The great debt scare

By Robert J. Shiller
September 23, 2011

By Robert J. Shiller
The opinions expressed are his own.

It might not seem that Europe’s sovereign-debt crisis and growing concern about the United States’ debt position should shake basic economic confidence. But it apparently has. And loss of confidence, by discouraging consumption and investment, can be a self-fulfilling prophecy, causing the economic weakness that is feared. Significant drops in consumer-confidence indices in Europe and North America already reflect this perverse dynamic.

We now have a daily index for the US, the Gallup Economic Confidence Index, so we can pinpoint changes in confidence over time. The Gallup Index dropped sharply between the first week of July and the first week of August – the period when US political leaders worried everyone that they would be unable to raise the federal government’s debt ceiling and prevent the US from defaulting on August 2. The story played out in the news media every day. August 2 came and went, with no default, but, three days later, a Friday, Standard & Poor’s lowered its rating on long-term US debt from AAA to AA+. The following Monday, the S&P 500 dropped almost 7%.

Apparently, the specter of government deadlock causing a humiliating default suddenly made the US resemble the European countries that really are teetering on the brink. Europe’s story became America’s story.

Changes in public confidence are built upon such narratives, because the human mind is very receptive to them, particularly human-interest stories. The story of a possible US default is resonant in precisely this way, implicating as it does America’s sense of pride, fragile world dominance, and political upheavals.

Indeed, this is arguably a more captivating story than was the most intense moment of the financial crisis, in 2008, when Lehman Brothers collapsed. The drop in the Gallup Economic Confidence Index was sharper in July 2011 than it was in 2008, although the index has not yet fallen to a lower level than it reached then.

Most confidence indices today are based on survey questions that ask respondents to assess the economy today or in the near future. George Gallup, the pioneer of survey methods and creator of the Gallup poll, created a confidence index in 1938, late in the Great Depression, when he asked Americans, “Do you think business will be better or worse six months from now?” He interpreted the answers as measuring “public optimism” and “the intangible mental attitude which is recognized as one vital element in the week-to-week fluctuations of business activity.”

But it hardly seems likely that big changes in people’s confidence (the kind of confidence that affects their willingness to spend or invest) are rooted in expectations over so short a time horizon.

When George Gallup wrote, almost nine years after the Great Depression began, a sense of ultimate futility – a belief that high unemployment would never end – was widespread. That sentiment probably held back consumption and investment far more than any opinions about changes in the next six months. After all, consumers’ willingness to spend depends on their general situation, not on whether business will be a little better in the short term. Likewise, businesses’ willingness to hire people and expand operations depends on their longer-term expectations.

The Consumer Sentiment Survey of Americans, created by George Katona at the University of Michigan in the early 1950’s, and known today as the Thomson-Reuters University of Michigan Surveys of Consumers, has included a remarkable question about the reasonably long-term future, five years hence, and asks about visceral fears concerning that period:

“Looking ahead, which would you say is more likely – that in the country as a whole we’ll have continuous good times during the next five years or so, or that we will have periods of widespread unemployment or depression, or what?”

That question is usually not singled out for attention, but it appears spot-on for what we really want to know: what deep anxieties and fears do people have that might inhibit their willingness to spend for a long time. The answers to that question might well help us forecast the future outlook much more accurately.

Those answers plunged into depression territory between July and August, and the index of optimism based on answers to this question is at its lowest level since the oil-crisis-induced “great recession” of the early 1980’s. It stood at 135, its highest-ever level, in 2000, at the very peak of the millennium stock market bubble. By May 2011, it had fallen to 88. By September, just four months later, it was down to 48.

This is a much bigger downswing than was recorded in the overall consumer-confidence indices. The decline occurred over the better part of a decade, as we began to see the end of debt-driven overexpansion, and accelerated with the latest debt crisis.

The timing and substance of these consumer-survey results suggest that our fundamental outlook about the economy, at the level of the average person, is closely bound up with stories of excessive borrowing, loss of governmental and personal responsibility, and a sense that matters are beyond control. That kind of loss of confidence may well last for years.

That said, the economic outlook can never be fully analyzed with conventional statistical models, for it may hinge on something that such models do not include: our finding some way to replace one narrative – currently a tale of out-of-control debt – with a more inspiring story.

This piece comes from Project Syndicate.

Photo: A trader works on the floor of the New York Stock Exchange, August 2, 2011. The S&P 500 turned negative for the year on Tuesday as the wrangling over the U.S. debt ceiling faded and investors turned their attention to the stalling economy. REUTERS/Brendan McDermid


We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see

Ramblings of a madman

I believe that there are a lot of misconceptions about an economy, many is that wealth is unlimited, that money is almost always considered plentiful and that anyone who tries can make it and that we do not need to regulate the distribution of wealth because the market will balance out at a healthy level.
Let’s start with the basics, and see where it goes from there. Each nation has a obscure value given it by the rest of the world, and prints money that amounts to some unit of that value. If it is worth a million values, and prints a million units of money, each printed unit will equal one value. Now, it is up to the nation to balance things, and if its value increases by 10 values, each unit of money will equal 1.1 values, but if its value decreases 10 values, a unit will only equal 9/10th of a value. That nation can also print money to redistribute its wealth and control its currency’s value. If the nation’s value remains the same, and the above case printed an additional 500,000 units of money, each unit is now only worth 2/3rd of a value, and you get inflation. The more money printed in excess of the increase of the nation’s value, the higher the inflation rate. And a small bit of inflation is actually healthy to ensure that the currency stays competitive against others, and that wages, prices, and costs can be incremented slightly as well to maintain that balance. If the currency gains too much value, things made in that nation become more expensive in the rest of the world, and the nation loses its competitiveness.
Stability breeds success, and without a good regulator to balance things out, all wealth will eventually rise to the highest level, as wealth will slowly be accumulated by a few, and as it is accumulated, there is less for all the others. Using the example above, if there are a thousand people, and the first year each got 1000 units as salary. Half saved and half spent, and the savers took 100,000 units out of circulation, thus the additional printing of 100,000 units of money, and while everyone the second year got the same number of units as salary, its value was reduced to 10/11th of a value by inflation. If this continues over 10 years, the savers will own 75% of the nation’s value.
Of course, everyone does not make the same, but we all do need the same basic necessities to live, food, shelter, transportation, clothes….and these things we must buy to live, so the less you earn, the greater part of your earnings will be used for just these things, thus limiting your ability to save anything, while the higher your earnings, the more you can accumulate each year, and that accumulation only grows each year, transferring wealth on up the line. Using the above example, if 250 people earned 500 units, 500 earned 1000 units, and the last 250 earned 1500 units, and it costs 500 values just for the bare necessities, and an additional 500 values for comforts and fun, after the same 10 years, the highest earners will own over 72% of the nations value, and the 500 units that are earned by the lower earners are now only worth less than 250 values, and that 1000 units earned by the middle earners are less than the 500 values needed for the bare necessities.
Most economies are quick to grow, and last only a few centuries because this imbalance reaches a critical point where they are just torn down to start again by a younger, healthier, more competitive economy. A good government is needed to temper the need to balance the distribution of wealth with the need to reward success and innovation and motivate its population to grow and expand and do big things. I see today the ignorance of the facts of economics, and while a economy is much more complex then the example listed above, you can look at the above example and see that if limits are not set, those that can will eventually end up with everything, while those that are just able to get by will start to fall further and further behind as the portion that is available to them continues to diminish. Wealth must not only flow from the bottom up, but also from the top down, some abstract limits must be set that ensures that without restricting growth and new ideas, or not rewarding the innovators for their risks. There is a very thin line between a society where new ideas progress are so restrictive that there is no profit for the innovators and no growth for the society with stagnation and fading from history as the outcome, or a quick buildup of wealth by the few until there is a collapse every few generations to redistribute the wealth to all when the imbalance makes it impossible for the many to survive.
One of the biggest threats to today’s economy is probably the stock market, which may seem like a bit of a puzzle, how could investing in a company be counter-productive? It is quite easy, after the initial public offering of a stock, stocks are then traded and sold outside of the main economy, drawing capital from creating jobs and infrastructure into this isolated bubble. This bubble has continued to siphon money from Main Street to Wall Street, until it has reached a point where it is no longer symbiotic in its relation, but more parasitic.
I do not believe that government should control or interfere unless lines are crossed, that it should stimulate competitiveness and ingenuity with rewards, but it also has a responsibility to ensure that no class walks on or tramples the future of another, that some basic distribution of wealth should be allowed for all. Wealth should be available at all levels, even if only a percentage point or two to the lowest earners. There needs to be a path up to keep ingenuity and hope for improvement alive. As things are today, there is very little wealth or hope available to the lowest earners, and not a lot of chance an average child born at the lowest level will have much of a chance to obtain any wealth in its lifetime, and even a gifted one has little chance to obtain the opportunities needed to excel as more and more people compete for the ever shrinking piece of the American pie that is left over from above.

Posted by Cliffster | Report as abusive

[...] Robert Shiller: The debt debate destroyed any exuberance the American consumer might have possessed — Reuters [...]

[...] The great debt scare | The Great Debate. Share [...]

Cliffster betrays a fundamental misunderstanding of how a capitalist economy functions. Post-IPO stock trading is critical to capital raising. Here are two reasons why. First, why would anyone invest in an IPO if there were no secondary market holding out hope of selling at a profit? Every stock at one time effectively was an IPO, so without IPO’s it would be much more difficult for new ideas to get capital, hence jobs that might have been created won’t be. Second, demand for existing shares is necessary if they are to increase in value. And why is it important for shares to go up over time? Because rising stock values ipso facto lower the weighted average cost of capital for issuing corporations – making it cheaper to issue more stock,thus lowering the bar for new corporate investment and job creation. So Cliffster’s assertion that secondary market trading is a “parasitic” bubble which siphons money from the real economy couldn’t be farther from the truth.

Posted by hurryharry | Report as abusive

[...] Shiller: Consumer confidence levels have plunged in reaction to the debt [...]