Sunday, August 26, 2012


By Shan Saeed

Some people feel that fiscal policy is the only hope to get the economy out of recession or to get into the growth momentum. Its debatable. I know there is a portion of the economic populace out there who thinks the government needs to spend its way and stimulate its way out of this recession [see Nobel Memorial Prize in Economics Sciences-winning economist Paul Krugman]. Expansionary fiscal policy could be devastating for some economies in the developed world. I think it is the monetary policy that gets the economy out of recession. Nobel Laureate Late Milton Friedman from Uni of Chicago was a strong advocate of this policy and I follow him very closely in terms of economic strategy. Christina Romer [ ex-Chairwoman Obama Economic team] while addressing at Brooking institution in March 2009, made the same emphasis on the importance of monetary policy over fiscal policy.
However, I do not think it is possible at the moment. Let’s forget the writings of John Maynard Keynes and if spending by the government would even succeed. The fact of the matter is that I do not think the United States is even in a position to do this with analyst, economist and other experts talking about fiscal cliff hanging on the wall.
According to the International Monetary Fund, some of the countries in the world that have debt-to-GDP ratios of over 100 percent, or larger debts than the size of their economies.
Countries                   %Debt to GDP                      Year                Region
Japan                                        230                              2011                Asia
Greece                                     160                              2011                Europe
Saint Kitts/Nevis                      153                               2011                North America
Jamaica                                   139                              2011                North America
Lebanon                                  136                              2011                Asia/Middle East
Eritrea                                     134                              2011                Africa
Italy                                         120                              2011                Europe
Barbados                                 117                              2011                North America
Portugal                                   107                              2011                Europe
Ireland                                     105                              2011                Europe
USA                                        103                              2011                North America
Singapore                                101                              2011                Asia
Sources: IMF Via Wikipedia, World Bank, ADB, Economist, Bloomberg

As you can see, other than Singapore, these are mostly really weak economies. There are four of the five PIIGS (Portugal, Italy, Ireland, Greece and Spain) and some small Caribbean nations that have been hurt by the global slowdown as it hit the tourism industry. Most of these countries are experiencing near zero growth or in a recession. In the case of Greece, we have an out and out collapse of the economy, and Japan has basically been in a 20-year recession.

My point is, even if the USA can stimulate the economy by QE3, it will not have a positive impact in the long run. With a debt-to-GDP ratio near 103 percent, and headed to more than 110 percent by next year, the debt is too high to spend more. Most studies show that when your debt gets over 100 percent of GDP, your economy slows, productivity slows down, purchasing power is reduced, living standards come down and inflation rises

When President Franklin D. Roosevelt started his New Deal in the early 1930s and Japan began its downturn in the early 1990s, both countries had debt-to-GDP ratios of less than 30 percent. They had room to spend to stimulate the economy not only in the short run but also in the long haul.
Therefore, even if you believe in Keynesian economics, the United States has betrayed the belief that you should save during bad times to have money to spend during bad times. The United States for the last 40 years has mostly run deficits and failed to save for the rainy day that has now arrived. It’s not so much that austerity works. It’s that it is forced. It’s either you cut back or default or print money and go into hyperinflation.

Right now, USA need tough decisions to made. A combination of defense cuts, streamlining of entitlements (e.g., raising the retirement age) and decreasing taxes must be implemented. However, both President Barack Obama and Mitt Romney, the likely Republican Presidential nominee, are failing to address any of these real problems. This will probably see the so-called fiscal cliff pushed back another year no matter who gets elected.

The way this will end is either in stagnation, with rates staying low and little to no economic growth; mediocrity for the next 10 years; or, more likely, sometime in the next three to five years, despite all of the Federal Reserve’s efforts, interest rates will begin to spike and it will cause a crisis that will force streamlining of the economy and real change to occur. My money is on the latter. I feel that the market will force the hands of politicians, not the other way around.

What does this mean? In the long run, it means the USA will need to reshape it economic model to show the turnaround. When cuts are made, it will be the closing of dozens if not hundreds of U.S. military bases and a change in the U.S. political system. It may seem unlikely because it will have been open for so long. 

However, remember that at one time the “Sun Never Set on the British Empire,” with Britain controlling one-fourth of the world’s land mass. The British Empire was far more powerful and greater than the American Empire has ever been. It might come under pressure as well in the next 3-5 years. The only way to really get out of this mess is by making tough decisions, decreasing taxes, cutting entitlements, cutting spending and letting the free market system to work without government intervention /regulation. The question is, does the United States have politicians with guts enough to make these changes or will the market force the government’s hand?

Disclaimer: This is just a research piece and not an investment advice. All financial transactions carry a RISK. 

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