Economy & Budget

Europe Accepts Fiscal Discipline, America Goes Other Way

When a zebra inexplicably starts to lose its distinctive stripes, it becomes news. That situation currently is taking place as European nations combat economic weakness by reducing government deficits and spending, just as the United States seems to be heading in the other direction.

Rising concerns from market forecasters about a double-dip recession are forcing elected officials in the Western world to stake their political futures on making the right choices as economies sputter. The recently rising value of the euro compared to the weakening U.S. dollar shows that investors increasingly are viewing Europe as a place of fiscal responsibility, while America is perceived as a free-spending nation that has lost its way.

By echoing words of fiscal discipline associated with the United States during President Reagan’s administration, European representatives at the Group of 20 (G-20) economic summit held June 26-27 in Toronto told U.S. Treasury Secretary Timothy Geithner that their governments would focus on balancing their budgets. They were not interested in adopting President Obama’s idea of pursuing a new public-sector economic stimulus.

Falling Dollar
The stark reality of American leaders receiving warnings from their European counterparts about the need to curb spending and government deficits has been accompanied by the rising euro and falling U.S. dollar. On Monday, Aug. 2, the euro soared to a three-month high against the dollar and the U.K. pound reached its highest value in six months.

Policy decisions can and do affect the value of currencies. Look no further for a recent example than the United Kingdom and its new government’s unveiling of a fiscal austerity plan. Within a few months, the British pound has gained more than 11% in value, following a drop in May, after assuaging uncertainty among market observers about whether the U.K. government would address its troublesome deficit.

The International Monetary Fund on July 8 specifically called for the United States to intensify efforts to curb budget deficits. The 185-member international lending agency warned about a potential double-dip recession in housing, continued problems in commercial real estate and risk to the U.S. economy from the European debt woes.

Unprecedented Debt
Even though countries such as Greece, Spain and Portugal grabbed headlines for receiving credit downgrades from rating agencies, U.S. government debt of $13.28 trillion, or an average of $42,845 per citizen, has been soaring to unprecedented levels. Indeed, U.S. government debt has nearly doubled since 2007. That mountainous U.S. debt now equals about 64% of the annual American gross domestic product, marking the highest percentage since 1950.

The G-20 Toronto summit issued a July 27 declaration that warned of the need for fiscal restraint. The G-20 concluded that sound fiscal finances are essential to sustain recovery, to provide flexibility to respond to new economic shocks, to meet the challenges of aging populations, and to avoid leaving future generations with "a legacy of deficits and debt."
Advanced economies committed to fiscal plans that will at least halve their deficits by 2013 and stabilize or reduce government debt-to-GDP ratios by 2016, according to the G-20 declaration. On its current course, the U.S. government appears unlikely to be able to meet the deficit reduction goals set forth for "advanced economies" by the G-20.

Results Trump Rhetoric
Professional investors need to look past political rhetoric and decide right now if the U.S. government is minding its fiscal store. Even though the U.S. dollar typically is considered a safe haven in times of global economic distress, the dollar recently slipped to its weakest value since April, in comparison to other major currencies.

St. Louis Fed President James Bullard cautioned on July 29 that the United States was vulnerable to a period of deflation and slow growth for the next few years, much like what has been plaguing Japan for a number of years. His view is that the Federal Open Market Committee’s statements that interest rates will be kept low for an "extended period" may be increasing the probability of a Japanese-style outcome in America.

Another risk is that the United States could slide into the kind of distress encountered by European countries in the 1970s and 1980s when uncharacteristically high unemployment rates became the norm. To avoid repeating the European experience, America will need to adjust its strategy, the European-based Economist magazine recently warned.

When international agencies and European publications are hammering the United States verbally about irresponsible spending and mounting deficits, it shows how far America has fallen as a global economic leader.

The longer the United States government waits to rein in its deficit and adopt the kinds of free-market policies that spur the private sector to invest in growth opportunities and job creation, the slower the recovery, the weaker the job growth and the greater the threat of an economic retreat.




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