04/06/2010: The markets won't dance with TINA anymore

Margaret Thatcher called her defense of economic liberalism the TINA argument, as in "There is no alternative." This discussion-ending dictum also goes under the names "pensée unique" or Washington Consensus. These days, the TINA mantra is invoked to justify the belt-tightening exercises underway in many European countries as they confront their sovereign-debt crises. But, ironically, the more it is preached, the more TINA seems to drag on these stricken economies.

It seems clear that old truisms no longer apply. Frugality in government has always been seen as a virtue, one that investors are happy to reward. Why, then, was Spain's latest savings measures met with a downgrade to its credit rating by Fitch and renewed pressure on the euro?

To find the answer, we need to go to the one place in the world where the Washington Consensus is routinely ignored: Washington, DC. In a week that saw Germany announce new austerity measures and France declare that it would make a public-deficit cap the law of the land, Larry Summers, President Obama’s chief economic advisor, argued for further USD 200 billion in fiscal stimulus in a speech at Johns Hopkins University on 24 May. This sum would add to the already eye-watering US deficit of USD 1.5 trillion for 2010.

One of Summers’ statements must seem particularly heretical to Europeans in the midst of an austerity frenzy: "It is not possible to imagine sound budgets in the absence of economic growth and solid economic performance."

Here, we think Summers has captured how market participants are reacting to Europe's new frugality. In their efforts to save, European governments are burdening their economies with low growth rates that could threaten their recovery. Indeed, surging unemployment and falling tax revenues could well deepen their deficits. Despite the Herculean savings efforts by Greece, for example, the International Monetary Funds projects that its public debt-to-GDP ratio will increase from 115% in 2009 to 150% by 2012. In fact, Greece and other Eurozone countries could end up trapped in a Japanese-style paradox of thrift.

Although its infamous debt-to-GDP ratio is almost 200%, Japan is by far not the most profligate G7 country in terms of public debt growth over the last 20 years. That distinction goes to the birthplace of TINA, the UK.

Between 1989 and 2008, Japan's debt ratio increased from roughly 68% to over 170%. The UK, meanwhile, managed to contain its debt ratio to 60% as of 2008 (although it has since surged rapidly) despite growing its public debt by over 8% a year on average during this period. What explains this apparent anomaly? The difference in nominal growth rates: 5.5% on average for the UK and only 1.2% for Japan.

The thrift paradox refers to the Keynesian notion that when people save during a recession, demand collapses, prices and output fall and everyone suffers as incomes shrink accordingly. Ultimately the drop in income could even lead to a drop in overall savings. We think it explains why markets currently prefer the more positive growth prospects in the US over the somber deficit-reduction efforts in Europe.

Another paradox prevails today: the European Central Bank's effort to restore its inflation-fighting credentials could in fact backfire and ultimately weaken the very euro it aims to strengthen. TINA and the Washington Consensus would favor diehard monetarism – a balanced money supply aimed at price stability – but the US and the UK are running their printing presses night and day to revive their flagging economies. And this, we think, is precisely why markets are rewarding them and strengthening their currencies versus the euro, with its limited growth prospects.

While TINA may be the markets' favorite in good times, she is definitively less welcome when times are tough.