When Information IS the Problem… Or… Living on the Margin

Last week the business section of several papers had headlines reading something like, “Retail Sales Plummet.” Because I’m an economist by educational background and training and also because I’m skeptical of scare-style headlines, I read the stories. The bottom line was simple. Retail sales dropped off about 2.8% in October compared to sales in October 2007. Now, the papers also had a graph that showed what appeared to be a convincing drop from one month to another — unless you read the numbers. The scale showed only the range of sales figures from $360 billion to $400 billion, or roughly ten percent of the total sales range — so of course a drop of nearly 3%, close to $12 billion, shows a “visual” drop of one third of the graph. Pretty scary — but it would have been hard to pick out that three percent drop on a graph that showed the entire $380 billion.

Needless to say, following the news story, which doubtless ran coast to coast, the stock market sank, and I wouldn’t have been surprised if more Americans decided not to purchase unnecessary goods.

All of this illustrates one of the greatest problems in a generally free market economy: everything literally rests on the margin… and much of what happens on the margin reflects popular perception. Since mid-summer for example, the price of crude oil has dropped from almost $140 a barrel to about $50, a decline of more than 60%. Did crude oil supplies increase by 60% or even 20%? Or did demand for gasoline drop by 20%-60%? Hardly. In fact, crude oil production has been cut, and demand for gasoline is down around 5% from last year at the same time. The same sort of marginal “tightness” and increased demand in housing was what fueled the housing boom… and a comparatively small, in percentage terms, number of defaults and lessened demand led to the subsequent bust.

A similar set of circumstances is wracking the stock market, if with slightly different mechanics at work. Hedge funds and private investors seemed convinced that the market would continue to rise, and they leveraged their investments through buying stock on margin and in various other creative ways. But when the market turned down, and investors in those funds wanted out, the hedge funds had to liquidate huge blocks of stock at whatever price they could, and prices headed down. That panicked more investors into selling… and so the cycle went. Then, because business outlooks deteriorated, a number of dividend-paying stocks cut or eliminated dividends — one financially solvent Canadian power trust even cut its dividend by over 70% — and the prices of those stocks deteriorated even more.

Effectively, on average, most pension and retirement funds have been cut between 30%-60% over the last few months, but especially in the last month. As more Americans saw their assets melt away, they further decreased their buying, and sales of large items like automobiles fell dramatically. Now the big three American manufacturers, who never understood that they couldn’t sell oversized and overpriced SUVs forever, are begging for a bailout from Congress.

In an economy as large as that of the United States, comparatively small changes in supply and demand, generally all on the margin, so to speak, can have enormous financial and economic consequences.

Now… when you add to that the scare tactics of the media, always in search of the next headline, small problems get bigger, and moderate problems become major… and that, unfortunately, is what is happening… and it will most likely get worse.