Double dip on its way? Ask Paul!

The raging debate among economists, academics and policy-makers about whether the recent shift in economic policy in Europe from "fiscal stimulus" to "fiscal austerity" will help a recovery or cause a new recession has started to percolate to smaller party circles in Dubai.

Last week I was at one such party. It had a deadly mix of bankers, economists, academic types and some of us from the media. I tried to stick with the media crew, comparing notes on the current gossips in town. But I couldn't help overhearing a discussion among a small group of bankers and some academics on a table close by.

A college professor in the group said with some sense of authority: "It is widely acknowledged that the re-discovery and implementation of Keynesian policies in the last two years saved the world from a potential depression."

"But the Greek crisis has struck fear into governments, that if their budget deficits are too large, they may not be able to borrow enough at a reasonable rate of interest, and may be forced to default," declared a neighbouring economist.

Louder noise on the media table prevented me from keeping track of this dialogue. The chat amongst us was more about the job scene in the local media industry. I couldn't care less, but pay keen attention to what was going on in our own back yard rather than listening to what could happen in Europe. Eventually I also aired a few of my thoughts on the local media sector.

Suddenly I heard something which caught my year. "I think we should check that with Paul", said a banker sitting opposite to our table. This was followed by thunderous laughter from the rest of the group.

My heart sank. I thought the guy overheard something I had said and wanted to cross check it with my boss, of the same name.

On paying careful attention to their conversation I figured out they were still stuck in the stimulus versus austerity debate and I presumed that it was Nobel laureate Paul Krugman that they were referring to.

Moments later I heard someone in the group saying, "Paul has been proved correct 100 per cent as far as world cup match results are concerned. I think he should have better insights on global economy than many economists."

Voila, it was Paul the oracle octopus they were talking about. His keepers at the zoo in Oberhausen, Germany claim he is psychic. Paul's unwavering accuracy this year has even seen him become a target for furious Argentinean fans, who blamed him for their side's quarter final defeat against Germany.

I don't know how comfortable Paul would be when it comes to making predictions on fiscal options for some of the debt-laden European Union countries that have little choice. Most governments around the world can choose to borrow from their own central banks (printing money) and/or devalue their currency to make their exports attractive as a means to escape from deflation and recession.

But countries in the Eurozone such as Greece don't have this option. Not least, they don't have their own currency to devalue and they have to rely on the market to lend to it. Countries that rely heavily on foreign investors — like Greece, France, Ireland, Italy and Spain — must cut spending to avoid being shut off from the capital markets, who might otherwise lose faith in their commitment to restraint.

Governments can't make bad debt go away through continuous stimulus. They simply can't prevent a correction and a de-leveraging; they can only delay it. One way or another, excess debt needs to be reckoned with.

Across Europe, governments are announcing new austerity regimes featuring spending cuts and higher taxes rather than stimulus spending. Some economists including Krugman think these are terrible changes that will throw Europe back into a depression

What about the oracle? Given a choice between Krugman and fiscal rectitude, Paul is likely to choose the latter. After all he lives in Europe.