The T Report: Austerity, Spending & the Black Market in the Room

Posted by on May 1, 2012 in Uncategorized | No Comments


A dull morning with the Euro markets shut down. Stock futures have meandered throughout the overnight session, trading up and down, but in a narrow range. We get the ISM data and vehicles sales today. It would be surprising if ISM didn’t disappoint, which means the market has already priced in a print lower than the expectations of 53 calculated by Bloomberg. Vehicle sales will be more interesting. They have been helpful for the markets, but weather, and some evidence of channel stuffing, could make for a disappointing report this time around. Any upside surprise in this number will be a welcome relief for the bulls.

In spite of the holiday in Europe, it is still one of the biggest issues in the market. I am not sure how the debate has turned into austerity versus growth? Growth, or at least sustainable debt levels is the goal. Austerity and Spending are ways of achieving that sustainable debt level.

Growth is one way of achieving a sustainable debt level. A bigger economy would more easily support the existing debt. The key here is not creating more debt than the growth can cover. That has been one of the big problems in recent years the spending hasn’t resulted in enough economic growth to cover the cost of that growth. If finding an investment that could easily pay for itself was that easy, the earnings of the S&P 500 would be much higher. Projects that can create more than enough growth to cover their cost should be pursued. It has to be a mix of near term projects and longer term projects. Longer term projects may offer the best possible return, but they have more risk, and the market may be too impatient if the spending outpaces the growth potential for too long before the project comes on line. So yes, spending to create growth has to be an option on the table, but assuming it is easy, is wrong. The tendency to fund fancy projects, like Green Energy, rather than dull things like highway expansion, is bad, because the dull project may add a lot more value.

Reducing debt and reducing expenses is another way of achieving a sustainable debt level. It is depressing and a bit scary that governments have promised far more than they can deliver. We all know that the social security and medical care that has been promised will be very difficult, if not impossible to deliver. Demographics, life expectancy, low interest rates, advancement in medicine, etc., all have played a role in making these promises so difficult to fulfill. Cutting these now is realistic and actually lets people prepare and adapt. Cutting these programs has limited impact today, but is key to creating a sustainable future, and as bad as it is to take away promised benefits, it is better for people to have a realistic expectation of the future and be able to prepare for it. This may be very difficult to achieve from a political perspective, but has the least impact on the current situation while creating a future bond investors can trust in.

Then there is all the existing spending that has limited value. Just like new spending should be examined in terms of what can generate growth, existing plans need to be reviewed. Obama never got around to the line item review of all expenses (at least not that I know of), but that might be required. While embarking on new spending programs, let’s figure out what programs should be cut. Clearly they aren’t achieving the goal of a sustainable debt goal. Some things may have to be cut back. This also won’t be easy, but can probably create some immediate benefits without disrupting the economy much. Yet, for politicians, this is also hard. Spending new money is easy, taking money away from someone is hard, yet that is what needs to be done.

So new spending that creates more growth than it costs should be pursued. It won’t be easy to find that many obvious projects, but at least politicians have an easy time spending more money. Cuts, both in the near term and to future promises are also required to create sustainable debt levels. These are easier to find, but more difficult for politicians to implement.

Then there is the pink elephant in the room, or in this case, the black market. Spain has an official unemployment rate of 24%. They project it to be 22% in 2015. This is structural. I cannot imagine the U.S. surviving with that level of unemployment. The unemployed would have taken to the streets long before it hit that level to demand change. In fact, I find it difficult to imagine any country surviving on that level of unemployment, unless it is structurally encouraged. Are the benefits too good? Is it too easy to avoid working? The longer that unemployment insurance lasts, the more likely people are to use it. The closer the unemployment benefits come to covering your working wage, the more likely you are to stay on it. Then if you can supplement your unemployment benefits with a thriving black market and some under the table jobs, why not? The U.S. may have too small of a safety net and that creates its own tensions, but it seems likely that other countries have too comfy of a safety net, especially when combined with an underground economy. If a country like Spain is paying huge amounts of money to the unemployed, and that is causing a spike in debt to unsustainable levels, then something needs to be done. Maybe the benefits can be tied to work or doing some of the projects deemed necessary for growth? This is a touchy subject for everyone, and I certainly don’t have the answer, but it is time to stop ignoring the pink elephant in the room as these economies and countries try to revive themselves.

Anyways, back to a dull and quiet morning in the markets.