At the start of every economic downturn in memory 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 FDR’s famous line in his first inaugural: “The only thing we have to fear is fear itself.” But not even the most talented writer can muster either FDR’s eloquence or the gravity of the moment in which he spoke, March 1933. Today they are reduced to a narrative that it was the budget battles of July that produced a lack of confidence, leading to the current economic weakness. Those nasty Tea Partiers and other extremists who failed to give the president what he wanted are the cause of today’s malaise.
The trouble is, the data do not support this hypothesis. In fact, the September 30 release of personal income data reminded us that the current economic weakness began long before the budget battles and speaks to a sustained economic problem that policy has yet to redress. Worse, from the point of view of the confidence narrative, it suggests that confidence has yet to break—and implicitly that the worst may be yet to come.
Consider a set of numbers that hardly require a Ph.D. in economics to understand: monthly personal income growth. In January, personal income grew
1.2 percent. In February it was
0.6 percent. In March, 0.5 percent. In April, 0.4 percent. In May,
0.3 percent. In June, 0.2 percent. In July, when the budget debate was in full swing, the number was just
0.1 percent, and in August growth was a negative 0.1 percent. Even in Economics 101, you don’t often get dots that are this easy to connect, much less ones that connect in a straight line. There was no sudden break in July. What consumers are suffering from is a drip-drip-drip decline in the growth of their household income.
Another measure of income, used by the National Bureau of Economic Research to date the business cycle, shows a similar pattern. Known as “real personal income less transfers,” it adjusts for inflation and takes out things like unemployment compensation, which, while still income, are hardly positive indicators. This measure averaged 0.6 percent in the first quarter of 2011, 0.2 percent in the second quarter, and is likely to come in at minus 0.2 percent in the third quarter. This is another straight line decline that shows no break for the budget debate.
The personal income report gives still more indications that confidence did not collapse. Spending actually increased in spite of the decline in income. If people become fearful, they usually stop spending and hold on to their money. It is even more urgent that they do so when their income is declining.
In fact, a typical “jolt to confidence,” whether it be today or back in FDR’s day, 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. It was 5.0 percent in both April and May, 5.3 percent in June, 4.7 percent in July, and 4.5 percent in August. 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 data suggest that households were completely unfazed by the budget debate in their spending and saving behavior. The confidence narrative collapses on empirical grounds. 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 data 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. The president 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.
Lawrence B. Lindsey served in the Reagan, George H. W. Bush, and George W. Bush White Houses and at the Federal Reserve during the Clinton administration. His most recent book is What a President Should Know . . . but Most Learn Too Late.