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Fiscal Cliff and Austerity – Why the Canadian Plan Would Work in the USA

Posted by nexvucapital on November 21, 2012

We have taken the liberty to comment (in our humble opinion) on Mr. Dutta’s report for Bank of America Merrill Lynch which concluded that “Canada’s experience (in the 1990s) is more the exception than the rule.” Key points from Dutta:

• In Canada, austerity helped lower interest rates. Rates are already super-low in the U.S., so there’s no room to improve.

Nexvu: if lower interest rates are a benefit of austerity then the US is already benefiting. We know that higher rates would not be beneficial and therefore the low rates in the US must be beneficial. Mr. Dutta is obviously thinking that it would be more beneficial to have even lower rates. Since US rates are already negative in real terms this is impossible. The benefit of lower rates is that they stimulate economic activity. The problem in the US is one of confidence not lower interest rates. Confidence in the Federal government’s plan to reduce the deficit and the debt should invoke confidence and spur the activity that benefits from lower rates. The cash pool in the US private sector is enormous but without confidence it is stuck under the mattress. They do not teach psychology in Economics but it is the key ingredient to any Austerity plan.

• In Canada, austerity lowered the value of the Canadian dollar, which made Canadian goods more competitive on world markets. The U.S. is a relatively self-sufficient economy, so it would benefit less from a depreciation, even if one occurred.

Nexvu: this point can be debated as basic economics tells us that a depreciation in the currency with all other currencies held equal will benefit the exports of the depreciated currency. With the US GDP 70% the US consumer this effect is muted and we agree. What we will do though is take you back to point 1 and make the statement that consumer confidence in the US is the number one factor in US GDP growth.

• Canada benefited from growing demand for its products from the U.S. and China, which compensated for the chilling affect of deficit reduction. No countries today are eager to soak up more imports from the U.S.

Nexvu: see point 2 above. It is our opinion that the US needs to become a net-exporter of its plentiful resources but this is a long-term plan that would only have positive effects over the very long-term. A cheaper US dollar will benefit US exports.

Bottom line: If an economy is already suffering from a shortfall in demand, as the U.S. is today, cutting demand further through fiscal austerity can make matters worse, not better.

Nexvu: the shortfall in US demand is exacerbated by the current hoarding (money under the mattress) activities of the consumer, corporate and banking sectors. One needs to ask why is this activity taking place? There is a lack of confidence and clarity in the US and and in that environment money does not move. A plan of any sort to tackle deficits and debts will help to provide clarity and that will help to provide confidence. Therefore, an austerity plan can only be better than no austerity plan when deficits and debts are the worry of all – nough said!!!

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