VOL. 127 | NO. 194 | Thursday, October 4, 2012
The Worldly Investor
Self Reform Can’t Come Soon Enough
By David Waddell
We Have Seen the Face of Reform In 2008, a prolonged lack of credit scrutiny led to a financial crisis. While the clean-up of the financial system continues, the bulk of the rationalization happened very quickly. Massive institutions failed, while remainder institutions began internal austerity programs to reconstruct rotten balance sheets.
These reforms were not an election but a requirement for survival. Private sector reforms occur through bankruptcy, bold restructuring or surrender to competitors. This process seems “Darwinian” because it is. In a free market economy, we know this and we expect this. The process of creative destruction enables stronger institutions to form. That’s how private markets evolve. It may be unforgiving, but it is admissible in the name of progress.
The process in the public sphere is different. Public reform takes significantly longer than the harsh Darwinism of the private sector. Riots in Greece, Spain, Chicago and Wisconsin all represent resistance to the reforms now being imposed by the capital markets. The good news is that this slow moving fire across overly indebted nations will produce taller and stronger institutions. The bad news is that each reform will be met with reluctance, strong political opposition and media hyperbole. Nonetheless, just as the financial sector had to be rationalized, the public sector has to be rationalized as well. No matter how bad it tastes, the medicine will go down.
Progress Reports You cannot fix old debt with new debt, the money being printed and the “bailout” funds extended only buy time. It’s incumbent upon the recipients to use the time wisely. Let’s survey three troubled nations and assess their progress on bought time:
Greece: For Greece to stabilize, the government must move its primary budget (excludes interest payments) to 1.5 percent of GDP from -1.5 percent, amounting to another $9 billion adjustment. The Greeks have been at this “rightsizing” for a while and have made progress.
Spain: Spain’s economy approximates $1.5 trillion, with the government occupying about 40 percent of the economy. Last year’s government deficit was 8.5 percent of GDP. The goal is to have a deficit of less than 3 percent by 2014. That’s equivalent to a swing between the public sector and the private sector of $83 billion. It will be raining in Spain for a while.
The U.S.: The U.S. receives better treatment in the credit markets than Spain or Greece. We have control over our own currency, our own central bank and our own fiscal policy. Consequently, the continued escalation in our government spending and our annual deficits (now rivaling those of Greece and Spain) go unpunished. However, the “fiscal cliff” is nothing more than a U.S. austerity package and the 2012 election has become a referendum on the size of government, providing voters the opportunity to proactively address reform rather than reactively respond to crisis.
Clearly, from the riot coverage pulsing out of Cyprus, Italy, Portugal, Greece and Spain, reform at our own hands is preferable. The sooner the better!
David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Memphis-based Waddell & Associates.