New York, May 15, 2013, Advisor Update®
One would think that the major topic of discussion in financial circles should be the survival of both the Knicks and Rangers this late in the season. After all, isn’t the circus supposed to be in Madison Square Garden by now?
But to our disappointment, it is worldwide quantitative easing by central banks that has generated a frenzied debate in the media as to the consequences of monetary policy. The debate has heightened as fiscal policies around the world have failed to achieve their objectives. It’s a shame that the discussion has shifted so far in this direction because a sensible fiscal policy is much more effective at generating economic growth and employment than is aggressive monetary policy. Kind of like having a healthy big man or a productive third line, right?
So we were pleasantly surprised to see the New York Times publish an in-depth discussion of the current economic debate on fiscal policy. The article was framed as a debate between two very influential economists: Larry Summers, former Treasury Secretary under Bill Clinton, on the left, and Glenn Hubbard, former Chairman of the Council of Economic Advisers under George W. Bush, on the right.
Unfortunately, the article’s conclusion embodied the reason behind the gridlock in Washington, namely that these two viewpoints are polar opposites and therefore completely incompatible—that we must adopt one or the other. Nearly every country experiencing economic stagnation is employing one idea or the other, and none have so far succeeded. The fact that no plan has adopted some ideas from each camp and that they have all failed to achieve their goals is not a coincidence.
Perversely, as a result of the total dysfunction that has overcome Washington during the past few years, the US may have a strong advantage in developing a sensible fiscal policy, if we can just agree that we need one. This is because most of the developed world is experiencing very similar problems, and different countries have tried to tackle the problems in different ways. We can look to their successes and failures for guidance, giving us a strong second-mover advantage.
The NBA Bobcats and NHL Coyotes of failed policy is Europe. Many European nations have high levels of public debt and have been left with high fiscal deficits following the global financial crisis. In order to stabilize their debt ratios, these countries have pursued austerity programs of cutting government spending and raising taxes. These policies have been a complete failure. They have driven the continent back into recession and have failed to achieve their goal of reducing fiscal deficits, so debt ratios have continued to rise.
China pursued a much different path following the global financial crisis, when their export-driven growth model was shown to be vulnerable to slow growth abroad. To counteract this slowdown, the Chinese government funded a program of state-directed, unneeded and poorly executed infrastructure projects. These busted projects have forced the Chinese government to throttle back its stimulus—growth is actually slowing as a result.
What have we learned? First, cutting spending and raising taxes without enacting complimentary pro-growth policies is a recipe for failure. Second, government-funded infrastructure projects that are motivated by political interests rather than actual social and economic need are also doomed. Finally, enacting aggressive fiscal stimulus without a credible plan for long-term deficit reduction risks losing confidence in public finances. Getting this balance right is a huge opportunity for the US—getting it wrong means we will turn out to be the financial circus that most of the world has become.