What is to be done?

One of the market experts we follow is Jim Swanson who is the Chief Investment Strategist for MFS Investments. He typically provides an interesting and insightful perspective on global events. We especially enjoyed reading his comments on the recent European elections and have decided to share them with you.

Posted: 10 May 2012 02:14 PM PDT by Jim Swanson

“The fault, dear Brutus, is not in our stars,
But in ourselves, that we are underlings.”
-Julius Caesar by William Shakespeare

The recent elections in Europe have created a new crisis of confidence in the world markets. Last year, fear of contagion raged, as bank failures spread throughout eurozone. This year, we are experiencing a different kind of contagion. Voter backlash has swept two austerity-imposing governments from power and now threatens other eurozone regimes that have tried to impose their harsh brand of fiscal authority in an effort to appease European creditors.

In France, the president has been thrown out. In Greece, newly elected legislators from the left-of-center party are demanding a reversal of what they are calling the “barbarous” austerity measures agreed to by the former government.

With more elections on the way, politicians are now taking a fresh look at the timing of budget cuts that are being implemented with the eurozone in the midst of recession. They seem to have concluded that growth and austerity are incompatible. But, is that really the case, or is it rather a case of who or what is fueling the growth that will enable a country’s economy to be lean at the same time that it is prosperous?

Deficit spending by the central and peripheral governments of Europe and here in the United States has led to mountains of debt that are out of proportion to the size and growth of the underlying economies. European electorates seem to be telling their governments that they are going to have to find another way out of the budget mess. But what is that other way? No one seems to know.

Too much debt in Europe and the United States is a significant problem, but in Europe, the debt crisis is a symptom, not the cause, of its woes. It is clear from our data that labor costs in Europe are too elevated to allow European production to be competitive; this is especially true in the peripheral countries.

Falling market share in exports and expensive and rigid labor pools are hallmarks of these countries. The promises leaders have made to their voters to gain power have been geared toward making life comfortable now, but not toward making economies competitive.

As a result, the government grows, the private sector does not, and the key symptom of distress, the debt burden, expands relentlessly.

Let’s look at France. French voters embraced the bold and exciting ideas of the country’s new president, François Hollande. Hollande, a socialist, is in favor of lowering the retirement age, not raising it, as was championed by his center-right predecessor Nicolas Sarkozy. Hollande favors 35-hour work weeks and wants greater protection for labor. But even if Hollande can deliver on this promise, shorter work weeks and more protections for labor are hardly a good prescription for this second-largest economy in Europe. In fact it’s this uncompetitive work force that has caused the drop in French exports.

Government spending accounts for about 55% of the French economy. In the United States, where the government makes up 25% of the economy, there has been bitter debate about the government and its role in the economy. What is going to happen to France’s percentage if Hollande gets his way? Hollande and his supporters may be correct in concluding that now is not the time to cut back, but it seems to me cutting back is not in his plans at all. So, in effect, Hollande, with his election promises, may not only be ignoring the symptoms but actually worsening the spread of the disease. This may be true of Greece and Spain as well.

The United States has debt problems too. But unlike labor costs in these European countries, US labor costs are low and the business cycle is flourishing. What’s the secret? What do the Americans know that the Europeans don’t?

Well, Americans have not really discovered anything new. Rather, it is the classic debate between Keynesian and Chicago School economists. It seems that the flexibility and resilience of the US labor markets have some key economic advantages. So, Hollande may actually be taking France further away from prosperity by strengthening the country’s labor laws. The real path to growth and balanced budgets lies in allowing the market, and not the government, to bolster the economy.

No investment strategy, including asset allocation or diversification, can guarantee a profit or protect against a loss. No forecasts can be guaranteed.

The views expressed are those of James Swanson and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation or solicitation or as investment advice from the Adviser.

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The information in this material is only as current as the date indicated, and may be superseded by subsequent market events or for other reasons. While all information prepared in this document is believed to be accurate, any statements of opinion constitute only current opinions of Payne Wealth Partners, Inc., which are subject to change and which Payne Wealth Partners, Inc. does not undertake to update. Accordingly, you should not put undue reliance on these statements. The information does not attempt to examine all the facts and circumstances that may be relevant to an individual’s financial needs. Payne Wealth Partners, Inc. is not soliciting any action based on these statements.

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