One Emerging Market To Buy

by James Gruber

Emerging market, really?
Challenges today
2014 economic outlook
Long-term powerhouse
Valuations stack up
Potential risks

Investors can’t bail fast enough on emerging markets at the moment. And rightly so, given the potential for further problems as I highlighted in last week’s post, Emerging Market Banking Crises Are Next. But the indiscriminate sell-off of emerging markets also opens up some potential opportunities. Asia Confidential thinks South Korea stands out as one such opportunity.

South Korea isn’t really an emerging market though. It’s a US$1.1 trillion economy, the 15th largest in the world. With populations above 50 million, the economy ranks 7th globally. Nonetheless, those in charge of indices such as MSCI still classify South Korea as an emerging market. Which should make you question the entire notion of “emerging markets”, as I do.

That aside, South Korea has tremendous long-term prospects. It’s an open economy with a robust democracy. It’s a world-class manufacturer which has every chance of becoming the next Germany. It has a highly educated and hard working labor force. Unlike its former coloniser, Japan, it’s shown the ability to adapt and reinvent itself. And importantly, the prospect of reunification with North Korea in the not-too distant future would prove a tremendous boon for the South and drive an unprecedented investment boom.

The short-term outlook is bright too. Unlike many other emerging markets, South Korea runs a current account surplus and therefore isn’t vulnerable to capital outflows from QE tapering. It also never had the credit boom that other Asian countries experienced. Significantly, it’s highly exposed, via exports, to economic recoveries in the US and Europe (the latter being more dubious than the former).

To top it off, South Korea is the cheapest country in Asia with a 2014 price to earnings ratio (PER) of just 8.8x. There are a number of world-class companies in South Korea trading at just 6x earnings. Bargains in plain sight, you might say.

Emerging market, really?
To get a sense of the long-term opportunity, it’s important to understand a brief bit of history. South Korea tends to get lost in the headlines of much larger neighbours, China and Japan. Only the threat of North Korean conflict or music poking fun at rich people (Gangnam style) occasionally breaks this trend. But the success story of South Korea is on par with its neighbours.

As many of you would know, South Korea was brutally occupied by Japan from 1910-1945. Post-World War Two, it was split into North and South Korea by the US and Soviet Union. The Cold War was the central driver to the Korean War soon after. The 1953 armistice signed at the conclusion of the war split the peninsula along a demilitarised zone. Technically, South and North Korea are still at war. Some 2 million troops patrol the demilitarised zone, making it the most heavily-guarded border in the world.

Fast forward to 1961 and the rise of Park Ching-hee to the leadership. Chung-hee is known for being the most important ruler in South Korea’s history.

When he came to power, South Korea’s GDP per capita was just US$72. Needless to say, a very poor country. Chung-hee drove South Korea into the modern age with often brutal efficiency. He did this through export-led industrialisation and oversaw the creation of the now-famous conglomerates known as chaebol. Along with Hong Kong, Singapore and Taiwan, South Korea became known as one of the four “Asian Tiger” economies.

During the 1970s though, economic growth slowed as the investment-led model ran out of steam. And resentment grew towards Chung-hee’s authoritarian rule. The President was subsequently assassinated in 1979.

South Korea recovered and, along with many other Asian countries, experienced rapid growth in the early-to-mid 1990s. When exploding foreign debts led to the collapse of Asian currencies, South Korea had to go to the IMF for a record US$58 billion bail-out package. This was humiliating to a proud nation.

South Korea handled the Asian crisis in a very different way to other countries, however. People in countries elsewhere moved their money to the Cayman Islands for protection. In contrast, South Koreans banded together, determined to pay off the debts. People queued up for hours to donate jewelry to the cause.

Unlike a number of other Asian countries, South Korea also let companies fail instead of bailing them out. Some 40% of the biggest companies were allowed to go under. This included multinationals such as Daewoo. Staggeringly, the IMF debt was repaid by 2001 and South Korea’s economy was back on track.

South Korea’s adaptability under dire circumstances stands in stark contrast to others. Its once colonial master, Japan, hasn’t shown the same attributes since 1990. And Taiwan, another former Japan colony, has also failed to remake itself post the crisis.

From 1998, the chaebol brought in professional managers to oversee operations, while the founding families retained control over strategic decisions. They moved fast to build plants in China to give them a low-cast labor advantage. They outspent rivals on research and development. And they weren’t afraid to expand abroad and take on the big boys.

Hyundai is a case in point. It first entered the North American car market in 1986. Funnily enough, its cars initially met with some success as Americans mistook them for Honda cars (they had similar logos). Post that, Hyundai’s cars became a bit of a joke, known for poor design and numerous quality issues.

Instead of retreating though, Hyundai doubled down. In 1998, it offered a ten-year warranty, more than twice its competitors. The move was laughed at by many. By it proved a game-changer for the company and the industry.

In 2005, Hyundai opened its first American plant in Alabama. US competitors dismissed the move, given the enormous problems they were having with high-cost union labor forces in Detroit at the time. The difference was that Hyundai didn’t have these same labor issues. And the plant has now become one of the most efficient in the US.

Turn to today and Hyundai is one of the world’s top-5 car companies. Though it’s certainly not the only South Korean company to have proved itself on the world stage.

Challenges today
South Korea does resemble some other emerging markets in one respect: it relies extensively on an export-led economic model. Exports account for 56% of GDP. And chaebols account for 82% of GDP.

It’s obvious that the country needs to become less reliant on exports and look to the next drivers of economic growth. Those drivers are likely to come from the still undeveloped services sector.

South Korea’s leaders realise the urgency of the task. Recently, President Park Guen-hye (daughter of Park Chung-hee) outlined her so-called 474 plan: 4% economic growth, 70% employment rate and average per-capita income of US$40,000.

Simply put, the plan involves the following:

• Shift tax benefits from chaebol manufacturers to start-ups
• Rein in state-owned enterprises
• Provide support to venture capital
• Cut back on regulations in a variety of sectors including health and education to promote competition
• Incentivise employers to hire more young people and women

This isn’t the first time that South Korea has tried to reduce its reliance on exports. In the early 2000s, it granted tax breaks to credit card users in order to spur domestic spending. Predictably, consumers got carried away and delinquencies on credit cards reached 30%. Companies had to be bailed out and economic growth stalled by 2003.

Corporate deleveraging and government restrictions on business borrowing since the 1997 crisis have also encourage bank lending to households. That borrowing has mostly found its way into real estate. Consequently, household debt has grown about 2x GDP since the crisis. And household debt in South Korea is now around 150% of household disposable incomes.

The risks from this debt are limited though. More than 70% of the debt is owed by the top two quintiles by income, which have twice as many assets as debt. Also, South Korea has imposed strict 40% loan-to-value ratios on property purchases. Finally, the central bank has forced some lenders to write off 40% of the value of personal loans, reducing the risks of a consumer debt bust.

However, the challenges of rebalancing the economy and finding new sources of growth remain. Given its track record of adaptability, Asia Confidential is confident that South Korea can reinvent itself again.

2014 economic outlook
So what about the short-term outlook for the economy? Here, the prospects seem reasonable.

Unlike many emerging markets, South Korea consistently runs current account surpluses and therefore isn’t susceptible to capital outflows from QE tapering. It also hasn’t had a credit boom over the past 3-4 years and thus isn’t vulnerable to a hangover on this front.

Prospects for growth look ok too. South Korea’s still large dependence on exports may play in its favour as the country is geared to any recovery in the US and EU. While on paper the US and EU only account for 20% of Korean exports, the number is actually much larger as these are the ultimate destinations for the bulk of Korean exports to emerging markets.

South Korean exports to the US and EU bottomed in 2012 and have steadily improved. Bank of America Merrill Lynch forecasts 8% growth in exports to the US and EU in 2014.

South Korea is highly correlated to US growth. Every 100 basis point change in US GDP growth impacts South Korean GDP growth by 80 basis points.

In addition, deflationary fears in South Korea appear misguided. Inflation is likely to return to the 2% level this year after bottoming at 1.3% last year. Signs of rising inflation can be seen in core inflation, which rose almost 3% quarter-on-quarter, in seasonally-adjusted terms, over the last several months. Any rate hikes though aren’t likely until the end of the year, at the earliest.

Lastly, the housing market is showing signs of life after five years in the doldrums. Transaction volumes and prices improved in the second half of last year. Volumes could reach 80,000 units/month in the first half, the third-highest level since 2008. That said, high household debt should limit the extent of the property recovery.

In sum, the near-term outlook isn’t outstanding. But it’s better than most.

Long-term powerhouse
The long-term prospects for South Korea look brighter, for three reasons:

1. Its already world-class companies are likely to move aggressively up value chains to find new niches to dominate. South Korea is well known for its cars and electronics. It’s also found success in less sexy industries such as shipbuilding too. The top three global shipbuilders are from South Korea. I not only expect continued gains in these type of industries, but new ones too. A highly educated workforce, high investment in R&D and a proven ability to compete and adapt should ensure this.
2. The aim to boost service industries should pay dividends and provide the next leg of growth for South Korea. Skeptics will point to South Korean historical failures on this front. But it’s increasingly clear that South Korea realises the risks of the country being left behind if it doesn’t rebalance the economy.
3. The real potential kicker is North Korea. Yes, North Korea is exceedingly poor but it has a disciplined population of 24 million and immense natural resources. Put this together with South Korea’s capital pool and management capability and you have an irresistible combination. It would likely produce an investment bonanza of unprecedented proportions. South Korea is already preparing for unification by keeping its debt low to absorb the huge costs in rebuilding the North. Note also, the President is pushing for unification, recently saying:

“Unification will allow the Korean economy to take a fresh leap forward and inject great vitality and energy. People would even sing “We dream of unification in our dreams”".

If I’m right about the bright long-term prospects for South Korea, the so-called “Korean discount” should fade. For the uninitiated, markets continue to impose a discount on the valuation of South Korean stocks given the often murky operating structures and financials of the large companies.

This view is somewhat outdated given the substantial improvements in business structures and accounting over the past decade. Further improvements should eventually see the discount disappear, providing further upside to Korean stocks.

Valuations stack up
Price is ultimately what matters with any investment. And on this front, South Korea looks attractive. It’s the cheapest market in Asia, trading at just 8.8x this year’s earnings, a 24% discount to Asia ex-Japan’s 11.6x PER. Consensus forecasts 13% earnings growth in 2014, versus 12% for the Asian region.

If you dig a little more, there are some exceedingly cheap valuations for world-class companies. For instance, Kia Motors is trading at 5.9x 2014 PER. Samsung Electronics is also priced at just 6.9x earnings.

Some of the domestically-focused large caps are also priced at levels not seen in other markets. For instance, KB Financial, a consumer bank, trades at a 40% discount to tangible book value (net asset value, in other words). Yes, return on equity at KB Financial is a low 6% but if this improves from abnormally depressed levels, then the discount to book value should diminish too.

Potential risks
No investment is without risks and these risks need to weighed against the potential rewards. I see three key risks for South Korean stocks:

1. Any recovery stalls in developed markets. The US recovery is painfully slow, but it’s better than elsewhere. Particularly the EU, where deflationary risks remain. If economies in these regions lurch downward again, South Korea would be disproportionately impacted.
2. The yen is also a big risk. Regular readers will know that I foresee a much lower yen in the medium term given the Abe government’s insane money printing policies. Given a lower yen, Japanese exporters are expected to provide much stiffer competition to their South Korean counterparts going forward.
3. The obvious long-term risk is North Korea. A messy and violent reunification with the South would seriously dent future economic prospects.

In my view, the first and second risks are already partially if not fully factored into South Korean valuations. If these things don’t eventuate, or not to the extent envisaged, then the upside for stocks is pretty clear.

AC Speed Read

- South Korea stands out as a buying opportunity amid the indiscriminate emerging markets sell-off.

- The country’s short-term economic prospects are positive given its sound financial position reduces risks from QE tapering. Also, its export-led economy has significant exposure to the US recovery.

- Long-term, South Korea manufacturing prowess could turn it into the next Germany. There’s also the prospect of reunification with North Korea, which would prove an investment boon to the South.

- Valuations are cheap as well, with South Korea trading on just 8.8x 2014 earnings. World-class companies such as Kia are priced at just 6x earnings.

- Potential risks include a slowdown in developed market economies and a lower yen making Japanese exporters more competitive vis-a-vis their South Korean counterparts.

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Don't bet on dollar weakness

by SoberLook.com

The US dollar has been surprisingly weak recently. In fact we are at the lows not seen since just after the US government shutdown when treasury default jitters (see post) sent investors fleeing.

Source: barchart

Why is the dollar so weak? Reasons include some economic improvements in the Eurozone and the ECB's persistent hawkish stance. That's been driving up the euro. But the main reason has been the barrage of soft economic data out of the US in the past couple of months.

Source: ISI Group

However, as discussed earlier (see post), the soft economic patch in the US could be transient. We saw a sign of that in the latest US employment report (see story), which is the justification the Fed needs to continue reducing securities purchases. As the weather across the US improves, economic activity should pick up (some leading indicators already support this thesis) and longer term rates are likely to move higher. And with that we should see the dollar strengthen.

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The Innovation Enigma

by Joseph E. Stiglitz

NEW YORK – Around the world, there is enormous enthusiasm for the type of technological innovation symbolized by Silicon Valley. In this view, America’s ingenuity represents its true comparative advantage, which others strive to imitate. But there is a puzzle: it is difficult to detect the benefits of this innovation in GDP statistics.

What is happening today is analogous to developments a few decades ago, early in the era of personal computers. In 1987, economist Robert Solow – awarded the Nobel Prize for his pioneering work on growth – lamented that “You can see the computer age everywhere but in the productivity statistics.” There are several possible explanations for this.

Perhaps GDP does not really capture the improvements in living standards that computer-age innovation is engendering. Or perhaps this innovation is less significant than its enthusiasts believe. As it turns out, there is some truth in both perspectives.

Recall how a few years ago, just before the collapse of Lehman Brothers, the financial sector prided itself on its innovativeness. Given that financial institutions had been attracting the best and brightest from around the world, one would have expected nothing less. But, upon closer inspection, it became clear that most of this innovation involved devising better ways of scamming others, manipulating markets without getting caught (at least for a long time), and exploiting market power.

In this period, when resources flowed to this “innovative” sector, GDP growth was markedly lower than it was before. Even in the best of times, it did not lead to an increase in living standards (except for the bankers), and it eventually led to the crisis from which we are only now recovering. The net social contribution of all of this “innovation” was negative.

Similarly, the dot-com bubble that preceded this period was marked by innovation – Web sites through which one could order dog food and soft drinks online. At least this era left a legacy of efficient search engines and a fiber-optic infrastructure. But it is not an easy matter to assess how the time savings implied by online shopping, or the cost savings that might result from increased competition (owing to greater ease of price comparison online), affects our standard of living.

Two things should be clear. First, the profitability of an innovation may not be a good measure of its net contribution to our standard of living. In our winner-takes-all economy, an innovator who develops a better Web site for online dog-food purchases and deliveries may attract everyone around the world who uses the Internet to order dog food, making enormous profits in the process. But without the delivery service, much of those profits simply would have gone to others. The Web site’s net contribution to economic growth may in fact be relatively small.

Moreover, if an innovation, such as ATMs in banking, leads to increased unemployment, none of the social cost – neither the suffering of those who are laid off nor the increased fiscal cost of paying them unemployment benefits – is reflected in firms’ profitability. Likewise, our GDP metric does not reflect the cost of the increased insecurity individuals may feel with the increased risk of a loss of a job. Equally important, it often does not accurately reflect the improvement in societal wellbeing resulting from innovation.

In a simpler world, where innovation simply meant lowering the cost of production of, say, an automobile, it was easy to assess an innovation’s value. But when innovation affects an automobile’s quality, the task becomes far more difficult. And this is even more apparent in other arenas: How do we accurately assess the fact that, owing to medical progress, heart surgery is more likely to be successful now than in the past, leading to a significant increase in life expectancy and quality of life?

Still, one cannot avoid the uneasy feeling that, when all is said and done, the contribution of recent technological innovations to long-term growth in living standards may be substantially less than the enthusiasts claim. A lot of intellectual effort has been devoted to devising better ways of maximizing advertising and marketing budgets – targeting customers, especially the affluent, who might actually buy the product. But standards of living might have been raised even more if all of this innovative talent had been allocated to more fundamental research – or even to more applied research that could have led to new products.

Yes, being better connected with each other, through Facebook or Twitter, is valuable. But how can we compare these innovations with those like the laser, the transistor, the Turing machine, and the mapping of the human genome, each of which has led to a flood of transformative products?

Of course, there are grounds for a sigh of relief. Although we may not know how much recent technological innovations are contributing to our wellbeing, at least we know that, unlike the wave of financial innovations that marked the pre-crisis global economy, the effect is positive.

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Global Debt Crosses $100 Trillion, Rises By $30 Trillion Since 2007; $27 Trillion Is "Foreign-Held"

by Tyler Durden

While the US may be rejoicing its daily stock market all time highs day after day, it may come as a surprise to many that global equity capitalization has hardly performed as impressively compared to its previous records set in mid-2007. In fact, between the last bubble peak, and mid-2013, there has been a $3.86 trillion decline in the value of equities to $53.8 trillion over this six year time period, according to data compiled by Bloomberg. Alas, in a world in which there is no longer even hope for growth without massive debt expansion, there is a cost to keeping global equities stable (and US stocks at record highs): that cost is $30 trillion, or nearly double the GDP of the United States, which is by how much global debt has risen over the same period. Specifically, total global debt has exploded by 40% in just 6 short years from  2007 to 2013, from "only" $70 trillion to over $100 trillion as of mid-2013, according to the BIS' just-released quarterly review.

It should come as no surprise to anyone by now, but the only reason why global stocks haven't plummeted since the Lehman collapse is simple: governments have become the final backstop for onboarding risk, with a Central Bank stamp of approval - in other words, the very framework of the fiat system is at stake should global equity levels collapse. The BIS admits as much: “Given the significant expansion in government spending in recent years, governments (including central, state and local governments) have been the largest debt issuers,” according to Branimir Gruic, an analyst, and Andreas Schrimpf, an economist at the BIS.

It should also come as no surprise that courtesy of ZIRP and monetization of debt by every central bank, debt has itself become money regardless of duration or maturity (although recent taper tantrums have shown what will happen once rates start rising across the curve again), explaining the mindblowing tsunami of new debt issuance, which will certainly never be repaid, and whose rolling will become impossible once interest rates rise. But of course, under central planning that is not allowed. As Bloomberg reminds us, marketable U.S. government debt outstanding has surged to a record $12 trillion, up from $4.5 trillion at the end of 2007,  according to U.S. Treasury data compiled by Bloomberg. Corporate bond sales globally jumped during the period, with issuance totaling more than $21 trillion, Bloomberg data show.

And as we won't tire of pointing out, China's credit expansion over this period is easily the most important, and overlooked one. Which is why with China out of the epic debt issuance picture, and with the Fed tapering, all bets are slowly coming off.

Bloomberg also comments, humorously, as follows: "concerned that high debt loads would cause international investors to avoid their markets, many nations resorted to austerity measures of reduced spending and increased taxes, reining in their economies in the process as they tried to restore the fiscal order they abandoned to fight the worldwide recession." Of course, once gross government corruption and incompetence made all attempts at austerity futile, and with even the austere nations' debt levels continuing to breach record highs confirming there was never any actual austerity to begin with, the push to pretend to reign debt in has finally faded, and the entire world is once again engaged - at breakneck speed - in doing what caused the great financial crisis in the first place: the issuance of record amounts of unsustainable debt.

All of the above is known. What may not be known is just who is issuing, and respectively, purchasing, this global debt-funded spending spree, especially in a world in which one's debt is another's asset. Here is the BIS's answer to that question:

Cross-border investments in global debt markets since the crisis

Branimir Grui? and Andreas Schrimpf

Global debt markets have grown to an estimated $100 trillion (in amounts outstanding) in mid-2013 (Graph C, left-hand panel), up from $70 trillion in mid-2007. Growth has been uneven across the main market segments. Active issuance by governments and non-financial corporations has lifted the share of domestically issued bonds, whereas more restrained activity by financial institutions has held back international issuance (Graph C, left-hand panel).

Not surprisingly, given the significant expansion in government spending in recent years, governments (including central, state and local governments) have been the largest debt issuers (Graph C, left-hand panel). They mostly issue debt in domestic markets, where amounts outstanding reached $43 trillion in June 2013, about 80% higher than in mid-2007 (as indicated by the yellow area in Graph C, left-hand panel). Debt issuance by non-financial corporates has grown at a similar rate (albeit from a lower base). As with governments, non-financial corporations primarily issue domestically. As a result, amounts outstanding of non-financial corporate debt in domestic markets surpassed $10 trillion in mid-2013 (blue area in Graph C, left-hand panel). The substitution of traditional bank loans with bond financing may have played a role, as did investors’ appetite for assets offering a pickup to the ultra-low yields in major sovereign bond markets.

Financial sector deleveraging in the aftermath of the financial crisis has been a primary reason for the sluggish growth of international compared to domestic debt markets. Financials (mostly banks and non-bank financial corporations) have traditionally been the most significant issuers in international debt markets (grey area in Graph C, left-hand panel). That said, the amount of debt placed by financials in the international market has grown by merely 19% since mid-2007, and the outstanding amounts in domestic markets have even edged down by 5% since end-2007.

Who are the investors that have absorbed the vast amount of newly issued debt? Has the investor base been mostly domestic or have cross-border investments grown at a similar pace to global debt markets? To provide a perspective, we combine data from the BIS securities statistics with those of the IMF Coordinated Portfolio Investment Survey (CPIS). The results of the CPIS suggest that non-resident investors held around $27 trillion of global debt securities, either as reserve assets or in the form of portfolio investments (Graph C, centre panel). Investments in debt securities by non-residents thus accounted for roughly one quarter of the stock of global debt securities, with domestic investors accounting for the remaining 75%.

The global financial crisis has left a dent in cross-border portfolio investments in global debt securities. The share of debt securities held by cross-border investors either as reserve assets or via portfolio investments (as a percentage of total global debt securities markets) fell from around 29% in early 2007 to 26% in late 2012. This reversed the trend in the pre-crisis period, when it had risen by 8 percentage points from 2001 to a peak in 2007. It suggests that the process of international financial integration may have gone partly into reverse since the onset of the crisis, which is consistent with other recent findings in the literature.

This could be temporary, though. The latest IMF-CPIS data indicate that cross-border investments in debt securities recovered slightly in the second half of  2012, the most recent period for which data are available.

The contraction in the share of cross-border holdings differed across countries and regions (Graph C, right-hand panel). Cross-border holdings of debt issued by euro area residents stood at 47% of total outstanding amounts in late 2012, 10 percentage points lower than at the peak in 2006. A similar trend can be observed for the United Kingdom. This suggests that the majority of new debt issued by euro area and UK residents has been absorbed by domestic investors. Newly issued US debt securities, by contrast, were increasingly held by cross-border investors (Graph C, right-hand panel). The same is true for debt securities issued by borrowers from emerging market economies. The share of emerging market debt securities held by cross-border investors picked up to 12% in 2012, roughly twice as high as in 2008.

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An End To Austerity?

by Mark Thornton

President Barack Obama has recently released his budget in which he calls for an “end of austerity.” This is an amazing statement from a president whose government has spent the highest percentage of GDP in history and added more to the national debt than all past presidents combined. What must he mean by austerity?

There are demonstrations around the world over austerity on an almost daily basis. It is condemned as an evil poison for tough economic times while others tout it as the elixir for economic depressions.

The president’s rejection of austerity represents the Keynesian view which completely rejects austerity in favor of the “borrow and spend” — increase aggregate demand — approach to recession. What he really is rejecting is the infinitesimal cutbacks in the rate of spending increases and the political roadblocks to new spending programs.

While the 2009-2012 budgets have been relatively flat, they are still more than 15 percent higher than in 2008 and 75 percent higher than in the previous decade. This four year leap in spending was financed with a $5 trillion increase in the national debt. No austerity here!

The type of austerity that gets the most worldwide press attention on a daily basis is that promoted by economists at the International Monetary Fund. This “austerian” approach involves cutbacks in government services and tax increases on the beleaguered public in order to, at all costs, repay the government’s corrupt creditors. This pro-bankster approach is what generates a massive amount of media attention and sometimes violent demonstrations.

Austrian School economists reject both the Keynesian stimulus approach and the IMF-style high-tax, pro-bankster approach as counterproductive. Although “Austrians” are often lumped in with “Austerians,” Austrian School economists support real austerity. Real austerity involves cutting government budgets by reducing salaries, employee benefits, and retirement benefits. It also involves selling government assets and even repudiating government debt. Instead of increasing taxes, the Austrian approach advocates decreasing taxes.

Despite all the hoopla in countries like Greece, there is no real austerity except in the countries of Eastern Europe. For example, Latvia is Europe’s most austere country and also one of the fastest growing economies. Estonia implemented an austerity policy that depended largely on cuts in government salaries. In contrast there simply is no significant austerity in most of Western Europe or the U.S. As Professor Philipp Bagus explains, “the problem of Europe (and the United States) is not too much but too little austerity — or its complete absence.”

Real austerity for individuals means living a highly restricted lifestyle. The best example is the monk who lives on a subsistence-level diet, wears simple clothing, possesses a few basic pieces of furniture, and uses only necessary utensils. His days consist of long hours of work and prayer with no leisure activities and he may not even enjoy indoor heating or plumbing.

Austerity applied to whole countries, is not necessarily so harsh or ascetic. It simply means that the government has to live within its means.

If government were to adopt a thoroughgoing “Libertarian Monk” lifestyle, then the national government would be cut back to only national defense without standing armies and nuclear weapons. The national debt would be wholly repudiated. This would involve certain short-run hardships, although much greater long-run prosperity.

In contrast, the typical austerity policy is not severe. Government employees would be given cuts in wages, benefits, and retirement benefits necessary to balance the budget. The biggest cuts would fall on politicians, appointees, and senior bureaucrats. Given that such cutbacks occur when most everyone is facing cutbacks and hardships and given that government employees are typically very well compensated, it is not unreasonable to expect them to bear most of the burden of an austerity policy.

One particularly promising area for cutbacks is government regulation. Regulation is a burden on taxpayers, discourages entrepreneurship, and makes us less safe. One recent empirical study found that regulation was extremely costly and that “eliminating the job of a single regulator grows the American economy by $6.2 million and nearly 100 private sector jobs annually.”

Real austerity actually works best with tax cuts. To help austerity create growth it needs to be understood that certain taxes are highly discouraging to production. Tax cuts on investment and capital in contrast stimulate economic activity and production.

IMF-inspired tax increases make no sense. In hard times, government policies should be guided by the idea of increasing production, not of making production more burdensome via higher taxes. In much the same way, our ascetic monk does not force his duties and burdens on ordinary citizens.

President Obama has also suggested higher taxes (again) this time such as the removal of “tax breaks” for the retired rich. This would be the first step toward robbing our IRAs. Some have even suggested that “austerity” should involve extending existing taxes onto charities and nonprofits. Others have suggested taking away the tax-exempted status of charities and non-profits, which is nothing but a backdoor tax increase. These are some of the dumbest suggestions, especially in economic crises and are not real austerity.

Austerity does not mean, for example, budget cuts that would eliminate garbage collection or shutting down the fire department while leaving the military, education, and the spy state untouched. This is just a form of extortion that does not solve the problem. It only reveals the true nature and intent of those who work in government.

The Keynesian stimulus approach does not work. The IMF-inspired austerian approach also does not work. Only real austerity works. This means cutting government employee incomes, benefits, and retirement benefits. This alone would encourage them to run a tighter ship in the future. Eliminating regulators and regulations, cutting taxes, and selling government assets would all aid in the recovery process.

President Obama and Congress should get busy doing what is best for the economy and the American public instead of enriching themselves and those who feed at the public trough.

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a Sunday Stew

by Marketanthropology

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