Politicians across the developed world are rushing to embrace the New Austerity as if it were a beloved relative just returned from a long trek in the wilderness. After depleting public coffers and borrowing heavily to keep the financial system and their own economies from collapsing, governments appear eager to put a cork on public spending before the inflation genie climbs out of the bottle and investors shun their bonds.
Even new Japanese Prime Minister Naoto Kan is talking up major fiscal reform in a country that has been waging a remarkably unsuccessful war on growth-sapping deflation for much of the past two decades. Following the lead of some of his European counterparts, Mr. Kan evoked the image of downtrodden Greece, every leader’s favourite canary in the debt mine, as well as that mysterious community of investors that is supposed to be clamouring for iron financial discipline.
“We cannot sustain public finance that overly relies on issuing bonds,” the prime minister told parliament in his maiden policy address. “As we can see from the euro-zone confusion that started in Greece, there is a risk of default if growing public debt is neglected and if trust is lost in the bond market.”
In his eagerness to join the frugality club, Mr. Kan forgot to mention that Japan is no Greece or Spain or even Britain, for that matter. It runs a healthy trade surplus (even with China), it’s a net creditor and it finances most of its massive public debt in the domestic market. What’s more, previous efforts at containing government spending have only made things worse.
An austerity plan in the face of prolonged deflation sounds a bit wonky. And some observers fear cost-slashing governments elsewhere could end up in the same boat as Japan.
The whole austerity kick is coming at the wrong time for the world economy, insists Robert Kessler, a well-placed member of the international bond world. “In a serious recession, if you don’t stimulate GDP, then you have none. Suddenly, you’re going from some [growth] to nothing, because there won’t be any stimulus out there.”
An Investor's Guide to Understanding the Economy:
|
Mr. Kessler, whose eponymous Kessler Investment Advisors of Denver devises and runs U.S. Treasury portfolios for large corporations and financial institutions around the world. has waged a long battle against the inflation-is-nigh crowd. Last October, he issued a blistering rebuttal of a cover story in Barron’s that warned inflation was coming back with a vengeance and urged the Federal Reserve to jack up rates to keep the U.S. dollar from crumbling. Low interest rates by themselves do not trigger price inflation or asset bubbles or hurt the value of the greenback, Mr. Kessler fumed.
Deflation, he argues today. remains the real threat, as the current “balance-sheet recession” plays out. The description was popularized by influential Japanese economist Richard Koo. In this scenario, corporations and consumers follow a credit binge with a laser-like focus on reducing debt. This deleveraging process can take a decade or more. Banks sit on their money, borrowing dries up and demand shrinks, leaving public-sector spending as the only alternative. In Japan, heavy deficit-spending prevented a full-blown depression that could have seen the Japanese economy shrink by as much as 50 per cent. But Mr. Koo contends the government made a critical error by attacking its deficit in 1997 and again in 2001, prolonging the slump.
And now, as a similar spectre looms in southern Europe and elsewhere, the inflationistas are once again giving ground. One signal of the shift in attitude: Yields on 10-year U.S. Treasuries have slid to 3.23 per cent from nearly 4 per cent just two months ago.
Mr. Kessler, a long-time bull when it comes U.S. government bonds – “the most maligned asset class in the marketplace” – still regards them as a screaming buy, and not merely because of their status as the safest of havens. “Up until about a month ago, you had virtually every economist saying that the average rate of a [10-year] Treasury at the end of the year would be 4.14. And everyone said that you wouldn’t want to buy a Treasury. … The reason they end up being a stupendous buy is because the whole concept of a credit recession is deleveraging. The whole concept is deflation. And that’s all we’re seeing.”
The prevailing wisdom has been that if governments don’t pay down deficits really fast, the effect is bound to be inflationary, Mr. Kessler says. “There is absolutely not an iota of truth in that statement. Deficit spending usually comes when a country is in terrible shape, so why would inflation or interest rates be an issue?”
A gaggle of top economists now agrees that, at least in the short term, deflation poses the biggest threat to recovery in the advanced economies.
Mr. Kessler’s advice to G20 policy-makers: Stop focusing on the wrong stuff and comparing this slowdown to others of recent vintage. “Those were not credit recessions. This is straightforward economics, and the pity of it is that there’s no easy fix. They could say everyone will have to tighten their belts and change their lifestyle; and once [public] debts are paid down, you’re going to have a better country. Okay, so call me in 10 years.”
