Spending Cuts and History

May 22, 2012

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The problem in Europe is the spending cuts have been fake, and the tax hikes have been real. In fact, spending is still increasing across Europe, including the UK, which not only has a weakening economy, but inflation in excess of 3.5%. Stagflation is not possible in the minds of the central planners and Keynesians.

Give Verionique de Rugy credit for calling out the anti-Austerity contingent. In the LA Times, she points to David Cameron, who came to office in 2010 pledging to cut spending in exchange for tax hikes. However, in 2011-12, spending “increased from $1.15 trillion to $1.2 trillion, and public pensions have yet to be reformed. Instead, the government increased the capital gains tax, national insurance tax and value-added tax along with other fees and duties.” Likewise, Greece has cut nothing, nor has any other country, enabled by the printing and additional loans extended. Rugy also backs up her work with a study:

In a 2009 paper, Harvard economists Alberto Alesina and Silvia Ardagna looked at 107 examples in developed countries over 30 years and found that successful austerity packages — defined by a reduction in debt to GDP greater than 4.5% after three years — resulted from making spending cuts without tax increases. They also found that this form of austerity accompanied by the "right policies" (easy monetary policy, liberalization of goods and labor markets, and other structural reforms) is more likely associated with economic expansions rather than with recessions. This makes intuitive sense: Austerity based on spending cuts signals that a country is serious about getting its fiscal house in order in a way that taxing and spending certainly does not.

American Thinker pointed out that President Warren Harding cut the federal budget 48% from 1920 to 1922. Horrified, Keynesian Paul Samuelson, another winner of the badge of shame, predicted the cuts would create the "the greatest period of unemployment and industrial dislocation which any economy has ever faced." Incorrect, The economy boomed.  Then, as World War II wound down, the US cut spending by 75% as a percentage of GDP, as spending fell 44 percent in 1944 to 9 percent in 1948. Again, the economy boomed 

This has real implications for traders and strategists. If you see printing as the solution, you should expect default via inflation or stagflation, like the UK. This will fail. If you see more loans on top of bad loans, you should expect defaults on a larger amount. If you see tax hikes in lieu of spending cuts, you should expect more misallocations and the economy to sink, creating a larger problem.

It’s disappointing to see the thieves of economic and political freedom, and advocates of such, destroying country after country. But at the same token, the distortions create opportunity, if we’re open to accepting the truth.

37 year Study Shows Spending Cuts, Not Tax Increases, Best for Debt, Growth, Bond, Stock Markets

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