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IT MAY NOT RANK with the Hatfields and the McCoys, but there's a battle raging. It's the Austerians vs. the Keynesians.
In one corner are the advocates of fiscal austerity, many of whom are adherents of the Austrian School of economics. Hence, the contraction into "Austerian." Their motto is to rip off the band-aid and get the pain over with.
Opposing them are the Keynesians, who contend it's counterproductive to tighten belts when people are hungry. Over the years, their prescription has evolved to Bloody Marys after every binge and bust instead of sweating out the previous excesses. So, each binge and hangover gets worse, requiring more relief the next day, which only encourages another bender.
"The whole stimulus vs. austerity debate is increasingly sounding like a Mel Gibson rant," observes Max Bublitz, chief strategist at SCM Advisors in San Francisco.
Pimco's Bond King, Bill Gross, likens government outlays to maintain consumer spending to flushing money down the toilet. Government investments in infrastructure are a different story, but fiscal initiatives to stimulate spending is futile, he writes in his monthly missive.
To which James Montier of GMO, the Boston-based institutional investor, counters that spreading support for fiscal austerity, notably in Europe, is counterproductive. What he doesn't mention is increasing move to fiscal austerity in the U.S., between the reversal of the previous administration's tax cut to the sharp, virtually unavoidable tightening on the state and local level.
Echoing Federal Reserve Chairman Ben Bernanke's characterization last week of the outlook as being fraught with "unusual uncertainty," the Beige Book of economic reports prepared for the Aug. 10 meeting of the Federal Open Market Committee said only eight of the 12 Fed districts were growing. That followed news of much-weaker-than-expected new orders for durable goods in June, down 1.0%, the second straight monthly drop.
The advance report for second-quarter GDP, due out Friday, may show annualized growth of only 2%, according to Goldman Sachs. Moreover, the firm thinks growth could slow to just at a 1.5% annualized pace in the second half, in large part because of the end of various fiscal stimulus programs.
Despite that, there are calls to cut the deficit in the face of weakening growth. Writes GMO's Montier : "If the examples of history are ignored (as is all too often the case) then policy error is likely to be a serious source of deflationary pressure.
"This is the last thing a debt-laden economy needs, especially a debt-laden economy that is teetering on the brink of deflation anyway. But that doesn't mean that policy makers won't try to tighten. Indeed, one of the world's worst economists and a paragon of orthodox belief, Alan Greenspan, opined in a recent Wall Street Journal OpEd that 'an urgency to rein in budget deficits' is 'none too soon.' Did you need more evidence that this was a really bad idea?!^
Such bad ideas do take hold. In 1937, both fiscal and monetary policies were tightened, setting the second stage of the Great Depression. Japan, meanwhile, tightened fiscal policy in 1997, prolonging its lost decade.
Can it happen again? Montier writes that Fed Chairman Bernanke understands the risk that deflation holds. Still, a new deflationary cycle could bring forth the sol-called QE2, short-hand for the second phase of Quantitative Easing, or QE2 Thus, he concludes, deflation can ultimately lead to inflation.
There is a third way, a via media as it were, which could be called Augustinianomics. To paraphrase St. Augustine, "Please make us fiscally sound, but not just yet."
The more likely scenario is more of the same, for now. The "unusually uncertain" outlook cited by Bernanke and the FOMC suggests as much for monetary policy.
New fiscal initiatives are unlikely before the November elections. But without Congressional action, the biggest tax increase in history takes effect with the sunset of the Bush tax cuts. The Obama administration favors only hiking taxes on the top brackets, that is, for couples making over $250,000. But that would require Congress to act, so who knows if it will happen, even in a post-election lame-duck session.
Thus, "unusually uncertain" could apply equally to fiscal policy as the standoff between Austerians and Keynesians drags on.
Email: editors@online.barrons.com
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