As a member of the U.S. Congress, I spent most of my 22 years as a vocal deficit hawk—warning against the danger of unchecked deficits and most particularly against mounting costs of entitlement programs such as Social Security and Medicare adding to a mounting debt load for future generations. So, I find myself in the strange position of worrying about the severe austerity programs being cobbled together in the European Union, led most notably by Germany.
There is no doubt that Germany is a nation of savers, worshipping at the altar of balanced budgets. The historical reasons are well known. The years of hyper-inflation in the 1920s that preceded the Nazi regime have left a lasting and deep imprint on all Germans and their public officials. We could benefit from a dose of their fiscal discipline here in the United States. But for the Germans, a sort of moral self-righteousness about avoiding deficits has taken the place of strategic economic thinking. Now, they have exported this thinking—or more precisely “imposed” it—on their partners in the eurozone.
Europe is in the midst of an unfolding fiscal crisis. Most see it as a sovereign debt crisis, though it is more likely a massive banking crisis about to implode. The markets understand this : non-stop meetings of finance ministers and prime ministers, large commitments of budget support (bail outs) for the most fiscally challenged countries, and pledges of even more help if needed, European bank purchases of faltering countries’ bonds—all have failed to stop the euro’s steep slide or the growing gap between bond spreads. The result : a shaky European economic recovery looks perilously close to plunging into a second, double-dip recession.
Under such circumstances, the European austerity program led by Germany seems like the right prescription, but the wrong moment. President Obama warned as much in a letter to the G20 on the eve of their Toronto summit. The only thing missing in the President’s warning was an admission that the United States has been woefully short on a commitment to getting its own fiscal house in order. But that is another subject for another day.
So how do the Europeans hope to overcome what would appear to be an inevitable second recession brought on by a combination of a debt and banking crisis and the simultaneous imposition of budget austerity ? The answer is to export their way out of the crisis and hope that such exports can sustain at least a weak and prolonged economic recovery. For this to succeed, however, the euro must remain weak against the dollar. Meanwhile, the Chinese, despite promises to allow the renminbi to upwardly revalue, have taken no action to accomplish this. Their thinking appears to be that they have already done so because of the falling value of the euro, and that they need not go further to placate the United States.
So with a weak euro, a weak yen, and an artificially weak yuan, who is left holding the bag ? The United States, of course, where the dollar becomes the currency of last resort. Our interest rates stay low (which amounts to a massive tax on savers to benefit the government as borrower), the dollar stays strong, and the result is more imports, less exports, larger current account deficits, more borrowing, and increased fiscal deficits. This may be a solution that works well for the near future and saves the Europeans from falling into too big a recessionary hole. But, in the long run, this crudely mercantilist, beggar-thy-neighbor policy can only bring greater grief and a more prolonged recession to a world already weary of two years of retrenchment and stalled recovery.
The point is relatively simple. Fiscal discipline is a virtue, one that Americans would do well to embrace. But in a world whose economies and financial systems are deeply intertwined, policies of fiscal austerity, stimulus, financial regulation, and monetary policy all must be coordinated. The current fiscal crisis in Europe, infecting the rest of the world, serves to highlight this imperative. Let’s hope Toronto is a serious effort to find a way to fix the mess in which we collectively find ourselves and not just another photo-op for world leaders.
