Questions Of Confidence

13/07/2012 at 4:15 pm 1 comment

During his inaugural address in 1933, President Franklin D. Roosevelt famously asserted that “the only thing we have to fear is fear itself.” Of the many comparisons which have been made with the Great Depression in recent years, this is one of the more tempting. Various catastrophes have been predicted; have failed, as yet, to emerge; and yet have damaged confidence to the point where the predictions have themselves produced an economic effect.

A good example of fear in action concerns the Indian rupee. Foreign exchange markets are wild beasts at the best of times, but the poor old rupee has taken a worse beating than most. Pretty much all the emerging market currencies were battered last summer – all the floating rate ones, at least – as US GDP was revised down, employment growth stalled and panic grew over a double dip recession. If this panic had proved correct (which it of course did not), this might have reflected a reasoning bet on reality: that developing world growth would turn to contraction on the back of contraction in major developed markets.

Then there was Europe. Fear over Spanish banks and Greek elections sent the rupee plunging further; having lost 18% of its value against the dollar over the second half of last year it fell another 5% during the first half of 2012. Soberingly, the Reserve Bank of India, which had been expected to cut its policy rate by 25bp last month, held it steady, citing concern over inflation – one consequence of a weaker currency.

A statistician revises GDP methodology in America, a coalition falls two seats short of a majority in Greece, and the effect is felt on monetary policy in India. The US did not have its double dip, Greece did not leave the eurozone, but the fear of both was enough for the job.

Of course, FDR’s statement was only arguably true when he made it. And today it would surely be only the most resolutely optimistic of politicians who would adopt “Happy Days Are Here Again” – or, perhaps, “Things Can Only Get Better” – as their campaign anthem.

Let’s take one more example. The $4.4bn accidental loss made on carefully calibrated, meticulously modelled and fully hedged derivatives trading announced today by JP Morgan (previously estimated at $2bn, then at $9bn) reminds us, if we needed reminding, that real bad news does crop up. That loss has led to a fall in the bank’s reported earnings per share of nearly 5% on the year at a time when Wall Street has already put on its bear suit again when it comes to the outlook for earnings.

And yet JP still reported falling loan writeoffs, an increase in mortgage lending as unemployment fell, and a resulting quarterly profit of $4.96bn. Without its derivatives turmoil – which it blames on its office in London, this month’s favoured destination for the financial scandal – it said that EPS would have risen by almost 50%. Now clearly this information tells us something just as material as the $4.4bn haemorrhage. But in a fearful world it is more often the ammunition for the bears that packs the bigger punch.

There was more to Roosevelt’s presidency than putting on a happy face, of course. Then, as now, policy action was by turns innovative, panicked, contentious, essential and disastrous. But his famous phrase has surely lasted because its neat paradox captured something true. It is not the only force at work, but the power of confidence on policy, markets, businesses and consumer behaviour is real.


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