Austerity vs. Stimulus, May 2013

There has been a significant development in the “Austerity” vs. “Stimulus” debates.  If you missed it, let me refresh the picture a little, because this may be one of the more important turning points since the recovery began in March of 2009.  As the U.S. and global markets were spinning out of control in the fall of 2008, the U.S. government initiated a series of corporate bail-outs and stimulus programs designed to support our economy until it could recover on it’s own.  Most economists agree that despite various errors along the way, these strategies probably kept our economy from going over the proverbial cliff.  Since then, a debate has raged as to whether or not these stimulus programs should be continued. The “stimulus” advocates have been led by Paul Krugman, a Nobel award economist who has argued that austerity measures in a contracting economy will significantly impede growth, and that continued government  stimulus programs  are crucial for a long term recovery.  In contrast, the “austerity” advocates want to terminate the stimulus programs and reduce the deficit.  They maintain that if the deficit is brought under control, then confidence will return and our economy will strengthen and recover on its own.  The austerity theory was anchored by a Harvard study showing that a 90% debt to GDP ratio (Gross Domestic Product: the sum of all goods and services produced in the U.S.)  will seriously inhibit  a nation’s economic  growth.  As the 90% ratio is passed, a nation’s bonds will then carry substantially greater risk, leading to increased interest payments, runaway inflation, and eventually economic decline.  With the U.S debt to GDP ratio closing in on the 90% mark,  there has been increasing  alarm from the austerity camp.  Krugman, however, has argued that the 90% ratio is far too low,  and that there is a wide margin for continued stimulus.  Please, no political statements here; I believe there is merit to both arguments. The austerity vs. stimulus debates were not limited to the U.S.  In the European Union, Germany has been a staunch advocate for austerity programs, and forced these measures upon the more economically vulnerable countries in the European Union.  “Common sense” seemed to agree with the austerity position,  but the deepening recession in Europe suggested that stimulus programs might be the better solution, as evidenced by our own recovering economy.  Then along came the developments of last week.  A new study exposed several fundamental mathematical errors in the Harvard paper, and the 90% Debt to GDP has become virtually irrelevant, validating Krugman’s argument for a much greater Debt ratio before warning lights flash.  So what does this mean for the future, and how will it affect our investments? My personal opinion is that the wealthy nations will begin to replace their austerity programs with stimulus spending based upon the U.S.  model.  The global economies and markets may recover more quickly, thus creating a growing sense of stability and confidence.  Hopefully, small business will begin to seek additional capital for expansion, lowering the unemployment rate, and increasing the overall tax revenues.   This may be a reasonable assessment for the next three to five years, and if so, then we should look forward to continued growth in our portfolios. But the caveat is whether the politicians are capable of controlling the budgets once the global recovery has taken hold.                         Unless the U.S. and the other wealthy nations begin to confront the entitlement programs that now consume such staggering percentages of the respective national budgets, the next Debt to GDP ratio could be a brick wall.  As frightening as those consequences may be, I am hopeful that our leaders will gravitate towards a culture of more reasoned debate and long term fiscal responsibility.  At the risk of being overly optimistic, I am confident that we are at the beginning of a new growth cycle, and that the more positive aspects of globalization are still ahead of us.  Let’s continue to adjust our portfolios accordingly, taking advantage of the varied growth opportunities, stepping back into Emerging Markets when the evidence suggests it will be to our advantage, and continually looking over our shoulders for signs of economic danger.  Please do not forget the StoneRidge mantra, “Protection First, Growth Second.”                                                     Van Mason, CFP™, CLU, MBA