February 2, 2010

Confidence More Important Than Stimulus or Deficits

The economic stimulus of 2009 helped us avoid another great depression, but that stimulus itself will not decide our economic future.

We could still fall back into a depression, or continue this recovery, and the stimulus is only an aid, like shock paddles in an ER.

The patient will decide whether to live.

Consumer spending is the biggest part of our current nascent recovery. And that consumer spending has held up recently, neither strong nor weak. Tomorrow will show us another piece in this picture, but we already know the most important data: confidence.

Consumers have relatively more confidence in recent months than they had a year ago.

Of the handful of dominant economic factors that will push the U.S. economy up or down, confidence outweighs all other factors. Only the dollar exchange rate effect on exports comes close to confidence in determining the direction of the economy.

People decide whether to buy extra goods and services when they feel confident in their own income over the coming months. Confidence in the broad economy is decisive.

Since confidence dominates other economic factors, usual situations can arise, as now.

If you listen to any news media lately, all you hear is deficit-reduction.

The meme (idea) of medium-term deficit reduction has lately climbed to the top of the heap and dominates all other economic ideas in the broad popular imagination.

This has lead to the novel idea that reducing government spending in the future will strengthen the long run economic prospects of the nation.

People presume simply that if the nation doesn't follow the rules of budgeting that they themselves must follow in their own household, that the consequences would be similar to what would happen in their own household -- bankruptcy.

But reality is different from the popular imagination.

In reality, large nations like the U.S. do not go bankrupt. If faced with an impossible budget squeeze at some point due to debt, nations like ours simply end up printing money in some fashion, and thus inflate the national debt into a smaller relative size to their economy. In short, the holders of the national debt (treasury bonds) take the hit, in that scenario, since their bonds lose relative value.

In this way, national bankruptcy or national debt squeeze (debt burden) downturns are avoided.

But...since the American public has lately become convinced that our future economic health depends on deficit reduction over the next 10 years, the ironic fact now is that an expectation of less government spending in the future will strengthen confidence.

And that is why plans for deficit reduction actually will help the economy now.

Obama continues to smartly pilot this ship in the storm. He doesn't control the wind and the waves. But he adapts and reacts in a way that encourages me.

This may be an almost perfect storm. But we are not in a modest-sized fishing boat, and our pilot is working the rudder well.

On some level, Obama gets that expectations are the essence of an economy.

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