Since 2007 the consensus of the economic establishment—bankers, policymakers, CEOs, stock analysts, pundits—has been catastrophically wrong. They didn't see the economic storm clouds gathering. When the raindrops began to fall, they failed to forecast the deluge. As a result, throughout 2008, executives, investors, and consumers chased the economy down—cutting back after things unexpectedly got worse; cutting back again when the roof fell in.
The Great Panic of 2008 may have destroyed blind optimism. But if excessive optimism was the near-fatal pose in 2008, blind pessimism has emerged as the reflexive post-bust crouch. And it has led the economic establishment to miss yet another inflection point. While we were wringing our hands about America's financial and industrial crisis, we ignored a parallel narrative that was emerging: the repairing of balance sheets, an embrace of reality, a nascent recovery. The same folks who chased the recession down now are likely to chase the recovery up.
Even as the economy started improving, corporate America continued to prepare for Armageddon for much of 2009. Inventories of manufactured goods fell in 10 of the first 11 months of 2009. Between October 2008 and October 2009, retailers slashed inventories from $500 billion to $432 billion. Translation? Pessimistic about their ability to sell stuff, companies cut way back on their orders. But when consumer demand finally materializes, retailers will be caught flat-footed and miss out on sales. Like when you go into the local Gap, ready to spend, but it doesn't have the jeans you want in your size.
Excessive pessimism in other areas has been more costly. Virtually all the market geniuses who hung on as the Dow was scythed in half between October 2007 and March 2009 failed to call the market turn. Most hedge-fund managers have chased the 60 percent rally since March, not led it. Economic forecasters similarly missed the dramatic turn in the overall economy this spring. Having failed to forecast that the economy would shrink at a 6 percent annual rate through the first quarter of 2009, economists also failed to project it would start growing again at a decent pace in June. And they're still behind the curve. My bold prediction for 2010 is that the consensus of the forecasters surveyed by the Philadelphia Federal Reserve, which projects the economy will grow only 2.4 percent in 2010, is too pessimistic, perhaps by half.
As late as August, not even the most cockeyed optimist would have projected that, within four months, Bank of America, Citi, and Wells Fargo would return nearly $100 billion in borrowed funds to the taxpayers. But they did. On Dec. 23, the same day Citigroup and Wells Fargo paid back $45 billion in TARP funds, six smaller banks also exited the program. A year from now, the only TARP we care about may be the one rolled out when it rains during baseball games.
I don't expect all the pessimists to be swayed by a quarter or two of good results. There are those who can't fathom recovery for ideological and political reasons, the fools who believe—despite the evidence of the past 16 years—that the economy and the markets favor Republican presidents and policies over Democratic ones. Some pundits, meanwhile, have staked their professional reputations on the proposition that Keynesian economics no longer work and that the U.S. is in terminal decline.
Then there's a large population of nonideologues who may not fully embrace the narrative of economic recovery because they don't feel it yet in their paychecks, portfolios, or home values. Try telling a laid-off autoworker in Michigan or a laid-off magazine editor in Brooklyn that things are better. But they may soon be in for pleasant surprises, too. For all the advances of information technology, big economic turns always take us unawares. In 2007 all indicators flashed green—until the bottom suddenly fell out. In this environment, things can look awful, until a new order unexpectedly comes in or a few deals break in your firm's favor. All of a sudden, things seem much better. We're in a Missouri economy now, one in which recovery has to be shown, not told. Economic conditions may be improving, but it still may take more than a few quarters of growth before people fully commit to recovery, both financially and psychologically. If credit means belief, since the credit crisis began two years ago, belief has been in short supply. Maybe it's time for a little blind faith.