Austerity isn’t Dead, it will Come Back with a Vengeance

Jonathan Rochford
Jonathan Rochford Narrow Road Capital

There’s been a steady stream of recent articles claiming that austerity is dead. This one from James McCormack at Fitch argues that populist politicians are responsible for killing off pragmatic economic policy. Whilst I don’t deny the medium term tide is against austerity, the very high levels of sovereign debt mean austerity will return. To understand why this must happen we need to deal with the three key fallacies that austerity opponents are propagating.

First, austerity is wrongly blamed for reducing economic growth. This is such a deceitful lie as it seems so logical and seems to be backed up by examples like Greece. However, the deception here is the false starting point used to measure the “reduction” in growth once austerity is implemented. Countries facing austerity have used debt financed government spending to inflate their GDP, in the same way Lance Armstrong used performing enhancing drugs to inflate his cycling abilities. No one questions that Armstrong was better as a result of using drugs. Yet it is hard for many to acknowledge that GDP is similarly inflated when governments spend excessively. Greece and many others cheated their way to inflated GDP levels and measuring against that is clearly spurious.

Second, there is the avoidance of the reality that increasing debt drags down future economic growth. Anyone that has personal debt understands that those repayments reduce their ability to spend until the debt is cleared. Yet when it comes to government debt, many cite “animal spirits” as the magic that will allow governments to grow into their debts. Even with low interest rates, which also ultimately undermine economic growth, the debt is still there and spending must eventually be reduced to cover the higher repayments. It is true that government investment in a small number of areas can promote long term growth but this isn’t where the vast majority of government spending is going.

Third, many are propagating the view that printing money isn’t the bogeyman it has been made out to be. Nothing bad has happened to Japan, Europe and the US so why worry? This argument conveniently ignores centuries of human history of money printing, including recent examples in Argentina, Venezuela and Zimbabwe. There’s no magic at play, it’s just a matter of time before investors flee dodgy currencies. They will flood to the safety of hard assets and to countries with responsible monetary and fiscal policies.

Austerity isn’t in favour and it could be a while yet before the consequences play out. The “magic” of false measurements, animal spirits and money printing are used to convince the gullible that there is an easy way out. Governments with loose fiscal and monetary policies can get away with it for a while, but in the long term they will exhaust their credibility with investors and lose control over their spending levels. At the exact time when standard economics would advocate governments running a deficit, these governments will be cut off from borrowing more. Austerity isn’t dead, it is just taking a break before it comes back with a vengeance.

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