We’re not Greece. We’re not Europe. But we could become the U.K.
Europe is a mess. But it’s the type of mess that both the left and the right think validates everything they’ve been saying about what we should -- and shouldn’t -- do here in the U.S. “The right argues we have to cut deficits now or we’ll be like Greece,” says Tom Gallagher, a principal at the Scowcroft Group. “The left argues we can’t cut deficits now or we’ll be like Europe.”
So, who’s right? Well, which entity do you think is more comparable to the U.S.? Greece? Europe? Neither?
I come down somewhere between “Europe” and “neither,” but it’s worth going through each contestant in turn.
Greece is a country of 11 million. Geographically, it’s about the size of Louisiana. It doesn’t control its own currency, and its government spent years lying about its fiscal condition. After it joined the euro area in 2001, Greece went from paying about 7 percent interest on a 10-year bond to a bit more than 3 percent because investors assumed that its debt was backed by Germany and the European Central Bank. This encouraged profligacy in Athens.
The assumption also turned out to be wrong. When investors figured that out, they turned on Greece. Hard. With easy money no longer masking its problems, Greece’s economy was exposed for the mess it is. The World Economic Forum ranks it as the 90th most competitive country in the world, between Lebanon and El Salvador.
The U.S., by contrast, is a country of 313 million. It controls its own currency, which is also the global reserve currency. The U.S. Treasury bond is the safest of safe assets. Even after a lengthy financial crisis, the World Economic Forum ranks the U.S. as the fifth most competitive economy in the world, and it’s bigger than the first four combined. Whatever the U.S. is, it’s not Greece.
So perhaps it’s Europe? Or at least the euro area? After all, the euro area is also big and controls its own currency. Likewise, the euro area was once considered a safe bet.
But the euro area is also a fledgling institution facing an existential crisis. No one knows whether it will be around in its current form in 10 more years -- or even 10 more months. Its central bank seems more committed to forcing member countries to cut their deficits and reform their labor markets than to preserving the currency union itself.
The crisis has also exposed deep flaws in the basic structure of the alliance. The member countries increasingly despise and mistrust one another. Critical players in the drama -- France and Greece -- are on the verge of electing new governments that promise to radically renegotiate the terms of euro-area compacts. Meanwhile, Germany and the ECB seem determined to impose a moralistic, debt-focused narrative on a crisis that’s better understood as a problem of capital flows and growth.
The U.S. has its problems. Although we can borrow for next to nothing and unemployment remains above 8 percent, U.S. leaders often seem more focused on debts than growth. The political system is increasingly gridlocked and dysfunctional. One of our two major parties is engulfed in a civil war driven by an insurgency that wants to radically redefine government functions, preferring, for instance, to default on the national debt rather than increase tax revenue or borrow more. It’s a pretty safe bet, though, that the country itself will still be around, in much the same form, in a decade. Where the euro area’s lack of policy consensus threatens to tear the currency union apart -- a threat markets take seriously -- the U.S. poses no similar risk of suicide (which the markets know, too).
A better analogy is found in the U.K. Like the U.S., the U.K. has been around awhile and it isn’t going anywhere soon. Like the U.S., the U.K. has established institutions -- the Bank of England was founded in 1694 -- that have been tested before.
But unlike the U.S., the U.K. responded to the financial crisis with a quick turn toward austerity, imposed through tax increases and spending cuts, rather than Keynesian stimulus. As a result, the U.K. is falling into a double-dip recession, even underperforming its rate of recovery during the Great Depression. What’s more, with the economy sinking, austerity measures aren’t producing the desired fiscal balance. Economic health depends on the nation’s debt-to-GDP ratio: When GDP falls, as is happening in the U.K., debt must fall even further and faster to make up the difference. The result is America has actually deleveraged faster than the U.K., despite doing less austerity.
The analovgy isn’t perfect, of course. The smaller, more open U.K. economy is also more buffeted by events in the euro area than the U.S. is. It’s arguably more vulnerable to a bond run than we are. But as Gallagher says: “You never get perfect comparisons. You’re always approximating. The 1930s in the U.S. and the 1990s in Japan aren’t perfect examples either, but we use them to draw lessons.”
What lessons, then, should we draw? Don’t be Greece -- that’s the easy one. The more important lesson of the euro area is that a successful currency union should also be a fiscal and political union. The U.S. has little to learn on that score. As for the U.K., well, it’s more about relearning a lesson that some in our country seem to have forgotten: Austerity does not create growth, and it’s not something you want to try prematurely.
In a recent paper, economists Ugo Panizza and Andrea Presbitero analyzed the evidence that high levels of debt hinder a nation’s economic performance. They failed to find proof of a causal link. What did seem clear, they wrote, is that high debt can reduce growth “because high debt leads to panic and contractionary policies.” That’s essentially what’s happened in the U.K. We would be wise not to let it happen here.