Austerity Kills GDP

By Don Schreiber, Jr. – WBI Founder and CEO

Jim Edwards of Business Insider published a strong piece on Europe’s emerging recession. We suggest a careful read of his analysis and conclusions driven by last week’s dire industrial production releases, which confirm the recession outlook. Even more troubling is coincident white papers by The Institute of International Finance and Oxford Economics crediting Europe’s post-Financial Crisis decision to pursue austerity instead of stimulus with permanently damaging Europe’s economic potential. Both publishers independently looked at the difference between actual GDP growth in Europe and “potential” GDP growth before and after the 2008 recession. Further, both studies concluded that Europe’s decision to pursue austerity and budget balancing instead of stimulus created a self-inflicted permanent reduction in actual GDP growth following the crisis. We believe the Fed is making the same mistake by raising interest rates too far and too fast while at the same time shrinking their balance sheet.

The U.S. economy has experienced the most anemic economic recovery from recession in history. And yet the Fed has assumed they can lift rates back to “normal” levels without damaging the economy. We don’t believe their assumptions are correct. The lack of economic growth and momentum limit our economy’s ability to absorb tighter financial conditions without falling into recession. The absence of material inflation with historically low unemployment should be another warning sign of systemic risk and weakness, yet it seems to be largely ignored by central bankers. With their current quantitative tightening policy, we believe the Fed is offsetting the Tax Act fiscal stimulus the economy desperately needs to create a growth cycle that is strong enough to perpetuate itself.

While the U.S. economy has been the healthiest and strongest developed economy in the world, its growth rate is starting to slow. And comparing U.S. growth to weaker European and Asian economies only gives one a sense of comfort until they realize that global economies are on a synchronized path towards recession. Before breathing a sigh of relief because the Fed has recently become more dovish in their tightening commentary, ask yourself why they would flip-flop so quickly because of the Q4 market correction. The Fed typically ignores the markets moves in determining their policy intentions.

The conundrums become more clear when you remember the Fed’s quantitative easing monetary policies were designed to promote consumer spending through a “wealth effect.” These policies infer pumped up asset prices, which make people feel wealthier, driving consumer confidence and spending. Central bankers around the world adopted the same tactics after seeing success in the U.S. Now as central bankers try to back off and normalize policy, they risk letting the hot air out of the asset bubbles they’ve created. As asset prices adjust to tighter monetary policy and recession risk increases, central bankers fear the strong consumer spending cycle they spent a decade promoting will abruptly come to a halt.

Central bankers should be cautious not to implode the recovery cycle they worked so hard to nurture by ignoring the clear warning signs flashing slowing growth, a lack of inflation, and adverse market conditions. It seems the global economies’ most significant problem as we move into 2019 is generating more growth — not less.

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