‘No confidence’ is no excuse for an idle economy 

At the start of every economic downturn in memorym there has been a chorus of voices saying that recovery is just a matter of “confidence.” Supposedly all we have to do is pick ourselves up and “not talk ourselves into a recession.”

Politicians, particularly those in power, are the ones who adhere most fervently to the confidence hypothesis. After all, it couldn’t possibly be the failure of their policies that is the cause of economic distress.

Speechwriters, always seeking to channel the rare moments of memorable political oratory, love the confidence theme. It echoes Franklin D. Roosevelt’s famous line in his first inaugural: “The only thing we have to fear is fear itself.”

The trouble is, the facts do not support this hypothesis.

A typical “jolt to confidence,”  shows up as an increase in the saving rate as people pull back and save rather than spend. FDR’s “fear itself” was manifested in a downward spiral in which a rise in household saving caused less consumption, less production, less employment, less income and, in turn, even less consumption.

But since late spring, just before the budget debate, the household saving rate has been falling, not rising. In terms of nominal dollars, personal saving was almost $100 billion lower in August (at an annual rate) than in June, before the supposed “shock to confidence.”

In fact, the facts suggest households were completely unfazed by the budget debate in their spending and saving behavior.  But we can’t rule out the possibility that spending will decline in the future ?— ?not because of the budget debate, but because of the continuing decline in household income growth.

The facts suggest that households have responded to their troubles so far by digging deeper into savings to maintain their spending levels. This would actually be a good sign if household incomes were not still dropping. But an economy cannot sustain itself with ever-dropping saving rates in the face of dropping incomes. The current, long-running “shock to cash flow” will probably soon be reflected in a higher saving rate and a real shock to confidence. It will be another reminder that confidence follows cash flow, not the other way around.

History suggests that it was a revival of cash flow, not FDR’s eloquent talk about fear and confidence, that caused the economy to turn upward back in 1933. One of his very first acts was to confiscate gold from the public, paying just $20.67 per ounce. Once it was in the government’s hands, FDR revalued it by decree to $35 an ounce, leading to a huge increase in the money supply. With more cash flowing around, prices rose, confidence grew, and the economy began to expand. Even then, confidence followed cash flow.

Today, things aren’t that easy. There is no gold standard to revalue. Instead, the government will have to make more with less, creating value in the process. This means using rigorous cost-benefit analysis for spending programs and regulations and passing sensible tax policies.

President Barack Obama is not temperamentally, intellectually or ideologically suited to this unglamorous work.

Instead he will continue to use his rhetorical gifts to talk about how the Republicans or the Europeans or someone else destroyed confidence, taking down an otherwise promising economy. But cash flow, not rhetoric, is and always has been the precursor to economic confidence.

This article appeared in The Weekly Standard.

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