Austerity Ex Machina?

Horace urged ancient poets not to rely on god like miracles to resolve the complications within their plots. Fast forward a couple of thousand years and we have all forgotten his advice. Apparently we have discovered the ultimate economic fix-it device we can pull from the machine and resolve any manner of crisis: austerity.

Admit it, it feels good having this Swiss Army knife policy.

Feels good, that is, to sleep safely in the knowledge that no matter what ails the economy all we have to do is impose, with a suitably grim voice, a repressive set of policies and our economy will perk right up. At least for some people. We can’t expect, any longer, to please everyone.

Exhibit A: look at Ireland. Well don’t, because the austerity magic isn’t having the results it is supposed to. Spreads on Irish debt have scarcely fallen from the near panic levels reached a couple of weeks ago despite the awful and regressive nature of the whipping handed out the the Irish public. It’s almost as if the market in its infinite wisdom doesn’t believe the Irish crisis is solved.

You and I know it isn’t, but we aren’t omniscient market makers. They were supposed to look on happily at the sight of Ireland pummeling its own, and breath a deep sigh of relief. Those bank creditors at the heart of the problem will emerge fairly complete, having managed once again to foist the entire risk onto the local population. It’s funny how that seems to be a recurring theme recently: banks take risks. Banks make illusory profits. Bank managers earn big bonuses from said profits. Bank creditors earn large returns from said profits. And when said profits are revealed to be an illusion: hey presto! The only way to save the world is to impose austerity on various unsuspecting passers by. Bonuses are not repaid. And creditors absolutely must be paid in full. It is the way of the world.

Not my world.

But then again, as many of you have pointed out, I tend to be rather simple minded about these things.

You see, I naively thought that these creditors knew they were taking a risk, and that they therefore knew that they stood to lose if their bets didn’t turn out too well. In the case of Ireland the bets were a spectacular failure. So, the creditor losses should be spectacular also. Right?

Apparently not.

Which only goes to show you that after all those years in banking I clearly missed something.

That risk/return trade off we all talk about has been twisted about a bit. It now reads my return/your risk. It’s a lot more fun that way. As the Irish are learning. And when you sink under the consequences of accepting all that risk, when the creditor errors pile sufficiently high, the serious people – those high minded public figures appointed to protect the system from itself – pull austerity from the machine in order to clean up the mess.

Exhibit B: America. Yes, the USA is awash with plans to whack away at its “debt crisis”. It used to be that the only certainties in life were death and taxes. Now we know better. That we are facing an existential debt crisis trumps those. It is taken for granted that, unless Americans rein in their debt, their economy will follow, inexorably, the path trodden by the profligate Irish. Please don’t even mention the Greeks, no one wants to mimic them.

So slash away we must. And slash away the plans certainly do. I must admit I am taken aback by the zeal with which some of these serious people go about swinging the axe. It’s almost as if they enjoy the work. We are told, in no uncertain terms, that we simply cannot go on looking forward to the level of entitlements we are used to. This is even before most of us have had a chance to get them. It turns out there is a shortfall in Social Security seventy-five years from now. Yes, seventy-five years is a long time, and I know that the cynical amongst you might be snickering a little over the sight of serious people making solid projections out over the best part of eight decades. But darn it, this is a problem. Those projections are accurate to within a few tens of billions either way. Given this accuracy, it is urgent that we raise the retirement age, reduce pay outs, and switch to a different index to ensure future increases lag behind general inflation. Now.

We must also hammer away at health care costs, although we must not do this in the context of anything resembling a European style plan. Oh, and we will exhort Congress to behave itself when it hands out the goodies to local voters, especially those who donated to the re-election funds.

Along with this we will amend the tax code to eliminate all the middle class deductions and we will reduce the top rate of tax to increase the incentive for our wealthy people to work harder. I think this is meant to help the bankers who lent to Ireland.

Finally we will try very hard to slow the growth in defense spending. My suggestion is that the US changes its targeted defense spending ratio from being bigger than the next nineteen countries added up, to being only larger than the next seventeen countries added up. I particularly liked the clause that suggests we limit the annual war budget. This is presumably like the annual Christmas party budget. I pity future presidents being so limited – we can only afford a small war this year. What a shame.

Now, you sense my humor. But this is a serious subject. Why, I ask, are we pulling austerity ex machina, when the biggest single issue is getting demand pumped back up? Is austerity all we have?

If, as I believe is true, much of our debt problem stems from the collapse of revenues due to the recession and the consequent massive slack in our economy, how does deflating the economy help? Should we not be inflating it? Perhaps there is a long term debt problem, but seventy-five years seems a long way off, and given the unerring accuracy of our predictions as recently as 2005/2007, I suspect that no one, not even the folks hunched over those massive economic models at the Fed, have a clue what the debt will be like that far away. Come to think of it, if there is one group whose predictions I would discount fully it is the macroeconomic modeling crowd. They can’t even predict their own birthday next year.

As an aside: this makes me wonder whether there isn’t an “efficient birthday hypothesis” wherein any day I say is my birthday becomes my birthday simply because I said so. If it is, it must be so.

But back to austerity: surely we have to separate the near term problem from the longer term. Getting people back to work may actually cost us something. That will add to the debt. But as those people crank up their spending, taxes will rise, GDP will grow, and the debt will appear to be more manageable. Then, and only then, will be able to focus on the size of that longer term problem. We have a demand problem, not a supply problem. And definitely not a fiscal problem – have you checked US Treasury bond rates lately? We can finance this fix. So we should.

Aah! All this ‘if that, then the other’ is too complicated. And we tried stimulus already and look how that ended up. So we should keep economic policy simple.

Hence, austerity ex machina.