The Kroog Versus The Confidence Game

Paul Krugman takes a look at the austerity hysteria from another angle:  if we did cut spending in order to satisfy the bond markets, would the bond markets even notice?

Consider, if you will, the comparative cases of Ireland and Spain.

Both countries appeared, on the surface, to be fiscally responsible until the crisis hit, with balanced budgets and relatively low debt. Both discovered that this was an illusion: revenues were buoyed by immense real estate bubbles, and when the bubbles burst they plunged into deficit — and found themselves potentially on the hook for large bank losses.

The countries responded differently, however. Ireland quickly embraced harsh austerity; Spain has had to be dragged into austerity, and still faces major political unrest.

So, how’s it going? This article is typical of what you read: it describes the Irish as doing what has to be done, while the Spaniards dither. And it has good things to say about how the Irish response is working:

Much bitterness but also stoicism; markets impressed by Irish resolve to bite the austerity bullet.

Well, I guess that’s right — if by “markets impressed” you mean a CDS spread of 226 basis points, compared with 206 points for Spain; not to mention a 10-year bond rate of 5.11 percent, compared with 4.46 percent for Spain.

So, I’m glad to hear that Ireland’s stoic acceptance of austerity is reassuring markets; it must be true, because that’s what everyone says. Because if I didn’t know that, I might look at the data and conclude that markets actually have less confidence in Ireland than they do in Spain, and that austerity in the face of a deeply depressed economy doesn’t actually reassure markets at all.

Surprise surprise:  Ireland's austerity actually has it in worse shape than Spain is right now and investors find the Emerald Isle an even tougher sell to invest in, because austerity means crippled growth.  The reason we've been told austerity has to happen is because the markets will demand it.  The evidence points to the opposite of that.

The reality is that austerity is political, especially in the US.  The goal of creating a permanent underclass in the US means we have to cut spending on social and jobs programs so that the rich can recover from the recession quickly and the rest of us can...well, it really doesn't matter to them, does it?  Never waste a crisis, as the saying goes.  Always time to make the inequality curve that much worse through destroying the social compact.  England is heading there next with David Cameron in charge.

Krugman's coming around, slowly.  But he's coming around.