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Tuesday, December 02, 2008

Consumers individually vs. society as a whole? (Consumer confidence just a lagging indicator, Part II

We hear all the time that in a time of recession, what is rational for the individual – strengthening a rainy-day war chest, paying off debt, hunkering down – is irrational as far as the economy is concerned, since 70% of the economy is consumer spending. Saving, then, becomes unpatriotic. Something about that juxtaposition of conflicting principles sticks in the craw.

Well, how about this for a theory that breaks that Gordian knot? It is ultimately the aggregate confidence in the future of all participants that drives an economy. When a downturn begins, consumers have been in relatively profligate spending patterns, and the future for being able to maintain that lifestyle looks gloomy. Consumer confidence plummets. Business confidence does, too, investment slows and we enter a recession. Eventually, professional economists see what everyone else has seen for a long time.

But maybe it’s the saving and the slower rate of spending that ultimately sets a floor on that confidence downturn among consumers: once consumers have adjusted their lifestyles to a more modest expenditure level, or more likely, a slower rate of gratification, and they find they can still do most of what they need and enjoy without a major hit to their happiness, confidence in their own ability to meet their future needs stops dropping. That may not be enough to turn confidence up very much, so some stimulus from government or elsewhere that actually promises an increase in jobs may be necessary – i.e., an increase in the likelihood of employed consumers that they will hold onto their jobs, and of the unemployed that they will have a better chance of finding one – but it may be a socio-economic phenomenon that slows down the freefall.

In that sense, then, there is no conflict between rational individual behavior and ultimate recovery on a macro level – with “ultimate” in this case being a lot closer than the “ultimately we are all dead” counsel that in slightly different words Keynes gave us (“in the long run”). The thread is in the central role of aggregate confidence in the future. The individual rational thing lays the groundwork for recovery, even if in the short term it appears to make things worse.

“Or elsewhere,” I said above in weasel words. What is that “elsewhere” where a source of re-building consumer confidence might be found? Besides some deus ex machina -- like sudden discovery of a way to make large, safe automobiles reach 100 MPH in 4.7 seconds and run for 5000 miles before a recharge on nothing more than four AA lithium re-chargeable batteries, or maybe a fashion change in China and India that demands only made-in-America goods – perhaps it is the prescient business-investor who senses that the confidence decline has reached bottom, and that goods produced from a restored night shift will sell.

Just noodling. Optimism beats despair, doesn’t it?

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