Two routes to recession

"Lord, make me chaste and pure," wrote St. Augustine around the year 400, "but not just yet." That sounds a lot like the G20 countries and their deficit cutting plans made last weekend in Toronto.

While outside the fence one army in black struggled against another army in black, inside, two groups of leaders in black suits were struggling to make promises weak enough for them all to keep.

The inside battle, though less physical, was just as obstinate. Each group insisted the other group's path would lead to economic destruction.

The promises, or should we say (com)promises, they made can be found in the Toronto Declaration, section 10, which is surprisingly easy to read.

But in case you don't feel like reading bureaucratese, let's put it in more familiar terms.

Imagine these countries as people with credit cards, running up debts. For example, let's pretend one of them is your Uncle Sam. He earns $100,000 a year, but spends $111,000 a year. He puts the rest on his credit card bill.

Under the G20 promise, your Uncle Sam (who already owes $100,000) is permitted to keep on spending more than he earns for another six years.

In three years, in 2013, he promises to cut his overspending to $5,500. By 2016 he promises he will begin paying down his credit card bill (the debt to GDP ratio referred to in the declaration) … which by then will have grown much larger.

It won't be easy, but it's far from going cold turkey. And those cynics who can count on their fingers will note the 2013 austerity deadline falls just after the next presidential election in November 2012.

This is not what the Europeans wanted. But because the agreement sets a minimum standard ("will at least halve deficits by 2013" says the declaration), the Europeans can and will do as they please and begin to make budget cuts sooner.

Two opposing views

As weak as it this resolution is, it is causing much hand-wringing among some of our southern neighbours. Writing in the New York Times, economist Paul Krugman says the deficit-cutting plan means nothing less than another economic depression.

There is a different, opposite view, however. European economists, and many of the reports coming out of the G20 meeting, called the austerity plan the only way to stave off another world recession.

How strange. How could two sets of economists have completely opposing views with the same data?

Actually, it's not so surprising to anyone familiar with the opinions of economists. But in this case, perhaps the answer is that they are working from two different sets of data. One for the U.S. and one for Europe. Each of the two conflicting strategies apply to a different set of conditions and will benefit one country more than the other.

The Americans want to keep the economy hot by fanning it with dollar bills, hoping it will burst into life. If that causes inflation, so much the better. Inflation means wages rise with prices, and money is worth less. Savings become less valuable, but so do debts.

The U.S. dollar is widely held in the world, so not just Americans but the whole world pays a price for the weakening dollar. With inflation, the U.S. government, its businesses and its indebted citizens can then pay off their loans with money that is worth less than when they borrowed it.

Deflation on the other hand, would just make their debts more painful.

Compared with Europe, America has a young and growing population. That means they have a better chance of cutting the debt-to-GDP ratio by growing the economy, rather than shrinking the debt.

And in the U.S., the alternative to spending is much worse. Another downturn will hurt. Their "free market" employment system creates a poor safety net for the long-term unemployed, making a return to recession much more socially divisive.

Different in Europe

In Europe, however, the social safety net makes the risk of an austerity-led recession considerably less painful. And that is just one of the differences between the two economies.

Unlike the Americans, the Europeans have an aging and shrinking population. Letting their debt get out of control now means they may never be able to out-grow it.

Their currency, the euro, is much more narrowly held. Euro inflation cannot be easily shared with the rest of the world. European debts are largely owed to other Europeans. Inflation would make Europeans poorer, without making their debt disappear. And a collapse of the euro area because one or more country's debt gets out of control would create a destabilizing crisis.

According to Germany's finance minister Wolfgang Schäuble, writing in the Financial Times, "restoring confidence in our ability to cut the deficit is a prerequisite for balanced and sustainable growth."

So who is right?

Will too much austerity too soon push the world into a long depression? Or will running up the credit card lead us to collapse under a load of debt?

Right now we have two experiments underway. One is Japan. The country has been balanced on the knife-edge of deflation for decades as Japan has tried to spend itself into growth. So far, despite the worst debt-to-GDP ratio in the rich world, it has not succeeded in using yen to fan its economy into sustained growth. But then, neither has it collapsed under the weight of that debt, despite an aging population. The experiment is not yet over.

The other experiment is Ireland, the booming green tiger that was suddenly devoured by its own debt. The Irish have adopted the European austerity solution, making brutal cuts to government spending.

So far economic growth is continuing to plunge and unemployment to soar. As Havard Gould recently reported on The National, Canada is benefiting as a new wave of clever young Irish follow the path of our mutual forefathers to these shores.

Even as they export their unemployment problem, the Irish leaders realize their loss, but are hoping the tactic will shock its companies and its people, forcing them to buckle down and reignite the Irish Miracle.

Since I started with a quote from Augustine, I looked for one to resolve the issue. I found the following words of encouragement for the Irish and the Europeans.

"Do you wish to rise?" he asked. "Then begin by descending."

On the other hand, I also found a criticism of doctrinaire austerity: "To many," he said, "total abstinence is easier than perfect moderation."

Unfortunately, this is not just a theological or an academic exercise. One way or the other, real people will be hurt. In Greece Tuesday, there were anti-austerity riots that made Toronto's G20 demonstrations look like a slightly unruly grad party. Friday's jobs numbers will likely show that 10 per cent of Americans are still unemployed.

And if either the U.S. or Europe goes into back into recession — or worse — Canada will not escape.