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High Debt, High Unemployment, Low Growth ..... Austerity And Higher Interest Rates?

Author : Currency Professor

Austerity - Austerity's original meaning, taken from the Greek word austeros, was "bitter or harsh taste." While it's rarely used that way anymore, it's still a great description of the word's current meanings. As well as describing a personal quality of sternness, it also means "a simple, plain manner" and "an extreme frugality." So you could talk about the austerity of a very plainly decorated room or the austerity you're forced to live with ever since your parents stopped giving you a weekly allowance. If your lack of money had a taste, it might very well be "bitter or harsh."
---- According to

I thought a definition would be a good way to start this argument.

Let's review some facts:

· U.S. Government debt - current estimate (note it is always an estimate) $14.2 Trillion

· Current U.S. Unemployment - 8.8 percent OR 13.5 million people (and this is an estimate as well)

· GDP last Quarter - $14.7 Trillion year end 2010; an increase of 3.1 percent over 2009

· European Union (27 countries) total government debt - Current estimate $12.89 Trillion (this is converted to U.S. Dollars at 1.35 €/$)

· Current European Union (27 countries) Unemployment - 9.9 percent as of April 1, 2011

· GDP last quarter European Union (27 countries) - $16.1 Trillion (this is converted to U.S. Dollars at 1.35 €/$); 1.8 percent higher than 2009.

Inflation numbers came out Friday April 15, 2011 for Europe, China and the U.S. Latest numbers show Europe with yearly inflation at 2.7 percent, China at 5.4 percent and the U.S. at 2.7 percent.

How is debt paid off? Two ways, by income or by asset sales. Now, within a government environment one might argue for other ways but basically it is only these two, every other way is simply a form of either income or asset sales. Debt can also be reduced by way of default but that is not paying it off. For sake of argument we will not use default as an option. Also, for the sake of argument we will ignore asset sales as governments usually do not perform large scale asset sales to reduce debt. This then leaves income only to reduce debt. So, on the income side governments have the option to increase taxes and/or decrease spending, thus reducing debt.

In the last 12 months the U.S. budget deficit was $1.4 trillion; meaning the U.S. Government spent $1.4 trillion more than it received in income. Income was about $4.5 trillion so that means the Government spent $5.9 trillion (Government is now 41 percent of GDP). Spent on what? That is a lot of money by anyone's standards. The argument in Congress last week about cutting spending resulted in $38.5 billion in cuts - that is 6.5 percent in spending reduction. WOW, that'll make a difference.

The only way for any government to pay off debt efficiently without stifling the economy, especially when it is 41 percent of the economy, is to increase growth. Increased growth increases tax revenues. More people are working making more money, tax revenues increase without the government raising taxes and debt gets paid off. More companies become profitable forcing them to pay more taxes as there are fewer write-offs. As the economy grows government spending can be reduced without depressing the economy, but not when the government makes up 41 percent of the economy. When the government is that large, slowing government spending will most certainly slow down the economy thus slowing down tax revenues and creating a vicious cycle - Austerity in it's truest form. As growth increases the economy's largest spender, the consumer, becomes even a larger percentage of the overall economy and the government becomes smaller. Once the government is less than 30 percent of the economy then it can reduce spending without affecting growth.

Sometimes inflation is good and now is one of those times. If we could increase core inflation to 3 percent this would be a good thing. It would allow firms to cover their costs more effectively, hire more people and spend more money. Growth would increase, tax revenues would increase and debt would get paid off; without the pain of Austerity. Then interest rates can rise and inflation can be controlled. Just remember inflation can be controlled, deflation cannot.

So, Europe instituting Austerity measures with a 9.9 percent unemployment rate, 2.7 percent overall inflation rate - core is 1.3 percent, and GDP growth at 1.8 percent all to pay down debt of 80 percent of GDP will be more "bitter and harsh tasting" then anyone can imagine for a very long time. Europe's long-term growth prospects will decrease and it's currency value will decrease. Think of it this way; if you had a billion dollars just sitting around, where would you put your money? In an environment where one tenth of the population was not working, pricing is only climbing about 1 percent a year and the prospect of prices climbing are very little because any extra funds are paying down debt (Europe)? Or, would you rather put your money in an environment where one tenth of the population is not working, pricing is climbing about 1 percent per year and the prospect of prices climbing are very high because the focus is on growth and not paying down debt at this time (U.S.)? Money will flow to where investors can get the highest return for their investment. Returns cannot happen unless prices are rising. Prices cannot rise unless demand is high. Demand cannot be high unless the largest segment of the economy (60 percent to 70 percent is consumer) has money. The consumer cannot have money if they are not working. There are no jobs available unless there is growth. Raising interest rates and instituting Austerity does not promote growth it slows growth. Why would you want to slow growth, slow government revenues when your revenues are already less than they were because of persistent slow growth?

Follow the growth, currencies always do. The U.S. Dollar will once again reign supreme.

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Submitted : 2011-05-10    Word Count : 1031    Times Viewed: 639