How are you feeling?
No, I'm not asking if you have the flu. Rather, how are you feeling about your financial situation and the economy? Good? Even euphoric? If so, you aren't alone. When it comes to people's finances and the economy, the collective psyche is about as upbeat as ever.
It has been a long time since we felt this good. For much of the decade since the financial crisis struck, sentiment has been held in a dark grip. That downturn was so severe and debilitating, and the subsequent deleveraging process so painful, that the nightmare was hard to forget.
No longer. Global investors, businesses, and consumers have finally shaken off the pall of the Great Recession. This is clearest in financial markets. Stock prices are surging across the globe, with prices up by double digits in most bourses over the last year. Even more astounding, U.S. stock prices are up by closer to 25 percent.
The wildest investor optimism is in the runaway cryptocurrency markets, such as for bitcoin and ethereum. Prices have gone parabolic, consistent with a market overrun by speculation. That is, buyers of these currencies are buying simply on the expectation that since their values have risen sharply in the recent past, they will rise similarly in the future. Whether there are good uses for the currencies isn't really germane, and there don't appear to be, at least not yet. Investors just don't want to miss out on making quick money.
The small cryptocurrency markets are symptomatic of the euphoria that is steadily mesmerizing investors and financial markets more broadly.
Businesses are feeling great, too. Small business optimism has never been higher, according to a survey by the National Federation of Independent Business. Most encouraging is that over one-fourth of participants in the survey, near a record high, say it is a good time to expand their businesses. And a net of more than one-fifth say they plan to add jobs.
Consumers rarely have felt better than they do today. According to long-running University of Michigan and Conference Board surveys, the only other time people felt better about their economic and financial situation was around Y2K. That was also the last time that the stock market was regularly hitting new highs, and unemployment was as low as it is today.
Most times, sentiment doesn't lead economic activity; it reflects it. For example, consumer confidence improves when there are lots of jobs, unemployment is declining, and inflation is low. But, it is harder to connect the dots in the other direction, from improving confidence to consumer spending.
Except in boom times and in busts. Then, sentiment doesn't simply reflect what is going on in the economy, it helps drive it. This is evident most vividly via the so-called wealth effect. Quickly appreciating stock prices and housing values lift household wealth, persuading more-confident households to save less and spend more.
This wealth effect is currently in full swing. Stock and housing wealth have surged over the last year, and more-confident households have lowered their saving rate. The only other time personal saving was lower was briefly at the tip-top of the housing bubble. About half the growth in consumer spending last year was fueled by the wealth effect.
In the boom times, euphoria typically fuels increasingly risky and ultimately poor economic decisions. Investors speculate, real estate developers overbuild, businesses and households borrow too much, save too little, and overextend themselves. That's what happened during the housing bubble a decade ago and prior to every other recession in recent decades.
Fortunately, there are no ostensible bubbles today — cryptocurrency markets aside. Policy and regulatory changes in response to the financial crisis also make bubbles less likely. Bankers also remain generally circumspect in extending credit, perhaps because they suffered near-death experiences during the financial crisis.
The banking system is also on much sounder financial ground than in boom times past. The system significantly increased its capital levels and liquidity postcrisis, and is much better positioned if the economic expansion were to derail for any reason. As long as credit growth remains modest and capital levels strong, odds are good that the economic expansion will remain intact.
Having said this, it is very difficult to pinpoint the economic mistakes that ultimately take down an expansion. A subprime mortgage wasn't even well-defined prior to the financial crisis. But — if history is any guide — it is in the boom times, like now, that sentiment can become unhinged, impacting economic decisions and sowing the seeds of the next bust.
How are you feeling now?