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Is austerity the right policy to implement in a debt-laden economy?
In Europe, Germany holds the wallet and Finance Minister Wolfgang Schäuble believes the only way to grow is to continue to rein in budget deficits and pay down debt via spending cuts and tax increases.
The public’s response was a May Day filled with demonstrators protesting austerity policies in countries across the continent, turning up the heat on politicians dealing with contracting economies. The Dutch and Romanian governments already have failed and, in France, President Nicolas Sarkozy may lose the May 6 election.
Countries are walking a tightrope trying to address their debt problems: Slash too much and the result is economic contraction, but cut too little and markets penalize with rising interest rates. A delicate balance between austerity and growth policies is needed and the formula is different for each country.
Europe is like a modern-day reality show for what happens when the end of the debt line is reached. While the travails of Greece have temporarily been dealt with, all eyes are now on Spain and Italy to see if their teetering economies can handle austerity measures.
The UK, while not a European Union member, nevertheless has chosen an austere path and its economy has re-entered recession. While the UK deficit is expected to fall below 8 percent next year—down from over 11 percent in 2010—the Labour Party has argued that officials cut spending too much and too fast. Britain’s Treasury chief George Osborne relented by lowering taxes on high earners (from 50 percent to 45 percent on income over $238,000) and corporations (from 26 percent to 24 percent) in an attempt to spur growth.
Meanwhile, in the United States, the highly criticized Federal Reserve is pursuing a low interest rate policy accompanied by monetary stimulus called “quantitative easing” to keep our economy from falling back into recession. So far, the U.S. government still has not agreed on a plan to attack its debt problems.
Erskine Bowles, of the Simpson-Bowles Commission, was interviewed last week at the Council on Foreign Relations. Bowles delivered the bad news: 100 percent of the tax revenue that came into the Treasury in 2011 went out the door to pay for mandatory spending—Medicare, Medicaid, Social Security and interest on our staggering $15.6 trillion national debt.
That means every single dollar we spent on anything else—national defense, education, infrastructure, and the like—was borrowed. Mercifully, interest rates are low, for if they were at more normal levels, the annual interest cost on the U.S. debt would rise $350 billion.
Actually, much of the Simpson-Bowles plan is now being crafted into legislative language. Bowles believes our government will need to act quickly to implement a rational plan in the short window after the election. Otherwise, at year-end, the Bush tax cuts and the payroll tax cuts expire, and the $1.1 trillion cuts forced by the failed supercommittee kick in.
The global austerity push is much like the chicken-and-the-egg problem. Countries need to reduce debt by cutting costs and raising revenue, but those actions dampen growth. And growth is the elixir that provides the financial resources to repay debt and boost standards of living.
The unenviable task is striking that balance between growth and austerity.•
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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebaran.com.
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