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Could America Live with European Austerity?

Tuesday, 18 May 2010 | 4:26 AM ET

European finance ministers meet in Brussels Tuesday and much of the talk will focus on how the sinners can be punished.

Riot policemen push back demonstrators as they try to approach the finance ministry in Athens.
Louisa Gouliamaki | AFP | Getty Images
Riot policemen push back demonstrators as they try to approach the finance ministry in Athens.

Led by Germany, Europe’s frugal governments will demand Greece, Portugal, Spain and others put their houses in order and cut government spending sharply if they want access to European Union funds and even exercise decision-making privileges within the union.

European finance ministers will also be grappling the details of last week’s rescue package.

French Minister of Economic Affairs, Industry and Employment Christine Lagarde said the EU “still has some homework to do.”

EU Monetary Affairs Commissioner Olli Rhen told reporters “the principles are clear but ... some technical details and legal matters will still have to be clarified. It should take a few days."

Figuring out how to administer the €750 billion ($930 billion) from the EU and International Monetary Fund will be difficult, but the main question taxing European leaders is whether voters born and bred on some of the most lavish benefits in the world will accept the cuts Germany and its allies demand.

We have already seen riots on the streets of Athens, but we have also seen some action from all the PIIGS (Portugal, Italy, Ireland, Greece and Spain).

Portugal just unveiled new measures, including a crisis tax on businesses and wages. Ireland started work on cutting spending months ago, Italy is reportedly eyeing cuts of more than €27 billion, Greece has been forced into action by the IMF and the bond market and Spain’s measures have been described as courageous by EU finance ministers.

It remains to be seen if any government implementing austerity measures can stay in power, but even the UK just elected a Conservative-led government that campaigned aggressively on a platform of austerity.

Admittedly, Prime Minister David Cameron did not win a majority, but he still says he believes he has the mandate for sweeping cuts in government spending, or waste as his party tends to describe it.

Given talk of euro/dollar parity is now commonplace, the euro zone’s exports are likely to become more competitive on the global stage and in particular in the US and China. There is a long way to go before Europe gets out of crisis but when the euro finally bottoms out where will investors focus their attention?

American Austerity

The American economy is powering along after a very difficult few years. Fueled by huge stimulus spending funded by debt, loose monetary policy and strong demand from Asia, the US economy grew at an annual rate of 5.6 percent in last quarter, while 290,000 jobs where created last month by the world’s biggest and most powerful economy.

The US budget deficit for 2010 is estimated to come in as high as $1.5 trillion. As the euro crisis saw investors flee for the relative safety of the US bond market, it took a lot of focus off America’s need to fund that deficit through Treasury sales and, as a result, lowered the cost of that borrowing for US taxpayers.

Borrowing of 11 percent of GDP would make even a European government wince. The question it raises is can the Obama administration get to grips with deficit as it prepares for mid-term elections and ultimately the next presidential election?

In America’s favor is growth. The euro zone is hardly growing, but the US economy rebounded strongly and with jobs being created again, the balance between social security and tax receipts is again on the right path.

But there is a lot of work to be done and if somewhere down the road the US loses its safe-haven status, pressure could grow on Washington to take the knife to government spending.

In April, Federal Reserve Chairman Ben Bernanke told a bipartisan committee on Capitol Hill that America needs a “credible plan” to pay down its debt and warned in the absence of such action “the federal budget appears set to remain on an unsustainable path.”

One of the strange things at the moment there is too much pressure on some Europeans to cut deficits urgently, while others problems are ignored, said, Steve Barrow, the head of G10 research at Standard Bank.

“It will be the US that comes into focus in the long term over cutting deficit spending,” Barrow said.

The euro will remain a reserve currency and there will be diversification by central banks across the world, but the single currency will keep on dropping to $1.15, he added.

The European Debt Crisis - See Complete Coverage
The European Debt Crisis - See Complete Coverage

Jon Moulton, chairman of private equity company better capital, said the US clearly has more expenditure than income and is on an unsustainable path.

“The US has a lot in its favor, like labor-market flexibility, a dynamic economy and smaller government than Europe,” Moulton said. “However, I have seen analysis that shows every government that has spent $1.40 for every $1 raised since the Second World War has seen their economy collapse into hyperinflation. The US is nearly at that point”

There is denial across the global, he added.

“In the UK we have a £167 billion (242 billion) deficit and we fight an election on whether to cut £6 billion now or later,” he said. “It is akin to Winston Churchill warning in 1935 that we should buy a few trucks for the army when we need hundreds of Spitfires.”

"We must overcome the causes (of the crisis), that means we must reduce deficits, we must strengthen the Stability and Growth Pact, and we must discuss how to strengthen growth,” German Finance Minister Wolfgang Schaeuble said. “We must go beyond the stage of announcements, declarations of intent and testing, and implement facts”

Whether Europe follows through and whether that sentiment drifts across the pond remains to be seen.

Contact Europe: Economy

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