Guest Post: Some Observations on Austerity

Tyler Durden's picture


Some Observations on Austerity (pdf)

I’m at the Omni Shoreham on business the next few days, and all I’m hearing about is salary freezes here, and bank debt conditionality programs in Europe.  “Austerity” seems to be all the rage.  Problem is we don’t even know the meaning of the word.  Let’s face it: most of us are pretty coddled when it comes to belt tightening.

Austerity is not flashy.  Nor is it fun.  And it isn’t hopeless.  It is characterized by:

  • Ambiguous property rights
  • Extreme income inequality
  • And often enough, violence

So I found some data long forgotten and collecting dust to shed some light on the subject.  The data comes from a survey of 2,910 households, randomly chosen in clusters of 30 households, stratified across 32 of the 39 provinces in 1964.  The only region of this country not included in the survey was the Central Highlands, because the surveyors would surely have been killed as soon as night fell.  Half of the hamlets surveyed were “secure”, meaning that it was reasonably safe to travel there in daylight hours.  Whether or not the hamlets surveyed were under tight Viet Cong control is unknown, but they averaged around 16 miles from the nearest provincial town.  It covered all rice growing areas and most areas of commercial activity.  The country was South Vietnam. 

What clarity does this data provide?  It gives you glimpse of a world where people live without safety nets.  How similar economic life is a broad class of settings.  More importantly, it shows that austerity does not mean hopelessness.  Life goes on after a debt binge. 
In terms of income distribution, it is not much different than the United States… except that it is more egalitarian.  Richer people live in urban areas, and the poorest live out in the sticks. 

There was a heavier reliance on agriculture, of course.  But the majority of income came from wages and salaries, business income (entrepreneurship), and return on capital.

Even in a politically unstable, poverty-stricken, and violent environment… life goes on.  Even the poorest people spend money, some even sacrifice (7% of income), to educate their children.  Most Americans do this mostly through indirect subsidies via tax policy.  People buy big things even when ownership rights are tenuous.  But the take-away message is that austerity means little leverage, which implies people spend most of their money on subsistence goods like food and beverages.  Even the richest people in South Vietnam spent nothing near the affordability thresholds that banks use in issuing loans.  Most people spent less than 15% of their total income on housing.

Chart Porn

Note that the poorest spend relatively more of their income on subsistence goods. 

And even the wealthiest spend only 20% of their income on housing.  This is a function of the depth of financing, or the lack of it.  Banking matters to everyone, and a banking system that takes credit risk and manages that risk without backstops increases societal wealth.  Financial intermediation makes everyone better off.

While we are on the subject, the most substantive difference between South Vietnam and United States—the “developed” and “emerging” worlds lies in the finanical system.  We live in a coddled world that won’t understand austerity until it crushes the life out of our naivety.  At the same time, modern banks have been so used to easy money that they don’t really understand the origins of intermediation anymore.  For the record, intermediation didn’t begin nor end with a central banking cartel. 

Financial sophistication is all about funding modes.
Wholesale Bank Funding and Roll Risk

Financial intermediation is premised on acquiring pools of cheap funding and a lending to credit risk/reward profiles that create profits.  This funding consisted of deposits before we got a nutty professor as Fed chairman.  Intermediation meant this funding combined with assets held to maturity—loans and government securities—a safe business with reasonable margins.  As margins compressed, leverage become the common method to sustain profits.  Additional sources of financing drove down funding costs.  Wholesale funding was born.

Wholesale funding providers are money-market mutual funds (households), corporations, and other financial institutions, with excess cash to deploy on a short-term basis.  Wholesale funding instruments are repos, commercial paper, CDs, Fed fund borrowings and the like.  These instruments fuelled a lending model that borrowed at short durations with implied low risk and lent at longer term to greater credit risk profiles.  Banks extended leverage by accepting collateral that had value only so long as interest rates are subsidized by the central bank.  This is the chief reason for credit easing… it is the only way to control the long end of the yield curve.  To fall back on bank deposits as the chief funding source implies deleveraging:  the pool isn’t large enough to sustain current lending levels. 

When bank solvency is assumed and roll is assured at refinancing, wholesale funds are similar to deposit funds.  But when this house built of tarot cards collapses, refinancing aggressive short-term funding becomes incrementally more costly for banks.

Wholesale funding markets become sensitive to information and often are subject to maturity mismatches.  Information sensitive money markets mean the potential for acute roll risk.  Default implies that money market investors now know that they are not immune to loss of capital and liquidity.  Without precise information about specific institutions, refinancing becomes more difficult for all banks.  This can be seen when interbank rates, paper-bill spreads, and other spreads blow out.

Bear Sterns is a case in point.  48% of their liabilities were short-term collateralized funds.  When refinancing became impossible, high quality liquid assets plunged from $18.1 billion (March 2008) to $2 billion three days later.  

Why do you think that the government established a legal right to freeze money market accounts?

The problem is somewhat intractable.  So the tail-risk killers do what they do best:  throw money at the problem.  Hope that it allows for sufficient healing time before there is no more kicking the can down the road.

The George Costanza Moment

Perhaps the best course of action for Bernanke is a George Costanza moment:  doing exactly the opposite of what is expected.  The benefits of market-based interest rates are clear and obvious to everyone but the guys in charge of propping up the status quo.  It is probably clear to them to… not even they believe their bullshit anymore.  You may just get an Asian Miracle, meaning:

  • Savings will rise.  If you compensate depositors for their risk, deposit pools and wholesale funding will stabilize, minimizing roll risk. 
  • Institutions levered in all the wrong places will go the way of the dodo.
  • Things will heal in time, maybe sooner than anyone thinks.

South Korea was one of the poorest countries in the world in the mid-20th century.  It was absolutely impoverished by colonial powers and then devastated by civil war.  When Park Chung Hi acquired power, he went about subsidizing heavy industry and trying then then-conventional economic reconstruction programs. 

Maybe it worked after enough time elapsed, but all the data suggests all it created was inflation and misallocation.  Perhaps out of despair of anything better, Korean interest rates on deposits were allowed to rise.  The De-Reconstruction and return to the basics of rewarding risk and helping the prudent seem to me the real start of the Asian miracle.

Capital accumulation outstripped money supply growth and inflation.

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Mercury's picture

Perhaps the best course of action for Bernanke is a George Costanza moment:  doing exactly the opposite of what is expected.  The benefits of market-based interest rates are clear and obvious to everyone but the guys in charge of propping up the status quo.

Not just interest rates, let markets clear in real estate, bad debt, insolvent banks, mortgage defaulters and everything else that is being held together with government band-aids.

I don't see however why my or my government's austerity need be accompanied by "ambiguous property rights".  If that happens to any significant extent your economic miracle will most certainly not be happening "sooner than anyone thinks."

jm's picture

I was thinking about violation of creditors' rights.  Disorderly bankruptcy.  Government stepping in to help people avoid the consequences of their actions.  You know, punchbowl provision.

Mercury's picture

...or like Chrysler bondholders? residential RE foreclosure disarray? TBTF banks? FNM/FRE swept under the rug? the growing sense that bankruptcy law and bankruptcy itself is soooo 20th century?...I guess we're already there!

jeff montanye's picture

orderly bankruptcy.  bondholder haircuts or wipeouts (it's what happens in market capitalism, or should, with insolvency).  depositor protection according to law.  fnm/fre only given u.s. backing if so voted by congress, signed by prez (bad idea imo).  better, by far, than what we've got).

I need more cowbell's picture

Hello, my name is Ben, I'm unemployed, and I live with my parents.

williambanzai7's picture

This points to why the Asians are going to have the West for lunch once the shit really hits the fan. Their collective ability to survive on less dwarfs the West exponentially.

BTW, all those farmers living without safety a tough life, but they are essentially happier than a consumer serf.

Mercury's picture

...but maybe not happier than a surfing consumer.  Some of us like to think we find a decent balance on a level somewhat above subsistence agriculture ;)

Green Leader's picture

When "the shit really hits the fan" the Asians will be attacked with race-specific bioweapons. Bye bye.

trav7777's picture

people who talk this way do not understand debt-based monetary mechanics in a climate of contraction

Green Leader's picture

Do you have references I could look up?

I've noticed you keep mentioning the 'economics of contraction' and I see the social havoc it is creating.

DisparityFlux's picture

Charts for an austere agrarian economy that evolves into a mercantile/industrial economy.  But what happens when a pro non-caste society of an industrialized, high energy importing, consumptive economy declines into a two class system -- impoverished and wealthy -- without the ability to export the impoverished class or increase their economic utility?

Oh, lawlessness and violence.

But not hopelessness, because we got TV, Internet, iPods and the FRB.

jeff montanye's picture

there is a lot of talk of pitchforks and pikes and lampposts on this site but imo, it will take about one bullet (another shot heard round the world) to recast the power nexus of the bankers and governments vs. pretty much everyone else.  not to be interpreted as a call for terrorism, oh ones who can assassinate on executive order (this is a positive not a normative comment).

DisparityFlux's picture

I hear you.  I think the problem is that we have a target rich environment and the social mood leans more toward don't bite the hand that may feed you.  Speaking of social mood.  If mood rings of the 70's became faddish again, and indicated the level of the wearer's discontent, I dare say they would only emit a single hue with the brightest intensity.

jm's picture

The data shows that the majority of income was not agrarian.  It was wages, salaries, business income, and return on capital. 

The societies are not so different as to be incomparable.

RockyRacoon's picture

I think the drawing of parallels between the discussed societies and the United States will reveal some major flaws when the will and resolve of people are factored in.  A study of the economics involved is pertinent but the sociological factors are an undeniably large part of the equation. What happens when all the psychotropic drugs are cut off?

jm's picture

People will get sad, get angry, and ultimately accept the unpleasant realities of life with a delevered financial system.

People will still buy the same things and do the same things.  Just less of some things.


RockyRacoon's picture

If pendulum swinging is an apt analogy, there will be some historic social unrest to follow the reduction in brain-numbing drugs, then the swing to a "new normal" same as the old normal.

NewThor's picture

My butt was submerged in water. I farted. It made bubbles. Emperor Bernanke can you drop some dollars into my hot tub from your baby-blood powered gold helicopter?

szjon's picture

Meanwhile in the UK, council meeting stormed, police overpowered by anti austerity protestors.


The steam is building.

zalexs's picture

It is curious that now a deficit of 5% or 7% or even 9% for Greece is "austerity", what would be then  a deficit of 3% "torture"? and a deficit of 0% "crime against humanity" ?!!!

cashcow's picture

Here is what is really happening on the streets of the UK, but for some reason does not seem to get into the news:

Police attacking pregant woman.

Snidley Whipsnae's picture

Rural Japan from 1955-58 was an austere group of villages. Fishing with small skiffs and farming with small holdings growing rice, some wheat, and vegetables.

There were no tvs, few radios, and many bicycles. Schools were excellent and the youngsters studied long and hard.

The villages I lived in were basically unchanged for a thousand years or more. Japanese over 80 years of age, too old for the hard work of pulling nets or stoop labor in the rice paddies, would stay home and tend the children and winnow rice in the wind, cook meals, clean fish, etc. They were very healthy. Most of the Japanese I encountered had never seen an American except the occasional Catholic Priest or Nun. The Catholics were doing good work there, providing orphanages for the children left without families after WW2.

The Japanese seemed very happy to me and did not resent their lot in life. I learned their language and never expected them to learn English.

Americans do not know the meaning of austerity, have not experienced it, and therefore, cannot imagine it.

What is so great about a culture that takes it's cues from Hollywood, tv, and a rampant out of control government and FIRE sector? Why the drive to own multiple residences, million dollar autos and multithousand dollar shoes and handbags? I have never understood this.

Returning to the states was a shock for landing on a distant planet and discovering a new and very different 'intelligent' life form.

Mercury's picture

Revenge of the Nerds once seemed improbable.  We may soon see the Revenge of the Dwight Shrutes!

Actually I think there are still quite a few Americans who would thrive under the type of conditions you describe although I'm sure their number is a lot smaller than it once was.  I suspect that those closer to the bottom of the socio-economic scale who rely heavily on government support, government employees with minimal skills and those on the higher end of the socio-economic scale who have been almost totally insulated from many of life's privations are in for the worst shock if TS really HTF.

We all know someone like the ornery, Dwight Shrute and recognize him as a classic if anachronistic type of American character who seems  at least a little bit out of place in today's culture.  His star may yet rise again.

Snidley Whipsnae's picture

I agree....some Americans would do well in conditions of austerity. Some Americans that post their intentions to 'buy a small farm and live off the grid' do not have a clue.

The amount of work and know how required to run even a small farm is enormous. The work ethic and know how are not aquired quickly, but over years....usually passed down from father to son. There are few eight hour days on a farm if it is to include a few dairy cows, a few head of beef cattle, hogs, chickens, a truck garden, some fruit and nut trees, about a 40 acre wood lot, and a larger cash crop ie; corn, cotton, soy beans, sugar cane, etc. I know from first hand experience that the work on a place like this is endless. Wash up about dark, eat, fall into a bed into a deep sleep and awake before dawn to do it again. Six or seven days a week.

If rule of law no longer exists then running a farm becomes about the many wars that raged throughout Europe that devastated farms and their families. One of the reasons that the French finally accepted potatoes as a substitute for wheat is because the maurading armies were too lazy to dig up potatoes but would set fire to or harvest above ground wheat.

Actually, the time period that I lived in Japan was one of the best of times for the farmer/fisherman Japanese because the maurading Samurai and their war lords had been wiped out. The history of maurauding armies in Japan and Europe are not so different. Those wishing for anarchy should read some history....Although we have a steadily declining and really crappy government it is still better than anarchy for the average person.

Green Leader's picture


Add on top the romanticism of 100% organic fertilization.

My grandfather ran a 700+ acre coffee plantation--there were no motor vehicles nor electricity back then. The place was steam and mule powered (40+ mules and his horses) and ran on 100% organics (manure & coffee husk compost).

One day my grandfather was telling me about how the advent of chemical fertilizer in the early 50's saved him from becoming bankrupt. His eyes popped, clenched his fists and trembled as he spoke those words.

I never forget that moment when I interact with the organic groupies. To this day, I've always have been keeping quiet. I know one day I won't.

Mercury's picture

Didn't know that about the pomme de terre although it obviously makes a lot of sense under those conditions.  I can just see the French resisting a foreign vegetable with all their might until ultimately re-branding it as a part of a military tactic.

4xaddict's picture

YES! Finally someone else who can't tollerate this ignorant head for the hills and be a farmer horseshit.

"Well I'll just buy some land an become a farmer" (cue Mickey Mouse voice)

Sure, and when you find out that the land for sale is all the worst plots because the real farmers know how to value the good ones I guess you will just go work for NASA or become a Vascular Surgeon. With this level of natural ability one wonders why you haven't already made trillions trading brass razoos on the Mongolian Horse exchange and retired to your own island with an impregnable force field and a Targus for a quick exit.

Thank you SW.

Lndmvr's picture

I spend time each day with my uncle who at 96 is fading away in a nursing home. He still owns a 160 acres in Iowa and share farms it with a basically honest man. Owned it since the 50''s. Talks about the mules and horses he used. We (family) wre out there loooking to tear out the pastures and change to grain since cows have become onerous and in the hedge rows the we found a plow, 2 row corn planter and simular old timey stuff. Problem is if he lasts past Jan 1 , the inheritance taxes take the value away and it will leave the family. At least it will provide deer jerky for this year. One thing he always says when we talk about the past.  " Mans got to have some income".

steve from virginia's picture

Policy makers don't have the courage to let markets clear. Why?

Because they know the truth about the markets in our waste- based economy. There is no upside anywhere, no growth to be found.


Resource constraints are hammering the economy from the bottom and have been since 2004. On certain levels the economy has been hammered since the mid- 1960's when the US petroleum production relative to US demand started to diverge.

50+ years of bailing wire and duct tape expedients leaves a very large overhang of both debts and liabilities due the rest of the world. The hundreds of billions of barrels of crude sucked out of oil fields overseas and vented into the atmosphere from American tailpipes with nothing to show for them represent a bill the exceptional US owes that will be removed from that economy when 'The Market Clears'.

Neither you nor I want to be hanging around when this remarkable event takes place which is why Snr. Bernanke and Co. are doing their best to keep all the plates spinning, hoping for a miracle.

While I agree that accounts will balance in the end, realism suggests that the process will be beyond mind- boggling. Thermodynamics insists that the various and sundry accounts will fall to more or less zero which is where institutionalized brainlock combined with advertising have led us.

To summarize, if we all want to get to zero in a bigger hurry than events will otherwise allow, let's let the damned- fool market set interest rates!

RockyRacoon's picture

Ever seen one of those spinning plates up close?  They have huge depressions in the center and exaggerated lips around the edge.  The plate can actually hang on the stick without falling off, and it can sit centered on the stick without spinning.  The bottom line: The trick is rigged!  Just as this Fed/Wall Street market is rigged.

jmc8888's picture

You can't put a good face on austerity.  Especially when it's apples to oranges, and the apple you're comparing is very small and far away in a single picture.

Not to mention the ONLY, and I repeat ONLY reason for the budget crises around the world, sans a few fuckups that always occur, is the way the MONETARY system was run. The SYSTEM CREATED THE BUDGET DEFICITS.  If you don't understand that, you're one dumb fuck.

The only reason they call for austerity is to pay off debts and to balance budgets, as if what they were cutting was the cause of the deficits.  Fucking idiots think that, nothing more.

You can't hyperinflate the federal reserve and throw trillions upon trillions into insolvent entities that took fraudulent risks, and defrauded the countries bailing them out, pushing everyone into pm's and commodities, and expect anything but even more drastic budget problems to appear.

In this scenario, even if you cut social spending to 0, the budgets would still be worse than they are now. That's what this collapsing, monetary, perpetual bailout system is all about.

It's MURDER to try to balance a budget on one end, when the fed is hyperinflating on the other.

One could say if the safety net is providing golden toilet rolls, that perhaps it should be cut.   But you cannot say that, when for longer than I've been alive, and throughout my life I've seen nothing but the following, extracting little gains from improving efficiancy on small things.  Cut a little here, stretch a little there, combine jobs, outsource, go from paper to plastic, pay your bills in the first 10 days to get 2 percent discount, I could go on, and on, and on.  But for 40 years, that's all we did.  Print money, and TIGHTEN belts.  After 40 years, the belt is pretty small now, and yet NOW they are acting like we have to FIRST suffer.

Sorry, we've been cutting and paring stuff back for 40 years.  Austerity has been here for 40 years in America.  Not a direct, extreme variety, but a small, penny pinching, eroding the foundation type. You KNOW you've seen it.  Hell IBM turned into a business full of finding ways to cut costs.  It's what gave the 90's an extra boost on top of the bullshit.

But you can only stretch something so far, and we've already done stretched it to almost it's limit.

We've already allowed the bls statistics tell us inflation was so low during my lifetime, that the things that have gone up in price 300 percent since I was 10-15, 32 now, have on paper only gone up 30 percent.  BULLSHIT.  Guess what that means for social security?  That's right, if you're getting 1k a month, you should be getting 2k, etc.  

We've already had the equivalent of the hidden inflation trick pulled on us, and have had it pulled on us for DECADES.

Even in my home state of AZ, we have a fascist, dumbfuck, idiot, traitor, murderer, republican gov, who talked about how she didn't want the obama's deathcare isn't good, (it wouldn't of have been good, a tragedy compared to single payer), of course being a republican, she doesn't care to have an alternative on anything ever, but when the budget gets cut, what does she cut?  Oh that's right, people off the transplant list.  So the retarded gov, who was against Obamacare because of it's realistic death panels (nothing about the HMO's versions currently and for decades in practice deathpanels), was for her OWN deathpanels to balance the budget.  It just doesn't get much more pathetic than that.  Other than the amount of republicans who voted for this stupid bitch.

If you voted for Jan Brewer, god help your dumb ass.

If you allow austerity in, you'll be even stupid that dumbfuck fascist whore Jan Brewer. 

There is no place for austerity.  There is no need for it.  We can still change over, but we need Glass-Steagall. 




LoweredExpectations's picture

Hey fellow Arizonan. You're right of course. The only answer our troglodyte legislature has had has been to cut taxes. Budget surplus: cut taxes; budget deficit: cut taxes. No need to ever think about how to pay for essential services when the answer is always: cut taxes. Only now are the idiots just starting to look at the consequences of sentencing mandates - got to be tough on crime, ya know - even as the prisons fill up and CCA becomes a third branch of the legislature. Too bad we don't have any toll roads to sell to Abu Dabai.

jm's picture

Austerity has been here for 40 years in America. 

This is the most breathtakingly stupid comment I've ever seen posted by a seemingly sane person.  The total nuts I exclude from consideration.  If fact, I kinda question your sanity after considering U.S. federal, state, muni, consumer debt.   

kummar's picture

If indeed these are the actors set on setting the world ablaze, they are more than likely the same ones who are involved in Greece, Portugal, Dubai, and elsewhere. Presenting: Moore Capital, Brevan Howard and Paulson & Co... Oh and JP Morgan and, ahem, Goldman Sachs.1972 Toyota Pick-Up Truck AC Compressor