Recession – a self-fulfilling prophecy of doom

I came across this interesting article in The Star BizWeek, last Saturday, 22nd Nov'08 pg BW2. I'm always the staunch believer that our economy performance doesn't really 100% base on Technical or Fundamental Analysis alone. Human Behaviour does play an important role to shape the economic performances. (read more from the article below).

ACCORDING to the rational expectations theory in economics, people make decisions about the future based on their experiences. There is the suggestion that these expectations about the future are often accurate because they are, well, rational. But in practice, there are other things happening.Let’s take inflationary expectations as an example. If a company has a view that prices are going to increase, what will it do? If it can get away with it, it will simply increase the prices of its own products.

If everyone has the same view, and takes the first opportunity available to do the same, then what happens is that prices begin to spiral and inflation indeed does go up. Prices went up simply because enough people expected prices to rise. That leads us to this frightening thought – are we talking our way into recession? And will be faced with recession simply because enough people believe that we must move into recession?

But before we examine that, here is a 2008 Christmas Carol making its way on the Internet, It’s a useful, witty and humorous indicator of how low the mood is out there, sung to the tune of Santa Claus is Coming to Town.

Recession is Coming to Town

You’d better watch out; You’d better not cry

You’d better keep cash; I’m telling you why:

Recession is coming to town.

It’s hitting you once, It’s hitting you twice

It doesn’t care if you’ve been careful and wise

Recession is coming to town

It’s worthless if you’ve got shares; It’s worthless if you’ve got bonds

It’s safe when you’ve got cash in hand; So keep cash for goodness sake, HEY

You’d better watch out; You’d better not cry

You’d better keep cash; I’m telling you why:

Recession is coming to town!

Finance products are confusing; Finance products are so vague

The banks make you bear the cost of risk; So keep out for goodness sake, OH

You’d better watch out; You’d better not cry

You’d better keep cash; I’m telling you why:

Recession is coming to town

We have all read about how much more resilient the banking system in Malaysia is these days and how little we are exposed to the global financial crisis. And despite the scepticism and cynicism, that’s actually right. There is plenty of liquidity in the system and when people keep more cash, there will be even more liquidity – that’s not so bad.

But what could be real bad is if companies and businesses cut back even before things go bad and banks stop lending even if projects are good. If people are losing jobs and having their pay cut, even as companies are still making profits, that will be bad. If businesses and individuals don’t pay their bills, it starts a downward spiral from which it will be hard to recover in the current environment.

In short if enough of us believe there will be a recession, enough of us will behave such that there already is a recession. And that will itself cause a recession – a self-fulfilling prophecy of doom. We don’t need to go there if we maintain confidence in our systems and ability, and remain realistic at the same time. But it is a delicate balancing act, and one hopes the balance does not tilt in the wrong direction – it can, very easily. So let us maintain a sense of proportion about things.

P. Gunasegaram is managing editor of The Star. He prefers to be more optimistic than pessimistic, the theory of rational expectations notwithstanding.