The expectations we hold illustrate how important confidence is to an economic recovery. And because the latest unemployment report wasn’t what the pundits expected, stock prices tanked, causing interest rates to decline back to historic lows. (It helps that the Fed is also buying Treasury Bonds, driving down rates further, of course.)

It’s hard to say what is driving the disappointment in expectations. It has in part to be the Obama Administration’s overoptimistic growth projections. But there also has to be alarm over the growing deflationary wage spiral that affects so many consumers. Yet after 30 years of supply-side economic policies—that depressed wage and salary growth that make up 80 percent of personal incomes—it will take more than a few years for consumers to spend again.

In fact, one reason that consumers are now saving more than they are spending (savings rate is up 5.7 percent vs. just a 2 percent annual spending increase) is their expectation that incomes will not improve very soon.

And expectations affect the general level of consumer confidence which in turn helps to determine when general economic conditions will improve. The optimists hope the recession will end this year, including President Obama’s Council of Economic Advisors, while many reputable economists say we will have to wait at least another year.

Yet expectations are notoriously hard to measure, since they are based on feelings more than facts. And feelings cannot really be measured, yet we have no other way to assess our futures. That is why economist Robert Shilling has focused so much research on the importance of the components that instill—or deflate–confidence, including trust in our financial institutions that was broken with the subprime debacle.

We know a consumer expectations survey by the Conference Board has risen more than 16 points since November 2008. But it cannot rise much more without an improvement in wages and salaries. Such wage deflation last happened during the Great Depression, as a result of very similar policies that saw a massive redistribution of wealth in the 1920s. President Roosevelt’s Federal Reserve Chairman Martin Eccles said at the time:

“… a giant suction pump had by 1929-30 drawn into a few hands an increasing portion of currently produced wealth. This served them as capital accumulations. But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When their credit ran out, the game stopped.”

That is why so much of the Obama stimulus plan is devoted to creating jobs over the next 2.5 years. But it will be a slow process, since it has to reverse 30 years’ of policies that choked off wage growth.

What happens if the Federal Reserve worries so much about inflation that it begins to soak up all the excess liquidity before sufficient economic growth returns? A historical look at the 1937 recession (the Great Depression was actually 2 depressions, from 1929-33 and 1937-38) illustrates what happens when government tries prematurely to balance its budget.


The civilian unemployment rate had dropped from 25 percent to 10 percent by 1937, but quickly shot back up to 20 percent by 1938, prolonging the depression until the start of World War II.

The Obama Administration must therefore create more realistic expectations of future growth, a hard thing to do. One can only look at the various indicators that do the best job of measuring business sectors—whether in the service or industrial areas. Both have been improving of late. June business activity in the service industries shot up 7 points, for instance, and is on the verge of expanding after 2 years of contraction. Consumers (and so real estate) will be sure to follow.

Harlan Green © 2009