[Marxism] The Role of Animal Spirits in the Coming Severe US Recession

[Greg McDonald]

  Nouriel Roubini's Global EconoMonitor
The Recession News Barometer is Raising a Big Red Flag: The Role of  
Animal Spirits in the Coming Severe US Recession
Nouriel Roubini | Dec 01, 2007

There are plenty of forward looking indicators of economic  
recessions, including various asset prices (yield curve, risk  
spreads, equity markets, etc.), macroeconomic variables, the  
consensus of experts and analysts as well as more quirky indicators  
(such as sales of St. Joseph statues to indicate housing recessions,  
or sales of lipstick, a proxy for cheap make-up in tough tight- 
belting times). Certainly many of these indicators are now pointing  
in the direction of a very high probability of a US recession in the  
very near term. US growth in Q4 may be closer to 0% than 1% and will,  
in my modest view, turn negative (recession) in H1 of 2008.

Last year, when I started to talk about the risks of a US recession  
in 2007, one unconventional indirect indicator of the risks of a  
recession that I mentioned and started reporting  was the number of  
times the term recession was used in the news media (as measured by  
the numbers of mentions of the term “recession” in Google News). This  
Google New Recession Barometer is of course not a scientific measure  
of the probability of a recession; but, as far as forward looking  
indicators are concerned, it is a pretty interesting one for a  
variety of reasons: 1. it suggests how much media and analysts are  
concerned about an economic recession; so it is a proxy for the  
“wisdom of crowds”; 2. recessions can be, in part, self-fulfilling  
and due to what Keynes called “animal spirits” in the sense that,  
while weakening economic fundamentals are the crucial trigger of a  
recession the degree of confidence about the future of consumers,  
firms, investors is an important determinant of their economic  
decisions (how much to consume and invest in real capital) and their  
portfolio decisions (how much to shun risky assets because of  
increased subjective risk aversion).  If consumers and firms become  
less confident about the future and worry about a coming recession  
they will behave in ways – cutting consumption and capital spending –  
that will reinforce such recessionary trends and increase the  
likelihood that such a recession will take place.

To assess this element of “animal spirits” and confidence consider  
the 1990-91 recession that started in August 1990. It was indeed  
triggered by economic fundamentals: the boom and bust of commercial  
and residential real estate and the credit crunch caused by the  
collapse of the S&Ls; the sharp increase in oil prices following the  
Iraqi invasion of Kuwait in August 1990. Indeed, the recession was  
mostly driven by the boom and bust of the S&L as it started two  
months before such invasion; the oil price shock that followed that  
invasion only worsened and exacerbated a recession triggered by other  
factors. But one important element of the 1990-91recession was the  
effect of animal spirits and confidence. That recession is sometimes  
called the “CNN recession” as nervous consumers spent the summer and  
fall of 1990 watching on TV the unfolding Kuwait drama and the US  
preparations for war rather than going out to restaurants, movie  
theaters and to shopping centers. This was a combination of  
fundamental-justified fear and Keynes animal spirits pushing a  
weakened economy into a deeper recession.

And the role of animal spirits in ending a recession was also evident  
in this episode; the trough – or end - of the recession was in  
February 1991 when the US successfully freed Kuwait from the Iraqi  
invasion and the war was over.

Of course there are dozen of measures of consumers, firms and  
investors’ confidence and all of them in the last months are heading  
sharply south and raising red flags on the perception by such agents  
that a recession is coming; also recent polls have consistently  
signaled that 60% of Americans now believe that we will have a  
recession in the next 12 months.  So, the perverse effects of animal  
spirits and confidence are in full swing now on top of an onslaught  
of lousy and worsening macro and credit news.

So let us consider now what the Google News Barometer is telling us  
about the media and the country mood regarding the risks of a  
recession.  In July 2006 when this author started to talk about the  
risk of US recession in 2007 this Barometer showed 4,850 citations of  
the term “recession”.  That Barometer rose to 5,500 mentions in late  
August 2006 after the housing bust started to get into full swing and  
after the Fed stopped raising the Fed Funds rates as the first sign  
of a significant growth slowdown appeared. Today, the Recession  
Barometer is up to 22,047 mentions of the term recession.

As a matter of comparison mentions of recession in the onset of the  
last recession – that started in March 2001 - were:

June 2000                    1,620

January 2001                6,400

February 2001             5,540

March 2001                 7,290

April 2001                    6,350

May                             4,950

June                             4,250

July                              5,060


There are of course many shortcomings of this unscientific Recession  
Barometer: it may provide false alarms; it may mention concerns about  
recession in other countries; comparing its coverage in 2000-2001 and  
in 2006-2007 is unfair as many less online sources existed and were  
used by Google News in 2000-2001.  On the last issue, of course a  
comparison between 2001 and 2007 may be unfair as in 2001 the number  
of online new publications existing and covered by Google News was  
much smaller then.  To control for this bias compare the change in  
the mentions of the term recession between June 2000 (when the  
economy was still growing at a 5% rate) and June 2001(when the  
economy was clearly in a recession): this is the difference between  
1,620 mentions and 4,950 mentions or a 205% increase. Instead the  
change in mentions of the term recession between July 2006 and today  
is 355% or the change from 4,850 to 22,047 mentions.

It is also interesting to note that, as late as August 2001, when it  
was clear based on most economic indicators that the US was in a  
recession a lot of market commentary was still discussing whether the  
US was in a recession and whether a Fed easing would prevent such a  
recession. Indeed, while ex-post the NBER dated the start of the  
recession to March of 2001, that dating decision was made over a year  
after the recession had started. So, in the last US recession even  
five months after its onset – in August 2001 - many analysts on Wall  
Street were still arguing that we were not in a recession and that  
the Fed actions would prevent a recession from taking place. Since  
the NBER Business Cycle dating committee –  the official arbiter of   
the US business cycle (that is headed by Bob Hall of Stanford – has  
barely started this time its process of deliberations and will take  
its own time – more than a year – to decide if and when a recession  
has started in the past expect this time around the same saga of  
markets’ and analysts’ denial of a recession even after such a  
recession will be in a full swing in early 2008.

Like in 2001 expect most analysts to argue that Fed easing will  
prevent a recession (95% of economists polled by the Economist  
magazine in March 2001 – the month the recession started – argued  
that the US would avoid a recession in 2001 because the Fed easing  
will prevent it), expect the Fed to be in denial about the risks of a  
recession and expect the stock market to have its last legs of a  
sucker’ rally before the hammer of ever worsening macro and credit  
news will beat on the head of the most obtuse and in-denial observers  
the reality of an existing recession.

So consumers, firms, and investors’ confidence and animal spirits are  
always important determinants – complementary to economic and  
financial fundamentals – of economic recessions. And such animal  
spirits are now signaling a significant risk of a US recession in the  
near term.