The Austerity Myth

As economists go, Paul Krugman is about as good as it gets.  He was absolutely on the money when he predicted that the stimulus would not be big enough and he was among the first to sound the warning that the austerity measures Europe was embarking on more than two years ago would not prove successful.

While reading one of his latest blog pieces in The New York Times “A Mythical Anniversary,” the Nobel Prize winner was practically beside himself as he took a stroll down memory lane.  The reason for his “I told you so” moment?  Almost two years ago to this day, Krugman wrote what I call the signature piece on Europe’s economic woes, titled “Myths of Austerity.”  Prophetic would be a word in a half.  Quoting bits and pieces of it doesn’t do it justice; a full read is the only way to appreciate its sheer brilliance.

To sum up, Europe’s austerity measures backfired.  In essence they turned a weak but fledgling recovery into the motherload of all double dip recessions.  It isn’t just Spain, Portugal and Greece that are the problems, or for that matter the entire European Union.  Great Britain, which isn’t even part of EU because it had the good sense to keep its own currency, is now in a huge hole thanks to David Cameron’s obstinate policy of slash and burn.

The facts clearly indicate that while long-term debt remains a serious problem, the number one issue that needs to be dealt with is growth.  Matthew O’Brien in The Atlantic spoke to this point quite effectively:

Great Britain's experiment has been all pain and no gain. Britain's budget cuts haven't even bought them any more credibility in the eyes of markets than America's relatively spendthrift ways have.

That's the mistake Cameron's government made. They thought deficits mattered more than growth. They don't. That's not to say that Britain's budget cuts haven't reduced borrowing costs. They have. But not for the reason Cameron hoped for. Rather than "restoring confidence" in Britain's finances, austerity has destroyed confidence in Britain's growth. And, again, that's good news for borrowing costs. But it just shows how unnecessary austerity has been. Britain probably wouldn't be paying much, if any, more to borrow even if they hadn't narrowed their deficit. Consider that since Cameron was elected, British yields have fallen 181 basis points while American yields have fallen ... 170 basis points. But even if Britain did pay more, that would be good news! It would mean that their economy is growing enough that investors are more worried about inflation than low-growth.

The real test is going to be whether Barack Obama can hold off the horde of austerity buffs who want to repeat in America what has already pretty much failed in Europe.  The good news is that thanks to the debt-ceiling “deal” last year, we won’t have to go through another shut-down circus scenario until after the election; the bad news is that Republicans have basically taken a stand against any bipartisan measures to try and help the economy.  Translation: a political stalemate and a recovery limping along at 1.5% annual growth.

And while that may be a pretty hard sell for the President this fall, it’s a hell of a lot easier than the burden Mr. Cameron has on his hands in merry old England.