U.S. to EU: Do as I say, not as I do
In what now seems to be a weekly ritual, U.S. financial markets fluctuated throughout the past week based upon anticipated future economic and political developments. But as has become more and more common, it is not the potential outlook for our country that has memorized financial market participants, but rather that of the European Union’s 27 country confederation, or even more specifically, the euro-zone’s 17 member nations that utilize a common currency, the euro.
For better than two years this economic drama has unfolded, with Greece initially being the epicenter of the crisis that now wraps it unwanted embrace around the entire euro-zone. And to demonstrate just how rapidly the financial contagion is spreading, the ratings agency, Standard & Poor’s, recently announced that the 15 nations which were not already under review for a possible credit-downgrade are at risk of seeing borrowing costs rise as their sovereign debt is possibly classified as more default-prone. So serious is the issue that the German government, always a bastion of financial health, recently saw an issue of its debt instruments unfilled (not enough buyers for what the government wanted to sell), with yields rising even as they remain fiscally conservative in their spending/taxation decisions.
Over the past several months, a number of plans have been floated to address the concerns that euro-zone countries will be unable to meet their obligations of repaying principal and interest in a timely fashion. Within the past three months, this column described a plan to leverage the European Financial Stability Facility (EFSF) funds to help limit initial losses of buyers of questionable sovereign debt instruments from countries such as Greece, Spain, Ireland, Portugal, and Italy. At the time, I described a number of potential problems with the plan, even as the euro-zone governments proclaimed confidence in their plan. Since that time, world financial markets seem to have reacted unfavorably, with that plan now all but dead.
In its place, it now seems the euro-zone countries have come to the conclusion that a “financial-only” solution is no longer possible, that is, throwing money at a problem centered around fiscal policy issues is unlikely to be successful. So, last week the entire 27 country EU examined the possibility of some sort of fiscal union that would force fiscally insecure member nations to move toward a balanced budget or face potential sanctions/fines. Of the entire EU membership, only Britain indicated an unwillingness to even consider such a possibility, with all 17 euro-zone members indicating they will go-it-alone, if need be, to forge a monetary and fiscal union largely patterned along the fiscally conservative lines proposed by Germany.
In essence, the tentative outcome — which may be many months or even years into the future before it can be successfully implemented — would provide that each country submit their budget to the European Commission for review, and should deficits/debts be too large (above 3 percent of GDP on deficits and generally more than 60 percent on a debt-to-GDP ratio), changes would be required as a participating member nation. Required fiscal austerity, over time, would then bring non-compliant countries into balance and allow member nations and the euro to prosper, and (hopefully) bring the European sovereign debt crisis to an end.
And as all of this unfolded over the past few weeks, who was there to lecture the Europeans on their monetary and fiscal policy inadequacies? President Obama’s Treasury Secretary, Timothy Geithner. Basically telling the EU nations to do more, do it bigger, be bold. Lovely words and thoughts, but more than just a little hypocritical.
By EU standards, the U.S. would be seriously non-compliant. For example, in the last fiscal year the U.S. federal budget deficit was just a touch under $1.3 trillion, or nearly 8.5 percent of GDP; approaching three times higher than the percentage where the European Commission would require a significant budgetary realignment. And with a debt level (including entitlements) that is fast approaching $15.1 trillion, the U.S. debt-to-GDP ratio is almost 100 percent, far above the 60 percent that is considered sustainable.
So, were the U.S. a euro-zone country, sizeable changes would be required. Of course, keep in mind that within the past few weeks, Congress and the president could not agree on a measly $1.2 trillion in future deficit/debt cuts spread out over 10 years. So, one might reasonably wonder if the U.S. is the country that should be lecturing others on the importance of fiscal prudence.
Dr. James Newton serves as chief economic advisor to Commerce National Bank and is an auxiliary faculty member in economics and statistics at OSU-Marion and OSU-Newark. Dr. Newton’s views do not necessarily reflect those of Commerce National Bank or OSU-Marion/Newark.