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What's on the Other Side of Austerity?


And should asset managers count on central bankers repeating the mistakes of the past, or look for actual change?

European policy makers are continuing to digest the grim economic reports from the assorted countries within the eurozone, and the news is not good. Stalwarts like Germany and the UK are showing signs of reversion towards zero or negative growth, while France, Italy, and Spain face mounting unemployment. And don't forget, the smaller countries like Greece, Portugal, Ireland, and even tiny Cyprus are mired in a morass of hurt. In contrast, the US seems to be lumbering towards slow growth as a standard expectation. Asia continues to drive towards improvement with headwinds blowing; India, China, and Japan have announced expansionary activities over the past months. In the midst of this globally sanguine news, the US equity markets continue their march upward, with the US dollar even showing some pep in its step. So, what's a normal investor to make of all these contradictions? And importantly, what happens to the current stasis if Europe moves towards a true growth stance?

How can Europe drive growth?

This is a question that has been bedeviling the policy wonks in Brussels for some time. There are two factions, and the past four years have seen dominance by the austerity budget camp. The austerity proponents have garnered a strange partnership with the deeply socialist democrats. Together, these camps have aligned to impose cuts in government spending and concurrent increases in taxes on the wealthy. Add in a dash of conspiracy for offshore tax havens and global tax cheats, and you have the everyday news coming out of Europe. The mix of cut and tax isn't working, according to economic indicators such as GDP, employment, and budget deficit accounting. In response, elections have shifted power towards those espousing a "growth" platform. What does that exactly mean? Does it mean lower taxes? More spending? Increased deficits in the short term? In my humble opinion, the answer is likely to be currency devaluation, inflation, and perhaps a rally in gold prices.

My conclusion may seem abrupt, and here are the factors leading to such a brief conclusion:
  • Debt to GDP ratios throughout Europe are already high. Europe has had 20 years of deficit spending to support itself, and the world finally cried 'stop' in the sovereign debt crisis. And while the crash has been slowed by the European Union acting as a supranational issuer of debt, the trend of excessive debt, and debt service crowding out spending, has only grown. In other words, the markets won't let Europe gear up another 10 or 20% of its GDP in new debt.
  • Tax regimes can generate sensational headlines, but everyone knows that the middle class pays the most taxes. We can soak the rich, we can name and shame the rich offshore tax cheats, and we can badmouth the big rich corporations, but all these payers combined will not close the gaps in the budget deficits. Some may explain that these are the folks who provide jobs anyway, so if you press them too hard, they will simply go inside their shells and hide out for a decade or more. Rich people are patient, they can wait out political storms – that's why they maintain "tax havens."
  • Since Europe cannot issue meaningfully more debt, and it cannot tax its way to growth, there are only two other possibilities – miraculous organic growth, or inflation/devaluation/default.
Let's start with the positive scenario – "miraculous organic growth." It sounds nice, because it is nice. It is also unlikely, but should not be dismissed in its entirety. If one ascribes to the theory that economies are collections of individuals, aspirations, attitudes, and philosophies, and that these interactions make up our real economic activity, then a recession can be interpreted as a scenario where a preponderance of the individuals in the real economy have lowered aspirations and bad attitudes. They may be scared, unemployed, or feeling that the government should be taking care of them in their distress, so they become paralyzed and do not act. The result is a recession, or even a depression, and it can last for years as it takes a toll on the nation's psyche. Fortunately, as we all know, attitudes can change, and people can become happy. Better yet, social science tells us that happiness is contagious, and it can lead people to feel more confident, to invest, and to take on risk. Collectively, this happiness will make the economy stronger, and can promote growth – happiness is the opposite of depression, economically and spiritually. What can drive this kind of happiness? No one knows for sure, but here are some examples: good weather, increased birth rates, social harmony, plentiful harvests, and innovation. Sounds squishy, I know, but these are psychological drivers that can translate into growth, and they are all outside of the reach of policy makers – let's call them 'acts of God' – and hence this kind of organic growth would be indeed 'miraculous' and the corresponding virtuous growth cycle would be a welcome relief to a troubled world.
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