The Elusive Nature of Confidence

April 28, 2009

I’m not prepared to say that April is really busting out all over?  Sure, U.S. consumer confidence jumped to 39.2, about ten points higher than street forecasts.  The 12-month drop in U.S. housing prices finally declined according to the Case-Shiller indices.  In Britain, the CBI business group reported a swing in the distributive trades index from -44 in March to +3 in April, the first black-ink result since March 2008 and the strongest in 15 months.  France and Germany also reported improved consumer sentiment recently.  Even lowly Iceland saw consumer confidence recover to 39.0 from 37.8 in March and a low of 19.5 in January.

Revealed preference is a concept in consumption theory distinguishes between what people actually spend and what they might tell a survey about their consumption intentions.  Watch the walk, not the talk.  It’s not surprising to see consumer confidence revive, nor does a sharply improved mood according to surveys seem unreasonable.  Levels of confidence are still mostly low.  People were shocked during the past six months by the evaporation of wealth and the size of announced layoffs.  The world economy seemingly was falling off a cliff, and policy initiatives for long produced no more than fleeting relief.  From an extraordinarily low place in early March, the emerging evidence of a less steep decline in economic activity produced exaggerated improvement in confidence, because the survey lows discounted the possibility that economic activity would keep tumbling at a breakneck pace.

The patient that is the world economy remains seriously ill, and thus far symptoms of distress but not underlying unsustainable structures have been addressed.  At least four sea-changes must occur.  Housing markets need to stabilize.  Consumer debt has to be scaled sharply lower.  Banking has to be reborn in the boring but safe image that characterized an earlier post-depression era.  And economies whose people have been big savers must swap roles with others where people have lived well beyond their means.  All of these adjustments will be painful, and not everyone will emerge in a better place.

Moreover, global economic convalescence will not take place in a vacuum.  Everything is in flux as the repairs are being made, and new factors like the swine flu scare can introduce fresh shocks to jolt the process. As a litmus test, I’m watching equity markets around the world.  The biggest blow to confidence since Lehman has been the destruction of wealth.  People are conditioned to expect labor markets to remain very poor and to trail any turnaround in other parts of the economy.  But a new down-leg in equity prices would send consumer confidence and spending reeling again.  The up-and-down tribulations of Japan’s economy since 1991 are mirrored in its see-sawing stock market, which alas remains 78% below its end-1989 peak.

Copyright 2009 Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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