Wednesday, 20 July 2011

North Atlantic crisis: US, Europe edge toward economic disaster

Normally at this time of year, politicians on both sides of the Atlantic would be preparing for their August break. But there will be no relaxing getaways this year, in what is turning into probably the most anxiety-packed summer of my lifetime.

Both Europe and the US may be just days away from serious financial troubles. And if situations on either continent spin out of control, a worldwide economic panic could be ahead.

On both sides, there are obvious and straightforward solutions that could avert disaster. But in the US, the recent electoral success of a Tea Party movement that wants to see the US default on its debts has rendered the political process incapable of taking action. In Europe, the recent surge toward nationalism and a lack of political courage has rendered the EU incapable of confronting the debt crisis head on. It is a massive failure of the political systems of the Western world.

Last chance to save the euro

In Europe, leaders are scrambling to stop the spread of the sovereign debt crisis to Spain and Italy. They will be holding an emergency summit here in Brussels tomorrow on a day that is a Belgian national holiday (I can assure you that journalists will be working!). Economists are saying it is the last chance for the EU to save the common currency by taking bold action to protect the Italian and Spanish economies. As I wrote last week, unlike the earlier bail-outs of Portugal, Ireland and Greece, the Italian and Spanish economies are too big to be bailed out in the event they were about to default.

But it does not appear that any decisive action is going to take place tomorrow. Speaking to journalists earlier today, European Commission President Jose Manuel Barroso said the summit is going to mainly focus on Greece. It appears the leaders are planning to ignore the fact that Italy looked last week like it was teetering toward default.

Some economists are now saying that the only thing that can save the euro is an overhaul that would resolve the common currency's major flaw – that the Eurozone does not have a single finance policy. It is not enough for the countries that use the euro to have just a single national bank – the ECB. They need a pan-European finance ministry and a budget-sharing plan like a nation would have, one that would hold all the debt of all the eurozone states. It's a simple, straightforward solution to the current crisis. And it is also almost inconceivable given current political realities. As Gavyn Davies wrote today for the Financial Times,
"Imagine what would happen if the eurozone were a genuine single nation. The debt issued by that nation would of course be backed by the taxpayers of the entire union, and sitting behind them would be a mighty central bank, the ECB. Viewed as a single nation, the public accounts of the eurozone (EZ) would look very good. The EZ public debt ratio would be 88 per cent of gross domestic product, compared with 99 per cent for the US. The EZ budget deficit would be 4.4 per cent, compared to 10.8 per cent in the US. In other words, if the EZ were a nation state, sovereign default would be inconceivable, and bond yields would be around 3 per cent."
The problem is that collecting all the eurozone debt into one pot would be disadvantageous to the richer Northern European countries, especially Germany. They would see the yields paid on their debt rise, while the poorer Southern European countries would see their yields go down. Angela Merkel appears to be unwilling to consider such a move. But the alternative may be a collapse of the entire European economy, which would hurt Germany a lot more than a rise in its yields. Of course, this is a normal part of any economic union. In the US, wealthier areas such as the East and West coasts subsidize the poorer areas such as the South and Midwest. They do so because there is a strong cultural union among all the states. There is real doubt now whether Europeans have enough common sense of purpose for richer areas to help out poorer ones. And yet without the resolve to do so, the benefits of the common market may be in jeapordy of disapearing.

Germany owes its current prosperity to the adoption of the euro and full opening of the common market - in the 1990's the German economy was a mess. But the German people seem to have forgotten that, and they now do not seem willing to make the national sacrifices it would take to keep that market, and that currency, alive.

Merkel is in a tough spot, and it would take a bold and decisive politician to take a decision that would save the European economy even though it would be politically toxic at home. Bold and decisive are not words typically used to describe Chancellor Merkel. And yet, the consolidation of Europe's debt and the moves to give Europe single economic institutions that would mirror a nation state are long overdue. The current problem is the result of the fact that the Euro was introduced as a half-measure. They introduced the common currency, but because there was such strong resistance to the idea of creating common European financial institutions (particularly from the countries that never even joined the euro –Sweden, Denmark and the UK), they didn't follow the idea through to create the necessary institutions to support such a common currency.

Despite the resistance, creating these pan-European financial governance was possible ten years ago. But now with the rise in nationalism and eurosceptism over the past few years, such an idea is looking politically impossible.

Meanwhile, across the Atlantic…

The Tea Party Republican candidates were swept into office last year on a platform of anti-government anger. So it should surprise no one that now that they have taken control of the Republican Party, their ultimate goal is to destroy government. That is exactly what they're doing in the debt ceiling fight.

The fight over raising the US government's debt ceiling, which caps the amount it can borrow, has been portrayed widely in the media as a fight between two intractable sides who both want their way on the budget. But this is an odd way to portray this. After all, the budget and the debt ceiling actually have nothing to do with one another. Raising the debt ceiling is a stand-alone measure that is done every few years as a "housekeeping" operation. Republicans voted to raise the debt ceiling seven times under President Bush. The US is alone in even having the concept of a debt ceiling. The ceiling was invented by congress during World War I over concerns about the nation's debt. No European country has such a ceiling on how much it can borrow.

But this year the new class of Republicans, who now control the House of Representatives, said they would refuse to pass the debt ceiling unless the president agreed to massive cuts in government spending. The president agreed, but said the cuts needed to be accompanied by a tax hike for the wealthiest 2% of Americans as well as the closure of corporate tax loopholes. The Republican leadership, under pressure from the new Tea Party caucus to refuse any tax rise at all, refused his offer.

The debt ceiling must be raised by 2 August or the US will default on its debt and government payments such as social security will stop. The US would also not be able to pay its creditors. The credit of the US would be downgraded, which would likely send the financial markets into turmoil and possibly result in a worldwide economic crisis. Economists have warned of the prosepct of a worldwide depression if the US defaults on its debt.

And yet the congress could just vote to raise it tomorrow, without any deal on the budget. It is the Republicans who are holding the economic fate of the world as hostage in order to get their demand of spending cuts with no tax increases in the budget. To Europeans, it is truly shocking. As they grapple with their own real debt crisis that has spiralled beyond their control, the US is about to voluntarily default on its debt for no good reason. It makes no logical sense, until you look at the reality that there are elements in the Republican party who want the US to default on its debt.

It's not a secret. Just look at the video below of all the Republicans in congress who say they will vote against the debt limit increase, with or without a deal. Michele Bachman, who is now polling at number two in the 2012 race for the presidency, is actively working to make sure the debt limit will not be increased. And all of these politicians say that the dire predictions about what will happen f the US defaults on its debts are just scaremongering by the Obama administration. One Tea Party Republican has even said, bizarrely, that it is an excuse for the president to have a really swinging birthday party on 3 August.

The heavy influence of these tea party politicians already resulted in a near shutdown of the US government in April of this year. During negotiations over the actual US budget, Republicans were holding rallies chanting "Shut 'er down". This movement despises government. The less of it the better, and they want to achieve this aim at all costs. Even if it means the US will stop paying its international debts. Because apparently US exceptionalism is so strong, so powerful, that it even applies to whether the US should have to pay back money it has borrowed.

So what will be the effect of these two default crises happening concurrently? It's hard to say. The markets certainly haven't liked it, and we may be in for a wild ride over the next week. But what is perhaps the most troubling about all of this, regardless of what ends up happening, is that both of these crises could be so easily fixed if there was the political will and the strong leadership to do it. But strong leaders are hard to find these days, and the forces of nationalism, populism and isolationism seem to have grown stronger than the political systems we trust to keep us safe. That is a very ominous sign.


Anonymous said...

US:> it's all just political pandering for fund raising season. The markets are not falling for it: with CDS insurance prices on US so low on shouldn't blow this thing out of proportion..

Anonymous said...

EU:> FWIW, the markets seem to be more (to the tune of 80pts on CDS indeces more) worried about spain than italy at this point.

In both cases, we're basically back to CDS rates at around the level seen during the first leg of the Greek bail-out (12/2010). It's bad, but as fare as it&es are concerned, we've been here before.