... reigniting the austerity-versus-growth debate. Tom Stevenson reports.

For investors, the whole eurozone crisis must appear to be frustratingly circular. Among the nations of Portugal, Italy, Ireland, Greece and Spain, investors can’t fail to have noticed how the focus of market attention has shifted about.

Not so long ago, all the talk was of Italy’s problems, then it was Greece again. Now the spotlight has moved to Spain as its borrowing costs – the yields on its 10-year sovereign bonds – have moved above 6 per cent, which is widely considered to be an unsustainable level.

Investors have become increasingly concerned about Spain’s ability to pay back what it owes. Unsurprisingly, just as for individuals who become too indebted, the widely prescribed solution to the problem has been belt-tightening or austerity.

The Spanish government has been urged to cut back on its spending and is responding with what will be one of the biggest austerity programs in Europe in an effort to slash its deficit from 8.5 per cent to 5.3 per cent this year.

For individuals, austerity makes sense. If they spend less but maintain the same level of income as before, then clearly their financial positions should improve.

Unfortunately, the analogy doesn’t work quite so well with national governments and economies. If governments cut back on areas such as health, education, defence and the civil service, then this is likely to result in job losses.

Moreover, people who lose their jobs will contribute less to income tax revenue and will buy fewer things, which will also mean fewer and smaller consumption-tax receipts. So, unlike individuals, austerity for governments tends to come at the expense of reduced income.

The challenge for governments undertaking austerity drives is to try to ensure that what they save in terms of reduced spending is greater than the income-reducing effects on the economy. Getting this delicate balance right is a very difficult task.

Unfortunately, this is not the case in Spain, where investors are once again getting worried about the combination of the government’s ability to repay its debt and the lack of growth in the economy, which is projected to shrink by 1.7 per cent this year.

The problem is that the costs of the Spanish austerity drive in terms of lost income are exceeding the savings made from spending cuts. The economic situation in Spain is already exceptionally challenging – almost one in four Spaniards are unemployed and just over a half of all the country’s youth (defined by Eurostat as those under 25) are jobless.

Given these problems, it should not be a surprise that the prescription of further austerity measures is not going down well. The question that needs to be asked is whether it might not be more sensible to cut Spain a bit of near-term slack, perhaps through a new longer term debt-consolidation plan that puts more emphasis, at least in the short run, on generating more tax receipts through improved economic growth and a bit less emphasis on painful spending cuts.

As the austerity-versus-growth debate continues in Spain and elsewhere, perhaps the key takeaway for investors is that there can be no quick or easy solutions to the eurozone crisis.

Investors need to be wary of falling into the trap of thinking that the coast is clear if a particular country has not been in the headlines for a while. Today it’s Spain’s turn, but tomorrow could see another country in the focus of the market’s unrelenting spotlight.

By:   Tom Stevenson15 May, 2012
Source:  Professional Planner   
http://www.professionalplanner.com.au