Batten down the hatches for decade of austerity

By Mike Dolan – Analysis

LONDON (BestGrowthStock) — Greece’s debt crunch, for all its peculiarly domestic and euro zone ingredients, should be an ear-splitting alarm call for Western governments faced with one of the biggest fiscal hangovers in history.

The scale of the task facing governments in the United States, Europe and Japan to return debt burdens to pre-crisis levels of 2007 could, by some estimates, usher in a decade of severe austerity through the teen years of the new century.

For sure, the impact of this latest episode both for Greece itself and Europe’s single currency will be profound.

The budget squeeze needed to secure the 110 billion euro bailout from its neighbors and the International Monetary Fund will inevitably shrink Greeks’ standard of living and sorely test the social contract with their government.

For the euro zone, the lack of a fiscal backstop for its one-size-fits-all monetary policy has been badly exposed and the delays in agreeing the rescue merely intensified the crisis.

But while euro-skeptic voices may justifiably shout “I told you so,” this is hardly the time for “schadenfreude.”


For many, this is just a snapshot of “Credit Crisis, Part 2” — a sequel to the 2007/08 shock to over-borrowed households and banks that required unprecedented government financial rescues and dramatic easing of interest rates and credit policy.

Governments effectively nationalized large chunks of the private sector debt burden in order to buy their economies time and prevent deep recession morphing into depression.

Now those same governments are in another race against time to work off those debts — treading a fine line between shock therapy to their domestic economies and alienating nervous global creditors.

As Greece found out to its cost, the cat-and-mouse game with foreign lenders can be treacherous. Any market doubt about debt “sustainability” could see funding costs soar and trigger what some have termed a “death spiral” that feeds off itself.

But convincing creditors of debt “sustainability” is like convincing them you will survive a leap from a first floor window — you might do, but no one’s quite sure until you try.

“After the recent collapse in fiscal positions, simply stabilizing debt levels relative to GDP may not be enough to placate markets,” JPMorgan economists told clients last week.

“Perhaps a more reasonable path to ‘sustainability’ would be to reduce the levels of debt back to their pre-crisis levels over 10 years.”


The JPMorgan economists said their calculations, while highly sensitive to growth and interest rate assumptions, showed the task ahead for the world’s major economies was daunting.

Because the scapel is unlikely to be taken to public finances in earnest before 2012, it worked out what primary budget surpluses — which exclude debt interest payments — would be needed in the major economies to cut 2013 debt -to-gross-domestic-product ratios back to 2007 levels by 2023.

The upshot was the United States needed a sustained primary surplus of nearly 4 percent of GDP for 10 years to reduce a 2013 debt ratio of 101 percent back to 2007 levels of 62 percent.

That compares to an estimated 2010 U.S. primary deficit of some 7 percent of GDP.

To put it in some context, it would exceed the massive U.S. budgetary correction after World War Two when, according to IMF data, it took 17 years to 1963 get a bloated U.S. debt-to-GDP ratio of 108 percent back down to 1941 levels of 42 percent.

In that correction, the primary balance averaged only 1.4 percent of GDP and was in surplus 14 of the 17 years.

And this time around, governments have the added problem of an expected explosion of entitlement spending as the baby boomer generation starts retiring in droves over the next 10 years.

It’s not just the United States. JPMorgan’s calculations show Britain would need even bigger surpluses of up to 5 percent a year for 10 years to 2023 and Japan would need a whopping primary surplus of almost 7 percent of GDP by the same metrics.

The euro zone as a whole — despite big national variations obvious in the heat felt by Greece, Portugal and Spain — needs a still hefty but more modest 2.7 percent primary surplus due to the more stable position of its “core” in Germany and France.

One implication of all these numbers is official interest rates will likely need to remain as low as possible for as long as feasible both to control parallel debt servicing and to prevent spending cuts and taxes from clobbering the economy.

The Greek bailout gives us a glimpse of just what those measures might look like — slashed pension benefits, salary freezes, extraordinary levies and steep sales tax rises.

And while a Goldman Sachs study of big fiscal retrenchments since 1975 showed that leaning toward expenditure cuts rather than tax rises has been more successful in cutting debt, lifting growth and buoying markets, it rarely happens without a push.

“Decisive expenditure-driven fiscal adjustments are politically difficult to implement and tend to take place only following a change in government and/or once bond markets force the government’s hand,” Goldman economists concluded.

The Greek experience should be a powerful nudge for all.

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(Editing by Stephen Nisbet)

Batten down the hatches for decade of austerity