Forget quantitative easing. The most important thing U.S policy makers can do to save their country's battered economy may be to persuade Americans to take three deep breaths before leaving their homes each morning.
While the economic fundamentals may need some work, one of the biggest dangers facing the United States is the "negative feedback cycle" that sees consumers rein in spending because they are convinced things are only to going to get worse.
For an economy that depends on consumer spending for about 70 per cent of its activity, a simple change in attitude can be the difference between a slowdown and a recession.
"Bad news feeds bad news, and with rumours that even more bad news is lurking behind the bad news that has already been disclosed," said Louis Gagnon, a finance professor at Queen's University in Kingston, Ont., who specializes in risk management.
There are increasing signs that Americans are ready to give up on the prospects of an economic recovery of any sort.
U.S. consumer sentiment fell to its lowest level in three decades in early August according to the Thomson Reuters/University of Michigan survey. The overall index on consumer sentiment fell to 54.9, the lowest since May, 1980, down from 63.7 in July. The median forecast was 63 among economists polled by Reuters.
One component of the survey looks at the spread between the amount of good news versus bad news heard by consumers. It has tilted sharply in the past three months in favour of bad news, a dip that Credit Suisse called "unprecedented."
That means most of what American consumers are reading and watching on television is leaving them with a bad impression.
"Never before in the history of the surveys have so many consumers spontaneously mentioned negative aspects of the government's role," Richard Curtin, a research professor at the University of Michigan and director of the survey, said of the consumer confidence report.
"This was more than the simple recognition that traditional monetary and fiscal policy measures were largely spent. It was the realization that the government was unable or unwilling to act."
Respondents to the Thomson Reuters/University of Michigan survey worried about high unemployment and the embarrassing spectacle of the debt ceiling debates. Consumers were also startled by Standard & Poor's downgrade of U.S. debt last Friday, selling stocks en masse in subsequent days.
The stock markets have seen wild gyrations throughout the summer, with losses and gains of more than 2 per cent a day occurring with alarming regularity. In the past month, the Dow Jones industrial average is down 11 per cent.
"The big problem with all of this is that as markets tumble, households and businesses take notice and cut their spending in anticipation of an economic downturn," Prof. Gagnon said. "What starts as a purely emotional response in the stock market ends up pushing down GDP and this is the last thing we want to see."
The latest consumer confidence rating is a worse reading than what was seen in the depths of the last recession, when Federal Reserve chairman Ben Bernanke warned that the United States was stuck in a vicious cycle of bad economic news that was causing investors to retreat and damaging the prospects of the U.S. banking system.
"To break that adverse feedback loop, it is essential that we continue to complement fiscal stimulus with strong government action to stabilize financial institutions and financial markets," Mr. Bernanke said in 2008.
He doesn't seem willing to massage sentiment in the same way this time, however. In its meeting last week, the Fed acknowledged that the economic outlook had darkened since late June, the last time the central bank gave a statement. Growth so far in 2011 "has been considerably slower than the committee had expected," the central bank said, adding that it expects a "somewhat slower pace of recovery over coming quarters."
There are some reasons for optimism, however: Gasoline prices in the United States fell nearly 25 per cent as the economy slowed, putting more money in consumers' pockets. And house prices are at low levels, with cheap financing available because interest rates are so low.
And while Americans may feel gloomy, consumers actually spent much more than expected in July on discretionary items, pushing retail sales up 0.5 per cent across the country – the best showing in four months.
"There's a risk that we enter a negative feedback cycle," said Paul Dales, senior U.S. economist at Capital Economics in Toronto. "But I do think the consumer confidence numbers look worse than they are because they were taken during such an awful two-week period. Let's just all hope there is some kind of overreaction going on."