More Austerity or More Stimulus? – Chaos and Confusion Ahead

***Please feel free to leave comments or ask questions at the bottom of the article. We will reply or will write a special article to answer your questions.***


How to fix the economic malaise that is gripping most of Europe and North America?

One school of thought says that it has been an excess of government spending and entitlement programs that has caused the problem and we need to cut spending (austerity).  Another school of thought says that more spending by government will create growth and more jobs for a better future (stimulus).  Both of these schools of thoughts advance multiple arguments about why they are right.

Protesters in Montreal in April 2012.  Note the green and black flag
which identifies this group as anarcho-primivitists.
Photo by the author.

 

Here is another thought.  Maybe the debt driven financial system we have in the advanced economy democracies is so broken that neither of these approaches can have a positive effect.  What we need – or will get anyway – is a major financial reset that will be devastating.    

The Austerity School of Thought

This group includes major countries such as the UK. The British Chancellor of the Exchequer George Osborne is advocating cuts in spending and reductions in government programs. In short, Mr. Osborne believes (hopes?) that this policy will see less money going into the non-productive government sector and more money finding its way into the productive private sector.  Additionally, the government will not have to borrow as much money for next year’s budget, which in turn means lower debt payments and more money available for non-debt related spending.

The Stimulus School of Thought

Over on the other side, we find the new President of France with the somewhat confusing last name:  Francois Hollande.  He is a follower of the stimulus school of thought which suggests governments must spend in dire economic times and support failing industries though tax payer support or nationalization.  He and his supporters believe that the stimulus to the economy will create more employment which in turn means more tax dollars to be collected. In the medium to long term, this school of thought thinks that the growth created will more than outweigh the new debts (and costs) being created by borrowing more.   

What if Both are Wrong?

It is possible that neither school of thought is valid and both will fail. The problem may be that most of the advanced economy countries are so far in debt that there can be no turnaround. 

Increased austerity may only create greater economic misery and the savings from less debt will not be sufficient to allow the economy to take off again. As such, increased austerity means a shrinking economy with more unemployment and greater social welfare costs which means greater debts which means less government money which means more unemployment which means – well – you get the point.   It is a death spiral.  This problem was highlighted by a recent IMF report which suggests that austerity cuts do not have the positive impact hoped for.

Increased stimulus means greater debt, which means next year’s budget will have to support more interest payments on the debt which means that you will have higher debt payments which means you will have to borrow even more money which means even higher debt payments which means......another debt induced death spiral.   

Conclusion? 

If governments involved had only modest debt levels, then either approach might be reasonable based on the unique circumstances of individual countries.

However, with most national governments in Europe and North America having been on debt fueled spending binges dating back to the 1980s or 1990s, they are so far in debt that they are in a death spiral in either case.   (Hello to Norway, one of the notable exceptions which is cash rich due to oil resources and good long term planning!)

The solution – or at least the result -  will be a major system reset which will involve massive cuts in government spending or a number of governments defaulting on national debts – at least to foreign donors.  (Hello Argentina in 2002, Zimbabwe in 2006 or Brazil in 2000.)  This means at least another lost decade, especially for the youth group of 16-29.

This is economics for the rest of us – with chaos and confusion ahead as debt levels continue to soar and no workable solution in sight.

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 Annex on Debt

Some of the debt levels are so massive that they are literally not comprehensible to the average person. For instance: 

USA – 16 trillion dollars of debt or close to 100,000 dollars for every working American. This does not include unfunded liabilities such as entitlement programs which may equate to considerably more than the stated national debt.  It also does not include state and municipal debts (Hello Detroit!)

UK - £1,111.4 billion at the end of December 2012, equivalent to 70.7 % of GDP (Yup – that is more than a trillion pounds). This is only debt to the private sector and does not include unfunded liabilities. Even with low interest rates, this means the UK government will have to spend at least 47 billion pounds on debt payments next year.  Imagine what could be done with 47 billion pounds if it was not going to the money lenders.

Italy – somewhere north of 2 trillion (with a T) Euros and rising with a shrinking economy. 

Spain – close to 900 billion Euros and rising fast despite having ransacked the national social security savings pool last year.