Michael Pento continues:

“This principle applies to countries as well because the notion of embracing austerity on a national level goes against the grain of our collective psyche.  The Spanish economy continues its downward spiral, as the level of unemployment hit yet another record high (now north of 25%), as 5.78 million people were out of work at the end of the third quarter. 

Prime Minister Mariano Rajoy is faced with the dilemma of either allowing their onerous debt service payments to completely bankrupt his country, or voluntarily accepting the ECB’s austerity measures, which would mean Mario Draghi takes control of Spain’s interest rates....

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“Spain wants to have the European Central Bank buy its debt because without a Draghi put there is no private market for the debt unless yields were to increase many hundreds of basis points.  Mr. Rajoy is in an especially difficult position because austerity has already arrived on the Iberian Peninsula. 

He may soon learn that even if he accepts “help” from the ECB and cedes control of Spain’s fiscal authority over to Mario Draghi, having a central bank usurp the role of the private market in debt financing never has a happy ending.  However, real austerity in Spain would be to balance the budget and refuse to let the ECB buy its debt.

The United States faces a similar fate.  Our Q3 GDP report clearly illustrated that although growth is anemic (just 2%), inflation is creeping much higher.  Despite the fact that we are in a revenue, earnings and capital goods recession; the rate of inflation doubled from 1.5% during Q2, to 3% in the current quarter.  However, now the U.S. faces the Fiscal Cliff come January and that would throw the already fragile economy into a deep recession.  The question is will our government voluntarily push the economy over the edge.

The truth is that the developed world faces a decision that is unbearably sharp and impossible to avoid.  Either the West will drastically cut spending now, in the hope of getting our debt to GDP ratios under control; or continue to borrow and spend until the market causes a full-blown currency and bond market crisis. 

The problem is that accepting austerity at this juncture would bring recessionary economies much deeper into the abyss.  That’s because it will take some time before the private sector can absorb those individuals which were formerly employed by the government or relied on transfer payments for their consumption.  And tax hikes steal money from the job creators and hand it over to government to be misallocated.

As the U.S. approaches the Fiscal Cliff, markets have already begun to price in its effects.  The drop in government spending and increased tax revenue of around $700 billion in 2013 would cause most asset prices to fall.  The reduction in government spending would also lead to a fall in money supply growth.

But austerity is something that individuals and governments have a long history of avoiding at all costs.  It is my belief that the U.S. will back away from the cliff and decide to adopt a stopgap measure that extends the current tax rates and eliminates spending cuts.  The plan would then be to reach a grand bargain down the road where republicans and democrats agree on a combination of increased revenue and entitlement reform that cuts $4-6 trillion of additional debt over the next decade.

Washington appears to be offering us two choices; trillion dollar deficits every year until we have a currency and bond market crisis or to go over the Fiscal Cliff in January.  If D.C. cannot agree now to accept austerity, even after we have run up $16.2 trillion in debt, why should anyone believe they will reach an agreement when there is no sequestration forcing their hand? 

Another problem is that even if we do actually cut $5 trillion in debt over the next decade we will still be adding another $6 trillion in debt over the next ten years.  That’s because these proposed cuts aren’t really cuts in existing debt but merely a reduction in the growth rate of new debt.

The truth is that austerity is unavoidable in the debt-laden developed world.  Austerity is by its very nature both depressionary and deflationary.  That is why it is never chosen voluntarily.  It is simply much easier to continue to borrow and spend until your creditors finally cut you off. 

I fear that is the path of least resistance and we will see rapid growth in the money supply, a fall in the dollar and risk asset prices will take to the upside off once the U.S. decides to reject the opportunity to confront its debt issues yet again.”

To learn more about Michael Pento’s financial management services CLICK HERE. 

© 2012 by King World News®. All Rights Reserved. This material may not be published, broadcast, rewritten, or redistributed.  However, linking directly to the blog page is permitted and encouraged.

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