A Loss of Confidence

"What we anticipate seldom occurs; what we least expect generally happens." - Benjamin Disraeli

Economists are at a loss as to what causes a loss of confidence.  One minute everyone is happy with the status quo and the next people turn tail and run for the hills.  This is of particular concern given the precipice on which the global economy is balanced.  Confidence is fickle and right now it hangs in the balance.  This is of great concern when governments and companies need to roll over large amounts of short-term debt which is precisely what is required at present.  As an example of the size of short-term debt that needs to be rolled over, the recent stress tests performed on 90 European banks showed that EU 5.4 trillion of debt needs to be rolled in the next 24 months. 

While the number is huge, in good economic times this would not be a problem.  The issue is that unless there is the confidence that this amount will be repaid the market for these securities disappears.  To attract buyers for this debt there needs to be the confidence that the debt will be repaid in a timely manner otherwise the interest rate needs to reflect the risk associated with non-repayment.  A lack of confidence therefore leads to a spike in the interest rate right at the time when companies and governments can ill afford it.  If confidence collapses, lenders disappear and a crisis ensues.

So what makes up confidence?  Well unless you are an accountant you base your outlook on the current business environment and your expectation of future events.  People typically follow the consensus of opinion (that is why it is the consensus) so when things are good, everyone seems to expect the goods times to continue to roll (this is why economies overheat and bubbles are created).  The same is true when things turn bad; people generally take a bleak look at the future (this is why it is so hard to turn an economy around during a downturn).  The issue is how to determine the inflection point, the point at which people or businesses decide that enough is enough.

Certainly at present there is an air of despair.  In poor economic times people rely on their leaders to step up to the plate.  Governments and central bankers are paid to take steam out of the economy when it is overheated and apply the accelerator during economic hard times.  A look over the last millennium shows that there have been some success, but overall the timing of the government intervention, the amount of the intervention and the direction of that intervention is questionable.  Looking back just a decade brings into question why so much support was given to the technology front by Mr. Greenspan and then why so much attention was placed on supporting the stock market collapse.  This support in turn lead to the housing bubble and on and on it goes.  Certainly it is very questionable as to the effectiveness of our leaders ability to support and control economic activity and it is doubtful that the current policies will be effective in solving the problems that we now face. 

That aside the issue right now is one of a deteriorating level of confidence in our current administration and the governments of most of the first world economies.  Given that the population of the globe is reliant on them to return the global economy to a more normal state it is very concerning to see their floundering in the eye of the storm.  To the average man on the street the lack of quantifiable benefits from all of the trillions of dollars spent around the globe is feeding into their outlook.  Unfortunately it is up to the politicians to correct this and looking at the lack of leaders prepared to do anything of substance (which may jeopardize their political careers) is sickening.

The downgrade of America's sovereign debt in and of itself is of little consequence, but it could be the tipping point that pushes the first domino leading to another major crisis.  Only time will tell, but the lack of consumer and business confidence around the world comes at a very inopportune time and points at best towards another recession in the making and at worst a global crisis that few have ever witnessed.