European debt issues and the primacy of growth

We'd like to elaborate a little further on the question of US Treasury bond yields, which we touched on in our previous post about those who fear nobody will want to lend to America since "we don't make anything here anymore." The comparison is often made between the US and countries such as Argentina or Greece, with the admonishment that America will soon face a similar debt crisis.

Today, the news is focusing on the debt situation in Europe, where countries such as Ireland and Portugal are seeing their borrowing costs go up in response to fears about their economic strength. The sovereign debt of these countries (the parallel to US Treasury debt here) must carry higher interest rates in order to attract investors that are fearful about their ability to make good on their obligations. Their ability to pay the interest on their bonds is directly related to their tax income, which is in turn, of course, dependent upon the strength of their economy, the profitability of their businesses, and their levels of employment.

We recently wrote a series of blog posts about this subject relative to the debt problems in Greece, where an economy that doesn't produce very much is expected to support a massive number of government employees and retirees, who receive ongoing salaries at retirement of up to 80% of their "pensionable salary" for the rest of their lives, and who retire at an average age of 58. When it became clear that Greece could not possibly continue to support these lush pension plans forever, the more industrial and productive nation of Germany was called in to support Greece's debt payments to Greece's lenders, and Greek politicians began enacting "austerity" packages to slow down the runaway government benefits train (see "Greece and California" and "The Question of Our Time").

This situation is admirably laid out by Jan Randolph, the head of the Sovereign Risk Department at IHS Global Insight, in an interview on Bloomberg Television this morning (see above).* He says:

"If you take the perspective of German taxpayers and the German government, they're always called in at the last moment, at the height of the crisis, to come in and save the situation, and the way they do that is to provide the German government's balance sheet, and the taxpayer, to effectively guarantee, to ease the situation as far as investors are concerned; they've done that with the big backstop package now in place for Greece, Spain and Portugal, but they resent it -- they don't like being used like this. The Germans say this is, you know, we can't have a situation where investors are playing 'moral hazard' with German taxpayers, and if we do have, in future, a sovereign debt crisis, then investors have to understand those risks at the point of making the investment, rather than expecting the sovereign to come in and bail them out."

This is exactly the situation that many fear may take place in the United States in the not-too-distant future, substituting China for Germany as the lender that becomes fed up with lending money to a nation that "doesn't make anything" anymore.

The difference, however, is that the United States of America remains an extremely vibrant and productive economy, in spite of the protestations of the doomsayers. How much more productive we would be without government stimulus packages and excessive regulation and corporate tax rates is hard to say (probably many times more productive), but the fact remains that innovation and growth are still part of the DNA of our nation and there are plenty of young entrepreneurs trying to start companies right now (and coming here from other parts of the world to try to start companies as well).

And America's economic output is not merely "phony services" as some critics maintain: the nation's industrial manufacturing output is still at levels of magnitude above anything achieved in previous decades. Take a look at this graph of the most recent industrial manufacturing output as measured by the St. Louis Fed:

As the graph shows, America produces far more "stuff" than any time in its past history, even though there was a sharp dropoff during the recent recession. That steep drop has since rebounded sharply, as seen by the "V-shape" uptick at the end of the graph.

Because America is so productive, comparisons to Greece, Argentina, Portugal, or Ireland are really not valid.

However, just as the German taxpayers Mr. Randolph describes in the quotation above are resentful of having to bail out the lush pensions of the less-productive nations in Europe, American taxpayers (the producers) are resentful of having to bail out the lush giveaways of states such as California and Illinois, and of auto industry companies in Detroit. This is the resentment that makes some people quick to agree with the doom-and-gloom scenarios painted by those who argue that America's economy is falling off of a cliff, and that we won't be able to get it back because "China won't give us any more money."

Such talk has an air of wisdom and economic sanity, but it really misses the most important aspect of capitalism: growth. It grossly underestimates American capitalism and its power for growth. Yes, that growth can be retarded by foolish policy from Washington and foolish monetary policy from the Fed, but as we have said in the past, America has always had to "get by in spite" of such foolishness. Today is no different.

We believe strongly in the primacy of growth and human creativity, as we wrote here. The real solution for countries in Europe -- as well as for US states such as California -- is to foster growth, primarily through lower corporate and marginal income tax rates. That would spur even more growth and innovation in America. In the meantime, however, investors should realize that wild comparisons between the US and Argentina (or even Zimbabwe) are completely overblown.

* At the time of publication, the principals of Taylor Frigon Capital Management owned securities issued by IHS (IHS).

For later posts dealing with this same subject, see also: