The Core of the Economic Debate

In Europe and the United States, debates over deficits, austerity, and intervention are being conducted in several languages, but they share the same essential elements. Moreover, the debates all pose fundamental questions that cut to the core of government’s role in any society. What is a government’s responsibility for the economy? What are the limits of a central bank? How much influence should a government have over its central bank? And how do those limits (such as they are) affect the currency and price levels across the economy? It may seem that these questions are as simple as ‘Am I my brother’s keeper?’ But the consequences of these largely notional arguments will determine the course of generational financial stability and direction.

John Mauldin shares the following excerpt in this week’s missive. These are the essential debate points. (I am a faithful reader of Mauldin and commend his complimentary weekly analysis to you. Here is a link:

“If we apply this distinction to what money is, those who believe that money is a tool which belongs to the political sphere and can be manipulated to meet political goals, justify their destruction of money by an ethic of responsibility (fighting unemployment, creating economic growth, etc). For what it is worth, let’s call them Keynesians.

On the ethic of conviction, we have the Bundesbank and the German population (but not so much the German political system) who say that money is a common good which does not belong to the state, and that the economy has to adapt to this reality, and not the other way around. Let us call them the Austrians.”

The lines of debate are drawn clearly around the world. Regrettably these discussions grow more heated at times of crisis, and decision makers risk impulsive reactions. So will the Keynesians or Austrians prevail? In many ways we feel this is a bit moot in many countries where the enormity of the debt, and therefore the debt service, precludes any solution that is not in part monetization. That is to say that some destruction of currency will occur.

Monetization of debt is another way to suggest inflation. The idea is that if my debt represents 20% of my outstanding currency, I can reduce my debt to 10% by doubling the amount of my currency. Twice as much currency available to purchase the same amount of goods and services will drive up the prices for those goods and services. Linear reactions don’t really happen in economics, but for the purposes of discussion, imagine that you are an investor in the bonds of a country that doubles it currency. While the amount of principal and interest you ultimately receive will remain unchanged, the prices of bread and milk have doubled and therefore your purchasing power is eviscerated. You lose out because the payments you receive are not adjusted higher for inflation.

Finally, there is the issue of moral hazard. Countries like Greece, which have borrowed and contracted to repay, are being excused from billions of dollars of obligations. They are being supported by the good standing of other European nations that may have to bear the burden of Greece’s responsibilities. This sort of thing has happened many times in recent years. Culpability has yet again been separated from consequence, and it strikes us as the vilest virulence.

The world has gone through times like this before and lived to tell the tale. It will again this time. Some companies are positioned strongly to both endure and thrive through this storm. We have many of them in our portfolios and firmly believe they will leave us in good stead. No matter how these global debates and questions are resolved, market winds have been ferocious, and we don’t see that abating anytime soon.

Hang in there,