By James Bowden
It appears that the Eurozone may have, at least temporarily, staved off the possibility of rapidly collapsing into a debt-lined, lava-filled hole in the earth with a new, comprehensive strategy to deal with the mounting E.U. debt crisis. I thought this would be a perfect opportunity to look at some of the differences between the U.S.’s and the European Union’s fiscal, political and legal systems to illustrate why the same financial crisis has led to such different results, in convenient bullet-point format:
- Paging Joseph Stiglitz. Joseph Stiglitz to the white courtesy phone. For years, Joseph Stiglitz has criticized the IMF and what he has dubbed the “Washington Consensus” for their practice of enforcing draconian austerity measures on developing countries following a currency crisis and bailout. The criticism makes sense – while developed countries take a page from John Maynard Keynes and pour money into their economies to make up for drop-offs in demand, the same countries insist that the road to salvation for developing countries with currency issues is to impose “austerity” measures that are universally contractionary: tax hikes, cuts in government services and spending, government employee layoffs and the like. Now, with Greece we have an example of a developed country having austerity measures forced down its throat, and it ain’t pretty. Riots in the streets are common, and every round of new cuts further depresses the economy – effectively guaranteeing that tax revenue will be insufficient to pay back the emergency loans. If you need another example, look at Great Britain: austerity for all has taken an economy with high debt and a faltering (but admirably powerful) economy into a full-on depression. Joe says “I told you so,” and the point goes to the U.S.
- Bailouts are great when you can get the benefit without making the investment, but it will catch up with you. When the U.S. implemented the Troubled Asset Relief Program (“TARP”), the Eurozone criticized the U.S. as chicken little. When the U.S. passed a stimulus bill, the Eurozone criticized it as profligate. U.S. spending on those programs helped prop up the Eurozone, both indirectly by stabilizing a world economy on the edge of free-fall and directly by shoring up financial institutions that the Eurozone depends on, and the U.S. isn’t in crisis now. But look at the issues Europe has created by not bailing out their financial institutions at the first sign of trouble (and when they could have capitalized on the benefit they received from riding the U.S.’s monetary and fiscal coat tails). The size of the proposal to save the Eurozone is phenomenal: increasing the European bailout fund to $1.4 trillion (that isn’t a typo – “trillion” with a “t”). That is almost twice what the U.S. stimulus package cost. And that is on top of money already thrown down the hole in Greece – with the real possibility that more will be necessary to prop up faltering European banks after they take a haircut on the sovereign debt that they hold (there is a lot of Greek debt floating around that, if the proposed fix is accepted, will lose half its value instantly). This one goes to the stars and stripes, and the E.U. gets a personal foul for bad sportsmanship. We’ll enforce it on the kickoff.
- Know when to hold them and know when to fold them. Today, U.S. banks may not be completely healthy, but TARP and associated stress tests administered on U.S. financial institutions by the Treasury Department have ensured that they are no longer on the verge of collapse. The Eurozone is frightened by more than just the possibility of a Greek default leading to financial contagion – if the European banks that hold Greek debt are forced to recognize their losses, they will likely be insolvent. The U.S. recognized that its financial institutions were in trouble and dealt with them. The Europeans pretended all was well, much the way the Japanese banking system refused to recognize accrued losses in a financial screw-up that ushered in what economists call “the lost decade.” Now, the Eurozone’s losses are bigger than they would have been, and the possibility of a calamity that could shut down financial commerce throughout Europe is real. European financial institutions are being given the option to take a 50% haircut on all of the Greek debt they hold – not really an option, though, since the other likely alternative is [complete] default. The stress tests that the E.U. belatedly performed have now been discredited, as well. Imagine if you woke up tomorrow and you couldn’t use a credit card or a debit card, go to an ATM, go to a bank branch, write a check, bank online – the only money you had were the bills in your wallet and the change in your couch – and everyone else had the same problem. That’s what a modern-day financial collapse would look like. The U.S. isn’t losing sleep over the possibility anymore, but the E.U. would have to be intentionally ignorant not to. Point U.S.A.
- I like my schizophrenic central bank, thank you very much. There is a wealth of academic and political debate over whether it is a problem that the U.S. Federal Reserve has two mandates that conflict with each other, specifically (1) maintain price stability, and (2) maximize employment. The E.U.’s central bank has no such conflict – it’s only mission is price stability. It is additionally effectively dominated by German thought, which continues to be scarred by the hyperinflation that occurred in the 1920s. I’m not trying to minimize the horror of hyperinflation; the possibility that the proceeds of a life insurance policy could barely buy a loaf of bread is truly terrifying, and that scenario actually happened during the German hyperinflation. But jacking up interest rates for fear of inflation that has no signs of materializing while unemployment stays unsustainable high? I’ll take my conflicting mandates happily, thx.
It looks like the U.S. soundly drubs the E.U. in round one, with a score of four to nothing. Tune in for Round 2, monetary policy sports fans, and see if the epicenter of western civilization can get a leg-up on its upstart North American cousin.