The 'Confidence' fetish

You’ll hear a lot of the ‘confidence fetish’ out there among the financial and economic pundits.  You know what I mean, all the talk of the current recession being due to a “crisis of confidence”, or a “lack of consumer confidence”, and bemoaning the fact that “business confidence is too weak” to expect new investment or hiring, or that “falling banking sector confidence” has caused credit markets to “dry up”.  Most of the mainstream opinion-givers argue that if confidence can just be raised, consumers will begin spending again, businesses will begin hiring again, banks will begin lending again, and recovery will be under way.

These are tired platitudes from the talking heads on TV and economically speaking they are almost meaningless concepts.

Economies don’t run on a fuel tank of ‘confidence’.  Economies run on reality.  

Apart from the fact that confidence is a totally subjective concept, it is also of little value to track, particularly in the consumer sense, because it is merely the result of events that impinge and impact on real economic actors’ sense of well being and is an expression of those actors’ outlook on their perceived prospects for improving their well-being in the future. 

High consumer confidence for example is not necessarily a bullish signal for an economy at all, but is instead merely a reflection of a comfortable state of being among the general population.  In a debt-driven spending boom, consumer confidence tends to shoot sky-high, but rather than being an indicator of economic health, it would be an indicator of impending collapse on a pile of bad debt, leading to considerable distress.

This is exactly what we saw prior to the current recession.  South African households had never had it so good, being able to leverage up to the hilt, borrow against their homes, renovate the pool, buy the flat screen TV, refurnish the beach pad, and get nice clothes.

Business confidence is pretty much an equally nebulous and unhelpful concept.  Companies are confident when they are selling product and making margin.  In a consumer credit binge companies sell a lot of stuff, and when the money supply is running so far ahead of real productivity growth, they’re able to keep passing cost increases onto the consumer.  Sky-high business confidence can be a sign of impending recession rather than good times ahead.

Even when banks lose confidence in one another and credit flow freezes up, it is a symptom not a cause of systemic problems.

Economic ‘confidence’ is a lagging indicator, so at best it tells you what you’ve just experienced, rather than where you’re going.  Human nature also dictates that material comfort and perceptions of an immediately comfortable future will drive confidence levels up, so measures of confidence are skewed toward consumption and away from productivity and thrift.

Here’s the ironic part.  When consumer, business, or banking confidence slumps, it is probably one of the most positive economic signals you could get.  Seriously.  It means households are hunkering down, restoring balance sheets, saving, spending prudently and within their means, and working harder and longer hours.  It means companies are trimming costs, right-sizing operations, improving products, and offering better value to consumers.  It means banks are realigning risk models with reality, calling in bad loans and making more prudent new loans, seeking out more credit-worthy and productive customers, and offering better rates on deposits to restore their impaired balance sheets and cash balances.

These are all healthy signs and indicate that an economy is beginning to be restored to genuine health.

Unfortunately, most economists and policy makers interpret these signs as proof of an economy suffering from a “lack of demand” and in need of government life-support.  So they opt to increase deficit spending, print more money and subsidise the worst-affected industries in the belief that this will rescue the economy from what Keynes called the downward spiral of recession, when falling demand expenditure leads to lower production, which in turn leads to lower incomes and profits, which leads to lower spending, and so on.

Nothing, sadly, could be further from the truth.

In the US, Europe and South Africa, business and consumer confidence is rising.  Should we be happy about this?  I don’t think so.  It proves that the pain that needed to be taken is being forestalled to some future date when recompense for the excess will truly have to be repaid.  Rising consumer, business and banking confidence at a time when underlying fundamentals are still so weak only shows that governments so far have been successful in moving toward recreating the false conditions of the preceding credit bubble.

The pundits will keep talking on and on about consumer and business confidence, and as it rises they will hail it as evidence of a recovering economy.

Pay no attention.