Thursday, April 25, 2013

Thematic Thursdays: Austerity Hysteria

The past week has not been an especially good one for those advocating austerity as the path to sustainable growth.

The big blow up occurred when a University of Massachusetts Ph.D. student, Thomas Herndon, and two associates, Professor Michael Ash and Professor Robert Pollin, identified three errors in the tome published by Rogoff and Reinhart "Growth in a Time of Debt" and its 90% debt to GDP outcome. The Rogoff/Reinhard research paper and its subsequent book, "This Time is Different", along with other research publications, quickly became the foundation upon which austerity programs in Europe and the US were embraced and implemented.

The Herndon/Ash/Pollin rebuttal threatens the very core of the newly advocated economic policy known by the oxymoron "expansionary austerity". Before we get to the implications of this fiasco, let's recognize a key item that FT chief economics commentator, Martin Wolf, notes in his most recent commentary: (a)"...slower growth is associated with higher debt. But an association is definitely not a cause." and (b) "...they (Herndon/Ash/Pollin) argue, average annual growth since 1945 in advanced countries with debt above 90 per cent of GDP is 2.2 per cent. This contrasts with 4.2 per cent when debt is below 30 per cent, 3.1 per cent when debt stands between 30 per cent and 60 per cent, and 3.2 per cent if debt is between 60 per cent and 90 per cent."

Therefore, although correlation is not causation, higher debt to GDP does coincide with slower growth but not to the point where the 90% threshold results in the virtually zero growth rate Rogoff/Reinhart stated. So, other than egg on the face for Rogoff/Reinhart and their austerity advocates what does this all mean to investors?

The good news is that the senseless pain and suffering incurred by those who were (are) unfortunate enough to be caught in the austerity crosshairs may be reduced and, potentially, reversed (assuming, of course, that irreparable damage has not been done). And with that comes the potential for a justification for governments to respond to any economic downturn that is virtually guaranteed to be a pro-cyclical disaster. For when economies are in a zero bound interest rate environment AND have embraced a zero tolerance for new fiscal debt, the counter force for such an experience DOES NOT EXIST. Now, use your imagination and consider what are the likely socio-economic and political outcomes of that.

The bad news is that egos and agendas are fairly well established and slow to reverse. Will the Eurocrats and American austerians admit they were wrong? And then there are the agendas that conservatives and libertarians advocate that using the Rogoff/Reinhart thesis has served them well. Will that be surrendered in the face of the facts? Doubtful.

Investment Strategy Implications

At present, bean counting (err, excuse me) earnings season is underway and macro issues are tempests in teapots for virtually all bottom-up analyst and investor types. Besides, macro issues are for economists and they will sort it out and advise on the impacts. And herein lies the problem.

When it comes to today's globalized economy and markets where interconnectedness is deep and transmission mechanisms are fast, silo thinking leaves one exposed to the very nature of a changed economic and market structure. Unfortunately, though, for many - jobs and careers (a/k/a "keeping my house in Greenwich") matter more. And like the austerians, ignorance is bliss.


Thematic Thursdays is a product of Blue Marble Research Advisory and focuses on important global trends and themes impacting the global economy and markets.

On average, thematic issues are longer term in nature, transcending the business cycle in time and economic sector categorizations. However, many shorter term players in the financial markets use trends and themes as a staple of their investment strategy.

Understanding how to incorporate thematic analysis - along with fundamental and technical analyses - is an integral part of the process that forms the three-legged stool of the analytical approach employed by Blue Marble Research Advisory.

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