A very interesting video by an Irish economist explaining how the current reduce government spending (“austerity”) approach to the Eurozone debt and currency crisis is doomed to fail. It is doomed because cutting government spending in a recession only makes the recession worse, which in turn, reduces tax collections which then makes the government deficits worse not better. But not only is the austerity approach all wrong to solving the debt crisis, it carries very significant risk of social upheaval. (hat tip to Philip Pilkington and New Economic Perspectives).
Now I’ll offer one pre-emptive comment. Critics of the arguments McWilliams makes often claim that either government spending isn’t really effective, that somehow only private investment spending will stimulate an economy. Or, the critics claim that any resources the government puts into use through spending actually detract from the economy by denying those resources to some supposedly better, privately chosen use. Both of these criticism fail. We are clearly discussing a situation in which there are excess, unused economic resources in the economy. In plain language: there’s high unemployment and people are out of work. The criticisms are all based on an idea called “crowding out”. For crowding out to occur, the economy must be at full employment – the opposite of being in a recession.
It’s now Monday morning, Aug 8. It’s been roughly 60 hours since S&P downgraded the rating on U.S. government bonds. In that 60 hours the media, particularly TV talking head channels, have been breathlessly awaiting what they felt was a certain market panic on Monday. Clearly interest rates would go up they said.
They were wrong. The early results are in. U.S. government bond prices have gone up this morning! That means government bond yields (interest rates) have actually gone down! The 10 year bond actually dropped from 2.6% yield on Friday’s close to 2.48% at 9:30 am ET on Monday.
It’s really no surprise if you pay attention to real economic events and not listen to the TV media types who think talking in serious tones is a substitute for actually understanding economics. First, serious investors, the ones who vote with their money in the market already know everything that S&P knows. In fact, they know S&P has a really bad track record. So the rating doesn’t mean much to them.
What does matter is what choices or alternatives they have for investing their money. Right now, the signs from the real economy in both the U.S. and Europe are grim. Europe is struggling to achieve any growth outside Germany with several major economies actually declining due to their governments’ embrace of budgetary austerity. The U.K. is on the ragged edge of another recession, again due to government cutbacks. The U.S. is barely registering postive growth with only 0.8% growth rate in the first half of 2011. It’s clear, too, from the debt ceiling debate that the U.S. won’t be seeing much stimulus anytime soon and likely will join the Europeans in austerity budget cutting. Cutting that will only slow the economy further and possibly drive another recession. So what theses investors know is that economic growth isn’t likely and that’s bad for stocks. Stock markets aren’t the place to be now.
Further, Europe is continuing it’s slow-motion debt default crisis issues. In the past week or so the crisis has spread beyond Greece, Ireland, and Portugal. Now it’s Italy and Spain too. Even AAA-rated France is finding it’s bonds trading at significantly raised interest rates. Now the debt crises in Europe are real problems because the nations inside the Euro zone don’t have control over their own currency, they don’t have a central bank, and they borrow in some other currency (Euro) rather than one of their own. This is unlike the U.S. The problem is the uncertainty the debt crises in Europe are creating. The global financial and economic system is once again showing great signs of weakness, fragility, and uncertainty – just like 2007 and 2008.
When uncertainty abounds and about the only sure thing is that growth will be weak at best, it’s time to put your money in something safe and wait it out. The safest thing in the world (in any volume) is still U.S. government bonds. So what we have is investors moving into U.S. government bonds because they don’t want to be in anything else. Everything else is too risky. So we get increased demand for U.S. bonds and that lowers interest rates on those bonds. This is what financial analysts and economists call a “flight to safety”.