Uncertainty, the Small Investor, and Recovery

By now, we have all heard the basic argument that a core problem impeding recovery during the 1930s was the uncertainty created by public policy. In Robert Higgs’ words: “the New Deal prolonged the Great Depression by creating an extraordinarily high degree of regime uncertainty in he minds of investor.” New or anticipated taxes and regulations were at the heart of this uncertainty. And as Burton Folsom notes in a recent book: “Roosevelt’s special-interest spending created insatiable demands by almost all groups of voters for special subsidies. That, in itself, created regime uncertainty.”  Obviously, the subsidies were used as a tool of coalition building. But at the same time, they created questions for all: “where would the line be drawn? Who would get special taxpayer subsidies and who would not?” (New Deal or Raw Deal, 251).

Things have changed significantly since the 1930s. Government has more than doubled in size relative to GDP and many of the forms of spending that seemed so novel during the New Deal have become a central component of what many consider to be a minimally functional state.

Another thing that has changed: whereas during the 1930s, the pool of investors was largely limited to the wealthy. In the past quarter century, in contrast, a majority of Americans have stepped into the market, often through a 401(k) or an IRA.  We became a nation of investors.

To bring things full circle, I turn your attention to a piece by Graham Bowley in today’s NYTimes, “In Striking Shift, Small Investors Flee Stock Market.”

The lead: “Renewed economic uncertainty is testing Americans’ generation-long love affair with the stock market.”

“For a lot of ordinary people, the economic recovery does not feel real,” said Loren Fox, a senior analyst at Strategic Insight, a New York research and data firm. “People are not going to rush toward the stock market on a sustained basis until they feel more confident of employment growth and the sustainability of the economic recovery.”

This trend is being reinforced by baby boomers readjusting their portfolios away from equities and toward bond funds and the loss of real estate value (and hence a loss in the capacity to use the house as an ATM).

For decades, political scientists and economists have spoken of a political business cycle wherein elected officials goose the economy in the months leading up to an election to maximize their votes, leaving the long-term economic fallout until after the election. Now that nearly every man and woman is an investor, things may be more complicated. One must ask whether the efforts to prove that something is being done are convincing voters qua small investors that the future is quite uncertain, thereby having the unintended consequence of prolonging the recession?

8 thoughts on “Uncertainty, the Small Investor, and Recovery

  1. I happened upon this article from asia times online.

    I find myself reading ATO about as much as I read the WSJ anymore.

    With that said…

    Austerity fails policy test
    By Henry CK Liu


    After providing quite a bit of empirical evidence, Liu’s argument is that if stimulus isn’t provided by the fed govt., the next great wave of unemployment here is going to come from the ‘public sector,’ further imperiling an already overall anemic job market and economy.

    At the end of the article he writes, “Thus a sound fiscal policy does not automatically mean a balanced fiscal budget even in the long run. The current mantra on fiscal austerity adds up to a poor fiscal policy.”

    Is Liu’s case compelling concerning more fed stimulus spending or not?

  2. Yes, we’ve all heard this argument about the New Deal, but that does not imply that we all buy this argument. A libertarian anarchist like Higgs is not exactly the neutral witness to testify on the New Deal. His “analysis” is mostly agenda driven. Thus the minimum when referring to Higgs would be some quantifiers like “the Austrian economist and libertarian anarchist” Robert Higgs claims …

    What about your small investors? Why don’t they invest? After all the corporate balance sheets are strong. US firms sit on piles of cash. The interest rate is zero. Because the stock market has a prospective, not retrospective, view. The stock market view of the economy and the aggregated views of business aren’t very far apart. Both view future uncertainty in one and only one respect: whether there will be enough nominal future demand to justify any investment.

    All other sort of uncertainties mentioned by pundits are part of the “supply-side” fairy tale book.

  3. As Milton Friedman put it, “I’m not a supply-side economist, and I’m not a demand-side economist. I’m a supply-and-demand economist.”

  4. Good to have Milton Friedman at hand. Unfortunately his theory on demand and consumption relies heavily on his permanent income hypothesis. Now with 10% of the US working population with definitely other worries than to assess how government spending and/or policies will effect at some future point their consumption pattern I consider this hypothesis (to put it mildly) mute. And his remedy for a recession — monetary policy — wasn’t exactly a big winner except for the bankrupt financial industry.

  5. My point was that we have to consider both demand & supply sides. To return to the point of Marc’s post, in addition to future income, which depends in part on demand for its products, a firm has to consider the costs of investment & hiring, which are related to the supply of available capital, the wage schedule, and the productivity of available workers.

    I wouldn’t agree that unemployment makes future income calculations moot. It factors into them.

    1. I don’t understand your point?

      AD in this period determines solely future income in the next period. AD determines how much output will sell and so firms produce that much (including inventories). Thus AD below output capacity imposes an employment ration on the labour market. So the short-side of the market (the AD constraint) is always in the driving seat. The supply-side of the labour market merely reacts to shifts in the short-side.

      The rest of your argument is about how AD is distributed among private sector agents (firms, housholds, banks, …) If productivity goes up and wages don’t rise accordingly a larger share of AD goes to the top-end-of-town.

      Anyway an unemployment rate of 10% is a shame and a scandalous economic and social policy failure on the part of the Obama administration. If some libertarian politician with Austrian pundits on his side would spearhead this i-can-do-nothing approach then OK. Nothing to wonder about. But this is essentially a let-down of voters because this administration has not guts.

      1. But “how much output will sell” depends on how both supply and demand set the price. If productivity is low and costs are high, then there is of course some price at which a firm could sell everything at a loss, but it’s not going to. It’s going to cut back. What brings back equilibrium after prices fall and inputs lie idle is that input costs fall and full employment of inputs returns.

        Of course, repeated shocks to the economy can keep this from happening. If small investors flee the market, whether rationally or irrationally, the supply of investment falls, raising its cost to firms and causing them to cut back further (or decline to increase production).

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