Economics & Access

It's About Time for Confidence to Come Back

By Gene Huang, Ph.D on December 4, 2008
 
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At this juncture in time, the economy faces two “systemic” near-term problems. First, the financial side the economy is very close to a “liquidity trap” – a situation in which conventional monetary policy loses all traction. Second, the real side the economy is in what Keynes called a “paradox of thrift” – when the entire private sector (businesses and households) tries to save more at the same time, it creates a downward spiral in business activities.

Neither one of the problems has a simple solution, yet both of them have something to do with a need for credit or liquidity creation. In the U.S., here are some ideas that economists proposed recently:

  1. A massive fiscal stimulus package.
  2. More monetary easing by pre-committing to keep the federal funds rate low for an indefinite period.
  3. More direct interventions by the Fed and/or Treasury, including purchases of credit instruments and agency backed MBS to bring down private-sector borrowing costs.
  4. Congress provision of authority to the Fed and/or Treasury to buy a broader range of risky assets as an extension of TARP.
  5. Arrangement of guaranteed restructuring in Big-3 (or at least GM) in exchange for bridge fund.

Globally, monetary authorities are coordinating policy actions with four major pillars: liquidity creation, direct capital injection, purchase of troubled assets, and provision of guarantees.

Given time, some or all of the above measurements will work. At some point, collective expectation in the marketplace will recognize the facts that asset prices have been severely dislodged across all classes from their fundamental values and energy prices have now turned supportive to growth. It is also helpful to see some initial confidence given to the new administration and its economics team. It may be about the time for sentiment to find and form a bottom.

I think a constructive perspective should be valued and warranted. Here is why: Sentiment has been embarking a self-fulfilled downgrading process in recent months that may soon prove overdone. More importantly, liquidity is probably more a state of mind than substance in the current financial system as the derivatives portion is larger than traditional money supply. Yet valuation of derivatives is significantly influenced by confidence. Once confidence comes back, liquidity will come back as well, to an extent that it may even bring some upside surprises to what’s been factored in the current market consensus.

The U.S. economy is the most resilient in the world due to a mechanism of market oriented incentives and risk-taking nature of its participants. This has not changed. Despite 50 percent decline in stock market valuation over the past 12 months, homes are still the same homes; lands are still the same lands; companies are still the same companies; technologies are in fact improving, and most importantly, people are still the same people. This fact itself should instill some optimism.

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Very nice articles thank

Submitted by evden eve nakliyat on 01/23/09 - 5:59 pm
Very nice articles thank you...

The rapid increase in energy

Submitted by michael on 12/10/08 - 3:54 pm
The rapid increase in energy prices acted as a significant catalyst to drive down individual demand. With the decrease in disposable income, families began to have less to spend in our consumer driven economy. We have now seen a dramatic decrease in energy prices, but the confidence on a macroeconomic level is yet to return. We tried the stimulus check, but these have not worked in the past, and didn’t work in 2008, because they are not indicative of permanent increases in wealth. If I was expecting $600 once, my spending or saving decisions would not change; if I was to expect a consistent tax decrease which would give me an additional $200 a month, my habits/confidence would be positively affected. A key ingredient, although not the entire recipe, is an income tax reduction on individuals and businesses if we are to see a quicker return to normalcy. (financial responsibility and energy independence would help to prevent future occurrences)

Dr. Huang, Given what we are

Submitted by Brian Burdette on 12/09/08 - 2:06 pm
Dr. Huang, Given what we are facing during this time of economic turmoil, what timeframe do you anticipate seeing before the economy begins coming back? Some have forecasted one year, two years, sixteen months, etc. Do you have a 'guess' as to how long this downturn will last? Thank you!

What would be the impact if,

Submitted by Carl Hardeman on 12/09/08 - 10:58 am
What would be the impact if, as suggested on talk radio, the government agreed to buy 1.5 million autos from the Big Three, and then sold them to the public at a discount?

Are we headed for another

Submitted by Carl Hardeman on 12/09/08 - 10:56 am
Are we headed for another huge crash when some large percentage of people have little or no credit card credit left? That would stop a lot of consumer spending. Would another bailout be required?

Thx, Gene. A nice

Submitted by Frankie Ng on 12/09/08 - 5:47 am
Thx, Gene. A nice analysis. From my perspective, confidence will finally come back, probably at the end of 2009: 1) when unemployment rate in major industrial nations could be stabilized 2) when Obama Administration run for a year and know the rules of games in such dynamic and complex global environment 3) people have higher purchasing power to spend after 16 months of saving 4) productivity has been further improved via resource allocation 5) when mild inflation comes to the market again due to increasing demand 6) China, a developing economy, can be on the upward spiral of economy growth after a merely 8% growth in 2009 Again, thanks for your sharing.

Gene thank you for the

Submitted by Greg Pittaway on 12/08/08 - 3:52 pm
Gene thank you for the interesting article on the U.S economy.there were several points noted.You had made mention that "Given Time" monetary policies that were put in place should take effect. depending on who you ask.The normal recession is approximately 16 months.Some have stated that we are looking at alot longer than that time frame.If so, how long and what major factors aside from the housing market will bring us out of this.| Thank you again for your time......Greg Pittaway

A lingering issue that could

Submitted by Roberto Lozano on 12/08/08 - 1:32 pm
A lingering issue that could create additional problems for the US economy in 2009 is the huge projected budget deficit which will surpass a trillion dollars. To finance the budget deficit, the Treasury will be forced to finance it by issuing treasury bonds. Yet, there is a high level of uncertainty in the capital markets right now, about the future willingness of potential bond buyers to purchase such a large amount at the projected interest rates. If these foreigner buyers (mainly China and Saudi Arabia) refuse to buy at existing rates, the Treasury will have to increase the yield rates significantly to make the bonds attractive. Such a move would in turn affect the entire interest yield curve and thus aggravate the debt burden in the future.

It would be helpful to

Submitted by John Suzanne, DSA on 12/05/08 - 1:27 pm
It would be helpful to non-economist readers to spell out acronyms prior to first use i.e. MBS - Mortgage Backed Security, TARP - Troubled Assets Relief Program, US Treasury

We need more logical articles

Submitted by Judith C. Abadie on 12/05/08 - 11:06 am
We need more logical articles like this inlieu of the constant negative reporting of all forms of

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