By Stephen Archer, Business analyst and director of Spring Partnerships

Two things lubricate an economy: liquidity and confidence. Without one or the other, an economy struggles. We have a new global, US and UK dynamic at play when it comes to confidence in the economy. Greece and oil to name a few examples but I will come to this.

Growth in the US and UK economies continues to be sluggish and the work out of private (never mind public) debt has yet to take any significant effect. Western consumers are still unwinding personal debt. Meanwhile, the US and UK to name a few western economies still have rising public debts. In tandem, currencies are not strong, unemployment continues at a high level and inflation is starting to look a little menacing. Certainly the Bank of England’s Governor expressing fears that inflation may be 5% by the autumn is alarming and I feel alarmist. We may even have stagflation, we may have stagflation because Mervyn King has created a self fulfilling prophecy! In truth, both the USA and UK are in the very long haul of recovery. This cannot be a rapid climb out as we have seen in earlier recessions. The damage to liquidity and the steep rise in debt will ensure that the partial recovery to reliable net growth will take at least another 3-4 years. The debt recovery will take much longer, especially the US debt.

Many of the economic issues are so complex and huge that most of the electorate will not have a firm grasp of the implications — but they have a firm grasp that things are not as they should be. They have very firm grasp of having less money than they used to. What else has dented confidence this year so far? : Japan’s Tsunami; question marks over future sources of energy thanks to the reactor failure; Bin Laden’s demise (yes, also a positive piece of news but reprisals now a new worry) Libya; BP’s continued attempts to take foreign stakes; higher taxes, maybe even a new Volcano eruption.
On the plus side we have had a Royal Wedding which for a week gave the UK a great retail and service industry boost. With the Royal Wedding we had living proof that confidence or at least a ‘feel good’ attitude can over ride everything. Of course it’s short lived but it is a fascinating case study. It does not have to be short lived, one might argues that the last 5 years of the 1980s were a continual feel good era. It is perhaps no co-incidence that this was the first period of growth in private debt. The most explosive growth in public debt came much later; in the UK under Blair and in the US under Bush.
One other factor on the minus account. Greek debt and the Eurozone have been somewhat compounded by the Strauss-Kahn debacle. This may have a silver lining but now it is hanging over markets and the Euro economies in a most ominous manner which brings us to the Greece and Oil connection. Fears of the debt re-structure damage to the Eurozone and its growth is leading to futures on oil being downgraded. Such is market’s low confidence in the ability of Europe (and the IMF) to come to a balanced and damage limiting solution for Greece and other Eurozone economies.

On the plus side — there will be a solution for Greece but the nature of that solution is going to be quite different to today’s bandage and this will re-kindle confidence. In my travels, by the end of the summer I expect to see business men in large and small enterprises whether they are healthy or not — all feeling more confident. But then again, as Harold MacMillan once said: “Events dear boy, events.....” !

Intuitively we all know that confidence is a critical factor in the economy but economists struggle to measure it and some struggle to even fully acknowledge it and its effects.

When the crunch effect was rampant between autumn 2008 and mid 2009 the confidence amongst business and financiers was close to zero. In a unique turn of economic trend the consumer confidence level was nowhere near as low and the consumer economy trickled along — all be it at a much lower level. Had consumer confidence in the damaged economies had taken the same plunge as business did, then we would almost certainly have seen a total collapse of the financial systems. It was close enough as it was.

So how should we view the confidence factor? Certainly it is by nature volatile. One day strong, the next it can weaken. It is infectious — it spreads around communities and cultures — both positively and negatively. It affects decisions in a tangible manner; people will say ‘I will not make that financial commitment because I am not confident’. It is time bound; it may stay up or down for some time and sub —consciously people will feel a need to review their own confidence levels — and perhaps change them as a result.

Paradoxically in this age of vast, open, instant communication it can remain contained within communities. For example, the estate agent world is a community as is the telecoms world. The two communities do not necessarily infect each other — provided that there is enough evidence within each to maintain the existing mood. The mood of bleakness in banking did not fully migrate to other parts of the economy. The media obviously has huge role to play in this and the BBC came in for criticism during the crunch for ‘talking it down’.

So how can we measure confidence? To some degree it can be anecdotally assessed and therefore measured. We may even build a picture of what factors are influencing people’s confidence. E.g. GDP, economic outlook for the US, jobs, bank regulation, Davos pronouncements etc etc. David Smith, a serious economist none the less refers to the ‘skip measure’ how many skips can be seen as signs of people making home improvements. I have heard worse ideas. During late 2008 it was noted that traffic speed fell on the M25 motorway by 5mph — drivers felt there was no point in hurrying. The speed is now back up I believe.

Can we manage it? Yes, with facts and behaviour. The dissemination of economic facts that support the growth assumption. Secondly it is by leadership and the demonstrable understanding of what is holding back confidence. It’s no good George Osborne telling business to invest to help the recovery — he has to provide cogent reasons to underpin belief that such action will make a difference. The leaders of the western world need a very sure touch.

Above all, leaders must stay in touch with the people — only then can they really be entitled to speak to them and do so effectively. Confidence may be intangible but it’s critical and right now we are at another tipping point — confidence is lower than at the end of 2010. How do I know? Like you, I just know. Call it gut feel, that will do since gut feel leads to gut reactions.