Keynotes – February 2015

Anti-Austerity – Political Choice or Economic Disaster?

Greece, the ancient cradle of world knowledge, culture, intellectual understanding, philosophy, mathematics, science and politics, has often been the starting point of ideas that have spread to the rest of civilisation. The word ‘politics’ comes from the Greek word ‘polis’ or ‘of the people’ and it was in Greece that the philosopher Democratis first conceived democracy, more than 2500 years ago. It is to Greece that we now turn for the latest political idea to hit Europe: Anti-Austerity.


Gaining Democratic Legitimacy

Opposition to Austerity policies in Europe is gaining political and democratic legitimacy, boosted by Greek elections that saw two very different bed-fellows; one from the left and one from the right of the Greek political bed, sharing the Anti-Austerity duvet. Encouraged by this, the Podemos party in Spain is busily making an Anti-Austerity bed to lie in, if they can win the election later this year.

Spain, unlike Greece, is not small or irrelevant. Its economy is one of the largest in Europe and its contribution to European GDP is significant. The Spanish Anti-Austerity movement needs to be understood.

To do that, we need to remind ourselves of what Austerity is and why it has been adopted as the main deficit reduction weapon and how it relates to the other ‘big gun’, Quantitative Easing, designed to stimulate growth ultimately from expenditure.


Austerity – What is it?

Simply put, Austerity is public spending cuts designed to reduce the large government deficits that arose as a result of the 2008 Credit Crunch. Most countries borrow money from each other, and from central banks, to finance their national public expenditure projects and to stimulate their economies. This is perfectly normal but needs to be carefully controlled.


Deficits and Dreaded Defaults

Deficits arise when this borrowing becomes out of proportion to their income and/or their asset net worth. It’s a bit like borrowing a mortgage only to see the value of the house fall and your income dry up, rendering the repayments unaffordable and the debt unrepayable even if you sold the house, due to the negative equity.

Governments that find themselves in this position can move quickly to the dreaded ‘default’ where a country simply reaches a point where it can no longer afford the debt and it refuses to repay either the interest or the capital. Then those it owes money to have to negotiate a restructuring of the debt in a bid to get something back. Typically this has been a South and Central American problem, with Argentina and Mexico both recent examples of defaults. The USA itself came close to default and Russia has defaulted in the past. Greece, like Ireland, because of its membership of the Euro, avoided default only because the Eurozone absorbed the impact of its inability to pay, in a sort of pre-default restructuring.


Austerity: No Instant Gratification for Voters who don’t see the Benefits.

After that the cost of borrowing for the country goes up and they find it more difficult to finance their activities, leading to cuts in public services and currency problems that affect international trade, in particular their ability to import goods and services. Entire populations have felt the negative effects of these Austerity measures. The benefits are less obvious to the average person, particularly in less well-off areas. It is not really surprising that voters tend to follow the promise of instant gratification.

The theory that you should spend less than you earn is easily understood but as is so often the case, a simple message can mask a more complex reality. Without adequate levels of expenditure, public or private, there can be no growth and economies will stagnate.


Just a Cover Story to Achieve a Political Aim?

Many on the political left and it would seem, some on the right, believe that Austerity is a cover story for often right-leaning policies that transfer responsibility from the state to the private sector, achieving a political aim rather than an economic one, causing misery amongst the less well-off and making less impact on the deficit than is claimed by the policy makers. Conversely most others from the centre left to the centre right are convinced that Austerity is the best way to address the deficit. Up until now this has been the majority view and few have challenged it.


Politically Dangerous and Selfish or Just Another Way to the Same End?

It is easy to dismiss Anti-Austerity as a potentially dangerous and seemingly selfish movement that fails to acknowledge that we cannot spend more than we have coming in, which in turn threatens to derail European plans to get back on economic track after the disaster of 2008. There are cogent arguments that can be made against Austerity, particularly when one considers the apparent failure of Quantitative Easing to increase the money supply, to enable expenditure to occur that is able to stimulate economic growth, as evidenced by the emergence of deflation and negative real interest rates in Europe and the rest of the world, quite the opposite of what you would expect when massive amounts of new money is pumped into the global economy.

If one accepts that expenditure is a vital part of the solution, it is not a long way from understanding that the main difference between pro-Austerity and Anti-Austerity is more about who is doing the spending, than the nature of the spending. Anti-Austerity campaigners believe the state should be doing the spending whilst Austerity advocates want the spending to be carried out by the private sector and consumers.


Public and Private – We Need Both but Employment is Crucial

In reality we need both but what cannot be denied is that governments have a vital, crucial and integral role to play in stimulating growth and do so through capital expenditure on large scale projects that are unlikely to be fully embraced by the private sector without governmental assistance. Governments, local and national are massive employers and Austerity has seen cuts to employment levels in all government departments, without corresponding increases in the private sector, which are needed if we are to move from a recession prone environment to one that is trending towards growth. Without reasonable employment levels, economies cannot grow.


A Wedge to Determine the Future Shape of European Union

This means that both sides are addressing the basic economic requirements in politically different ways, driving a wedge between Greece (and probably Spain) and the rest of Europe, which will probably determine their continued membership of the Eurozone. It does not mean though that Anti-Austerity is necessarily wrong, although it could be, if public expenditure is not effective and fails to stimulate growth. But it is at this point that one should consider the failure, so far, of the Austerity programme coupled with Quantitative Easing (increased money supply designed to boost expenditure), to satisfactorily boost expenditure and stimulate growth.

Austerity has allowed the banking system to absorb the additional money produced by Quantitative Easing whilst Anti-Austerity could allow the public sector to do the same, resulting in a similar failure to stimulate growth and leading to two paths, politically determined and both equally likely to fail or succeed.


A Matter of Political Choice

In Europe, the decisions made by the populations of Greece and Spain are about political choice and highlight potentially insurmountable differences between the individual nations that make up the EU. This shows how tenuous the bonds between member states really are. Austerity versus Anti-Austerity is most probably the defining moment for the EU. It will define who belongs and who doesn’t, creating a stronger bond between the remaining members and releasing Anti-Austerity nations from the union to progress their political objectives separately. The best we can hope for is that the EU will move to an understanding that allows this to happen relatively painlessly. Whether this is the case remains to be seen and given the emotional rhetoric and anger caused by the Greek and Spanish movements amongst the mainstream I am pessimistic about the outcome.


What Does It Mean for Investors?

For investors there are two main themes in the European story. Bonds are held for income and it is likely that there will be volatility in European bourses (bond markets) for sometime to come, created by the same uncertainty that affects the share markets. The prospect of rising interest rates seems unlikely in the short-to-medium term and this indicates that fundamental bond values are likely to remain at their current levels although any rise in base rates by the ECB would have a significant impact on the capital values of European bonds. Only the high yield market is likely to be less affected, being less interest rate sensitive, as I have explained in previous reports. So for our portfolios, this remains an important main focus.

Equities (shares) are likely to remain volatile and easily shaken by an exit from the Eurozone and or the EU by Greece and even more so by the far more economically significant Spain. But any such shock is likely to be short lived, as these events would eventually lead to a stronger union and less uncertainty. There is nothing the markets love more than certainty, even when that is brought about through apparently catastrophic events.

Of course, ultimately we will continue to rely on sensible diversification, not placing all our eggs in one basket and looking to the long term for capital growth, whilst recognising income as a stabilising factor in any investment portfolio.

Chris Welsford


Warning: Investment returns are not guaranteed. The value of investments and their associated income can fall as well as rise. Past performance is not a guide to future returns. This report represents the views of the author and does not constitute investment advice and no action should be taken as a result of its contents.