A Self-Fulfilling Prophecy
Kimo Gandall, Fiscal Policy Associate Editor
Two words describe the variable that plays one of the largest roles in market growth in the US: investor confidence.
It is generally accepted that investor confidence affects the value of the standing marketplace. This investor confidence translates to the actual risk investors are willing to take in enterprises. In effect, investors are able to scale the economy, which impacts interest rates, inflation, and spending. Similarly, consumer confidence can indicate financial growth, and many times correlates to investments.
Confidence by it’s nature is subjective. Confidence reflects a general attitude about the economic climate; thus, the way people feel matters. In many ways then, both economic downfalls, and economic recoveries are self-fulfilling prophecies.
A growing breadth of academia is beginning to find that different policies and crises could potentially shift economic patterns not on panic, but on natural fluctuations that occur within economies, i.e. the rather erratic patterns we see in economic cycles.
The first question is on the aggregate response to shocks. A researcher from the National Bureau of Economic Research published a paper in 2016 that found that a market with constrained equilibrium suffered from a higher vulnerability to financial crisis. This research potentially indicates that government policies, such as high levels of foreign debt trading to maintain economic stability, actually resulted in a Fisherian debt deflation crisis due to pessimistic views on the actual value of invested collateral. Basically, people didn’t trust an economy that was constrained or reliant, i.e. an artificially driven economy that wasn’t fully dependent on supply side economics.
If this line of reasoning is true, then the current plans by President Obama, which included subsidizing the economy to recreate growth, is a one-stop path to economic collapse. This article, as with nearly all economic predictions, is purely theoretical. Let’s look at some case studies on variables that affect the economy: in 2016, one research paper found that lower gasoline prices had large aggregate effects on the economy, and another paper found that trade frictions play a dominant role in manufacturing percentage points. These studies, however, only portray a variable influence on confidence, which could potentially be independent of government influence. Nowhere within the studies is government intervention taken into account; thus, an empirical question on lingering variables is posed: Is the cumulative idea of government intervention bad (such as, say, subsidizing oil companies to lower gas prices), or is it just a changing perception?
The empirics are contradictory. Clearly, investors like the consumer confidence that results from low gas prices, or ample jobs. Growth models such as the one created by the National Bureau of Economic Research, however, conclude that cumulative government regulation and work in these areas result in economic vulnerability.
I propose a new model: economic vulnerability can be explained by potential for loss, rather than the potential for growth. This ‘loss hunch’ more thoroughly explains the crippling effect of stagflation, and the pessimistic view of debt, even when traditional economic models, such as high demand for the dollar, imply that both would be rather moot.
Of course, many other economists have beat me to my game; risk factor analysis is already a significant player in predictions, and have already prescribed several different branches of risk, such as interest risk, and business risk. But risk is growing in importance; a recent paper published by Ohio State University showed that certain population groups were less willing to take financial risk, and another paper released in 2016 found that the current dominant paradigm for currency trading valued stability. This leads to an obvious conclusion: there is a growing affiliation of capital to follow stability, or perceived stability of market trends, over actual growth.
This trend ought to scare those who value actual worth over perceived worth, because the market is also taking a turn towards value trading. As a previous article I published explained, value trading is growing at an unprecedented rate, and could result in massive earning inflation, making investors believe the economy is stable, when in reality, the actual rate of return is simply nonexistent.
While risk is always important to analysis, it seems that the American spirit for entrepreneurship, or taking risks for a brighter future, is slowly being replaced by an economic confirmation bias that favors derivatives propped up by investment banks on Wall Street. In essence, the banks are gradually reinvesting in potential value (future contracts, commodities, etc.), over traditional stock growth investments. And, based on their increased demand for such, other investors are joining in. Simply put, we have before us a dangerous mix of a pessimistic investor cultural climate, a turn towards purely value based trade, and a paradoxical reliance on the government to maintain the economy. It’s only going to take one match to light up this powder keg of an overvalued economy.
As I’ve concluded before: hopefully President-Elect Trump can keep the perception of the dream chugging, or, much like the economic disaster China faced in 2015, it might all come to an explosive end.