What's eating consumers? The latest numbers show that consumer confidence is close to 40-year lows, suggesting the economy is in worse shape now than in times that seemed far darker, like in the early 1980s, when inflation and unemployment both crept into double digits. Yet inflation—despite record gas prices—remains at a manageable 5 percent. And unemployment is a modest 5.5 percent. So I asked Dan Ariely, a behavioral economist at Duke University and the author of Predictably Irrational, to help explain why a modest economic slowdown has produced such dismal public attitudes. Excerpts:
Why are consumers so gloomy even though the economy, by traditional measures, isn't all that bad? Is it $4 gas? Or falling home values? Or something else altogether?
I think there are three reasons. First, cars are very important to the American psyche. Think about James Dean and his motorcycle, "On the Road Again," and all that. The American psyche has associated freedom with cars, and now it costs a lot more just to use your car and get this feeling of freedom. Second, bankers have told us for years, "Your house is your most important asset. You should stretch and buy as much house as you can." Now, it looks like they lied to us in terms of how much we should borrow. And they personally made money in the process!
Third, I think the American people are really losing trust in our institutions. Think about all the meltdowns. First, it was the Internet. Then, Enron. Then, a banking crisis. Then, housing. Now, oil. All of these disasters are coming relatively close to each other. To people, it seems like there's something incredibly wrong with the way markets and institutions operate. Bankers giving crazy loans to people who can't pay them back, then they turn around and sell the same mortgages to people who know even less about them. It's incredible. It's a new version of the Wild West, and it's causing incredible distrust in the markets and institutions.
So, is the gloomy outlook justified?
I think the psychology is justified. If you thought you lived in a world where you understood the forces at work, and all of a sudden you didn't understand what's going on, your trust in the system all of a sudden becomes pretty low. Bankers can give loans to people who don't deserve them... It's not a world we understand or can predict. Yet a lot of people aren't really that bad off. For all the foreclosures, most homeowners are still doing OK, especially those who bought before the bubble. Gas is expensive, but other things are cheaper, and overall inflation isn't that bad.
In general, you are right, but I think these problems are signals. Going into the stock market, for example. We've been told for years that's where you should put your money for the best return, but it turns out that's not the best thing to do. People told us: Housing is the best investment we can make. It turns out not to be such a good deal—and not because of anything we did wrong. It's the bankers who went wild. Right now, it's the oil crisis. We went into Iraq in 2003 partly because of oil. And then we see a rapid sequence of events like this, and we have no control over the price of oil. Even for people who are doing OK, the problem is their inability to know what's right and wrong, and know where the next hit is going to come from.
What about market forces? One way or another, the markets would correct themselves, even if it's ugly. Doesn't that give people any confidence? That sooner or later this will end?
The only force I think can bring back consumer trust is regulatory force. People talk about market corrections. OK, there will be some price reductions but still, there are all these crazy people who made these stupid decisions. And they're still part of the market forces! Without serious regulations, there are good reasons not to trust the system. And, on top of the people involved, it turns out some of these sophisticated financial products were too sophisticated. Even the bankers didn't understand them. So when all of these meltdowns are over, will consumers end up scarred in some way?
I think so. If you look at some of our experiments with cheating, what happens is, when people are a step removed from cash, that makes it much easier for them to cheat. So, think about stock options, and some of these complex derivatives and other securities. They're many steps removed from actual cash, and I think that makes it easier for people to do bad things with them. They're using ambiguity to color reality in a way that suits them. This is why I think that most of these meltdowns come from these complex financial products. Isn't healthy skepticism a good thing?
If we're overworried, it will create a huge deficit to the economy. Trust is an incredible lubricant to the economy, and erosion of trust is hugely important. Yet the level of trust in the United States is sliding. Will this new mistrust change the way consumers actually behave? Or the way we spend money? It's not like there's some alternative economy where we can spend our money instead.
Over the long term, I think we'll end up less trusting, and this will play out in small bits. The next generation will be unlikely to invest in the stock market at the same level, for example. It's true that most people's financial lives have not been affected by all these events as much as the news suggests. And it's true that in some sense we're talking way too much about all of these issues. But, in another sense, we're not talking enough about the real problem, which is the erosion of trust. Have we become a nation of whiners, like Phil Gramm said recently?
I don't think so. In some ways, we don't whine enough. When was the last big public demonstration? Or the last big public outcry? Yet these are issues that deserve an outcry. There ought to be consequences. People should get fired or go to jail. These are things that do deserve high-level attention.