Carr's Call: Whatever happened to austerity?

Economic conditions have improved … and that’s good for markets.

Summary: Rewind six or seven months and the global economic outlook was decidedly gloomy. But the rhetoric of austerity has changed, removing the major millstone from the market’s neck.
Key take-out: Global growth looks set to be much stronger over the next year than it has been over the last two.
Key beneficiaries: General investors. Category: Economy.

In one way or another, the actions of policymakers – governments in particular – have been the key deadweight on global economic expansion over the last few years.

You can see this most clearly in the US. I’ve noted before that the private sector expansion underway in the US is robust – you can see it in jobs growth and you can see it in the national accounts. It’s been the public sector that has been dragging the chain some. But look at private demand in chart 1 – it’s actually above the trend.

Over in Europe, the problems seem never ending. We had concerns over insolvency – Greece, Portugal, Italy and Spain.  Many investment banks and globetrotting economists were telling us a ‘Grexit’ was inevitable – a 90% probability – and actions to try and mitigate it were simply ‘kicking the can down the road’. We now know that some of this commentary was a little rash. Despite this, the unfortunate truth is that it did weigh heavily on growth. European policymakers paid a heavy price, not only in terms of bailout sums, but in terms of economic growth, for the sloppy way they handled the crisis – real or perceived.  

Going into 2013 the global millstone morphed, from one of crisis to the cure – austerity. If you think back to the beginning of the year, this was one of the greatest risks cited. Growth would be weak, if not recessionary because of it.  In the US we had the fiscal cliff, and while public demand has fallen, the cliff idea fizzled into nothingness. That aside, significant concerns remain over European austerity. Perceived by many as draconian, these policies were and still are expected to weigh on growth and not by a small margin, as you can see in table 1.

Official forecasts from institutions such as the IMF still have the fiscal contraction at a full percentage point for this year. That is, fiscal policies by the advanced economies are expected to knock off 1%. Note that the fiscal contraction is the difference between the fiscal balance in each year. For Europe, the fiscal contraction was expected to be around 0.7% this year while for the US it was 2% – this was expected by some to cause near recessionary conditions in the US this year.

You’ll note that it’s not something we hear a lot about now however. Austerity seems to have dropped off the radar, which may not be that surprising given we had heard so much about it previously. Fiscal fatigue was bound to set in.  This is unfortunate though, because when you consider the concerns of the market and then take a look at what has actually eventuated, well, it turns out that one of the key millstones for the global economy has turned out not to be that big. We find ourselves at a turning point for three reasons:

1. Consider that in Europe, as each month passes, ‘austerity’ becomes less severe – well the announced austerity. The European Commission only recently extended or delayed deficit deadlines for a number of countries. So for Spain the new deadline is 2016, for Portugal 2015 and for Italy, the recommendation from the European Commission is to lift the “excessive deficit regime”. Italy’s deficit, currently within target, was expected to fall below next year.

2. This continues a pattern. Take a look at chart 2. In it you will see a pattern observed in the US and in Australia as well. There hasn’t really been any cut to government expenditure for the union as a whole anyway.

Recall that the widely held belief, and the expectation, is and was that austerity is weighing on European growth. The ensuing recession was a necessary evil to get bloated public balance sheets into at least some semblance of respectability. So what gives? Austerity it seems was more rhetorical flourish to help assuage panicked markets – markets that were panicked over a debt crisis that in truth was never really a crisis. How do you fight distorted perceptions? With a distorted reality, that’s how.

3. Even if you are critical of my above view, or don’t quite believe it, we are past the worst anyway. For the US, that strength in private demand that I showed in chart 1 is leading to solid gains in government revenues. Now take a look at chart 3. Spending hasn’t really changed at a federal level and in nominal terms – really most of the decline in spending that we see in US national accounts (measured in real terms) is actually the effect of inflation. Not genuine austerity or harsh spending cuts.

Now take another look at table 1. Even if you do adhere to the official line that austerity was in place and it was sharp – the expectation is that the fiscal contraction will be much smaller over the next year. For Europe only -0.3% in 2014 compared to -0.7% this year. For the US, the IMF was expecting a 1% detraction to growth in 2014, down from 2% in 2013. The thing is these numbers don’t take into account the Congressional Budget Office’s latest update. They suggest the fiscal contraction will fall from 3 percentage points suffered this year to 0.6 percentage points next year – which is nothing in comparison.

All of that is good news for investors. Good anyway you look at it and it’s probably why, consequently, the rhetoric of austerity has changed. It no longer really exists! And in a world where this was the key restraint to growth in 2013, it has some quite significant implications – at the very least for market confidence.

Basically it removes a major millstone – the major millstone – from the market’s neck. It means that there are very few, if any, real headwinds to global growth.

More than that, recent announcements from the European Union, European Commission and individual governments have been decidedly more pro-growth and market friendly. The big picture out of all of this is that global growth looks set to be much stronger over the next year than it has been over the last two.

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