America and Britain's Economic Policies Will Soon Be Similar

America and Britain share many things in common. Among the less pleasant similarities is the unfortunate experience of having gone way too far in embracing the "Great Age" of leverage, credit and debt-entitlement.

Many have set it up as an economic competition: Britain's austerity versus America's dash for growth. And, not surprisingly, strong views have been expressed on which approach is better for restoring sustained employment creation and financial stability.

It is a good setup. Unfortunately, it is also incomplete as it fails to distinguish between desirability and feasibility. As such, it will not provide definitive answers to an important question: the best way to safely de-lever an economy so that it can grow and prosper in a lasting fashion. Instead, the two countries' initially contrasting situations will end up with them adopting rather similar approaches!

America and Britain share many things in common. Among the less pleasant similarities is the unfortunate experience of having gone way too far in embracing the "Great Age" of leverage, credit and debt-entitlement.

Both countries behaved as if "finance" was a legitimate stage in the economic maturation of a society - coming after agriculture and industry. In the process, they lost sight that the "financial industry" is not a stand-alone that can be sustained by clever financial engineering. Instead, its legitimacy depends on how well it facilitates real economic activity.

That is why it should always be called the "financial services industry," and not the "financial industry." It cannot, and should not outgrow the real economy that it serves And it is also why it will take years for the UK and US to undo the damage of the Great Age.

So, now that they are here, what is the best way to recover? On the surface, it appears that the two countries have opted for different approaches to deal with problems of over-indebtedness and strained balance sheets.

Many characterise the situation as follows: Through austerity, the UK is hoping to free up resources that can be devoted to pay down debt; and through growth, the US is hoping to create resources to pay down debt.

Put in this way, only a hardline disciple of the Austrian School - who believes, among other things, that a recession is a "cleansing" experience - would pick austerity. But before dismissing Britain's choice as inappropriate, remember two things.

First, growth is by far the most desirable approach but, unfortunately, it is also the most difficult one to pull off. As such, it can have disappointingly narrow feasibility.

In effect, this option is available to countries that have very patient creditors, possess the structural conditions for high growth, and are able to capture the value added to pay off liabilities. Otherwise, the dash for growth leads to an even heavier debt burden, and eventually a more painful adjustment.

Second, austerity and growth are only two of the five approaches that countries have pursued in the past to rehabilitate their balance sheets. The others three involve restructuring and/or defaulting on the debt, inflating out of it, and imposing financial repression (by paying creditors a lot less than they deserve).

In most cases, countries are forced into a mix of approaches. And I suspect that both the US and the US will also end up mixing and matching over time.

Given these two issues, it is not surprising that the US opted for growth. After all, having patient creditors is part of the "exorbitant privileges" enjoyed by the supplier of the world's reserve currency.

Unfortunately, and despite worrisome unemployment data, American policymakers are yet to put in place the conditions for sustained economic growth. Unless this changes quickly, they will have no choice but to also resort to other, less pleasant options to deal with the debt overhangs. This will likely involve a two-step process.

Initially, more financial repression will take place. It will involve the Federal Reserve maintaining very low interest rates for an exceptionally long time and, under the guise of prudential actions, additional regulatory requirements imposed on financial institutions forcing them to buy more government bonds.

But, the longer a pro-growth strategy is postponed, the greater the probability that the benefits of financial repression will give way to increasing costs and higher risks, including by eroding the global standing of the US as the provider of global public goods. The country will be forced into greater austerity and larger inflationary financing.

For the UK, the choice of austerity reflects the government's understandable belief that the growth option, while desirable, is not feasible; and financial repression cannot be sustained for long given the openness of the economy.

Again, it is unlikely that just one option will suffice for the UK. At some stage, the government will be forced to move more aggressively on growth-enhancing structural reforms to accompany budgetary austerity.

On the surface, it appears that America and Britain have opted for different approaches to deal with their debt hangover. As such, many characterise the situation as a horse race, with bets being placed as to which will be more successful in restoring sustainably high employment.

The reality is different. Contrasting starts will give way to greater commonality as each country resorts to more than one approach to safely de-lever the economy. It is a process that will take time. Hopefully, it will also serve as a constant reminder that any great age of finance can only be justified on the basis of serving the real economy, and enabling it to prosper.

Mohamed A. El-Erian is CEO and co-CIO of PIMCO, and author of "When Markets Collide"


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