Courage! Carmignac's Leroux issues rallying cry for eurozone chiefs

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European governments’ thin gruel of an austerity diet, mixed with household and corporate frugality, is economic suicide. If growth isn’t stimulated, tax revenues will crater and public deficits and government debt will skyrocket – despite tax rises, since these taxes will be levied on a shrinking tax base as economies contract.

Households and businesses are reducing debt by saving more, so economies can only avoid a depression if public spending makes up for the lack of private investment. Japan shows how vital compensatory public spending is when the private sector enters ‘pay down debt’ mode.  Japan, through tax hikes mainly, prematurely tightened its belt in 1997 and again in 2001 with devastating effects on economic growth.

Over and above the necessity to slash administrative costs, governments must go beyond the talk and actually launch major R&D and infrastructure programmes to boost their economies’ productivity in the years ahead. Imposing fiscal discipline through spending cuts and tax hikes alone is certain to fail.

Why are European governments, one after another, falling into the trap of strict fiscal austerity? 

This willingness to deleverage has been poorly thought through because of a lack of experience. Effective solutions seldom reach the ears of politicians, and if they do, they contradict official thinking so drastically that they are barely considered. It is easier to make the wrong decision when you won’t be challenged by those who will suffer the consequences, than to make the right decision if people will see it as irrational.

Decision-makers in all fields are familiar with this dilemma.  As Voltaire said ‘it is dangerous to be right in matters where established men are wrong’.  Taking the risk of being right alone requires a freedom to act which few democrats enjoy.

Imagine being in the Italian shoes of Mario Monti, or Nicolas Sarkozy’s footwear: while everyone else has ’accepted’ that reducing deficits  is essential, these men would need to propose and implement a policy that clashes with popular belief, while ignoring rating agency recommendations and risking the wrath of financial markets. Such a move demands vast political courage.

But it has to be done before the disastrous consequences of current fiscal policies leave no option.

To implement a fiscal policy focused on infrastructure investment, while simultaneously cutting current expenditure, requires an expansionary monetary policy to already be in place.  The cost of public debt could be trimmed despite spending being higher.

Without an openly expansionary monetary policy, it will be impossible to implement a fiscal policy to stimulate growth because so many market participants are convinced that to cut the cost of financing public debt we must first shrink deficits.

The European Central Bank has to become lender of last resort.  This is anyway the role played by all other major central banks which can buy up unlimited amounts of their own government’s bonds. Believing that the ECB is shackled by its mandate and limited to maintaining price stability is mistaken.

Price stability depends on the integrity of the financial system which, judging by the impact of monetary policy decisions on the real economy, is no longer guaranteed.

This malfunction justifies unorthodox solutions, such as setting key interest rates at zero and making unlimited purchases of struggling countries’ bonds.

Why is this not being done? A lack of courage is to blame, again. Everyone is shirking their responsibilities, hiding behind the fact that Germany refuses to see the ECB's role as similar to other major central banks despite the obvious deflationary risk the Eurozone is facing.

There are two problems with this mistaken view, which places unbearable strain on the German Chancellor’s shoulders.  First, Germany is saying repeatedly that the ECB is politically independent. The ECB’s independence applies as much to politicians clamouring for an American-style central bank as it applies to those clamouring for a Germany-inspired central bank.

Second, monetary policy decisions are taken by the ECB’s 23 member Governing Council based on the one member, one vote principle. So while there is one German, one Dutchman and one Finn on the Council, there is also one Greek, one Irishman, one Portuguese, one Spaniard, one Italian, one Frenchman, and so on.

The decision to protect the integrity of the financial system through extensive purchases of troubled countries’ debt and very low interest rates, justified by the magnitude of the crisis, is in the hands of the 23 individuals on the Council.  It needs the courage of 12 men, free to vote as they see fit, to form a majority capable of taking the right contrarian decision.

The simultaneous implementation of stimulating fiscal and monetary policies is vital to putting the European economy back on the path to salvation through growth. Growth and a weaker euro are the only cure for the agonies of the Eurozone.