Perception in the Current Economy

Clearly, perception is very important to the economy. I made my case for this in my previous blog, so it would be a good idea to read that one first if you haven't already. So, if we assume that to be true, then it should also be true that perception is incredibly important in any economic recovery. I don't claim to be an expert on the economic crisis, I think that the causes are incredibly complex and it will take time for economists and historians to pinpoint the exact causes and what solutions helped to improve the economy. Obviously, a big cause was a housing bubble, which was encouraged in large part by the Federal government through Fannie Mae and Freddie Mac. Too many people were encouraged to buy more than they could afford on dubious terms. Too much credit was loaned to risky borrowers. I think that perception has also played a role in this. The first major collapse in terms of credit was Bear Stearns. From the pages of information I read on the collapse soon after it happened, I gathered that noone expected the firm to collapse (not even executives) even a couple days beforehand. A few creditors stopped lending money to the firm, which turned into a domino effect. No company wants to be one of the last creditors of a company, so when other investment firms/banks saw creditors withdrawing credit lines from Bear, even though the company may have ended up fine, they followed suit. Bear's credit lines dried up, the firm collapsed. Sure, the issue was much more complex than this, but still, when the firm's perceived reputation tanked, so did the firm. More firms proceeded to fail and the government's response was inconsistent. Some firms were 'rescued', some were not. Investors were nervous; the stock market does not like uncertainty.

The government responded by spending money. Lots of money. Most of it went to banks. Americans were looking for reassurance from the government. Instead, they saw inconsistent behavior. Furthermore, since most Americans did not understand the complexities of the crisis, they did not understand why banks were receiving bailouts while other industries were not. The government was relatively quiet for a few months as economic policy transitioned from President Bush to President Obama. I think that President Bush addressed the crisis fairly poorly, but as his term is now over there's no point in looking at it in detail. What I'm concerned about is President Obama's policies.

I think that a lot of the problems that caused this crisis have eased. Home values have plummeted and any market-based price corrections are probably complete. Bad assets have been identified, the government has injected billions into banks that were on the verge of failing. Now the issue is how to get the economy back on the right track. A significant obstacle that must be overcome is improving investors/consumers' perception of the economy. Obama's first order of business in addressing the economy was to put together a massive "stimulus" package that increases government spending to an unprecedented level in comparison to post-WWII history. The budget deficit over the next 20 months will be greater than the deficit over the previous 8 years. So, we're fixing an economic problem caused in part by too much borrowing by borrowing substantial amounts of money. Even if we assume this is sustainable, and perhaps it is, there's the whole issue of spending to fix the economy.

My problem with the current response to the economic crisis is that the government seems to be aiming to improve the perception that the government can help us out of the crisis rather than the perception of the actual economy. It's true that there's something to be said for this. Consumer confidence is extremely important and knowing that the government is spending massive amounts of money to prop up the economy undoubtedly is reassuring for some people. However, consumer confidence is also significantly affected by the stock market, which theoretically is a fairly accurate representation of the value of all publicly traded companies. I don't think that the economy can recover to a large extent until the stock market begins to recover (true, they kind of go hand in hand, so that statement could be argued). Government spending CANNOT replace private spending in the economy. The economy IS private spending, and the more the government spends the less capital is available to the private sector. A short-term stimulus to the areas of the economy hurting the most could be used to potentially boost private spending in those areas as well. Instead, we have a stimulus bill that increases spending for years and funnels money to areas of the economy that aren't suffering, i.e. education and healthcare. These areas may be deserving of more funding, but a lack of funding there is not ailing the U.S. economy. Investors agreed, as the stock market tumbled when the stimulus package was announced. If our goal is to improve the economy, i.e. the private sector, than how is legislation that causes the stock market to tumble good for the economy?

My impression of the stimulus package is that it's a massive spending bill filled with pet projects for which the Democrats have been wanting funding for years. Analyses I've seen suggest that at most 12 cents of every dollar spent are going to something that could remotely be considered 'stimulating' for the economy. Obama further convinced me of this by his change in attitude before and after signing the bill. Before the bill, Obama stated that the economy is the worst it's been since the Great Depression. He attacked McCain for saying the economy was fundamentally sound. After getting his stimulus bill passed, he claimed the economy is fundamentally sound (in different words, I don't feel like looking up the quote right now). Also, he signs a bill filled with some 9,000 earmarks and then starts talking about the need to cut down on earmarks. I congratulate President Obama on realizing that it's about time to start building Americans' faith in the economy itself by saying it's fundamentally sound, it was a good sign of his intentions. However, the timing suggests that the 'stimulus' bill was political and nothing that needed to urgently pass to save the economy. Granted, I think that if McCain had been elected, he would have also created a stimulus bill, but it would have gone to Republican pet projects rather than Democratic pet projects. My point: I'm not trying to demonize President Obama or the Democratic party, but as they are in charge they get to answer for the policies.

I'm sure that the stimulus bill will create jobs, but they are jobs that depend on government funding. If government was the answer, then fixing the economy would be a cinch. We must not create dependencies on the Federal government, but create incentives for the private sector to grow and for the stock market to increase in value (when investors see added value in the economy). Tax cuts, incentives, and healthy regulation would be far more beneficial than adding trillions of dollars to the national debt. If we lowered the capital gains tax, then investors would pour money into the stock market as it would be cheaper to own stocks. This would ease the difficulty many companies are having in borrowing money. If President Obama is convinced that we need to spend our way out of the recession, than perhaps limits should have been put on the bill to significantly scale back or halt spending when key economic benchmarks were met i.e. Dow Jones reaching 9,000 and unemployment less than 5.5%. Just a suggestion, but it would clarify his intentions for people like me. Many of the other policies being proposed right now (i.e. cap and trade, ending secret ballots for unions) are anti-business and will not increase confidence in the economy. These policies should not be debated until the economy is back on its feet.

On a side note, it's important to notice that the stock market DID jump when Citibank unexpectedly announced they expected to make a profit. That announcement was apparently more beneficial to the economy than the announcement of the stimulus package. Let's not advertise the government as the answer to our problems, but use the government to clear the way for the companies that are the bread and butter of our economy to be successful on their own.