By Michael Baxter 7 Jun 2010 [0 Comments | 666 views]
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It’s amazing how a phrase can sum up the big ideas of each era. Not so long ago the mantra of the world seemed to be ‘spend now, save later’. Now it’s ‘cut one’s cloth according to one’s means’. Today, the media will be full of David Cameron’s big cloth-cutting plan. But they are all at it. Globally, the great austerity drive is beginning as leaders across the world all find they are on the same page, the page that has the heading of ‘austerity’. From Germany to the IMF, this weekend saw a remarkable turnaround as fans of Keynes became converts to the sensible, common sense, great cost-cutting drive.
It has got disaster written all over it.
In Germany, Angela Merkel has begun a two-day series of meetings with the great and good of her country, planning the great German cost-cutting drive. With a fiscal deficit of around 86 billion euros likely for this year, Germany wants to knock 10bn euros a year off spending. “We can only spend what we take in,” said Ms Merkel.
At the IMF, its top man, Dominique Strauss-Kahn, seems to have had a road to Damascus conversion, and has gone from being a great advocate of Keynesian spending to being a spokesman for austerity. “I am not the champion of fiscal stimulus but the champion of right fiscal policy,” he said.
An official IMF communiqué published this weekend said: “Those countries with serious fiscal challenges need to accelerate the pace of consolidation.”
Back in Blighty, David Cameron is expected to say today: “The decisions we make will affect every single person in our country. And the effects of those decisions will stay with us for years. It is precisely because these decisions are so momentous … I want to make sure we go about the urgent task of cutting our deficit in a way that is open, responsible and fair.”
The Telegraph quoted someone from deep inside the Treasury as saying: “For 13 years spending reviews have suffered from the assumption that central government always knows best. The result has been falling public sector productivity and waste on an industrial scale. Anyone who thinks the spending review is just about saving money is missing the point. This is a once-in-a-generation opportunity to transform the way that government works.”
The model for the UK’s cuts is based on the Canadian cost-cutting drive of the 1990s. Canada emerged from its austerity as just about the most healthy of the G7 economies during the recession.
Why this sudden and worldwide change? This weekend was another of those G20
meetings, this one held in South Korea.
But politicians who say it is they who are leading the quantum shift in economic policies are kidding themselves. The pace setters are the markets. They dived on fears over a Greek contagion spreading to Spain and the rest. Then at the end of last week, Hungary got the markets spooked. Last week, Lajos Kosa, vice president of Hungary’s ruling Fidesz party, which recently won the country’s election, said the chances of Hungary avoiding a Greek-style crisis are “very slim”. See Hungary heading Greek way, Eurozone banks heading back to 2008 .
On Friday the Dow fell 323 points, falling to 9,931.97, its second lowest reading this year. (Lowest 9,908.39 – 8 February.)
It is all a little odd, because while markets panic and fears of global sovereign default mount, markets decide the only safe place for their money is bonds relating to countries in massive debt. The yield on 10-year government bonds in the US, Germany and UK has fallen rapidly over the last few weeks. Back on 10 May, the yield on UK 10-year government bonds was 3.92 per cent. Last night it was 3.51 per cent.
But it isn’t really odd at all. The only oddity is that few people are pointing this out. In times of trouble, markets rush for safety. The irony of the sovereign debt crisis is that it was in part caused because markets were so spooked by sub-prime debt that all they wanted to do was to lend to governments. This caused a recession, which in turn made it necessary for governments to borrow.
This is why this column would say it is misleading to say the world has a debt crisis. For every debtor, there is a creditor. What the world faces is a distribution of the ‘fruits of capitalism’ crisis. The problem is not merely that some countries are in debt. It is that some parts of the world have saved, and relied on indebted consumers from other regions to buy their goods.
According to research from Roubini Economics, the Great Depression became much deeper because the government of that time pandered to demands from the media and the electorate to start applying common-sense policies. So they held back on spending, encouraged saving, and tried to foster a spirit of thrift. But the common-sense policies were wrong. The Second World War followed. That is not to say the Depression caused the last world war, or that the ignorance of the electorate caused the Great Depression, but matters were not helped.
The Canadian fiscal austerity drive of the 1990s worked, but then Canada applied these policies while the rest of the world spent. By cutting back while others spent, Canada was effectively able to freewheel on others.
Professors Reinhart and Rogoff have drawn praise for their book, “This Time it is Different”, which covers what the authors call eight centuries of financial folly. Their argument is that financial crises nearly always follow a build up of debt. This time, they argue, it never is different.
And yet Reinhart and Rogoff may not be entirely correct. It is possible their study is a victim of the confirmation bias.
To explain, consider this sequence of numbers: 2, 4, 6 8. What number comes next? Did you say 10? If you are right, what is the sequence? If you say that each number is two greater than the one before, you are wrong. In fact, the rule here is that every number in the series must be greater than the one before, If instead of saying ‘10’ you had said ‘9’, you would still have been right. The confirmation bias meant you only tested your hypothesis by using numbers you thought were correct. Had you tried to disprove your hypothesis you would have discovered it was wrong.
It is true to say that every debt crisis follows a period in which debt levels had risen. Well, ‘duh,’ what would you expect?
But not every period which has seen debts mount was followed promptly by a debt crisis. Or indeed, inflation. After the Second World War the UK’s fiscal debt hit 250 per cent of GDP, but a 25-year golden period followed, without a hint of inflation. Japan’s period of deflation has gone hand in hand with a mounting fiscal deficit, which has now hit terrifying proportions.
Keynesians argue that the massive government borrowing that occurred during the Second World War caused the end of the Great Depression, and proved that fiscal expansion can work.
This column is not a fan of the public sector, and 100 per cent signs up to the view that the private sector is usually far more efficient. A fiscal austerity drive in the UK could work, providing sterling remains cheap and the export led recovery in manufacturing continues. In this way, people who lose their jobs thanks to government cuts can be re-employed in more productive sectors.
But when the fiscal cutting drive is global, and when there is pressure on currencies to move down across all our major trading regions, then things could go horribly wrong.
Right now, the global economy faces a new crisis. This is a crisis that could be years in the making and decades in the unwinding. There is a very real danger that public and market, and now government, overreaction to the previous crisis will create a new one that is far, far worse. Common-sense policies work when carried out by individuals, but when we all carry out cost cutting in times of hardship, the times of hardship become far worse.
You have no doubt read that there is a growing rift between France and Germany. France is saying Germany must do more and spend more. In Germany, such a response is seen as an anathema. Relations between Ms Merkel and Mr Sarkozy are at an all-time low. She has resisted French plans as much as she was able, and huge resentment in France has built up as a result. But in Germany, her electorate are hugely resentful of the way she has apparently caved in to French demands.
But the truth is, Germans must spend more. Germany’s pre credit crunch economic recovery was paid for through other countries’ debt. Germany is the world’s second largest exporter. Exports are everything to German economic success. But if Germany maintains current account surpluses, the rest of the world, by definition, must have deficits.
Within the EU, France has won the round, as the EU agrees to fund its indebted members. But globally, the victor is the German model, as cost cutting and ‘living within our means’ becomes the new mantra.
As a result, the world is now teetering on the brink of depression.
See also The great imponderable
