Austerity to End With No Investment Plan in Place

Now that the elections in France are over, it is clear that the voters want an end to austerity. Assuming that governments in France and elsewhere agree to increase spending, deficits will increase. A significant portion of the increased spending will go to transfer payments, not investments. Growth rates will move only slightly. Inflation will increase. The Euro will decline in value relative to the dollar and remnibi.

European inflation may influence U.S. inflation. Therefore, it is prudent to shift into inflation-resistant investments, especially income-producing real estate, consumer goods stocks, railroads, and other companies that have big moats around their business model.

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Some older news related to the ending of austerity in Europe:

Bundesbank’s Weidmann Says What No Politician Wants to Hear
http://www.bloomberg.com/news/2012-04-22/bundesbank-s-weidmann-says-what-no-eu-politician-wants-to-hear.html

Hollande Vows Not to Ratify Euro Pact, Auguring Merkel Clash
http://www.bloomberg.com/news/2012-04-25/hollande-says-france-won-t-ratify-euro-fiscal-pact-as-it-stands.html

Europe awaiting France to temper austerity: Hollande
http://www.reuters.com/article/2012/04/25/us-france-election-idUSBRE83I0EZ20120425

More on that "Austerity" Thing

Several days before I wrote yesterday's article, I sent Mr. Livingston an email in hopes that I'd have a chance at a dialog on the subject of his article against austerity. When he didn't respond, I decided that the only way to carry the dialog forward was to write and post my article, and also post a comment on the Bloomberg excerpt.

The comments on Bloomberg seem to go heavily against Livingston. I'll cite some of the comments you can find on Livingston's excerpt:

"This is outright wrong...."

"The logic here is horribly flawed...."

"Austerity is bad??? Badly-wrong sentence...."

"...the idea that work is a function of what is wrong with the human condition flies in the face of not only some of the most enlightened thinkers throughout history but also most people's own feelings...."

"The more I read this the less sense it makes..."

Another Bloomberg columnist, Caroline Baum, posted a different viewpoint that also tilts against Livingston's thesis. Her piece, Mall Rats Can’t Bring About the Wealth of Nations, starts out as a comment on Black Friday and retail sales as an indicator of economic health, but necessarily turns deeper and more analytic, concluding with a definition of consumption from Webster:

"the utilization of economic goods in the satisfaction of wants ... resulting chiefly in their destruction, deterioration, or transformation."

Why harp on this? Over-spending is a bad idea, but although some people think it might be bad for the individual, I don't get the sense that they feel that it hurts society. There is the underlying assumption that an over-spender slightly hurts themselves while benefiting the rest of us by making the economy go faster. And this is absolutely incorrect. A unnecessary purchase is the opposite of a vorpal trade. Poor purchase decisions harm the economy for everyone.

I am not against spending or consumption. Several articles in Vorpal Trade have described what a good purchase might look like. This might be a good time to write down some of the characteristics of a purchase that fits the definition of a vorpal trade:

- it costs less than you budgeted

- the purchase comes at exactly the right time for the seller

- it arrives just in the nick of time

- it generates cash shortly thereafter, or significant time or cost savings

- the payback period (moment at which net benefits exceed the price) is very short

- it is elegant, beautiful, or has character in its form or function

- it lasts

- it is a good candidate for using it up, wearing it out, making it do

- it greatly empowers you professionally, artistically, or personally

- it fits in your budget

You know a vorpal trade when you see it. When you think about the all-star products you have owned in the past, or present, it is quite clear that some things were simply vastly better investments than others. Couldn't we all use a few more things like those?

True Frugality/Prosperity Too Bitter for U.S. Leaders?

One of the essential elements of the business cycle is that it instructs market participants. When times are too good, immoderate behavior is rapidly rewarded, but soon after is then rapidly punished in the subsequent collapse. When times are bad, those who stored resources against bad times pick up bargains and benefit from their careful attention to economic reality.

The financial crisis of 2007 to 2009 is firmly rooted in overextension of credit to non-worthy borrowers. Clearly the lesson to be learned was "stop lending to poor credit risks; stop lending aggressively." As painful as a recession is, it really does reinforce the message that people must engage in economic behavior that is tied to reality. Unlike bubble behavior, in which people make investment decisions that are unsupported by economic fundamentals.

The collective decisions of consumers and businesses drive the economy. Each individual misallocation of resources hurts the long-term economy, even if in the short run it "feels good" or would seem to increase the velocity of money. When money is scarcer, the quality of these individual decisions rises. That is what generates recoveries.

If you have a recovery that is based on the millions of tiny gains that arise from good resource allocation decisions, then it is a sound one. If your recovery is based on a command-driven push to increase lending in order to restore some measurement of economic activity to a former level, then you are in danger of undermining your own long-term prosperity. Economic lessons in frugality are expensive; they hurt. We should not throw away the benefits of those hard-won lessons.

Are banks presently lending enough? It is a poor question. Better: Are banks meeting the existing demand for loans at prices that repay them for their risk? My sense is that commercial banks are lending appropriately, and if loans outstanding are dropping, it isn't their fault. Demand for loans is low and will stay low while consumers and businesses make prudent decisions based on the hard lessons they just learned.

This concept, that loan demand is dropping and is a good thing seems to be hard to grasp. Some people assume that loan levels are just set by the banks, and currently banks are being mean or trying to inhibit a recovery by failing to lend. This is echoed in the words selected by the interviewer in this video story at Tech Ticker. Mike Shedlock and Peter Atwater make the case that banks are reserving for current risks based on their customers' assessments of economic prospects, and that the building of non-loan assets is a reasonable use for their liquidity and has good historical precedent.

Conclusion: Profits are good now because of the steep yield curve, but consumers are laying a good foundation for a recovery through their credit decisions. There is a risk that this prudence could be short-circuited by governmental action, though my guess (95%) is that lobbying efforts for windfall taxes on banks, and other measures to force new risky lending, will not succeed.