Escaping the economic crisis

Economists can be an interesting group of people. Although they don't like to be wrong, occasionally they will fess up when they've been way off the mark in the past. To an extent, that's what happened at this year's Capital Economics Annual Conference in Chicago. The conference kicked off with an admission from Capital Economics Managing Director Roger Bootle that they had been wrong in their forecast last year. Although they had said world economies would continue to be bad, reality was that economies were even worse than they had expected.

Looking forward, this next couple of years don't look very promising, either. Based on issues plaguing world economies now, Capital Economics analysts covered topics such as austerity vs. default and other options, the continued viability of the euro, how the United States stacks up against Europe and the state of emerging markets. For now, let's look at the options for getting out of a recession and watch for future blogs on the other topics.

Of the options to get out of a recession, austerity seems to be the newest buzz word for politicians that like to equate running a country with running a home. While it makes sense in the one setting to not spend more than is coming in, the problem is that to get out of a recession, someone has to spend more. And that's probably not going to be consumers, at least not right away. Further, there are other consequences if a government reduces expenditures, namely that money is no longer going into anyone's checking account causing even less spending. See where this is going?

If austerity alone won't do the trick, perhaps defaulting on the debt is the way to go. In the past, some countries have done very well by defaulting and then restructuring, Argentina is a great example. The key to that, though, has always been to default to foreigners only because defaulting on domestic debt transfers the problem from governments to domestic citizens. In today's world, though, it is a global economy and as such there are no real foreigners anymore because everything is so interconnected. So, any default would be likely to see the banking crisis reemerge.

Inflation is another way out of a crisis, but ultimately that's just "default by the back door." By increasing monetary supply so that it takes more money to achieve the same results, past debts are "paid" at a lower cost. Of course, this method achieves debt reduction gradually and spreads the cost fairly widely across society. There are other risks to this strategy, too. Bond yields rise dramatically and it can be difficult to keep inflation under control. Not to mention, bringing inflation back down again requires a recession.

The last way out of a financial crisis is through growth. That growth, usually has to start with government spending. This is arguably the most painless way, but it takes confidence and patience to see it through, and it still requires some form of fiscal restraint. Growth could be strengthened by a number of things including stronger currencies in Asia, particularly China, lower commodity prices or relief from the European debt crisis.

So, how do we escape the current economic crisis? Bootle says the best way is fiscal restraint combined with economic growth. Unfortunately, he adds that few countries can manage that combination. Bootle's outlook, then? "The world faces a toxic mixture of austerity and default, currency instability and depression." Sounds just swell.

About the Author
Michael McFarlin

Michael McFarlin joined Futures in 2010 after graduating summa cum laude from Trinity International University, where he majored in English/Communication. With the launch of the new web platform, Michael serves as web editor for the site and will continue to work on the magazine, where he focuses on the Markets and Trading 101 features. He also served as a member of the Wisconsin National Guard from 2007 to 2010. mmcfarlin@futuresmag.com

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