Guest Post: Why Austerity Is Necessary

Tyler Durden's picture

Authored by Jeff Young of Woodbine Capital,

Austerity Is Necessary

Austerity is under attack again, with Cyprus about to enter a program. Critics charge that austerity is self-defeating because it depresses growth, pushing up the debt/GDP ratio. However, austerity is a necessary (although far from sufficient) condition for countries with low national savings Indeed, there is some evidence that austerity is beginning to have positive effects. Higher savings have improved market perceptions of debt sustainability, making countries more resilient to shocks (Cyprus, Italian politics).

What is austerity for?

Austerity is sold as a way to reduce public deficits, but what it is really supposed to do is raise net national savings (savings minus depreciation) in the entire economy (not just the public sector, the private sector too). Certainly one lesson of the rolling European crisis is that excess debt can create funding crises regardless of which sector – the government, banks, households, or corporations – did the borrowing. What is important is, are savings in the entire economy sufficient to finance debt in the entire economy? If no, debt sustainability will be questioned. But if a country increases its internally generated savings, it can service its current debts, and it can invest to create a stream of income to service debts in the future.

In this sense, the commonly used debt/GDP ratio – the stock of debt divided by the current year's income – is misleading. More relevant is the amount of GDP that will be created over the lifetime of the debt, and this is surely related to the amount of savings generated by austerity. Market perceptions of debt sustainability can improve even though the debt/GDP ratio rises. This will happen when austerity depresses current growth but raises net national savings. After the ERM crisis in 1992-1993, debt/GDP ratios in the hardest-hit countries rose for many years, but bond yields declined rather quickly, as net national savings rose.

To be sure, European governments have been guilty of false advertising. They claimed that fiscal austerity would not hurt growth. But in order to raise savings, it is necessary to consume or invest less (unless a country is lucky enough to enjoy an export or productivity boom). As a result, growth will suffer as a country raises savings. But once savings begin to recover, elements of a "virtuous circle" begin to fall into place. Debt is serviceable and investment can return, which further enhances perceptions of sustainability. Appropriate banking and monetary policies are also necessary, but they do not obviate the need for higher savings.

Which countries are saving themselves?

Let's look at the performance of the three program countries – Greece, Ireland, and Portugal – and Spain and Italy. Greece and Portugal had negative net national savings in the five years preceding the outbreak of the European sovereign crisis in 2010. This means that they were not even saving enough to maintain their existing capital stocks. Ireland had positive net national savings, although the level declined sharply. Spain looked more like Ireland – positive but declining net national savings – whereas Italy had lower levels.

As of last year, Greece had improved to about -5% of GDP (from -14% in 2011), Portugal to -4% (from a trough of -8% in 2009), and Ireland had managed to maintain small positive net savings. Greece and Portugal in particular have much further to go, but it is noteworthy that both countries managed to raise their net savings last year: gross savings rose, investment declined, and depreciation fell.

Ireland was almost lucky to have had its problem centered in real estate overinvestment. Once the real estate bubble ended and investment crashed, net savings rose more or less automatically. The crash of investment and real estate prices necessitated banking support, but once that was in place, higher net savings allowed the bond market to stabilize. Ireland has even begun to invest again (capital formation rose 2.6% in the fourth quarter of 2012, from a trough of -31% in early 2009).

This is an early sign that the process is entering into a virtuous circle.

Greece is a different story. There, excess consumption (both private and public) had left gross savings chronically low, and there was not a lot of investment to slash. The only way to raise net savings is to cut consumption, which is much more difficult than cutting investment.

Spain resembles Ireland, in that it sported an Asia-like investment rate of 30% of GDP before the crisis, mostly in construction. Since Spain hit the wall, investment has plunged, but almost entirely in construction (-10% of GDP), which has helped repair national savings with only a minimal impact on future growth potential (machinery and equipment investment is down by just 1.5% of GDP). Italian dynamics are less favorable, as savings were lower to begin with, and investment rates are low enough that they cannot be cut much further. This implies that politically difficult cuts in consumption will have to be the primary means to raise savings.

The scale and timing of the required increase in savings is a different question from whether savings need to increase. In some cases an official sector program, or even restructuring, might be necessary. But this does not reduce the need to raise net national savings. It just suggests a different path for higher savings, or in other words, a different dosage of the same medicine, rather than a different medicine altogether.

Limited contagion from Cyprus?

Contagion to other sovereign markets has been muted since the Cyprus crisis flared up, despite poor crisis management and losses on certain classes of claimants (bank depositors and creditors) that constituted about as severe a shock as could be imagined. Perhaps Cyprus is just too small to matter. But perhaps the increase in net national savings in periphery countries has left them in a stronger position to withstand shocks. With a bigger pool of domestic resources available for debt service, contagion is less likely. Much more remains to be done (after all, Portugal and Greece still have negative net national savings), so the improvements might be enough to withstand a really large shock. But they have made the system less fragile.

In a similar vein, the EUR has been largely stable since the Cyprus shock: the EUR is down, but only modestly and in line with cyclical factors, with no contribution from fragmentation and ‘redenomination’ fears. Since last year there have been greater self-efforts to rebuild savings, and a wider mutualized backstop at the European level, effectively reducing (although not eliminating) euro redenomination risks. To some observers, the high reliance on self-help to save a currency union is contradictory and maybe even mutually exclusive, but such is the hybrid that is the EUR.

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tenpanhandle's picture

Austerity is coming one way or another.

otto skorzeny's picture

austerity for everyone except those that carry a gun on the government's behalf

Ahmeexnal's picture

Aaah. Austerity. Doublespeak term for "socializing the losses of the kleptocratic gambling oligarchic banking mafia".

But don't tell the sheeple. Let them believe austerity is good for them, it says so in the bible.

Supernova Born's picture

Stealing middle class earned wealth is the divine right of the moneychangers.

EnslavethechildrenforBen's picture

Austerity is a nice way of saying " work for nothing slave, or you'll be shot in the face by that drone that has you under surveilance 24/7"

Humans simply need to accept that they are 100% owned by other superior humans.

 Why resist when you get to go home every evening and watch TV?

Freedom would really suck, wouldn't it?

pods's picture

Austerity is merely the signal that the banks have healed their balance sheets enough to take possession of the property from the serfs.

Same as it ever was, you know, the "business cycle."

Expand phoney credit, make the skim.  Contract credit, take property.

Fucking good gig ain't it?

Night all.


ebworthen's picture

Fuck Austerity, what a canard, what a lie!

Enrich the bankers and banks while fucking over the little people.

Jesus H. Christ, what have we not learned?  No bailouts, clawback of banker salaries and bonuses, hang the politicians and bankers, end the neofuedalism!  Starve the beast!  Fuck the investment banks and their lackey politicians!!!!

TomyT's picture

If you guys are right about austerity,  Japan will be a powerhouse in a couple of years.  We can see the results play out before our eyes.  It is Krugman vs Bass.  I will put my money on Bass.  Austerity is just another way of saying we are broke.  This heated rhetoric does nothing to help with the debt problem.  Japan, Argentina, Greece, Italy, Portugal, Spain,  and Ireland.  No defense spending or Bush tax cuts in those countries.  It is all entitlement spending and it is dooming those countries just like it will doom the US.  Reality will win in the end.

BigJim's picture

Exactly. I don't understand how so many ZH'ers are down on 'austerity', per se. The original article is not proposing continuing TBTF policies or bailing out our oligarchs, or droning more shepherds, merely pointing out that government spending - which arises from deficit financing and QE - needs to be cut back.

Yes, it would have been good if he'd pointed out that, in our debt-based monetary system, cuts in government spending and saving actually lead to monetary deflation, and thus 'austerity' on its own isn't going to fix anything; but cutting government spending is one of the key ingredients of getting our economies fixed.

Presumably, if he'd addressed fractional reserve banking in our fiat currency milieu, military overspending, majoritarian tyranny and crony capitalism, all within the context of a 500-word article, ZHer's would be applauding him? 

jeff montanye's picture

yes this article does propose continuing too big to fail policies: "The crash of investment and real estate prices necessitated banking support".

and he's talking about ireland man.  where the taxpayers straight out paid the banks (and without being able to print euros, unlike bernanke, etc.).  what do words mean?

the whole thrust of this article is all the debts must be paid.  well, no.  they must not and, tis true tis true, they won't be.

jeff montanye's picture

what is hurting japan since 1989 is exactly what is ailing the west since 2008: the refusal by the governing elite to reorganize the banking sector, liquidate the stockholders, the bondholders and the toxic debt, while protecting insured depositors, and, in an orderly fdic style fashion, recapitalize the financially functioning parts of these banks, replacing the, apparently, incompetent managements that led their companies into bankruptcy.  

keeping the "zombie" banks prevents an organic recovery, as japan since 1989 so amply demonstrates.   

how much of the recent additions to world wide government debt is a result of weak economic growth and how much the secular trend toward more spending and less taxing is a matter of considerable debate.  what isn't or shouldn't be is that too big to fail/jail is wrong on every level but the odious, and short sighted, selfishness of the corrupt rulers.

CheapBastard's picture

What would a person hate the most:

1. root canals w/o anesthesia;

2. being trapped in a 6x6 room with a life insurance salesman for 2 hours (w/o anesthesia);

3. a fork lift running over your foot (w/o anesthesia); or,

4. austerity w/o anesthesia ?


You choose.

Bicycle Repairman's picture

OK.  Austerity with legalized pot.  Wait.  No.

francis_sawyer's picture

Ned?... Ned Ryerson?... Ned the Head?...

Awakened Sheeple's picture

The austerity argument implies the system can be saved. It can't. Reset now and let's get it over with.

flacon's picture

The usury is the root problem. Creating money out of nothing and charging interest on it. So yes, I agree with you completely. Let's start again with an interest-free "money". 

HardAssets's picture

The system was designed to crash so that national sovereignty and governments minimally accountable to their own people would be destroyed. 'Austerity' is about breaking people so they will be compliant.

Ghordius's picture

"The system was designed to crash..." nope. it goes always back to what fractional reserve fiat banking is and an endless conspiracy theory behind it

nope. fiat systems are designed for... war

get it in your heads, fiat central banking (not it's joined-at-the-hip older brother Fractional Reserve Banking) was born as instrument of sovereign power made for "great efforts" - usually war

note: a sovereign with a national bank is not automatically using it for war or other "great works" (for example the great Fannie and Freddy give-a-house-to-everybody programs which the US has and the UK might copy, soon) but it has the potential of going into a first-war-then-we'll-see-who-pays situation that gives a strategic advantage

this design thing has little to do with our real situation: the deep capture of the USD by a couple of megabanks for their own purposes: seven-figures bonuses

go and look at the real history of CBs, of which the FED (born 1913) is a late newcomer and an odd bird, to boot

nmewn's picture

May have been designed to finance war(s) but in the absence of REAL war where survival of the state (any state) is the object it (and its designers) have turned its use to the financing of social programs.

What better way to protect itself from attack by all constituencies?

It says, to the masses huddled around the ATM at the titty bar, if you touch me your family will

Probably shouldn't have interjected here because I have to go to work...but I couldn't resist commenting on the two-headed snake that is...central banks & government ;-)


Ghordius's picture

100% correct - though note the ugly truth behind the US "make-homeownership-affordable-to-everybody" programs which heavely subdidized for decades what we call the "US Middle Class" - robbing Paul's son to give to Paul, in practice

MrPalladium's picture

Instead of the savings from austerity being invested in productive enterprise it is being used to keep alive and service bad debts. Until those bad debts are written off or restructured "austerity" is just servitude to banks.

Remarkably stupid article.

Bee's picture

Wrong.  The Bible says that bankruptcy is the solution. 

Bankers are substituting austerity for bankruptcy. 

The Bible calls for bankruptcy of the bankers, not bailouts.

Bendromeda Strain's picture

Good for you Bee. Honest weights and measures, cyclical rest and Jubilee. It is economic rocket science apparently.

Go Tribe's picture

And then sending their kids to die in wars to defend the U.S. mafia against other mafias.

prains's picture

if austerity means jailing banksters and their corporatist junkies then wiping clean the entire congressional infrastructure then i say RELEASE THE KRAKEN

DaddyO's picture


Austerity is a load of crap foisted on the populace by a bunch of lying, cheating imbeciles who have spent us into oblivion and now they are telling us we must tighten our belts, Bullsh*t.

Just like the same politicians now telling us we must give up our guns and ammo because some nutjob goes haywire, show me the logic in either argument, morons...


PS: I think Tyler posts these types of articles just to get my blood pressure up...

flacon's picture

Also, I didn't see any casualties or dead bodies or even blood at Newtown CT. Just sayin'.... 

HardAssets's picture

Theyre not imbeciles at all. They know Exactly what theyre doing on both the austerity and gun control fronts.

They want us broke and under control . . . a population of slaves.

DaddyO's picture

They are imbeciles for trying to do what has already been proven to be a "Fail", namely Socialism/Facism.

It just doesn't work...


Go Tribe's picture

As long as there is a single corporate building along the beltway, there will be room to cut government.

prains's picture

real austerity will NEVER be announced, it comes as slow drip inflation, stealth taxation/controls, death by a thousand cuts is the plan. This is the real austerity




rotagen's picture

Austerity: paying a cartel of "jewish" bankers for debt that doesn't exist, based on money that is printed by pressing a keyboard on a computer.  Otherwise known as "Phase 2 of the destruction of the economies of the world"  .. in preparation for phase 3... overt as opposed to the present COVERT control of every "citizen" by said WANKERS.


This may or may not be related to the birth of the internet, and subsequent loss of media control by these same wankers.

Confundido's picture

Neither austerity nor spending is needed. What we need is liberty and free markets, with prices signalling whether we spend too much or too little.

darteaus's picture

Because THERE IS NO MONEY.  There never was any money, just the same piece of paper with a couple of more zeros.

"Gold is money.  Everything else is credit."  JP Morgan.

StarTedStackin''s picture

Austerity = Paying your own way




No Shit it's needed!

StarTedStackin''s picture

Go blow me. -5 socialist trash........I'm tired of supporting you  ticks and leeches!

LetThemEatRand's picture

You don't support me and I down arrowed you.  The true leeches are the money printing scum who drove our economy into the ground so they can keep a new Bentley in the garage via crony capitalism.   Now go fuck yourself while listening to Rush or Hannity or whatever other pro-banker propaganda you enjoy hearing while fucking yourself.

pods's picture

Glad you stuck around LTER.  Nice right cross too.


Jack Burton's picture

Well Rand, I read the original article above and it stinks of Banker and it stinks of the Neo-Liberal economics of the past 30 years. Austerity in their minds is ONLY for the little people, while they feast off of ZIRP trillions that debase the working man's wages.

Some people are fooled into accepting that the global economci crisis is because Grandma gets too much of a Social Security pension and too much Medicare, and all those 50 years they paid into the system? Well, that went to invade Iraq and conquer Afghanistan. To build drones to bomb Pakistan. To bomb Serbia to bits. And to run a crooked war on drugs. But some people just don't get it. They know the SS fund was stolen for war since Vietnam, but still they hate Grandma for being a so called leech.

We ssaw how fast the banks and the markets were bailed out. We saw how military spending increased during the recession. But no matter how many billions the rich got from government, they lead the charge to strip old people of a puny little pension like what SS really is.

Austerity is needed. I agree. Lets start with the bankers, the hedge funders, the commodities speculators, the weapns makers, and the political class which feeds them tax payer money or destroys the dollar through QE to feed the banks.

TomyT's picture

You just described a liberal democracy, why are you blaiming Hannity or Rush?  Crony Capitalism is a liberal construct and always happens under liberal forms of government.  Crony Capitalism cannot thrive under a limited government.  You can blame Rush and Haniity for alot of things, this one is all on the liberal Democrats.  Look at Detroit and California.  In order to solve a problem, you have to correctly identify the root cause. 

TheFourthStooge-ing's picture

Anyone still playing the left/right democrat/republican liberal/conservative game is still clinging to their blinders.

They are phony choices presented to keep people arguing with each other, preventing them from seeing the big picture. The United States is ruled by criminals under a one-party system masquerading as two parties.

If you present cattle with a choice of entering the abattoir through the left door or the right door, the end result is the same. Those who cling to their blinders are choosing to remain cattle.

Hulk's picture

Austerity coming: There is no choice...

Accounting101's picture

I'm calling bullshit! Austerity is simply a fancy term for redistributing wealth from the middle and low classes upwards. US taxpayers bailed out Wall Street to the tune of $23 trillion dollars since 2008 and now tools like Hulk and the author tell us we need to give more.

Ireland is mentioned as a country who forced austerity on its populace and it is now leading to an Irish Spring. Bullshit!!! The Irish elite have destined generations of Irish to debtor status. How did this piece of shit piece ever get through Zero Hedge editors?

StarTedStackin''s picture

Bullshit, you are socialist garbage

fonzannoon's picture

the only bright side to austerity is that profligate banks and other institutions are allowed to fail....yep cause that definitely happens....

Liberty2012's picture

LOL ... ah well ... at least the comments are good

Work gives money value - money is work traded for work - current real time value - debt is a promise of future work - you can't get blood out of a turnip - an aging population produces less work, and the younger ones are waking up - the con is winding down

Saving in the context of this article is more like stealing -

Trading, sharing, giving, etc are all basically the same thing. Free will means "I choose" how to "spend" my actions and what "payment" I will accept.

Forced saving is the same as extortion.

Jack Burton's picture

Accounting101, Yes, you see through the bullshit. If someone calls you a socialist for speaking the truth, then that person who calls you a socialist is a shill.

StarTedStackin''s picture

Tick and leech O'Bowel Movement Voters have arrived!

fonzannoon's picture

you are flailing. It's okay. Take a breath and regroup. sometimes you get gut punched on here and while you are on the floor gasping for breath you realize you had it coming.