The Case For Austerity

by John Brian Shannon

Finally, finally, finally.

After decades of running endless deficits which, when left unpaid at the end of each year are added to the government debt — increasing the overall debt-to-GDP ratio numbers of nations, many governments around the world have begun to rein-in their spending.

Why is that important? Because those are the same debt-to-GDP ratios that the worlds major credit rating agencies cite when they lower the credit rating of nations which have managed to spend more than they take in year after year – through the good times and the bad times.

Decade after decade, deficits pile up, until one day your national credit rating has sunk from AAA+ to only B+ or worse! This brings about a number of unwanted consequences for those countries.

One, the cost of borrowing multi-billions of dollars to cover government debt is increased at each and every downgrade.

A small change to the interest rate doesn’t hurt much when the amount financed is a small amount, but it really hurts when the amount financed is in the hundreds of billions of dollars. For example, the U.S. is presently financing 15 Trillion dollars of debt (accumulated deficits) and will add another 1.4 Trillion dollars of deficit to the government debt at the end of this fiscal year – September of 2012.

Imagine the borrowing costs on 16.4 Trillion dollars. Now, imagine the borrowing costs on 16.4 Trillion dollars and add another 1% to that interest rate – which is the hypothetical equivalent of a one-point reduction in the credit rating, let’s say from AAA to AA for example. Forget about the B+ rating – you don’t want to know.

Year in and year out, in good times and in bad times, huge chunks of national treasure in the form of interest payments on federal debt and deficits are paid by the taxpayers to foreign lenders to cover the cost of government overspending. It is an automatic drain on a country’s wealth.

Credit rating agencies become empowered at times like these and begin making suggestions to governments in order for them to receive a better credit rating – and thereby lower their overall cost of borrowing.

One suggestion is to impose austerity measures to lower government spending – in an attempt to stem the economic bleeding of the economy in question.

Cutting the number of government workers to decrease government spending is one way to accomplish that – as is reducing the number, or quality, of services that a government performs. In fact, there are thousands of ways to raise revenue and lower spending to eventually produce a zero deficit condition. Levelization of government finances becomes the priority.

Which is a relatively easy thing to do during the good times when the economy is expanding, jobs are plentiful and the government is raking in boatloads of income tax, sales tax and other government revenue-generating schemes — although, even then it is rarely attempted.

Some excellent examples of exceptions to this paradigm do exist.

Austerity during the bad times has no redeeming value at all – except for one important point, which I will cover shortly.

Politicians have traditionally shunned austerity during the good times because in all but a very few cases it gets them voted out of office.

At the worst possible moment, we are now beginning to do the right thing — returning to balanced budgets and paying down government debt.

Everyone is beginning to ‘get it’ governments simply cannot run huge deficits decade after decade and not face a downgrade of their credit rating, which drives up the cost of financing that accumulated debt load. Which, in turn, slows the economy – code words for increased unemployment, higher taxation, stagflation and a lowering of services provided by the government.

So, what is the important point? Voter acceptance – which may be putting it too strongly – but at the very least an understanding is now forming in the consciousness of voters, that governments cannot continue spending at unsustainable levels for decades at a time. Tentatively at first, but now with increasing resolve, politicians have begun to feel empowered to speak out about lowering government deficits and cutting national debt loads.

Now that the process has started (very unfortunately, during the bad times) I would expect it to continue during the coming good times – which, according to the legendary words of economist John Maynard Keynes – is the proper time for deficit-cutting and debt paydown.

It has worked before. In the early 1990’s, Canada was facing high deficits, a toxic government debt load and a lowering of it’s credit rating — at a bad time economically speaking. The then-government of Prime Minister Jean Chretien and his astute Minister of Finance Paul Martin, jumped at the opportunity during a time of nominal growth and higher taxation to cut the deficit to zero and dramatically paydown the accumulated Canadian federal debt.

In short, a win for austerity. A wildly successful effort by those two gentlemen who made it look easy and who never, ever, once complained once about the task fate appointed them.

In fact, there is no doubt at all about it in Canada – austerity won and it won handily.

In the case of Canada, there was no option but to win, there were no better choices available and no big brother like some nations in the EU have available to them to bail us out. The government of the day decided to pare down spending, increase revenues and they were so successful at doing so their plan worked better than even they themselves had envisioned.

The reason Canada was so successful?

Theirs was anything but a clumsy attempt to balance the budget and paydown the debt and both the Prime Minister and the Finance Minister went around to meet the Premiers of each Canadian Province to sell the austerity package to Canada’s Premiers before attempting to take their plan further afield.

Then, and only then, they went to Wall Street to sell the world’s leading economy on the Canadian plan to eliminate Canadian deficits and lower the country’s total debt load.

Once all of that had successfully taken place, Canada’s Prime Minister and its Minister of Finance approached the credit rating agencies with a fait-accompli plan.

By ensuring the full support of every relevant player well-beforehand, Canada won over the credit rating agencies in a moment.

John Brian Shannon writes about green energy, sustainable development and economics from British Columbia, Canada. His articles appear in the Arabian Gazette, EcoPoint Asia, EnergyBoom, Huffington Post, the United Nations Development Programme – and other quality publications.

John believes it is important to assist all levels of government and the business community to find sustainable ways forward for industry and consumers.

Check out his personal blog at: http://johnbrianshannon.com

Check out his economics blog at: https://jbsnews.wordpress.com

Follow John on Twitter: https://www.twitter.com/#!/JBSCanada

SEE ALSO:

http://www.theglobeandmail.com/report-on-business/economy/the-lesson-from-canada-on-cutting-deficits/article4252006/?page=all

A short excerpt of this excellent article appears below. Please click on the link above to read the entire article.

The lesson from Canada on cutting deficits
LOUISE EGAN, RANDALL PALMER
OTTAWA— Reuters
Published Monday, Nov. 21, 2011 2:32 PM EST

“Finance officials bit their nails and nervously watched the clock. There were 30 minutes left in a bond auction aimed at funding the deficit and there was not a single bid.

Sounds like today’s Italy or Greece?

No, this was Canada in 1994.

Bids eventually came in, but that close call, along with downgrades and The Wall Street Journal calling Canada “an honorary member of the Third World,” helped the nation’s people and politicians understand how scary its budget problem was.

“There would have been a day when we would have been the Greece of today,” recalled then prime minister Jean Chrétien, a Liberal who ended up chopping cherished social programs in one of the most dramatic fiscal turnarounds ever.

“I knew we were in a bind and we had to do something,” Mr. Chrétien, 77, told Reuters in a rare interview.

Canada’s shift from pariah to fiscal darling provides lessons for Washington as lawmakers find few easy answers to the huge U.S. deficit and debt burden, and for European countries staggering under their own massive budget problems.

“Everyone wants to know how we did it,” said political economist Brian Lee Crowley, head of the Ottawa-based think tank, Macdonald-Laurier Institute, who has examined the lessons of the 1990s.

But to win its budget wars, Canada first had to realize how dire its situation was and then dramatically shrink the size of government rather than just limit the pace of spending growth.

It would eventually oversee the biggest reduction in Canadian government spending since demobilization after the Second World War. The big cuts, and relatively small tax increases, brought a budget surplus within four years.

Canadian debt shrank to 29 per cent of gross domestic product in 2008-09 from a peak of 68 per cent in 1995-96, and the budget was in the black for 11 consecutive years until the 2008-09 recession.

For Canada, the vicious debt circle turned into a virtuous cycle that rescued a currency that had been dubbed the “northern peso.” Canada went from having the second worst fiscal position in the Group of Seven industrialized countries, behind only Italy, to easily the best.

It is far from a coincidence that the recent recession was shorter and shallower in Canada than in the United States. Indeed, by January, Canada had recovered all the jobs lost in the downturn, while the U.S. has hardly been able to dent its high unemployment.

“We used to thank God that Italy was there because we were the second worst in the G7,” said Scott Clark, associate deputy finance minister in the 1990s.

Canada’s experience turned on its head the prevailing wisdom that spending promises were the easiest way to win elections. Politicians of all kinds and at all levels of government learned that austerity could win.”  read more…

 

 

 

 

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