EmailThe news out of Europe is so bad that the previously planned article on long-term investing and cost averaging will have to wait. Instead, your author feels a Santellian rant on the appalling developments in Europe is warranted. The near-term impact on market sentiment resulting from the elections across Europe is negative, and with full justification.
Austerity vs Growth is a False Argument
The election results in Greece, France, and now Germany are being widely reported as a rejection of austerity policies in favor of pro-growth policies. That may reflect how some voters were thinking, but to make such a simplistic policy distinction is to make a mockery of serious policy analysis.
Pundits and politicians that reduce the argument to one in favor of “pro-growth policies” do so primarily to argue for more government spending (of any kind). It is a Keynesian argument that has some merit if one is focused solely on next quarter’s GDP. The simplistic dichotomy between austerity and pro-growth, however, will be destructive in the long run if necessary reforms are not undertaken.
First of all, there has been little austerity in most European countries. For example, the austerity measures in France consist primarily of raising the retirement age starting in 2017 (in five years!) and raising taxes. Total French government spending was essentially flat in 2011 compared to 2010, and was up in the first quarter of this year. That isn’t exactly the severe cutbacks in social services as commonly assumed.
In Greece, austerity measures are real, but adding up the entirety of “austerity” across the continent hardly suggests that European governments are throwing poor people into the gutter. It is more a case of trying to rein in future pension spending.
Second, austerity measures are not the root cause behind Europe’s economic problems. European economic growth has been sluggish and trailing the US and the rest of the world for years.
The economic problem is that Europe is not globally competitive. Their companies are saddled with high labor costs and restrictive regulations. Outside of Germany, it is hard to even recognize any European companies with strong global brand names. The culture in much of Europe is in favor of a lifestyle supported by the government rather than industriousness.
Austerity measures may have made short-term economic growth lower than it otherwise would have been, but many of the reforms are necessary in the long run. To simply blame Europe’s problems on “austerity” will be to throw the baby out with the bath water. It will take the focus off necessary pension and labor market reforms and suggest that ramping up government spending in the short run to boost the math on GDP is the best policy.
But borrowing more money from China, or perhaps printing more Euros, so as not to reduce the growth in pension payments to any degree, is not going to improve the long-term position of Europe.
The “pro-growth” argument is typically presented by pundits as an argument for more government spending of any kind – perhaps some infrastructure spending that can plausibly be considered economically viable. Politicians, however, are using the argument in order to keep the pension, disability, and similar checks flowing. And people across Europe understandably voted for it.
The Worst Economic Policy Ever
Europe is thus rejecting even modest measures to take steps to rein in government transfer payments.
Instead, it now appears that Europe will desperately hang on to the idealistic view that the worst economic policy ever will somehow improve human conditions.
That policy consists of paying people more and more to NOT work. The method of paying for this consists partly of raising taxes on people who do work and partly on borrowing more to create an even greater debt burden for future generations.
A sound economy in the long run requires the production of goods and services that people desire, and that these products be produced by the use of fewer inputs than the value of the output. That means, yes – a profit.
When this is done, an economy creates current value and capital for further growth.
Recent European elections have given victories to “pro-growth” candidates that reject this philosophy. Instead, the focus will be on increased government spending, regardless of the efficiency of that spending in producing goods and services of value. That includes making sure that voters continue to receive their government pension checks.
There is now a very real risk that European countries across the board take short-term measures that will be palliatives to the current GDP woes, but that are destructive in the long run.
The global financial markets are legitimately concerned.
What It All Means
Europe matters. Until recently, it appeared that Europe would muddle through its current fiscal problems in such a manner that US corporations would be able to maintain profit growth. That could increase the value of US companies, and raise their stock prices.
If Europe rejects any efforts to address their fiscal problems, however, the risks to the global economy increase. Even your inherently optimistic author is struck with a small dose of dread over the future of Europe.
There is a real risk that Greece will not be able to put together a viable government and will leave the Euro. That may be the best policy for them, but it will cause near-term havoc in the financial markets.
The new Socialist government in France will be constrained by reality, but there is also little chance of needed reforms. Spain appears to be a slow-motion train wreck with no easy policy prescriptions. When a country has 24% unemployment, even the most prudent policies will take years to produce results.
For US investors, it almost doesn’t matter whether supposed “pro-growth” strategies are correct. The political debate in Europe has intensified and will probably get worse. Now, it is unclear the degree to which even Germany will follow policies amenable to the financial markets. The political turmoil will be a persistent problem for the financial markets.
It isn’t the specific news out of Europe this past week that is troubling. It is that the underlying commitment to reform has been weakened. That suggests a harder road ahead for policies that will improve the long-term competitiveness for European economies.
The news from Europe is bad. Very bad.
Founder and Chairman, Briefing.com
