UK austerity vs U.S. muddle

January 27, 2011

The trans-Atlantic economic contrast is shaping up as pitting British austerity against, not U.S. investment, but a do-little American muddle.

President Obama’s State of the Union Address offered him the opportunity to hold up a beacon of policy that invests for the future while taking credible steps to control future deficits.

Speaking not long after Britain, in the process of making severe cuts in spending, reported a shrinking economy in the fourth quarter of 2010, Obama instead delivered a vague mix of un-costed investments and symbolic cuts in discretionary spending.

This of course is not entirely the U.S. administration’s fault; it must work with an austerity-happy Republican party that controls the House of Representatives and in service to an electorate which appears to have lost faith in the ability of its leaders to invest wisely. That virtually ensures a muddle in which serious cuts will be elusive and investments watery.

In contrast, even a delicate coalition like the one in power in Britain can ram through Parliament a full-bodied program of spending cuts and tax hikes.

Britain on Tuesday recorded a 0.5 percent decrease in gross domestic product in the quarter ended Dec. 31 compared to the three months before, far below not only consensus but even the most pessimistic of forecasts.

While the data is partly explained by the coldest December in more than a century, there appears to be an excellent chance that Britain is in the process of double-dipping back into recession. That would be extremely awkward for the Tory-led coalition which last summer embarked on a plan of austerity that aims to cut spending at national agencies by 25 percent by 2014. It is unlikely that this plan by itself sank the economy in the fourth quarter, but it will certainly help to sink it going forward.

The argument in favor of austerity is pretty straightforward; Britain is small, is deeply in debt, its pound is not a reserve currency and so it must maintain the confidence of global investors in its debt or face a disastrous eventual buyers strike. Britain, this argument goes, has no choice but to take its lumps. As Bank of England Governor Mervyn King pointed out on Tuesday real British wages are likely to have showed no growth in six years to 2011, the worst such period since the 1920s.

Looked at from this point of view the U.S.’s inability to both invest and cut is even more of a wasted opportunity. While there are important differences between the British and U.S. economies — the U.S. is more diverse and carries less debt —  one crucial one is that the dollar is the premier global reserve currency.

That gives the U.S. a lot of built-in credit in global markets and makes possible policies which Britain simply could not risk, much less get away with. If the U.S. made up its mind to do it, it could make massive investments in infrastructure and other high-yielding projects while at the same time addressing its deficit over the medium term. That has the chance, not the certainty, of increasing growth and making the deficit melt proportionally.

The privilege of being a reserve currency also gives the U.S. the illusion that it can dawdle and in-fight indefinitely as it is not being punished in markets for its policies. Market confidence for the U.S. though may prove to be something that doesn’t erode, as it did for Greece, but shatters after long and hard use.

With the U.S. politically unable to get to grips with its economic future, the Federal Reserve is left as the one institution with the power and the means to act, and act it has, launching a successful attempt to drive up asset prices and a less successful one to drive down the dollar.

That of course is the problem, and the same one the U.S. had in the last decade; loose money leads not to long-term investment in great infrastructure or human capital but to speculative bubbles and financial chicanery. The contrast is not between a free market which will respond to price signals and inefficient central planning, but between inefficient central planning and a casino in which the house lends the players money to bet.

In the end, in both the U.S. and Britain, austerity or not, investment or not, the next several years will involve at best scant gains in real living standards as the bills for the financial crisis and the rebalancing of the global economy are paid.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. email:

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