An Outbreak of Fiscal Sanity in Europe? Insanity in the U.S.?

From The Daily Capitalist

The recent G20 meeting in Toronto came out with a joint statement endorsing "balanced and sustainable" growth for its members. It was one of those statements that are created by committees to placate all participants and don't really amount to anything. In this case, no meaningful agreements came out of the G20 meetings. Each government will just go back to doing what they have been doing and mouth high-sounding speeches of solidarity and fraternal love for their world co-leaders.

What really happened in Toronto didn't come out in the official statements (they never do). But the obvious and deep division between the U.S. and Europe was the main story of the event and that was fascinating to watch.

When Obama chides Merkel for Europe's (Germany's) proposed attempts at fiscal responsibility and when Merkel hits Obama for the U.S.'s fiscal profligacy, then you've got a good story.

The big split has to do with whether the world should continue fiscal stimulus. The Obama Administration believes that it's too soon to stop. Recent numbers have them scared about the future of the U.S. economy and it wouldn't hurt to have some global support when they try to beggar Congress for more spending to promote economic recovery. ("See," Geithner will say, "even the Germans are begging us to spend so we can rescue the world economy.")

Europe has a worse problem. Well run countries like Germany (actually about the only relatively well run economy in the EU), are being dragged down by their weak eurozone members, the well known PIIGS, lead by chief pig, Greece. They are being dragged down because they are the only ones in the EU that have the wherewithal to bail out its banks who will be in jeopardy once Greece defaults on its bonds. France should be included in this as well since their banks are also big PIIGS lenders. It will cost them a lot of money because they won't allow their banks to fail.

When the Greek crisis hit the EU came up with a credit line through the IMF which they believed was big enough to buy time to reform the PIIGS. And, a trillion dollars (€750 billion) is serious money. The EU had previously provided a credit facility of  €870 billion to its member banks in order to create liquidity.

It seems to me that Obama came back looking worse for the argument. Here is our president lecturing the Germans on how to run their country in a fiscally unsound way. He suggested that they spend more, encourage their citizens to spend more, and worry about it later. In essence he is saying that German citizens should buy more goods rather than produce them.

Merkel was not intimidated:

Ms. Merkel denied Germany is under pressure to change, predicting "a very relaxed discussion about this topic in Toronto." She suggested that the prevailing economic theory on stimulus—that increased deficit spending promotes growth— doesn't apply in Germany.

Continuing to run big deficits could backfire here, she said, because of Germans' angst over their aging society and rising public debt. Fear that the German welfare state could run out of money leads individuals to save their income as a precaution, she said. If Germany cuts its budget deficit instead, "then the citizen is more willing to spend money," she said, "because he knows that he can count on the pension, health and elderly-care systems."

Germany is the world's fourth largest economy, they are successful manufacturers and exporters, and their government's deficit as a percentage of GDP in 2010 is expected to be about 5.5% versus about 10.1% in the U.S. Their fiscal stimulus was largely in the form of tax cuts rather than government spending. Manufacturing is a higher percentage of GDP than is consumer spending:

This all breaks down into an argument about the efficacy of fiscal stimulus. The Germans, David Cameron, the ECB, and the IMF are worried about the longer term effects of stimulus: deficits and what the impacts will be on the euro and the PIIGS. They question Keynesian spending as a cure for recession, although many of them did it (including Germany, although Merkel was a reluctant spender). German Finance Minister Wolfgang Schäuble threw a grenade at Obama and said Obama's giant stimulus spending has had little impact on our country's jobless rate (9.7% at the time). He's right.

On the other side of the debate is Obama, Chinese president Hu, and France's Sarkozy who believe in fiscal stimulus through government spending, and believe the Germans need to buy more goods from others (especially the weak EU members) to help revive the global economy. Hu was especially worried because the Chinese apparently buy the Keynesian stimulus idea and they need the EU and the U.S. to recovery quickly so China's export based economy doesn't tank (which it is starting to do).

Merkel told her world co-leaders that Germany was not going to do that. They were opting for fiscal sanity.

What happened at the G20 meeting? They came out with a compromise statement that tried to cut between the two competing ideas: reducing deficits yet mindful of a need for stimulus spending.

The meeting's concluding statement, a compromise between two competing visions of the international economy, masked divisions between the U.S. and Europe evident in the run-up to the summit. The U.S. has warned that moving too fast to cut deficits and reduce stimulus spending could risk another global recession. European nations, especially Germany, have cautioned that moving too slowly could produce unsustainable debt loads, higher interest rates and even defaults.

With each side pushing, the U.S., and Europe cut what a U.S. official called a "combo deal." The U.S. agreed to make the goal of halving deficits a G-20 initiative, in exchange for G-20 support for language making growth the top priority, said a European official. President Barack Obama has already made similar deficit commitments back at home. ...

A G-20 statement called the global recovery "uneven and fragile" and said that to sustain growth, "we need to follow through on delivering existing stimulus plans, while working to create the conditions for robust private demand."

And how exactly do you create conditions for "robust private demand?" They view deficit cutting as "growth friendly."

Let me give you the background to that statement.

First, the news came in that the EU recovery was stagnating:

Released Monday, the Conference Board's Leading Economic Index for the euro zone dropped 0.5% to 109.7 in May, the first fall for 14 months. The index is an amalgam of eight indicators of activity and is designed to predict future activity.

And,

World trade volumes fell in April for the first time since January, an indication that the economic recovery may be losing momentum. Figures released by the Netherlands Bureau for Economic Policy Analysis, also known as the CPB, Thursday showed trade volumes fell 1.7% in April from the month earlier, having risen 4.0% in March.

They declined for the same reason we are declining: the artificial stimulus wore off and left no real sustainable organic growth.

Then two influential institutions came out cautioning countries on fiscal deficits and that they will inhibit growth. First the IMF reported:

The International Monetary Fund estimates that global growth in five years would expand 2.5% faster if the U.S. and other wealthy countries slash budget deficits more deeply than they are planning, and if China and other large emerging countries do more to boost domestic consumption.

Forget why they say this because their comments about Chinese consumers and consumption taxes are mostly wrong. They think China should increase consumption and take up the slack caused by reduced government spending. Obviously wrong. It's as if we are all one international economic aggregate and that isn't true. Why does Germany do just fine by exporting and China doesn't? It could have something more to do with governments' share of their economies' GDP.

Then the ECB, the European Central Bank under Jean-Claude Trichet came out and said:

Jean-Claude Trichet, the European Central Bank president, has put himself on a collision course with the US by arguing strongly that tighter fiscal policies are the best way to foster growth in industrialised economies. Firm control of government spending and tax policy was essential to restore the confidence of households, business and investors, Mr Trichet told the European parliament.

It is as if fiscal sanity is breaking out in Europe. Budget cutting is "growth inducing?" What will we hear next, stimulus is wasteful?

Where will this all end up? Germany will cut spending, perhaps raise taxes, and bring its budget deficit more in line. Maybe France and some other EU members will do the same thing. Greece has too many structural issues and will fail to reform sufficiently to prevent default. Germany will not bail them out further, but they will support their banks who lent to Greece. The euro will remain under pressure until the markets see results from fiscal sanity. Don't buy Greek bonds. Spain? Maybe they'll survive without a default. Portugal? Probably no. Ireland, Italy, probably yes. Germany will recover more quickly than the other major economies. China will have a real estate crash, more fiscal stimulus, and they won't recover until the U.S. and the EU recovers.

Obama's spending alternatives are limited, so another small stimulus package will be a token to his supporters. But he won't cut the deficit to the 4.2% of GDP he promised to his G20 friends (from the current 10.1%). He won't raise taxes soon because he wants to be reelected. The economy will stall for reasons I have previously discussed. That leaves inflation and he'll do it.

Comments

[omi]

Perhaps the effect of US threasury standard as described in

Super-Imperialism

http://www.amazon.com/Super-Imperialism-Origin-Fundamentals-Dominanc/dp/...

[lpard]

merkel is right - you know what can happen if the "german michel" gets in rage (think on hitler word tour 39 - 45) - dont misunderstood me, we are not proud of this - the germans want social security and peace and freedom - germans wanted war never ever again, now we are in afghanistan and have it - when i was a child and the soviets closed the borders to berlin, us pilots supplied the city, many died (still there is a monument called the "flying bridge monument" at the airport in berlin-tempelhof") - that times at christmas my brother and i get gifts from us soldiers - we will never forget this - but this was an us of jfk - not us today with its wall street gangsters plundering the world - make your second american revolution and hang up this guys - good luck

"The tree of Liberty must be refreshed from time to time, with the blood of Patriots and Tyrants." Thomas Jefferson

[techperson]

France is for stimulus because France is one of the secret PIIGS - their numbers are terrible, and they'll have to disassemble their social welfare system before this is over.

Did anyone else catch Merkle's sarcasm?

"She suggested that the prevailing economic theory on stimulus—that increased deficit spending promotes growth— doesn't apply in Germany.  Continuing to run big deficits could backfire here, she said, because of Germans' angst over their aging society and rising public debt. Fear that the German welfare state could run out of money leads individuals to save their income as a precaution, she said. If Germany cuts its budget deficit instead, "then the citizen is more willing to spend money," she said, "because he knows that he can count on the pension, health and elderly-care systems."

Let's see, aging society - check.  Rising public debt - check.  Angst - check.  Fear the welfare state could run out of money - check.  Can't count on pension, health and elderly-care system - check.

OMG, could she have been talking about US?

[DR]

"He won't raise taxes soon because he wants to be reelected",

Econophile,

So I take it you are for raising taxes to close the deficit gap. If the Bush tax cuts expire and the economy picks up( tax revenue) the US should be able to close the gap in the intermediate term at least on the federal income level.

Of course the paygo deficit is just beginning...

[Econophile]

Why would you think that? BTW, the economy isn't heading for a recovery.

[Ahmeexnal]

Those trade balance forecasts for 010 and 011 are dead wrong.
With a sinking economy, who's going to believe US consumers are going to buy more than in 009? And who are the Germans going to sell their exports to, specially since most of it's exports are to the eurozone and the US??
Wrong forecasts. Not going to happen.
But of couse we knew that after reading the fine print: it's a OECD chart!

[Wyndtunnel]

Medium term pain for very long term gain... What are those pith-helmeted sausage lovers thinking?  They must be stopped! Or will our former Teutonic enemies be the only ones capable of holding the course and saving the rest of the world from the United States' desperate quest for ever-expanding financial leibensraum? Tune in again next week for the next installment of this most exciting weekly serial adventure!

[aarskever]

You misunderstand why Germany is doing better exporting than China: it's not because of the size of the government, but it's about the fact that Germany is mostly exporting inside the Eurozone, where there are no currency fluctuation possible, and about the fact that China is exporting a lot more than Germany, large part of which going to the US, where demand has plummeted.

[Manipulism]

and maybe because Germany exports mostly high quality products while China exports mostly crappy stuff.

[williambanzai7]

Obama and his team have not the slightest clue about how to turn the ship upwind.

[Bear]

Nor does anyone else ... it's kinda like a blown oil well; it just keeps bleeding and we keep watching in HD and real time.

The only answers will hurt.

[jeff montanye]

as john hussman has noted, allocating public resources to the worst stewards of capital is not stimulative.  it is ruthless.  

less got spent on new wheelchair access sidewalks, unemployment payments or trees on medians (themselves relatively unproductive uses of funds as compared with investment tax credits, green energy projects or basic research funding) than on making bondholders of failed financial and gse enterprises whole, with interest.  that, imo, is where the worst mistake was made, other than the running up of government debt by reagan and the bushes, like the greek socialists, during the expansion phase of the disinflationary cycle.

[Apostate]

It's building in the US.

Even reliable mouthpiece Fareed Zakariah is calling for austerity (coded as "responsibility"). 

http://www.washingtonpost.com/wp-dyn/content/article/2010/07/04/AR2010070403856.html?hpid=opinionsbox1

They don't really understand the situation, but they feel nervous. They create a comforting narrative to address that anxiety, but action will be forestalled as long as possible.

Six months until the mid-terms. Can the US hold together for that long?

[RockyRacoon]

I watched Fareed on Sunday and he seemed a bit more ambivalent verbally.

Even dyed-in-the-wool types like Fareed are not sure what the hell to do.

Nor do I.  I'm a flea on the dog, just along for the ride.   Yippee ki yay

[maddy10]

didn't get ya?

Whaddaya mean , Fareed's was the simplest show on this matter

Insane krugman and insane Ferguson but pragmatic FZ IMO

One is too 2007 ; rates are low 'no demons under the bed' ish

while the other is like armageddon is here and now

FZ tried to be less academic but sounded too big-brushed in his conclusions

But- a nice show nonetheless