Stuck with 'synthetic austerity'
As stock markets roar to new highs, some urge caution. Meanwhile, so-called austerity measures, or reductions in the rate of government spending in the United States, United Kingdom and European Union, are a delicate balancing act for government officials worried that too much belt-tightening will harm efforts to restimulate their economies.
Other than Germany, few Western governments have any available money. For most, stimulation must be financed by increased borrowing or the printing of more money by central banks. Although politicians blame commercial banks, the recent asset boom and resulting recession were, in fact, caused by central banks, most notably the Federal Reserve.
According to Fed statistics, almost 48 million Americans are on food stamps. The $85 billion reduction over five years in the rate of increase in government spending, or “sequester,” has been cited as a major cutback causing inconvenience to Americans. For political reasons, “synthetic austerity” is being made to appear to bite.
In his Feb. 26 semiannual report to Congress, Fed Chairman Ben Bernanke reaffirmed his intention to inject $85 billion a month of synthetic money into the economy. This reaffirms his deep concern about the health of the economy, but the gamble still appears not to be working.
In the EU, civil unrest in Portugal, Italy, Greece and Spain has caused politicians to bring pressure on Germany to relax its demands for austerity and to replace them with unlimited cash infusion.
In the U.K., government attempts to cut the rate of increase in its spending are faltering as partial austerity takes hold. The new Governor of the Bank of England is a Canadian who, as an unabashed Keynesian, already has questioned the bank's 2-percent inflation limit. His deputy, Paul Tucker, even urges consideration of negative interest rates as an economic stimulus.
(A Keynesian is someone who follows the theories of British economist John M. Keynes. Keynes' view was basically that in the short run, the economy's productivity is heavily influenced during recessions by total spending or aggregate demand. Aggregate demand, however, is sometimes erratically influenced by various factors and doesn't equal necessarily the economy's productive capability.)
Reacting to the willingness of the Fed and other central banks to keep printing money, stock markets have soared. The Dow set a new record close last week of 14,397 — surpassing its previous record on Oct. 9, 2007, by 232 points.
But assuming an average inflation rate of 5 percent that some might think overly conservative, the Dow would have to be 17,876, or up a further 24 percent, to equal its “real” record high.
Investor sentiment moves markets. If the focus is merely on nominal returns, markets will react accordingly, regardless of inflation or economic realities.
If even interest rates rise, they likely will cause a huge rotation of funds from bonds into equities, causing stocks to rise further.
Not everyone in the central banks supports continued money printing, but simply ending it could cause panic. Investors who have failed in balanced asset allocation could suffer the shock of plunging securities' prices and even closed markets.
John Browne is a financial and economic columnist for Total Trib Media. Email him at firstname.lastname@example.org.