PIMCO boss Bill Gross is out with his latest investment outlook.
There’s not a lot new in it, but this part is important, as it represents the latest thinking on the benefits of so-called austerity, namely that it doesn’t work in many cases:
Granted, sovereign debtor nations are now saying all the right things and in some cases enacting legislation that promises to halt growing debt burdens. Not only Greece and the southern European peripherals, but France, the U.K., Japan, and even the U.S. are sounding alarms that might eventually move them towards less imbalanced budgets and lower deficits as a percentage of GDP.
Still, credit and equity market vigilantes are wondering if in many cases sovereigns haven’t already gone too far and that the only way out might be via default or the more politely used phrase of “restructuring.” At the now restrictive yields of LIBOR+ 300-350 basis points being imposed by the EU and the IMF alike, there is no reasonable scenario which would allow Greece to “grow” its way out of its sixteen tons. Fiscal tightening, while conservative in intent, leads to lower and lower growth in the short run.
Tougher sovereign budgets produce government worker layoffs, pay cuts, reduced pension benefits and a drag on consumption and the ability of the private sector to accept an attempted hand-off from fiscal authorities. Recession becomes the fait accompli, and the deficit/GDP ratio moves ever higher because of skyrocketing risk premiums and a plunging GDP denominator. In many cases therefore, it may not be possible for a country to escape a debt crisis by reducing deficits!
This isn’t just a theoretical point. Countries have already experience this (see: Ireland).
And we’re back left wondering whether anyone has any understanding of sovereign debt.
Ireland cuts its spending, and its debt problem gets worse. Japan has spent and spent (its own currency) for two decades, and its bonds have rallied the whole time.
Now don’t miss: Niall Ferguson’s complete guide to sovereign debt crises >