November 8, 2012

Growth focus is mending US while austerity stalls Europe

Posted in Irish Independent · 187 comments ·
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WHOEVER has won the US election, he will be reasonably assured that he will preside over an economy that is on the mend. Last weekend I spoke to someone who knows Obama well and is a big Democratic fundraiser in California. His assessment is that Obama knows that the economy is moving in the right direction but he also knows that the next president will gain credit and this is one of the factors driving him as he would be appalled if Romney took the economic plaudits.

Whether this is a fair assessment of the president’s state of mind, it is significant that the US economy, after a few years on the ropes, is recovering. One way to look at the last four years of economic policy in the US is that a battered, bruised and very sick economy has been nursed back to health by a central bank and a government that is putting growth first and is worrying about austerity later.

To achieve this, the central bank has kept interest rates as close to zero as possible in order to ease the severe deleveraging that has gripped the US since the property/credit bubble burst in 2008/9. In tandem, where low interest rates have not worked because the people have too much debt and the banks too much bad debt, the Federal Reserve has engaged in what is called “quantitative easing”, buying up collateral from the banks and giving the banks money in return.

This has allowed banks to clean up their broken balance sheets. This process is not over and this is the reason why American interest rates are likely to remain at historically low levels for a long, long time. In addition, the US government has run a massive trillion-dollar budget deficit pump priming the economy.

Despite these efforts, the recovery in the US has been considerably weaker than previous recoveries from recession. According to a recent study by the US Council for Foreign Relations comparing this recovery with previous ones, the Council concludes that:

“The current recovery remains an outlier among postwar recoveries along several dimensions, particularly those that relate to housing. The Federal Housing Finance Agency’s house price index declined in the first quarter of the year, after rising for two consecutive quarters. Consumers remain reluctant to take on new debt and the stock of debt is lower than it was when the recovery officially began”.

This reflects the vicious deleveraging which has had to go on as people try to pay back debts and companies do likewise. Of course, because in the US mortgages are non-recourse, people can walk away from their houses without being shackled with the debt personally. This is in direct contrast to the Irish situation where one mistake in buying a house at the top of a boom will condemn you to a life of debt servitude. In the US, this is not the case as the loan goes with the property not the person.

In fact it is the housing market and the evidence that it is stabilising in recent months, despite an earlier setback, which gives most cause for optimism. Looking at the way the economy works, it is almost impossible to have a sustained recovery if there is on-going negative equity and too much debt around the neck of the average person. In the US, the debt problem is sorted by non-recourse mortgages and the fact that people move about a lot. And, as the housing market stabilises, the negative equity legacy for those still in the same properties will ease.

The central role of housing in the economy was again reiterated by William Dudley, president of the New York Fed bank, who acknowledged some improvement in housing of late, but said, last week, that “credit availability remains “impaired” and argued that, overall, the pace of the broader US economic recovery has been disappointing.

He went on to say that the housing market is “a key impediment” to economic growth in US. But as we look forward, the key drivers of the housing market, income growth, employment and demographics are moving in the right direction.

However, this process of emerging from too much leverage, swinging to too much deleveraging and back to normal recovery has to be facilitated by economic policy. This is the responsible thing to do. Deleveraging is a long, slow difficult process as we know here and as the private sector pulls in its horns, unless the government keeps demand buoyant by spending, it’s hard to see how the economy can recover.

Contrast this American approach with what is going on in Europe. As noted, the Americans are putting growth first and worrying about austerity later. The fact that interest rates and long-term interest rates are at their lowest level for decades suggests that the financial market is broadly supportive of this stance.

If, for example, the dollar was about to collapse under the weight of printed money or the US bond market was going to fall off the much discussed “fiscal cliff’, bond yields would be much, much higher.

The bond yield or the long-term interest rate is only the short-term interest rate plus a risk premium for adverse future events. Obviously the general consensus in the US is that the government and the central bank are broadly doing the right thing in nursing the economy gently back to health.

In contrast, the EU, faced with broadly similar problems of too much inherited debt and consumers who are not spending, is opting for a policy of austerity first and growth later. This is forcing the EU economy into an entirely unnecessary recession. Policy is exacerbating the slowdown and in so doing practically guaranteeing the expansion of long-term unemployment.

When seen against the pragmatic discretion deployed by US policy makers, Europe’s rigid, ideologically-driven approach encapsulated in the “fiscal compact”, must seem like an economic suicide pact. Europe has 25 million unemployed and short-term interest rates in the core are negative. If that doesn’t scream at you the need for a fiscal expansion in the eurozone, I don’t know what does! Today, as the new president in Washington contemplates the future, he can at least be reasonably satisfied that the economy will be moving slowly in the right direction for the first time in five years. Is there any European leader that can similarly look forward towards what Churchill described as the “broad sunlit uplands”? Well who’s fault is that?

David McWilliams’ new book ‘The Good Room‘ is out now from all bookshops.


  1. GeorgeOat

    Seems to me that David McWilliams equates growth with good economic management. What does he think of the following well-known quote?
    “Anyone who believes exponential growth can go on forever in a finite world is either a madman or an economist.” – attributed to economist Kenneth Boulding
    The same is true of steady growth.

  2. martin O Halloran

    It is clear America and Europe have similar issues in terms of the growing debt mountains but have undertaking two completely different courses of action. America’s stimulus policy, which appears to be effective to some degree is succeeding in keeping unemployment low and protecting the most vulnerable in society albeit not reducing their national debt.
    The pro-austerity policies being implemented in Europe and in particular Ireland are having an untold impact on Irish society, through rising unemployment and business closures through lack of demand within the domestic economy. We know that within Ireland we have no control over monetary policy and in order to become more competitive an internal devaluation needs to occur. My solution would be to have both austerity and stimulus policies promoted. Each year we have been cutting billions and billions out of the economy which is hampering any form of recovery. One solution may be to make cuts of €3.5 billion for structural reforms whereby social welfare rates, public sector pay and professional services fees are benchmarked to the European average and brought back to that level. We need to be at least as competitive as other nations if we wish to retain the Euro. The €3.5 billion should not leave the economy. Instead a plan should be developed to see what industries we can create and expand. We should be looking at what we do best, the resources we have available and how we can exploit it. The world population is expected to grow by about 80 million each year, this brings to mind three main growth areas, energy, food and technology.
    Renewable energy could be one area we could develop, creating jobs, reducing our dependence on imported fossil fuels, increasing our balance of trade and promoting our green image. Community based renewable energy projects could also be developed to promote this.
    The food energy could be expanded through policies to increase farm production seeking out new markets for Irish products. Other areas such as deep sea fishing, new innovative food products and research and development should be pursued.
    The technology aspect can be addressed through reform of our education system. If we are serious about a knowledge driven economy then we need to look as the barriers current companies such as Facebook, Linkedn, Amazon etc are having within Ireland. One such issue is the sourcing of suitable qualified employees with the necessary IT skills and a second issue is the lack of fluency in a second international language. If we were to introduce a computer programming and international language modules from primary school I think we could create a world class talent pool for future IT success stories to flourish from this Island. The current historic educational system needs to be updated to fulfil future knowledge gaps. The systems where teachers receive three months’ holiday needs to be confined to a thing of the past. Instead during this time they should be learning new skills to pass on to their students in the next academic year.
    Finally and most importantly we need to build social capital within the economy and instead of cutting jobs in the public service we need to create employment in the public sector and create the environment for jobs growth in the private sector. In reality paying social welfare rates to 450,000 people while they could be a functional member of the economy and society for a few euro more in my view makes no sense.

    P.S David, keep up the good work, I am a big fan!!!

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