I recently finished Mark Blyth’s book – Austerity: The history of a dangerous idea. Blyth is professor of International Political Economy at Brown University. It concerned me that I didn’t understand how the world was going to get itself out of the overindebted state we are in. It seems economists don’t have any particularly clever ideas either.
In classical economic theory, there are four ways for governments to settle the enormous debt they have incurred:
- Inflate: low interest rates and printing money will achieve inflation, then governments repay the debt at vastly reduced real value. (Germany after WW I).
- Devalue: if debt is in local currency, again repayment is at a reduced value in time. (Zimbabwe)
These are the preferred ways for politicians as the other two result in unemployment and instability.
- Deflate: austerity – reduce state expenditure and employment.
- Default: non-payment results in governments being unable to access credit markets for many years thereafter. (Argentina).
Two other policy options exist and are being implemented aggressively:
- Financial Repression: these well-known measures include: deliberately keeping interest rates below inflation, representing a tax on savers, thus transferring benefits from lenders (savers) to borrowers (governments); directed lending to government (e.g. prescribed assets for pension funds in the 1980’s); exchange controls.
- Massive Tax Hikes: it is difficult to simply raise tax rates – at a certain level, tax morality declines. Governments turn to more politically palatable solutions; new taxes are introduced – e-tolls, sugar tax (?); dividends tax has gone from zero a while ago to 20% in 2018; CGT has increased from zero in 2001 to an effective 18% in 2018. Massive “fines” (taxes) are being levied on: foreign entities (e.g. Deutsche Bank $14bn by the US, MTN by Nigeria); industries that have been particularly profitable (e.g. banking); companies and industries where there has been collusion (e.g. bread, construction, now shipping). The taxpayer/voter has little sympathy for these companies and is quite supportive of these fines.
From an investment perspective, we need to take notice of these trends and adapt to the risks where possible, by avoiding industries that are likely targets and favouring sectors that may escape regulatory interference.