Impatience Will Lead To Our Demise
It seems that political leaders in Europe, particularly Germany, may be giving up on the idea of austerity measures to reign in the excessive debt levels that have run amok in these countries, as well as in the U.S., over the last 30 years. Angela Merkel, Germany's Chancellor, has been a driving force on the insistence of tough debt cutting measures and fiscal targets in exchange for bailout funds since the beginning of the Greek crisis. In a NY Times article published yesterday Jordi Vaquer i Fanes, a political scientist and director of the Barcelona Center for International Affairs in Spain stated: "The formula is not working, and everyone is now talking about whether austerity is the only solution. Does this mean that Merkel has lost completely? No. But it does mean that the very nature of the debate about the Euro-zone crisis is changing."
What is both disturbing and disappointing are the lack of foresight that is being exhibited by both the media and the leaders of not only Europe but the U.S. as well. It should not be a surprise to anyone that the austerity regimen, agreed to last month as a long term solution to Europe's sovereign debt crisis, is going to cause economic growth to slow. We have been very vocal about this point in past missives. Austerity measures cannot be imposed when an economy is saddled by rising debt costs and high unemployment. Austerity, by its very nature, will reduce economic output and therefore requires a strongly growing economy to offset the drag of the reduction of government spending.
The problem is that for the last 30 years, as the world economy was growing strongly, both Europe and the U.S. were spending like drunken sailors. The chart shows the impact of increases in debt relative to economic output. Debt acts as a cancer on economic growth long term because it diverts resources from productive investment to debt service. As increases in debt deplete economic growth more debt is required to maintain the current standard of living. The cycle continues until eventually the "debt wall" is hit. This is the problem that both Europe and U.S. face today. The difference is that the U.S. is a currency issuer and can print more money to meet its obligations, not without negative future consequences of course, whereas Europe cannot. This inability for Europe to print their own currency makes their problem much more immediate than in the U.S.
For either country to resolve their long term debt issues, in order to restore the balance needed for higher economic growth rates, austerity is a very bitter pill that will have to be swallowed. The problem is that everyone, from the citizens to the politicians, want an immediate fix with no pain. The Keynesian policies of spending to promote growth over the last 30 years is what has led the globe to its current state of affairs. Yet this is exactly the policy that the financial markets and mainstream economists and media keep hoping for. Think about this for a minute.
How did we get into this problem in the first place? Government spending has a near zero multiplier in the economy since it is merely recycled tax dollars. If increasing government spending would solve the problem then why is the U.S., the current king of government spending and intervention, growing at a sub-2% economic growth rate. If we calculate all the bailouts, liquidity programs, interventions, dollar swaps, etc. the U.S. has plugged more than 200% of GDP into the system over the past 3 years to barely keep the economies head above water.
The reason is obvious. You can not spend your way to growth. Period. The math doesn't work anymore than using debt to get yourself out of debt. The only obvious beneficiary to all the government spending has been Wall Street which is why they are so enthusiastic about spending for growth. However, for the rest of world the income inequality gap continues to widen at an unprecedented pace. Corporations, other than financial institutions supported by Government spending, have slashed and burned drastically cutting costs, reducing debt and increasing productivity. As a consequence many corporations are now in much stronger financial position than they were before the beginning of the financial crisis. The self-imposed austerity measures induced voluntarily in order to reduce waste and increase profitability have worked exactly as it should. It was painful for the first couple of years but now, for many companies, the benefits are being reaped.
Both Europe and the U.S. lack what is required by corporations to remain solvent. Corporations have to make decisions each day that will affect their ability to thrive and prosper in the future. Sometimes those choices are painful but most importantly corporations realize that there is no "quick fix" to any problem. Whatever decisions are made today will require the patience and discipline to see it through. The problem with both governments is the lack of patience. Rather than making the decisions to begin a slow process of reducing the long term debt and deficit issues and being patient and diligent with the process — the lack of immediate results implies that austerity will not work. The lack of realization that 30 years of mismanagement concerning debt and deficit spending cannot be cured in a couple of quarters or even years is disturbing.
Killing "austerity measures" before they have even had a chance to start working and reverting to a "spending for growth" policy may delay the inevitable conclusion of the "debt wall". However, the reality is that eventually, just as with an ill-run corporation, austerity measures will be imposed by force rather than by choice. That reality has been seen repeatedly over the last 800 years of history and in the famous words of Winston Churchill; "those who fail to learn from history are doomed to repeat it."