The threat of a "double dip" back into an economic recession looms, but if this comes to pass, the reasons would be much different from the body blow the U.S. economy received a few years ago. In 2008, a number of major financial institutions failed thanks to unchecked greed, in particular the lending of trillions of dollars to borrowers who lacked sufficient means to repay the money. Major deleterious results included a freeze on credit and a real estate crash as millions of homes went into foreclosure.
This time around the markets are sinking fast as a result of political missteps and indecision, some of it stemming from the attempts to remedy the original recession via an infusion of money. Meanwhile, "people have just become spooked by a crass failure of political leadership," George Magnus, senior economic adviser at UBS in London, told Reuters.
The U.S. government's approach a few years ago was to "stimulate" the economy by investing in it. This, along with expensive wars in Afghanistan and Iraq, helped create a mountain of debt, which led to a drawn-out, after-the-fact debt-ceiling debate this spring and summer on how and when this should be repaid. Congress's 11th-hour approach to addressing the nation's debt ceiling earlier this week was too little too late for investors, who saw a lot political posturing akin to rearranging the deck furniture on the Titanic while unemployment remains high, consumer spending is down and long-term economic remedies appear to be in short supply.
Research on financial decision-making often reveals a lack of rationality among "economic players," which counters assumptions made in many economic models. And other bodies of thought can muddy the dialogue and hold back policy-making efforts.
"America's budget deficit challenge is worsened by the country's deep political division over the role of government," Jeffrey Sachs, director of Columbia University's Earth Institute, warned in the July 2010 issue of Scientific American. "Tax increases are anathema, but contrary to common belief, there are few easy cuts in the budget for removing simple waste."
Still, the hit that the markets are taking this week—the Dow Jones industrial average was down nearly 130 points in midday trading Friday—may be a bit of an overreaction to what's actually happening. The U.S. economy managed to add 117,000 jobs in July, and hiring in May and June was not as bad as reported previously, according to the U.S. Labor Department. Yet, concerns that 117,000 new jobs isn't enough to keep pace with demand and fears about the broader U.S. economy are outweighing the improved jobs report and strong corporate earnings, Dan Greenhaus, chief global strategist at the trading firm BTIG, told the Associated Press.
Some scientists think that investors are wired to focus on negative news such as this and make hasty decisions that cause the market as a whole to suffer. As Scientific American reported in its July 2009 issue, "Behavioral economic theories, which focus on the psychology of finance, predict that, at times, irrational thinking and emotion will prevail, leading hordes of people to spend more and more on investments instead of recognizing that they are overpaying only to later stampede out of the market in a panic, precipitating a crash."
The end of this week certainly appears to be a stampede.
Image courtesy of Francesco Ridolfi, via iStockphoto.com