The Risks of Denying Reality

In "What If It Doesn't Work?" I highlighted a blog post by Information Arbitrage, "What Keeps Me Awake At Night: Economy Edition," that explored the issue of what could happen if the economy has not, in fact, turned the corner the government and others are saying it has.

In "Why the Government's Attempt to Instill False Confidence Will Backfire," George Washington's Blog further elaborates on the risks of denying reality and failing to apply the only real cure for what ails us.

The government is doing its best to try to "restore confidence" in the economy. Indeed, Obama's top economics advisors believe they can fool people into believing that everything is fine, and then the economy will recover.

And for that reason, defenders of the status quo think that it is important for everyone to keep quiet about how severe the crisis really is.

Are they right?

No.

As economist Irving Fisher pointed out (as recounted by economist Steve Keen):

Hobbled by this naive belief in equilibrium, the economics profession was as unprepared for today’s crisis as it had been for the Great Depression. Now that the crisis is well and truly with us, all conventional “neoclassical” economists can offer is the hope that the crisis can be overcome by a good, strong dose of confidence.

From [Irving] Fisher’s point of view, such a belief is futile. In an economy with an excessive level of debt and low inflation, he argued that confidence was irrelevant–and in fact dangerously misleading, as he knew from painful personal experience.

In short, happy talk and fake confidence-building exercises don't work.

Indeed, trying to instill false confidence will actually backfire on Geithner, Summers and the boys and make the crisis worse.

Why?

Because psychologists say that - until government and business leaders prove they can behave responsibly, and until the perpetrators of financial fraud are held accountable - real trust will not be restored and the economy will not recover.

Trying to put a happy face on a grim situation, continuing to do things which are transparent attempts to instill false confidence, and leaving in power the people who caused the crisis reinforces the market's convictions that (1) government and business leaders are behaving irresponsibly instead of addressing the fundamental problems and (2) there is no accountability.

 

So people's trust declines still further, thus substantially delaying any chance of a sustainable economic recovery. In other words, by trying too hard to instill confidence, the powers-that-be actually undermine it and exacerbate the financial crisis.

Keeping quiet about how bad things are won't help. As the leading independent economists and financial experts all agree, the three things that will help are:

1. Honestly addressing the causes of the crisis;
   
2. Honestly addressing the necessary - if bitter - medicine needed to get out of the crisis; and
   
3. Holding responsible those who caused the crisis.

As (further) evidence of the fact that the so-called "green shoots" of recovery appear to be more a case of wishful thinking and misguided policymaking than an assessment of what is really going on, I thought it was worth highlighting a recent Newsweek "Web Exclusive" by Kevin Kelly, CEO of Emerald Packaging, entitled "Recovery? What Recovery?":

Don't tell me that the economy is getting better, or has even hit rock bottom. My faith in an imminent recovery deserted me on May 5, when one of our customers, Salyer American Foods, based in Monterey, Calif., suddenly fell into receivership. There had been little to no indication that the company was so close to financial ruin. As it turns out, the company's lenders say Salyer owes them over $34 million, a debt equal to almost half its sales. A company attorney told local media that tight credit markets and the economic recession had pushed Salyer over the edge. If the receiver doesn't find some way to revive the company's fortunes, our bag manufacturing company stands to lose nearly $1.5 million in revenue, about 2 percent of our $60 million in sales.

On the same day my customer fell into receivership, Fed chairman Ben Bernanke told a congressional committee that he believed the economy was in the process of bottoming out and "would turn up later this year." He's not alone in his optimism. Over the past two weeks or so, it has become a cottage industry among economists and the media to spot the first "green shoots" of a recovery. Certainly shoots there may be. The stock market has rebounded smartly over the past two months, as has consumer confidence. Pending home sales have ticked up, while unemployment claims are easing. And many economists insist a manufacturing revival is in the wings because inventories have fallen so low that restocking must begin soon.

But I haven't found many small-business owners ready to jump on the recovery bandwagon, and for good reason. We're still experiencing the "bottoming out" phase and worry that another bottom remains below this one. Call us pessimists, but we're not sure the green shoots aren't just weeds.

Who can blame us? Take the experience of a friend of mine, who runs a $6 million company that provides promotional material to businesses. His sales are down 20 percent compared with last year. Over dinner last week, he said he certainly wasn't shedding customers at the same pace he had been in the fall, but customers were still defecting. "I can't see any reason why they'd come back soon," he said. So he's getting ready for a second round of layoffs and plans to end spending on marketing until things look more promising.

He's not alone among my friends and colleagues in his sense that bad times may be here to stay. One friend just decided to abandon her two-year-old Web-based gift boutique thanks to declining sales. She has another friend whose promising e-business startup had its venture funding yanked when it failed to meet sales goals. "Two years ago they'd have been given time to work things out," she says. Instead they recently closed. Another friend of mine works for a commercial real-estate company that's instituting 10 percent wage cuts beginning in mid-May. "It's better than people losing their jobs," he said to me, "but I don't expect to be getting the money back any time soon." Given the growing worries about commercial real estate, he's probably right.

Even some companies that are supposed to be recession-resistant remain worried. I know the general manager of a small candy company, who says his sales haven't stopped sliding despite the belief that people supposedly eat more comfort food during bad economic times. He has cut back a shift and won't be rehiring soon. Representatives for a small local bank have told me that they haven't seen an uptick in business lending, and that they don't have businesses looking for money other than those they wouldn't lend to in the first place. And a long-time machine supplier of mine has had a completed bag-making machine on its floor since late 2008, when the customer decided not to go through with the purchase. Despite a steep discount, the company can't find a buyer.

Based on my company's experience, I don't necessarily see a positive side to low inventories. Over the past several months, we've seen lead times on orders fall at least 30 percent. Where our customers used to give us three to four weeks to fill an order, now they give us as little as two. Shorter lead times have followed the trend toward smaller orders. Where companies would once order 3 million bags and hold them on their floors for several weeks, now they're asking for only 1.5 million and reordering at the last possible moment. In most cases, it's not that their sales are falling, just that they're slashing order sizes and reducing lead times in order to avoid tying up capital in inventory. Since they're entering smaller orders more often, we're less likely to hold inventory as well. In my corner of the manufacturing sector, the revival that economists have been pointing to seems a long way off. 

Now, I know businesspeople can be notoriously wrongheaded when it comes to spotting trends. Aren't the Big Three automakers at least partly responsible for their own demise because of their failure to anticipate the need for more fuel-efficient cars? I know I've almost blown the opportunity to capitalize on growth in the past by being too conservative about buying new equipment. In fact, I've angered customers by stretching out lead times rather than investing, because I've been worried that the sales growth isn't sustainable. Talk about a self-fulfilling prophecy. Even right now, when I can see that a judicious equipment purchase could propel our company forward, I worry about taking on more debt and hold back, even with one supplier offering terms that would give us a machine for a year without any payments.

Then I have a day like May 5. I read the Fed chairman's testimony and feel a bit upbeat, only to get surprised by the collapse of Salyer. Certainly, as my brother points out, it is unlikely we'll lose the entire sales volume even if our troubled customer disappears, because other customers will step in to fill the gap, and they'll buy product from us too. But is it insane to hold off on optimism when you're not sure whether another customer could bite the dust? Perhaps waiting to make any big investments makes sense until we're completely sure recovery is on its way. Of course, if I wait, and lots of other businesspeople like me wait, what will become of those green shoots that may be dotting the landscape?

Comments

[Paolo]

I've just finished to read "The Great Crash" by John Kenneth Galbraith and what really surprises me is how economists nowaday, as in the late 20s, seem to be "useless" in anticipating and solving crisis. As Galbraith pointed out, there won't be any new "Great Depression". Financial and economic conditions are now totally different (rules, regulators, wealth distribution, companies structures, banking system, balance of payments...).

The Great Depression was actually a combination of massive speculation, primitive economic/financial system and political incompetence. Now, I don't see anything like that, and I'm actually impressed by the current depth of the recession, which is simply unjustified IMHO.

Confidence-building in the late 20s was uneffective because it was not based on evidence and was not supported by concrete action. Now it is. But does it help? I think so, because most of the financial collapse and the subsequent recession is based on irrational panic.

Being pessimistic is easier and makes us feel more confortable, we know that, but again, I suspect that most of the economists out there are loosing another chance to prove they may be of some value.

[Ricardo]

I agree completely with Paolo's comment. No political incompetence. Nothing of the sort!
No massive speculation. No siree!

Indeed, the regulators all have different names! Can't be the great depression!

Different rules too! (that aren't enforced).

Now there are LLCs. Did LLCs exist back then? I think not! Therefore different company structures.

The banking system is different too. For example, back then ibanks had merged with regular banks. Totally different now.

Also, America was a net exporter back then. So the balance of payments was different.

Therefore, Paolo has proven beyond a shadow of a doubt that there cannot be another great depression. Ever!

Note to Paolo: Don't be impressed by the depth of the recession. It is purely illusory. All those seemingly bad numbers are just the result of corrupt statisticians who want to paint a picture that is not rosy. When you look at the real numbers, you will find employment is increasing, housing is booming, and the economy is in danger of overheating.

It's time to make these knuckleheads realize that they must stop their irrational panic!

I know what you mean Paolo when you say being pessimistic makes us feel more comfortable. Whenever I'm entertaining, I spout pessimism like a fountain to make my guests feel more at home. Works every time.

[robert breen]

I can only say that the situation in my humble opinion is indeed a depression. It is global and the world has never seen anything like the event that is unfolding.
Governments around the globe are or soon will be stimulating. This means printing money because there will be none to borrow.
Factories worldwide are shutting down. Consumers have lost confidence as have their governments.
Interest rates have to rise as risk of default is seen to increase. Look at bond yields for this evidence.
Debt costs will soar. GDP has fallen off a cliff and with it tax revenues and with that the ability to service the debt.
Unemployment will continue to soar. There is too much for an IMF to deal with. There may already be plans for a new currency in the US .
There will be massive social unrest as supplies of everything run out. There are already signs of this happening but reports by the mainstream press are being downplayed if mentioned at all.
Green shoots? The only green shoots we will see are the ones coming up thru abandoned homes and factories.

I wish I was wrong.

[Peter of Lone Tree]

Betcha didn't know The Onion had a "Business" section.
Their latest, entitled "Nation Ready To Be Lied To About Economy Again," can be found at http://www.theonion.com/content/news/nation_ready_to_be_lied_to_about

[susan]

Michael,

Would it be possible to add this following site to your blogroll. I'm not the owner of this site, but I have found much useful economic information on it, and thought perhaps your readers would benefit from it as well. THanks.

http://www.globaleconomiccrisis.com/blog/

[susan]

Hi Michael,

Forgot to add another blog/website that I think is a wonderful economic site, its run by Jim Sinclair, who I believe is a former fed board member. Its an excellent economic website, if possible, could you please add it to your blogroll as well? Thanks!

http://jsmineset.com/

[susan]

sorry, just realised that the website I posted above is already on your blogroll.
Never mind.

[John]

Interesting article, but flawed by the assumption that the peasants actually care "who was responsible" OR - even if they did care - lived in a system designed to punish the insiders.

Nope, dudes... like, dude, you're living in America, dude. Everybody is above average and waiting for the next scam to start. That's what makes America great, it's a nation of scammers that appreciates when a good scam is run, even if it's on themselves.

The "green shoots" are real; primarily because they are SO fake. American's LOVE to believe in "green shoots". DOW 14,000 dudes, I can feal it, so can the peasants.

[farang]

I would add the CEO of RBS to the list of economic realists: he sees no "green shoots" sprouting anywhere, and warns against belief everything is going to quickly turn around.

[none]

Thanks for the post. It's good to see the perspective from those 'on the ground' so to speak.

I've read that Galbraith book too and recommend it.

The reality is though, there was a massive credit-fuelled bubble that inflated over the past decade - in housing, consumer spending, commodities, equities and so on. Meanwhile, overall incomes were stagnant. This was similar to the 1920s but doesn't get discussed much - the growth in income disparities, but it is this very thing that causes these big credit squeezes.

As that famous saying goes, history doesn't repeat, but it does rhyme and while indeed some things are different, a lot of the fundamental problems are pretty similar.

[Bill]

Very persuasive post on the reasons why we are far from an economic turn.
The government has done everything to convince us that everything is fine when, in fact, nothing has changed. Those "green shoots" of recovery are an illusion.