sense of economic safety is a creation of modern man and takes the form of the various monetary and fiscal interventions that governments enact. These are actually good, sound tools that can avoid a worse recession and perhaps even hasten a recovery. But to work, they are forced to appeal to the modern brain and this requires a key ingredient that has the effect of telling the primitive brain to take a break -- yes, Confidence.