The world is witnessing a worrying trend: the rise of the “Austerians.”
The term refers to policymakers bent on reducing government spending, according to James Montier, a member of the asset allocation team of GMO, a Boston-based global investment management firm.
“This breed is the latest incarnation of what used to be called the deficit hawks, a group set upon reducing what it sees as the government’s profligate spending,” says Montier in a study released by GMO.
He questions whether austerity measures are indeed the antidote to ruin for today’s struggling economies.
The study highlights the paradox of thrift, which it says are often ignored by the Austerians. “If a fiscal surplus is pursued, and the domestic private sector is stuck in deficit spending mode, then the financial fragility of the economy is likely to increase, raising the probability that more fiscal spending will be needed in the future,” says Montier.
History stands witness to policymakers beating an incipient recovery on the head with overly aggressive tightening measures, and snatching recession from the jaws of recovery.
“If the examples of history are ignored then policy error is likely to be a serious source of deflationary pressure,” notes Montier. Austerity measures are the last thing a debt-laden economy needs, especially one that is teetering on the brink of deflation anyway. And yet it doesn’t prevent policymakers from trying to tighten, he says.
At the center of the argument is the theory that tightening leads to a relapse into recession. The report, however, concedes that policymakers are under tremendous pressure. “They are caught between a rock and a hard place,” says Montier. On the one hand are the Austerians and the bond vigilantes who argue that unless governments act, there will be sovereign debt crises. On the other are those opposed to fiscal tightening.
Montier warns if the Austerians have their way there could be some short-term deflationary pressures, which may prove to be even more dangerous than experienced previously, because now there are no margin of safety in terms of the inflation rate.
An economic environment marked by short-term deflation and long-term inflation calls for robust portfolios. A robust portfolio is one that is protected under a number of different possible scenarios, says Montier explaining the portfolio implications of austerity.
“Indeed, robustness is a much neglected trait in portfolio construction,” he says. “In the past, I have often talked about the need to consider cheap insurance in circumstances where we simply don’t know the outcome of events.”
An investment operation promises safety of principal and a satisfactory return. Against this backdrop, “bonds are a lousy investment.”
“Judged from a long-term perspective in which inflation must be a concern, bonds look exceptionally unattractive.”
(07/28/2010)