Portugal’s President Anibal Cavaco Silva warns about the great threat his country faces; the spending cuts and tax increases imposed by Portugal’s rescuers.
He warns that the austerity conditions tied to Portugal’s bailout are leading to a “recessionary spiral” that is “socially unsustainable”[1].
Cavaco Silva’s attack on austerity policies that have led to unemployment of 16% in Portugal is almost uncontroversial these days in terms of economic thinking. It’s clear to most that removing government stimulus from a weak economy undermines economic growth and, consequently, further fouls government finances.
Eurostat data shows how deep reductions in spending and sharp increases in taxes in Greece, Ireland, Portugal and the UK have shrunk their economies to such an extent that government finances are in worse shape. [2]
Even the IMF, a long-term fan of austerity for wobbly developing countries, has recanted. It now concedes that a dollar taken out of a troubled economy in recent years shrank that economy by more than one dollar. In economic jargon, the fiscal multiplier was greater than one, whereas proponents of austerity assumed the number would be about around 0.5. [3]
The worry for investors is that the US is imposing austerity. Politicians there are removing government stimulus from the economy in steps as they clash over Washington’s finances. Looming fights this year over the fiscal deficit, government debt, financing the government (a temporary measure allowing this expires on March 27) and the debt ceiling will no doubt heighten political anxiety and reduce business and consumer confidence in the US economy, which shrank at an annual pace of 0.1% in the fourth quarter.
There’s no question Washington’s finances need fixing. The US federal government is running a fiscal deficit equal to about 8% of GDP. Government debt has doubled to 73% of GDP in the past six years and is set to soar due largely to spending on health. Ideally, what the country needs is a plan to trim the debt-to-GDP ratio towards 60% over the next decade.
This proposal would entail phased spending cuts and higher taxes, timed so as not to sink the economy, while allowing for investment in infrastructure and education. No such plan is likely to emerge from the clashes timed around the latest artificial deadlines US politicians have imposed on themselves.
Sequester verdict
The best slant that can be cast on the deal over the so-called fiscal cliff that Congress passed on January 1 was that the expiring 112th Congress avoided the 3% to 4% hit to the US economy the associated spending cuts and tax hikes would have delivered over 2013.
But the decisions to boost income taxes on the richest 1% of taxpayers, raise the capital-gains tax, let the payroll tax reductions expire and allow cuts in discretionary and military spending will still trim government stimulus over 2013 by about 1% to 1.5% of GDP.
The US austerity hit will more or less match the self-imposed austerity blows on the UK in 2011 and 2012 that have sent its economy stumbling towards its third recession in four years. But the US austerity jolt won’t be as savage as the punches received by Greece, Ireland and Portugal. [4]
Not yet anyway. One unfortunate aspect to the fiscal-cliff negotiations was that a decision on one of the threats to short-term economic growth was postponed. The fate of the “sequester” involving US$1.2 trillion in automatic cuts over the next decade or so to military and domestic discretionary spending must be sorted out by the end of February.
The sequester came about when the Republicans insisted on spending cuts to match the increase in the federal government’s debt limit they allowed in 2011. They were designed to be draconian enough to prompt lawmakers to negotiate gentler ways to reduce government spending, as in it was never the intention they take effect.
But Republican resolve to let these spending reductions come to pass is hardening, especially since they backed down in January during the negotiations to raise the debt ceiling again. They agreed to suspend the debt limit for three months until May. Their retreat came with a requirement that Congress pass a budget by then so that both chambers of Congress can focus on lowering fiscal deficits over the long term.
Such negotiations promise to be fraught as Tea-Party Republicans appear intent on securing sweeping (but largely unspecified) spending cuts and have forced their party leadership into declaring Republicans won’t sanction any more tax increases. The Democrats appear determined to protect welfare spending, even though its ballooning cost in coming years is one of the biggest threats to sound government finances.
The most likely short-term outcome of the row over government finances is that the spending cuts tied to the sequester become law on March 1 – for it would take a new law, thus compromises by both sides, to prevent this happening. That would mean another US$100 billion of government stimulus disappears from the economy each year over the next decade or so, an estimated hit of about 0.5% to GDP in 2013. Obama, sensing the danger of another austerity hit, in early February proposed that Congress pass a US$85 billion package of spending cuts and tax changes to offset the damage the sequester would have for the rest of 2013.
Politician-proof
Austerity can be a sound government response to prevailing economic conditions. Classic Keynesian economics would tell a government to run fiscal surpluses when the economy is humming to keep inflation under control. Austerity is just not optimal policy-making when a country’s export partners are in recession, an economy is recovering from a financial crisis, confidence is fragile and unemployment high. (The composition of austerity matters, too. Policies that hit the richer harder than the poor are less damaging that ones that do the opposite.)
How will the US economy handle austerity in coming years? It’s instructive to note that federal government spending supported the US economy from 2009 to 2012, at a time when many state and local governments were forced by law to slash spending and raise taxes to balance budgets.
Over the same period, the Federal Reserve set interest rates at zero and used unconventional means such as quantitative easing to ensure maximum thrust from monetary policy. The result of these efforts was that after the US economy contracted 3.5% in 2009, it expanded 3% in 2010, 1.6% in 2011 and is expected to have grown 1.3% in 2012. [5]
These numbers suggest the US recovery is sluggish and that it will have trouble coping with austerity shaving 1%-plus off GDP growth.
The US economy, though, may be more resilient than recent numbers suggest. The US government’s overspending is supporting growth, easy monetary policy is virtually assured in coming years and bright spots are emerging across the economy. The most sparkle is coming from housing due to low interest rates – thanks especially to the Federal Reserve’s purchases of mortgage-backed securities as part of its quantitative-easing program.
House prices nationwide rose for the fifth consecutive month in December from a year earlier, while housing starts and new home sales are rising while the number of foreclosures is dropping. Banks are lending more to home buyers, giving builders more confidence to invest in new homes – residential investment surged at an annual pace of 15.3% in the fourth quarter. Home building, which historically has accounted for about 4.5% of US GDP, is expected to make a substantial contribution to economic growth in 2013, an impact that will be magnified because a robust housing market gives home-related industries a boost.
More good news is that big-data technology, cheaper energy from fracking shale and wage restraint have made US manufacturing more competitive. Companies such as Apple and General Electric are shifting production home. A better trade performance due to reduced oil imports thanks to fracking and the weaker US dollar helping exports is expected to add to GDP, even if exports struggled in the fourth quarter.
If consumer and business confidence and jobs growth survive the political dramas, domestic demand is likely to hold up – consumption rose at a 2.2% pace in the fourth quarter while business investment set a 12.4% tempo. The extra 1.84 million people employed in the US over 2012 will add to overall demand. Don’t underestimate how much pent-up demand there is in the US after five sluggish years of growth – the release of pent-up demand is capitalism’s way of triggering self-sustaining recoveries. (There’re only so many years old cars and fridges can keep going.)
Add on the US’ long-term economic advantages – the ability of its citizens to innovate, the country’s large natural resources and mobile population – and the US recovery is more likely than not to withstand the challenges thrown at it by politicians. US stocks at five-year highs suggest investors think this way too.
Perhaps the best perspective to view the antics in Washington is to realise that whether or not the US escapes a recession this year is a sideshow in terms of the biggest risks investors face in 2013. As the US-based Stratfor Global Intelligence says, high unemployment and social discontent in the US will not lead to the disintegration of the republic into 50 countries with their own currencies. [6] Whereas, the damage austerity is wreaking in countries such as Portugal could do just that to the eurozone.
Financial information comes from Bloomberg unless stated otherwise.
Important information
References to specific securities should not be taken as recommendations.
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The US is imposing austerity
Portugal’s President Anibal Cavaco Silva warns about the great threat his country faces; the spending cuts and tax increases imposed by Portugal’s rescuers.
He warns that the austerity conditions tied to Portugal’s bailout are leading to a “recessionary spiral” that is “socially unsustainable”[1].
Cavaco Silva’s attack on austerity policies that have led to unemployment of 16% in Portugal is almost uncontroversial these days in terms of economic thinking. It’s clear to most that removing government stimulus from a weak economy undermines economic growth and, consequently, further fouls government finances.
Eurostat data shows how deep reductions in spending and sharp increases in taxes in Greece, Ireland, Portugal and the UK have shrunk their economies to such an extent that government finances are in worse shape. [2]
Even the IMF, a long-term fan of austerity for wobbly developing countries, has recanted. It now concedes that a dollar taken out of a troubled economy in recent years shrank that economy by more than one dollar. In economic jargon, the fiscal multiplier was greater than one, whereas proponents of austerity assumed the number would be about around 0.5. [3]
The worry for investors is that the US is imposing austerity. Politicians there are removing government stimulus from the economy in steps as they clash over Washington’s finances. Looming fights this year over the fiscal deficit, government debt, financing the government (a temporary measure allowing this expires on March 27) and the debt ceiling will no doubt heighten political anxiety and reduce business and consumer confidence in the US economy, which shrank at an annual pace of 0.1% in the fourth quarter.
There’s no question Washington’s finances need fixing. The US federal government is running a fiscal deficit equal to about 8% of GDP. Government debt has doubled to 73% of GDP in the past six years and is set to soar due largely to spending on health. Ideally, what the country needs is a plan to trim the debt-to-GDP ratio towards 60% over the next decade.
This proposal would entail phased spending cuts and higher taxes, timed so as not to sink the economy, while allowing for investment in infrastructure and education. No such plan is likely to emerge from the clashes timed around the latest artificial deadlines US politicians have imposed on themselves.
Sequester verdict
The best slant that can be cast on the deal over the so-called fiscal cliff that Congress passed on January 1 was that the expiring 112th Congress avoided the 3% to 4% hit to the US economy the associated spending cuts and tax hikes would have delivered over 2013.
But the decisions to boost income taxes on the richest 1% of taxpayers, raise the capital-gains tax, let the payroll tax reductions expire and allow cuts in discretionary and military spending will still trim government stimulus over 2013 by about 1% to 1.5% of GDP.
The US austerity hit will more or less match the self-imposed austerity blows on the UK in 2011 and 2012 that have sent its economy stumbling towards its third recession in four years. But the US austerity jolt won’t be as savage as the punches received by Greece, Ireland and Portugal. [4]
Not yet anyway. One unfortunate aspect to the fiscal-cliff negotiations was that a decision on one of the threats to short-term economic growth was postponed. The fate of the “sequester” involving US$1.2 trillion in automatic cuts over the next decade or so to military and domestic discretionary spending must be sorted out by the end of February.
The sequester came about when the Republicans insisted on spending cuts to match the increase in the federal government’s debt limit they allowed in 2011. They were designed to be draconian enough to prompt lawmakers to negotiate gentler ways to reduce government spending, as in it was never the intention they take effect.
But Republican resolve to let these spending reductions come to pass is hardening, especially since they backed down in January during the negotiations to raise the debt ceiling again. They agreed to suspend the debt limit for three months until May. Their retreat came with a requirement that Congress pass a budget by then so that both chambers of Congress can focus on lowering fiscal deficits over the long term.
Such negotiations promise to be fraught as Tea-Party Republicans appear intent on securing sweeping (but largely unspecified) spending cuts and have forced their party leadership into declaring Republicans won’t sanction any more tax increases. The Democrats appear determined to protect welfare spending, even though its ballooning cost in coming years is one of the biggest threats to sound government finances.
The most likely short-term outcome of the row over government finances is that the spending cuts tied to the sequester become law on March 1 – for it would take a new law, thus compromises by both sides, to prevent this happening. That would mean another US$100 billion of government stimulus disappears from the economy each year over the next decade or so, an estimated hit of about 0.5% to GDP in 2013. Obama, sensing the danger of another austerity hit, in early February proposed that Congress pass a US$85 billion package of spending cuts and tax changes to offset the damage the sequester would have for the rest of 2013.
Politician-proof
Austerity can be a sound government response to prevailing economic conditions. Classic Keynesian economics would tell a government to run fiscal surpluses when the economy is humming to keep inflation under control. Austerity is just not optimal policy-making when a country’s export partners are in recession, an economy is recovering from a financial crisis, confidence is fragile and unemployment high. (The composition of austerity matters, too. Policies that hit the richer harder than the poor are less damaging that ones that do the opposite.)
How will the US economy handle austerity in coming years? It’s instructive to note that federal government spending supported the US economy from 2009 to 2012, at a time when many state and local governments were forced by law to slash spending and raise taxes to balance budgets.
Over the same period, the Federal Reserve set interest rates at zero and used unconventional means such as quantitative easing to ensure maximum thrust from monetary policy. The result of these efforts was that after the US economy contracted 3.5% in 2009, it expanded 3% in 2010, 1.6% in 2011 and is expected to have grown 1.3% in 2012. [5]
These numbers suggest the US recovery is sluggish and that it will have trouble coping with austerity shaving 1%-plus off GDP growth.
The US economy, though, may be more resilient than recent numbers suggest. The US government’s overspending is supporting growth, easy monetary policy is virtually assured in coming years and bright spots are emerging across the economy. The most sparkle is coming from housing due to low interest rates – thanks especially to the Federal Reserve’s purchases of mortgage-backed securities as part of its quantitative-easing program.
House prices nationwide rose for the fifth consecutive month in December from a year earlier, while housing starts and new home sales are rising while the number of foreclosures is dropping. Banks are lending more to home buyers, giving builders more confidence to invest in new homes – residential investment surged at an annual pace of 15.3% in the fourth quarter. Home building, which historically has accounted for about 4.5% of US GDP, is expected to make a substantial contribution to economic growth in 2013, an impact that will be magnified because a robust housing market gives home-related industries a boost.
More good news is that big-data technology, cheaper energy from fracking shale and wage restraint have made US manufacturing more competitive. Companies such as Apple and General Electric are shifting production home. A better trade performance due to reduced oil imports thanks to fracking and the weaker US dollar helping exports is expected to add to GDP, even if exports struggled in the fourth quarter.
If consumer and business confidence and jobs growth survive the political dramas, domestic demand is likely to hold up – consumption rose at a 2.2% pace in the fourth quarter while business investment set a 12.4% tempo. The extra 1.84 million people employed in the US over 2012 will add to overall demand. Don’t underestimate how much pent-up demand there is in the US after five sluggish years of growth – the release of pent-up demand is capitalism’s way of triggering self-sustaining recoveries. (There’re only so many years old cars and fridges can keep going.)
Add on the US’ long-term economic advantages – the ability of its citizens to innovate, the country’s large natural resources and mobile population – and the US recovery is more likely than not to withstand the challenges thrown at it by politicians. US stocks at five-year highs suggest investors think this way too.
Perhaps the best perspective to view the antics in Washington is to realise that whether or not the US escapes a recession this year is a sideshow in terms of the biggest risks investors face in 2013. As the US-based Stratfor Global Intelligence says, high unemployment and social discontent in the US will not lead to the disintegration of the republic into 50 countries with their own currencies. [6] Whereas, the damage austerity is wreaking in countries such as Portugal could do just that to the eurozone.
Financial information comes from Bloomberg unless stated otherwise.
Important information
References to specific securities should not be taken as recommendations.
1 The Telegraph. “Portugal warns EU-IMF troika to back off on austerity demands.”
2 Eurostat new release. “Euro indicators. Provision of deficit and debt data for 2011 – second notification.” 22 October 2012. http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-22102012-AP/EN/2-22102012-AP-EN.PDF
3 IMF Working Paper. “Growth forecast errors and fiscal multipliers”. Olivier Blanchard and Daniel Leigh. January 2013. http://www.imf.org/external/pubs/ft/wp/2013/wp1301.pdf
4 European Trade Union Institute. Working papers. “Withdrawal symptoms: an assessment of the austerity packages in Europe. 2011. Table 2, page 14. http://www.etui.org/Publications2/Working-Papers/Withdrawal-symptoms-an-assessment-of-the-austerity-packages-in-Europe
5 IMF. World Economic Outlook. October 2012. Table A1. http://www.imf.org/external/pubs/ft/weo/2012/02/pdf/tables.pdf
6 Stratfor Global Intelligence. “Europe in 2013: a year of decision.” 3 January 2013. http://www.stratfor.com/weekly/europe-2013-year-decision?utm_source=freelist-f&utm_medium=email&utm_campaign=20130103&utm_term=gweekly&utm_content=readmore&elq=f8595d076faa43899a87ff356f78fec
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