October 19, 2011 / 5:58 AM / in 7 years

Analysis: A divergence of sentiment and reality?

LONDON (Reuters) - If there’s nothing to fear but fear itself, as President Franklin Roosevelt contended during the Great Depression, then the world economy in 2011 has reached an interesting juncture between sentiment and reality.

The grim facts of the now four-year-old credit crisis and western economic funk are undeniable, even if still some distance from the ravages of the 1930s.

And there are some who argue the unhappy confluence of crippling household and government debt, policy exhaustion, aging populations and resource scarcity spells a long depression-like period of near-zero Western economic growth ahead.

But there is also a danger that all the negativity itself will push the global economy over the edge.

As Klaus Kleinfeld, CEO of the largest U.S. aluminum producer Alcoa Inc, said last week: “It almost looks like the world is worrying itself into another recession.”

The stability of the modern interlinked world economy, with its rapid transmission of information and shocks globally, has never been more dependent on confidence — confidence in the smooth functioning of markets, the predictability of government policy and future employment.

Any lack of visibility can have profound self-fulfilling consequences and fear of the future, justified or otherwise, can create a downward spiral all of its own.

If you are lucky to keep your job, anxiety about unemployment itself can delay household purchases or loans. Corporate angst about ebbing demand, government contracts, taxation changes or trade restrictions can similarly halt assembly lines, stall job creation or stymie new investment.

This is basically the dark side of what British economist John Maynard Keynes described in 1936 as the economy’s “animal spirits” — or “a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.”

The same human emotions trigger often irrational retrenchment and hunkering down when confidence about the future is doused by a cacophony of disaster warnings.

Amplifying nerves right now is a barrage of disaster commentaries from both sides of the political spectrum as well as the financial industry — each appearing to outdo the other on dire warnings.

Right-of-center politicians advocating a shrinking of government warn of a debt-fueled collapse and demand deep austerity. Liberal or left-wing voices invoke economic catastrophe unless government intervenes further with another series of demand-boosting investments.

And faced with the political fallout from a largely self-inflicted implosion and taxpayer bailout over the past four years, the financial world — the prism through which many people assess the economy’s health — has developed its own understandable line in apocalyptic futurology.

But are there signs of a sentiment overshoot? Or, as Morgan Stanley economist Joachim Fels asks, has “gloom fatigue” set in?

An illustration of how the “wall of worry” may have diverged from real activity was a surprising 1.2 percent jump in euro zone industrial production in August, a month marked by the white heat of the bloc’s sovereign debt crisis.

Crucially, production jumped even as business sentiment surveys indicated a contraction of factory output for the first time in two years. What’s more, the jump was not driven by the relatively robust giant Germany but Italy, Portugal and Ireland.

Similarly, U.S. consumer sentiment surveys over the past two months — where questionnaires gauge things like purchasing plans — plumbed the depths of despair. Yet, actual retail sales data out last week showed a 1.1 percent rise last month.

Trade statistics too, despite showing some cooling in growth engines like China, also appear to defy the gloom. UK exports in August, for example, hit a record high. Chinese copper imports were their highest in 19 months in September. Shipping prices, seen by some as a rough gauge of global trade activity, have also surged some 70 percent from the mid-year doldrums.


Of course, there may be good explanations for this divergence. Business and consumer surveys are watched closely because of their track record as leading indicators of real sector activity. Real data typically follows anecdotal survey evidence much more quickly than has been the case in recent months, as the graphics above demonstrate.

Some may also suggest that while unemployment remains high, it’s possible rising income disparity means the richest continue to buy in sufficient amounts to outweigh retrenchment at the bottom — in turn, keeping aggregate production going apace.

U.S. government data for 2010, for example, shows average annual expenditure of the richest 20 percent of households was, at $92,870, more than a combined total of the bottom 60 percent.

And for Roosevelt, confidence was rooted in fairness. “Small wonder that confidence languishes, for it thrives only on honesty, on honor, on the sacredness of obligations, on faithful protection, on unselfish performance; without them it cannot live,” he said.

Whatever the best explanation, the gap between survey evidence and real activity bears close watching for the months ahead. One of them will have to give. If surveyed gloom is correct, growth will weaken sharply into year-end and another recession on both sides of the Atlantic looms large.

“A striking gap between hard activity and survey data will need to be closed soon,” JPMorgan economists told clients.

On the other hand, it’s possible that fear itself may have been excessive and the truth more prosaic. If so, the political focus needs to be on boosting sentiment with credible policies soon.

“Until you can restore confidence you can’t move forward,” General Electric CEO and White House adviser Jeff Immelt said on Monday.

Graphics by Scott Barber; Editing by Susan Fenton

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