The Dangers of Wishful Thinking

The Financial World According to Inya Column, by Inya Ivkovic, MA

We may wish for it all we want, but there must not be a return to the way things used to be before the Great Recession. The knee-jerk reaction to keep everything as it was is logical, as we get caught up in reminiscing on the “good old times,” albeit impractical and downright dangerous. Why? Because that same kind of unjustified optimism often creates false positives, such as the short-lived bear rally in the spring.

Why did investors get so stock-trading-happy in the spring? One could say that the trigger was the March 10th surprise announcement from Citibank that the bank would return to profit in the first quarter. In hindsight, that announcement was anything but surprising, considering that, along with other large financial institutions in the U.S., Citibank was among those on the receiving end of $1.0 trillion in government bailout money. If $1.0 trillion doesn’t push at least someone’s bottom line, nothing will.

Regardless, it was good to hear the word “profit” after months and months of sheer doom and gloom. Just the thought of a troubled bank being profitable was enough to set the market on fire and spawn a round of self-fulfilling optimism, driven at times on nothing else but the absence of worse news (not even the absence of bad news, just worse news!). And, in the months that followed, North American indices — and many global ones, too — gained considerable ground, making many people hope that the worst was truly over.

But now is not the time to opt for selective memory and allow the collective economic engine to run on the fuel generated by the exuberant financial sector. Simply, so much more is needed to recover from the Great Recession than government-funded bank profits. The trouble with self-fulfilling optimism is that, unless it is founded on something tangible, it exhausts itself very quickly and only creates more heartbreak down the road. Instead, what real economic recovery will require is more people working more productively and producing more stuff. On that account, the global economy is not recovering; quite the contrary, it is still in fundamental regression.

What is the appropriate reaction? Obviously, wishful thinking would not be it! There is no such thing as self-propelling economic recovery; things will not start happening until roots of current failures have been pulled out. We need to base future economic growth on solid foundations, which would involve using tools such as leverage and credit in a responsible and controlled manner. Only if managed well can leveraging and credit facilitate real economic growth. Only if debt financing is channeled into meaningful investments can leveraging and credit work and prevent debt loads from spinning out of control.

But now what’s going to happen, after being rudely awakened from the pleasant dream that the worst was over in the spring? Some analysts are calling for a “double dip” type of recession, or a repeat of the first one. But that would be faulty reasoning, since the real economy (as opposed to the phantom one flickering on computer screens in trading rooms around the globe) hasn’t actually recovered at all. We cannot be dipping into the second recession when the first one isn’t over, right?

Instead, I believe we are still in the prolonged and thus exhausting stage of the “U-shaped” type of recession. What is needed is real spending on real goods by real and employed people. Re-inflating a financial and credit bubble and mood swings won’t do the trick.

The Dangers of Wishful Thinking
The Financial World According to Inya Column, by Inya Ivkovic, MA

We may wish for it all we want, but there must not be a return to the way things used to be before the Great Recession. The knee-jerk reaction to keep everything as it was is logical, as we get caught up in reminiscing on the “good old times,” albeit impractical and downright dangerous. Why? Because that same kind of unjustified optimism often creates false positives, such as the short-lived bear rally in the spring.

Why did investors get so stock-trading-happy in the spring? One could say that the trigger was the March 10th surprise announcement from Citibank that the bank would return to profit in the first quarter. In hindsight, that announcement was anything but surprising, considering that, along with other large financial institutions in the U.S., Citibank was among those on the receiving end of $1.0 trillion in government bailout money. If $1.0 trillion doesn’t push at least someone’s bottom line, nothing will.

Regardless, it was good to hear the word “profit” after months and months of sheer doom and gloom. Just the thought of a troubled bank being profitable was enough to set the market on fire and spawn a round of self-fulfilling optimism, driven at times on nothing else but the absence of worse news (not even the absence of bad news, just worse news!). And, in the months that followed, North American indices — and many global ones, too — gained considerable ground, making many people hope that the worst was truly over.

But now is not the time to opt for selective memory and allow the collective economic engine to run on the fuel generated by the exuberant financial sector. Simply, so much more is needed to recover from the Great Recession than government-funded bank profits. The trouble with self-fulfilling optimism is that, unless it is founded on something tangible, it exhausts itself very quickly and only creates more heartbreak down the road. Instead, what real economic recovery will require is more people working more productively and producing more stuff. On that account, the global economy is not recovering; quite the contrary, it is still in fundamental regression.

What is the appropriate reaction? Obviously, wishful thinking would not be it! There is no such thing as self-propelling economic recovery; things will not start happening until roots of current failures have been pulled out. We need to base future economic growth on solid foundations, which would involve using tools such as leverage and credit in a responsible and controlled manner. Only if managed well can leveraging and credit facilitate real economic growth. Only if debt financing is channeled into meaningful investments can leveraging and credit work and prevent debt loads from spinning out of control.

But now what’s going to happen, after being rudely awakened from the pleasant dream that the worst was over in the spring? Some analysts are calling for a “double dip” type of recession, or a repeat of the first one. But that would be faulty reasoning, since the real economy (as opposed to the phantom one flickering on computer screens in trading rooms around the globe) hasn’t actually recovered at all. We cannot be dipping into the second recession when the first one isn’t over, right?

Instead, I believe we are still in the prolonged and thus exhausting stage of the “U-shaped” type of recession. What is needed is real spending on real goods by real and employed people. Re-inflating a financial and credit bubble and mood swings won’t do the trick.