Thursday, April 30, 2009

Optimism and Economics

I recently wrote about the surge of optimism in the press regarding the world economy and the Economist magazine has recently detailed the number of press mentions of 'green shoots of recovery'. The Economist chart shows a steady rise of the use of the term in March, and an explosion in April.

In my post on the subject of this optimism, I highlighted that all of the indicators were negative, and wondered what might justify such optimism. For example, in the UK, there was a slight uptick in house prices, but I suggested that this was a false dawn. Since I wrote the post, house prices have continued their downward trajectory, though the rate of decline in prices is reported as slowing. Likewise in the UK there has been an improvement in consumer confidence, albeit from abysmal levels.

Perhaps the best summary of the optimism can be found in the Independent, with the headline 'US Recovery Hopes Grow Even as Economy Contracts 6.1%'. The article goes on to say:
US economic output contracted at an annualised rate of 6.1 per cent in the first quarter, almost as bad as the minus 6.3 per cent GDP figure for the final three months of last year, when consumers and businesses were reeling from the collapse of Lehman Brothers.
The report went on to say:
Other "green shoots" in the report included a surprisingly strong uptick in consumer spending, which contributed 1.5 percentage points to GDP, where it had been a net negative for the two previous quarters. Information on the price of goods and services helped to ease the fear of deflation taking hold. And economists also dismissed an unexpected drop in government spending as temporary.
However, we have this from the New York Times:
A day earlier, the government released figures showing an unexpected increase in consumer spending in the first quarter, offering one of the few bright spots in an otherwise dreary accounting of the country’s overall economic output. But the monthly report released Thursday showed that while consumer spending rose sharply in January, its gains tapered off in February and reversed themselves in March, declining by a larger-than-expected 0.2 percent.
So what exactly is this optimism all about? Perhaps the best expression of the depth of the ongoing problems can be found in the actions of the Federal Reserve. In particular, the Fed is currently printing $1.2 trillion and using the money to buy mortgage backed securities and treasuries. Does this action look like an expression of confidence in a recovery?

The most odd part of the so-called 'green shoots' of recovery is the sudden surge in bank profits. An article in the Economic Times sums up the reality of the situation:
The first quarter results of US banks mean little. In early April, the US accounting regulator tweaked mark-to-market rules for bank assets in order to help banks show lower losses on these assets. These modified rules were applied with effect from March 15, allowing banks to show better than expected results for the first quarter.

The idea that banks can work their way back to good health simply by making profits hereafter is absurd. US bank losses are huge — the IMF’s latest estimate of US bank losses is $1.6 trillion. US banks have raised an additional $400 billion in capital so far, which means they need another $1.2 trillion to get back to normal health. For banks to cover this amount through profits would take years. Until then, banks will not be in a position to provide adequate credit.
Quite simply, common sense should tell us that there is no realistic way in which the US banks can be returning to profitability. All of the US banks have massive exposures to the US economy, and every part of the US economy is heading in a downwards trajectory. How an earth can banks be making profits when real estate is falling, consumer spending is falling, insolvencies are up, unemployment is up and so forth...

I am increasingly of the view that we are departing ever further from reality. We are now living in a world in which insolvent banks that are living on life support from the government are apparently making profits.

I will freely admit that I have been increasingly puzzled by the optimism that is emerging. I have always accepted that commentators, analysts and markets can be somewhat irrational, but have always insisted that reality must at some point intrude. I still believe that reality will catch up with delusions, but have had trouble understanding the level of self-delusion that is taking place. I keep on wondering just what will it take for the underlying reality to sink in.

In the case of the UK, it is even more mysterious. The UK budget in particular painted an appalling picture of the state of the UK economy. In my post on the subject, I suggested that it would be interesting times for gilts and the £GB. However, the most recent gilt auction proved to be a success, albeit in a gilt that is part of the Bank of England's money printing purchase scheme. Meanwhile the £GB has gone through a roller-coaster ride:
Sterling fell against a broadly recovering dollar on Thursday after rising to a two-week high as initial optimism about the global economy petered out, even as share prices gained.

An improvement in British consumer confidence had pushed the pound sharply higher, but news that U.S. automaker Chrysler would file for bankruptcy later in the day and data showing a fall in UK house prices weighed on the pound.

I am starting to take the view that one of the problems must be that the paradigms being used in the markets is one in which the only reality is a belief in the inevitability of recovery. I suspect that, with no experience of a long term and sustained decline many people simply refuse to believe that such an eventuality is possible. Instead of asking the simple questions as I do, such as asking where the real wealth is generated, the markets hang on to figures which have no bearing on the broader reality. In this world an uptick in consumer confidence is a herald of recovery, a bank's profits are real even if they are simply an illusion. It is increasingly looking like drowning men clinging to anything that floats, even as the sharks circle round them.

What I am in fact doing is dramatically shifting my view of the world. I am finding myself in a position where I must accept a new reality. That new reality is that self-delusion is a fundamental part of the human condition and that rationality is a very rare commodity indeed. I am currently ploughing my way through several books that deal with economics and psychology, as it is clear that my model of the economy is incomplete.

I have already found one interesting insight, which can be found in 'Predictably Irrational', by Dan Ariely. He points out that when making a valuation of something, we develop what he calls an anchor price. Through a series of experiments he shows that the first price that we see for an item becomes an anchor for valuations, and that it is very hard for us to adjust to a new reality, to adjust our perceptions of price. Interestingly, for some of his research he used bankers as his experimental subjects, though the principles he establishes have wider relevance. In particular it is possible to stretch his insight, and see that we might have made a broad brush evaluation of whole economies, so that we have a fixed view of the Western economies. We have anchored our valuation of the economy to a certain level, such that it is very hard for us to adjust to a new valuation.

Whilst this is stretching the findings, I do not believe it is over-stretching them. He is reporting an underlying factor in human thinking, and there is no reason to think that his examples of decisions about individual valuation might not apply to a broader valuation. As a non-experimental illustration he cites the example of a DVD player, which starts out very expensive, thereby creating an anchor price that is high. When we later buy a DVD player, when the price has fallen, we believe that we are buying a bargain. However, as we know with these kinds of goods, our bargain of today will still look expensive tomorrow. Perhaps what we are seeing in markets now is this kind of process?

Essentially, what we must take from these examples is that there is a reluctance to adapt ourselves to new underlying realities, and that our sense of value is 'sticky'. This in part may explain the stock market rallies of late, and similar rallies that took place in the great depression. However, as in the DVD case, there is no reason why valuation and therefore price will not eventually move, even if our perception of value is sticky. The question that this does not answer is exactly how that shift might finally come about.

On that subject, I am increasingly wary of making predictions....

Note 1: I only have a brief moment to reply to some of the interesting comments on the last post. As such, apologies if I do not reply to your comments.

Escaping Eastwards: You raise an interesting question which I will try to address in a future post.

Anonymous (who posted a massive comment): I hope that you take note of the comments of other commentators, and try to format your comments in a way that will better express your point of view. I publish all comments, but was not happy to publish your comment simply because of the format problem. However, I published anyway on principle. I will echo Lord Sidcup, and suggest that perhaps you might start your own blog? Gina, thanks for a great job of 'translation' on the comment. I would like to answer the comment, but it is rather a large subject for a simple reply.....

Lord Keynes: I am glad that you use the term 'neo-liberalism' rather than liberalism for the record of Labour. Liberal would not be an accurate description.

Chas H: In answer to your question, the problem for the future of the UK economy in the medium to long term is that we simply do not know what the politicians are going to do. As such, it is impossible to guess at outcomes. For example, it is always possible for a 'great' leader to emerge, who might lead the country back to economic strength. Alternatively, it is just as possible that a populist demagogue might emerge. As for the social consequences, I will leave that to other commentators, except to say that my view is that there will be serious problems.

Lemming: Maybe the 'reset' will be the default and collapse of the £GB? As I have discussed before, such a reset has a price....

Acrobat_747: The problem with your thesis is that you are looking at debt in absolute terms rather than relative terms. It is possible for a country to rack up debts if they have prospects of growth, or rather there is a perception that a country has prospects for growth. The problems arise when there is no apparent method for that future growth, and when the markets realise this. In the case of the UK, there is no such prospect for growth. My question has always been 'where will the growth come from?' On one occasion I asked this question on the Guardian's CiF forum, and nobody was able to come up with an answer. I have, to date, still not seen any explanation of where the growth might come from. If you have an answer, you might wish to add it in a comment. When I asked this question, I was asking for specific sectors, rather than answers that amounted to 'it will just happen'.

At the moment, the best case for growth I have seen is growth based upon a falling currency. This is not real growth but a process of adjusting to relative impoverishment. Whilst this may make the UK more competitive, it is done at the cost of reducing the cost of UK labour, and therefore reducing the standard of living of everyone in the UK. It is also not a form of 'growth' that would please holders of UK debt that is denominated in £GB. Under such circumstances, would you invest in the UK or in government debt?

This is why the level of debt is relative. The growth in debt in the UK can not be paid back, as there is no growth that can provide a route out of debt, or to continue to service debt. The UK is structurally unable to service debt without incurring more debt. This is a scenario of ever expanding debt, with no means of payment in sight. Quite simply the output of the UK economy can not pay for the consumption within the UK economy, and there is no prospect of this situation changing (unless you believe Alastair Darling). As Lemming said in a comment; 'I have to ask, are we really serious about getting out of debt?'

As a note, there is no reason why the UK might create a new technology or process and achieve substantial growth in this way. However, this is highly speculative. Why might the UK come up with such innovations? It has the same prospects as other developed economies, but no particular advantage over and above them. I am not sure that creditors would invest on the basis of such a 'hope'.

Tiberius: An interesting point of view. It is interesting to see such diverse perspectives on the blog.

Gone: You mention that people will continue to buy bonds as long as they believe that they can sell it on. That is a matter of confidence, and that in turn is a matter of belief in the stability and sustainability of an economy. Just because there are buyers now does not mean there will be buyers tomorrow. Even though the government is still having success in selling their debt, confidence is waning, and this can be seen in the rising CDS premiums.

I am afraid I have run out of time, and apologies for rushed responses.


  1. Death to Bubble Addicts: I forgot to mention my thanks for some interesting links on my last post.

  2. If we are now looking at this mess in terms of human psychology then perhaps the Kubler-Ross model (a.k.a. 'The 5 stages of loss') comes into play. The model states that grieving people face up to loss along the lines of 'denial-anger-bargaining-depression-acceptance'.

    Are we still at the 'denial' stage? Were the G20 "riots" 'anger'? Is Will Hutton at 'bargaining' or 'acceptance'?

    Or maybe we are just stuck in 'depression' for the foreseeable future.

  3. Thanks for the update Cynicus.

    I agree that those consumers experiencing increased confidence are hugely adrift from reality. Perhaps an encounter with pestilence will finally dispel the fantasy?

    Jim Kunstler this week offers a memorable description of 'where they're at' in the US:

    "... the banking-and-investments sector has been on auto-pilot for a few weeks. Lesser banks are crashing around the country (Idaho, Florida, California last week), but the remaining Big Boyz are still lurching through the landscape like so many Frankenbanks, jazzed up on electric surges of digital cash. There are ever more hints of a peasant uprising against the castle of privilege, but no sign just yet of the flaming brands and shaking fists from the village below. This flu thing will put the schnitz on their distempers for a while."

    He also links to an interesting blog re: Obama -

    Worth a look.

  4. It's great to see you are flexible and honest enough to radically change your thinking. From the beginning I felt your reliance on a rational Adam Smith model as a the key weakness in your mission -- which I think was "to describe reality".
    So hopefully CE will continue to be one of the best economics blogs (that I'm aware of).

    Taleb's book "Fooled by Randomness" is pretty good on theis subject (better I think than the bloated and self-important "Black Swan").

  5. I have read that the US Bank profits in 1st Qtr 09 are possibly suddenly positive for 1 further reason. The AIG Bail out with taxpayer $ were used to settle AIG's counterparties CDS payouts where the counterparties are the US banks. So basically US Taxpayers via AIG spoon fed massive profits to these US banks. Again these profits are onetime unsustainable manipulations which have helped to push up the confidence levels and the US stock market.

  6. Cynicus says

    "What I am in fact doing is dramatically shifting my view of the world. I am finding myself in a position where I must accept a new reality. That new reality is that self-delusion is a fundamental part of the human condition and that rationality is a very rare commodity indeed."

    And here's a snippet from 'Why the West is supreme.' @

    ...."And there are those who wish to end Western civilization. James Burnham, a former communist, argued that liberalism (i.e., progressivism and all other leftist movements) is the ideology of the suicide of the West. What liberalism does—to paraphrase Karl Marx’s asinine “alienated from labor” theory—is alienates Westerners from their civilization through the acceptance of anti-culture (i.e., cultural relativism, modernism and post-modernism, secularism, globalism, etc)."

    This is the new reality you are coming to terms with, the taking down of Western civilisation.

    Science fiction? Just take a look around you, what do you see?

    At the commencement of the 21st century our values have been turned upside down and inside out, a new population has been imported to take over the future, the media is telling us every day to get used to the idea.

    Somebody is changing our world.

  7. Hi Cynicus,

    This article from Barrons has helped me understand the ongoing economic process:

    "Let's call it a "D-process," which is different than a recession, and the only reason that people really don't understand this process is because it happens rarely. Everybody should, at this point, try to understand the depression process by reading about the Great Depression or the Latin American debt crisis or the Japanese experience so that it becomes part of their frame of reference. Most people didn't live through any of those experiences, and what they have gotten used to is the recession dynamic, and so they are quick to presume the recession dynamic. It is very clear to me that we are in a D-process."

    Ray Dalio in Barron's 9/2/09


    There are three psychiatrists who are studying and writing about the markets:

    ~Dr. Ari Kiev.
    ~Dr. Brett Steenbarger.
    ~Dr. Richard Geist.

    The markets are constantly irrational thus shorting is the most dangerous aspect of trading.

    I have seen companies who are basket cases being valued at £250m and then eventually going bust - you could see it happen but other traders had not twigged. What I have learnt is that in the markets most participants do not dig deep to understand the fundamentals, they trade on noise and momentum.

    Trend Following by Michael Covel is a book that covers trend following. I belive TF is the magic elixir of the markets.

    Remember Marconi? Remember Enron?

    These companies had shareholders and directors who went wild on a buying spree, bought at the top of the market, loaded up the balance sheet and at Enron did dodgy deals off balance sheet. It was in the public domain what these companies were doing. Enron was viewed as one of the best run companies in the World. A few bears saw what was happening but they were ignored. Marconi went from c.£12 to 12p. My point is that some saw it coming but the majority lost their shirts. Many bought all the way down.

    Based upon my recent reading I see this script:

    Stages of Obama:

    1. Obamarama- campaign and election.

    2. Obamanomics - summers, geithner, stimulus and budget. A blend of Statism and Socialism.

    3. Obamageddon - 2011?

    Obama is the Chairman & CEO who has decided to load up on more debt and pray he can get the ponzi going again. Maybe 2011 will be when the markets realise that he has failed.

    Here is a link to a televised lecture in which Dmitry Orlov compares the fall of the Soviet empire to his expected fall of the American empire. It is a very sobering piece of television:

    Thank you

    Death to Bubble Addicts

  8. Isn't this a classic example of reification?:

    The 'economy' is being treated as if it is a physical entity whose course follows only its own internal dynamics, not (as you've cirrectly observed) an abstraction with roots in material goods and social relationships. That this has always been at the heart of the Marxist critique of the dismal science is no reason to disregard it ab initio.

  9. I've said plenty of times that you just *cant* look at economics without looking at psychology and sociology. It's been the root of several of my points.

    It's great that you're investigating this side of your argument. I enjoy your posts and support many of the things you say, but I've long felt the main weakness here was an unwillingness to acknowledge the 'human' component.

    Thanks for the interesting post.

  10. There is nothing much to be confident about.

    Notices of default have reached an all time high in the US housing market. The financial institutions are sitting on 600,000 foreclosed homes they dare not even list for sale as this will accelerate the downward spiral. We are still on the down slope.

    I think the arrival of spring tends to make people more optimistic about things, but autumn aint that far away; there is a lot of bad debt out there.

  11. I know this was posted before but the following petition :-

    We the undersigned petition the Prime Minister to resign. More details

    Submitted by Kalvis Jansons – Deadline to sign up by: 22 October 2009 – Signatures: 40,034

    : is now no.1 and the story is on BBC website.

    Does the 40k signatures count as a surge of optimism, or are those 40k departing ever further from reality (like it would make a difference)

    hey i signed up just in case, as my glass is still half full.

  12. Cynicus, Ave!

    Your comment about the 'the rationality of "irrationality"' - struck a chord.

    25 years ago I walked a Picket Line for 42 days!! I got to wondering why. I conjured up all sorts of esoteric reasons - until one day I had a Eureka Moment*. Intellegence allied to Arrogance = Incompetence. The obverse of this is that they KNOW they are right!

    The buggers are just psychologically inadequate and are sufficiently intelligent to be unable to realize just how inadequate their reasoning ability actually is. And, this is the kicker - they are completely unaware of the problem . Awful - but true.

    * I was reading 'A Bright Shining Lie: John Paul Vann and America in Vietnam' Neil Sheehan.

    Your Blog is marvelous - really!

    Brian P

  13. I think you have mentioned before, that as long as the west is considered rich, or a safe loan, by the East, that the party would continue?

  14. "This is not real growth but a process of adjusting to relative impoverishment." Why are we confident that it will not be 'absolute' impoverishment?

    As I have pondered before, growth has stopped globally so it seems to me that we are in a distinctly 'non-linear' region of economics where there may be no stable outcome.

    There may be no "bottom" to the spiral we are in, because we depend utterly on the free markets to not only manufacture but also distribute our food, fuel and all other goods.

    The Invisible Hand probably doesn't work once people start queuing for fuel rather than driving to work, or the electricity keeps going off. It almost seems as though we need some organisation like we had during WW2...

    Oh dear, this is going to get very bad isn't it..?!

  15. Cynicus, I would like your take on the comparative housing markets vis a vis United States and Britain.

    I think they are different for different reasons.

    I'm talking principly house prices and supply and demand.

    Britain is a small country with no great housing stock, and little housbuilding going on. Britain's population is rocketing. Given these facts, economics dictate Britain's house prices are (at some point) bound to bounce back.

    America, on the other hand, has sufficient (or maybe excess) available housing stock and therefore are not subject to the pressures of supply and demand - hence continuing decline in house prices.

    The bottom line is, how can Britain housing market avoid the spiral of returning to what was? In Britain, the dam of demand for accommodation is rising exponetially (as we speak) as I see it, this dam will burst and everything will let rip.

    I think civil disturbunce is on the cards, we are close to a world of ever increasing demand for shelter in a diminishing supply of properties available. A lethal concoction.

    What happened to Brown's millions of new homes plans?

  16. Anonymous said

    And here's a snippet from 'Why the West is supreme.' @

    ...and here are some more which tell you all you need to know about this psuedo-scientific nonsense

    "...Westerners most certainly have a historical destiny, because they do more than merely live in mud huts, eat grubs, and behave like packs of wild dogs..."

    "...No phrase more accurately describes the difference between the perpetual passivity of the [non-Caucasians] and the world-conquering activism and dynamism of the [Caucasians]...."

    Frankly I just don't know where to begin with rubbish like this. Generalised, racist nonsense.

    It wouldn't so bad if you wanted to put across a coherent argument (without hiding behind anonymity) but you've clearly got a point of iew and desperately seek whatever you can find on the web which sounds academic to back it up.

    At the commencement of the 21st century our values have been turned upside down and inside out, a new population has been imported to take over the future, the media is telling us every day to get used to the idea.

    ...which values? which population? which media?

  17. I've just read an article over at the Canadian website Global Research that suggests the market is being deliberately bumped up and down to try and fool people into thinking the bottom has been reached.

  18. Anonymous wrote 2:10 AM:
    "Remember Marconi?"

    It is my opinion that Marconi was wrecked on purpose and all media analyses have been cover-ups and disinformation.

    Lord Simpson and John Mayo's real mission was to get Marconi's (privately owned) defence industries under non-British EU and foreign control. Just look at what successive Tory and Labour governments have done to this nations ability to independently arm and defend ourselves. We don't even manufacture our own bullets anymore.

  19. It appears that the Chinese are still in touch with reality:

    China has 'canceled US credit card': lawmaker

  20. Many thanks for another thought provoking post.

    You said: 'Instead of asking the simple questions as I do, such as asking where the real wealth is generated..' This gave me pause for thought to wonder what 'real wealth' is. At first sight it seemed obvious, until I tried to spell it out.

    I ended up resorting to the idea that it is having adequate food, clothing, shelter & health with some left over to enjoy. If this is correct then we in the west are overburdened with real wealth already and may have reached a point where we simply neither want nor need any more.

    And yet it seemed that there ought to be more to it than this, so I thought maybe generating real wealth means finding something that other people want to buy and selling it to them. Sounds good at first, but then I realised that this would count as real wealth all the trivial tat that we buy and the many dubious financial products that people have bought over the last decade or so.

    I remain puzzled. Do any of us know what we mean by 'generating real wealth'?

    the above article may be of interest

  22. Lemming
    your mention of non-linearity and spirals in connection with hostory reminded me of this, which you might find interesting

  23. Cynicus, I think you're being far too harsh on yourself. Yes, people are still deluding themselves right now and you can list all sorts of reasons for that, what does not change however is the fact that your analysis and conlusions behind are right. The West is heading full-steam ahead towards a cliff while it still has some confidence left that could enable for 'real change'.
    Does it really matter why people are unwilling to face the truth and take it on head-first? Eventually they'll have to deal with it, and if not, the globe is still spinning around, other places don't mess around.
    Nowadays people don't act until they feel the consequences of something themselves. That's why nobody's been on the street protesting that budget.

  24. Blogs are so informative where we get lots of information on any topic. Nice job keep it up!!

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