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Michael Baxter

Bull and bear: Gaping deficit found in the theory of austerity economics

Written by: Michael Baxter on April 17th 2013

Category: Bull & Bear, News

Bull and Bear – an optimistic and pessimistic view of investment news. Today’s stories include: Gaping deficit found in the theory of austerity economics. Tesco’s US exit: a costly experiment, or a retreat too soon? QE leads to runaway nothing. IMF global outlook. US picks up, Germany slips

Gaping deficit found in the theory of austerity economics

Austerity economics has its bible, and now we have found out that this tome may not be gospel after all.

The book is called “This time is Different.” It was written by Carmen Reinhart and Kenneth Rogoff and is one of the most often quoted economics books published over the last decade or so. It has been referred to here many times.

The book looks back over what it calls eight centuries of financial folly, and draws one pretty unequivocal conclusion: whenever government debt rises over 90 per cent of GDP, growth is adversely effected.

The book, more than another other economic theory, has provided the ammunition for the austerians. It is the theoretical underpinning of the Osborne strategy, of Eurozone rescue packages, of why some say Obama is destroying the US.

Now some economists are saying that there are factual errors in the data behind the book’s key conclusion. The errors are such that its conclusions may no longer be valid.

Before we go further, many economists have expressed doubts before. Does government debt rising above 90 per cent cause economic troubles, or can economic troubles cause government debt to rise above 90 per cent of GDP?

But now a new paper by Thomas Herndon, Michael Ash, and Robert Pollin from the University of Massachusetts looking into the data contained within “This Time is Different” has questioned the accuracy of the data used. For one thing they say the data is weighted so that it puts more emphasis on a year of contraction than a year of growth. In other words, ignore all the good bits and things look really bad. For another thing, the data apparently misses out New Zealand from the equation, and New Zealand enjoyed both high growth and high government debt. For a third thing, they say that US growth after World War II fell for some pretty unusual reasons – women pulling out of the workforce being one, and therefore the link between government debt and GDP for this era may not be valid.

Put together all these apparent discrepancies, say the critics, and the premise that government debt over 90 per cent of GDP correlates to slower growth is no longer correct.

It is too early to say how reliable these new observations are. Reinhart and Rogoff have not had a change to give a full response.

But, in the game between austerians and anti-austerians, one might say the anti-austerians have just smashed their way to winning break-point.

And by the way, yesterday’s latest IMF economic outlook contained warnings against austerity in the UK. While discussing the UK at yesterday’s press conference, Oliver Blanchard, chief economist at the IMF, said: “In the face of very weak private demand, it may be time to consider adjusting the original fiscal consolidation plan.”

Tesco’s US exit: a costly experiment, or a retreat too soon?

And so Tesco’s attempt to rival Wal Mart as the world’s leading retailer has failed.

It came as no surprise to learn that Tesco is pulling out of the US. The £1 billion pound write-down resulting from the pull out must hurt, but can surely not have been too much of a surprise.

Tesco has also written-off £840 million worth of property and £494 million relating to the business in central Europe.

All in all then, a bit of an annus horribilis for Tesco.

You can see why it has chosen to close the US arm; it is losing too much money.

However, I’m not sure about the wisdom of giving up on the US just as the world’s biggest economy is in the process of staging an economic recovery, but hey, no doubt Tesco’s economists have spotted that one.

But the US retreat has clear implications. Tesco can never rival Wal Mart for global power without cracking the US. Maybe it will re-group and try again, but it is more likely that as far as Tesco is concerned, the US is a no go area.

Many analysts see Tesco as the retailer that will gain the most from emerging markets, especially China and India. But can the stores compete without a US stronghold?

Now the talk at Tesco is about focusing its strategy on online and convenience stores in the UK. This is good stuff, but maybe we have seen its global ambitions suffer a pretty nasty jolt.

Tesco may, on the other hand, be suffering from regression to the mean. See: Tesco’s troubles; Tesco’s opportunity 

QE leads to runaway nothing

The latest inflation data is out. In the UK it stayed put, but is still too high. In the Eurozone it is down to levels that make one think that inflation is asleep. In the US, the data may suggest it is comatose.

In the UK in March, inflation was 2.8 per cent, the same as last month and up on January. Yes it is too high. Yes it may well rise soon thanks to rising energy and food prices that we already know are in the offing. Yes, in as much as QE may have pushed down sterling, monetary policy may not have helped. Yes inflation is higher than wage growth, and that’s a problem.

But…producer prices show underlying pressures are muted, at worst. Inflation is likely to fall back later in the year.

And no, despite the predictions of doom, QE has not led, not even come close to leading to, runaway UK inflation.

Now pull back, and look at the global picture vis-a-vis QE and inflation.

In the Eurozone in March, inflation fell to 1.7 per cent, from 1.8 per cent the month before. In the US it was just 1.5 per cent. QE has been about as effective at creating hyperinflation as a chocolate teapot in retaining boiling water.

Admittedly, one offs were behind the fall in inflation in the US. Strip out food and energy and US inflation was 1.9 per cent in March – still distinctly modest.

If QE is the work of the devil, the devil must have become a liberal.

IMF outlook

We all know economic forecasts only tend to be right in years when things are average. We all know that of late forecasters have proven to be unduly optimistic about the “year after next.”

But, hey this is the IMF, and presumably it does have some kind of an inkling about what is going on in the world.

Here is a summary of key forecasts that were published yesterday:


IMF forecasts and actual: growth in GDP
2011 2012 2013 2014
World 4.0 3.2 3.3 4.0
US 1.8 2.2 1.9 3.0
Japan -0.6 2.0 1.6 1.4
Germany 3.1 0.9 0.6 1.5
UK 0.9 0.2 0.7 1.5
France 1.7 0.0 -0.1 0.9
Italy 0.4 -2.4 -1.5 0.5
Spain 0.4 -1.4 -1.6 0.7
China 9.3 7.8 8.0 8.2
India 7.7 4.0 5.7 6.2
Indonesia 6.2 6.3 6.4
Brazil 2.7 0.9 3.0 4.0
Mexico 3.9 3.9 3.4 3.4
Russia 4.3 3.4 3.4 3.8
Turkey 2.6 3.4 3.7



US picks up, Germany slips

And finally, there was good news to finish off a run of bad news on the US economy, but bad news on Germany.

According to official data from the Fed, US industrial production rose by 0.4 per cent in March, enjoying further robust growth after a stronger than previously reported 1.1 per cent rise in February. Over the first quarter as a whole, production is up 1.3 per cent compared to the fourth quarter last year. Manufacturing is likewise up 1.3 per cent, albeit with a 0.2 per cent decline in March.

However, Chris Williamson at Markit struck a bearish note saying: “While the manufacturing sector appears to have remained buoyant in March, job creation has disappointed, with non-farm payrolls registering the smallest increase for 20 months, and the consumer sector is also showing signs of weakness. Retail sales dropped for the second time this year in March, albeit after a strong February, alongside downturns in measures of consumer confidence, which suggest that recent tax rises which hit at the start of the year are having an impact on consumer sentiment.”

Paul Ashworth, Chief US Economist at Capital Economics, stuck with the bearish theme saying: “The unseasonably cold weather last month forced many Americans to turn up the heat at home. Aside from that spike, however, manufacturing output actually fell by 0.1 per cent m/m, although that decline doesn’t look quite so bad when we factor in the sizeable 0.9 per cent m/m surge in February. Overall, not as good as the headline gain suggests. The survey evidence suggests that any gains in manufacturing output in the second quarter will be very modest.”

As for Germany, the Zew Index – a measure of investor’s sentiment – fell from plus 48.5 to plus 36.3, which is quite a decline, although the index is still quite high by past standards.

Jennifer McKeown, Senior European Economist at Capital Economics, said: “Given growing fears about troubles in Slovenia, Portugal and Italy and their impact on the German economy and public finances, we suspect that further falls in sentiment are to come.” She added: “We maintain our forecast for the economy to stagnate this year and grow by just 0.5 per cent in 2014.”

Contrast the forecast with those from the IMF, see above.

These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Tags: austerity economics, Carmen Reinhart and Kenneth Rogoff, German Zew Index, imf austerity, IMF forecasts UK Germany China India Brazil Mexico Russia Indonesia France Japan, Tesco write-downs US, this time is different, UK US Euro inflation, US industrial production.

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