Being austere with economic growth
Updated: 2012-11-03 06:14
By Richard Harris(HK Edition)
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The debate between politicians, policymakers and economists on the relative merits of spending for growth, or austerity by cutting government spending is the single biggest economic question today.
Recommending more borrowing to relieve an economic crisis caused by excessive debt is paradoxical and will merely lead to "apparent growth". Increasing GDP numbers at the expense of building intolerable liabilities for our children, is like an alcoholic claiming that he is boosting retail spending. Indeed quantitative easing seems to be going directly from the central banks into financial and real asset, rather than the real economy. This has upped the GDP figures, helping the feelgood factor, but is merely apparent growth borrowed from the future.
Even the IMF, the poster boys for forcing austerity on errant countries, are now calling for more borrowing. There is even a suggestion that because the US government now owns a quarter of its own debt that it should just cancel it! Yet there seems something wrong with a government doing something that in the commercial world would be a criminal offence. But these are all the same arguments that encouraged the Weimar Republic or Mugabe's Zimbabwe to print money. "In God We Trust" may well become the only words of value on the banknotes.
Those who want to spend money to buy growth worry about the debt trap, where low growth (and consequent high unemployment) causes the government's debt burden to go up so high that it can never pay it back. But if debt becomes too high, no growth will be high enough to pay it back. The whole argument is self-defeating.
Growth fans look to the US, which has kept taxes largely unchanged from 2007 and still reduced its annual structural deficit by some 4.6 percent of GDP, while the UK with its austerity policies has cut its deficit by only 2.2 percent. This comparison ignores the sheer size of the US economy, which can resist difficult global economic conditions. The UK is a much smaller economy whose major trading partners are in recession.
Austerity changes the behavior and mindset of participants. It forces people and politicians to make rational economic decisions within their means. Continuing to pour borrowed (or more accurately printed) money into the economy will not change profligate behavior.
Take the role model of Greece. If they don't earn it and they can't borrow it, there is no money left to spend. So without warning, public services, perhaps lifesaving surgery or pharmaceuticals for the poor, cease unmercifully. A period of hard austerity now - creating a short time of negative growth - will remind market players just how bad it is when the music stops.
Just before the global financial crisis, former Chief Executive of Citi, Chuck Prince, uttered the quote of the decade when he said, "when the music stops ... things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing."
Growth people believe that they can dance and stop just in time. But we have become debt junkies, unable to stop dancing until we fall over. This time it really is different. We are almost at the end of the borrowing ladder, even in China.
On the other hand, austerity can never stop dancing, because of the natural buffer of the political cycle - politicians will be thrown out of office if austerity is too tight. The austerity cycle is around three years and the political cycle 4-5 years, so politicians never have the time to cut spending too much.
Economies are also surprisingly resilient to spending cuts. The cost of Britain's austerity may be as little as 1.2 percent of GDP growth against long-term US comparisons - and the UK has 1 percent fewer unemployed. The UK's lost growth is insignificant against none-too-austere France and Germany. This seems a small price to pay now, to avoid meltdown later.
The debt crisis may be solved in several ways - the most drastic being the destruction of the global economy as we know it, through profligacy. Greece has an easy solution, as a small country, which is to devalue by falling out of the euro. This is not a solution open to a globally indebted world where competitive devaluations by China, Europe and the US would be a zero sum game.
We can slowly grow out of it - an option not open to Greece whose debt is already so high it is past the point of paying it off through growth alone. The last debt crisis during the Reagan/Thatcher years was solved when double-digit inflation eventually eroded the debt burden, setting the scene for glorious 1980's - 1990's growth. High inflation in mid-decade is the most likely scenario as the debasement of money through quantitative easing is well advanced.
In truth, the balance is for governments to apply a little more stimulus and a lot of austerity, together with the application of supply side efficiency measures to destroy weak uses of capital. There is much to say for Mrs Thatcher's first law of Handbag Economics, "Only what goes in the handbag can come out."
The author is chief executive of Port Shelter Investment Management.
(HK Edition 11/03/2012 page3)