Why the United States is Not Greece or Italy – And Shouldn’t Act like It
In the run-up to the Super Committee deadline, the news is filled with headlines about the potential default of Greece and Italy on their government debts.
Some might think that these developments highlight the need for draconian austerity measures in the U.S. to prevent us from suffering a similar fate. The Republican Party claims that “our debt has put us on the same path as Greece.” They would be wrong.
To see just how wrong, all you need do is look at the difference in what the U.S. Government is paying to borrow money today – and the rates being charged to Greece and Italy. Last week the financial markets demanded 7% interest rates on 10-year Italian bonds. That ultimately forced the passage of unpopular austerity measures, and the resignation of Prime Minister Berlusconi. Similarly onerous interest rates forced out Greek Prime Minister Papandreou several weeks ago.
Meanwhile, the yield on 10-year bonds has been at near-record lows – around 2% throughout the summer. And 30-year U.S. Treasury bonds yields have hovered around 3%.
What explains the difference?
Is it the “excessive” social benefits offered by Greece and Italy?
As economist Paul Krugman points out, there is no relation whatsoever between the level of social benefits and the interest rates demanded by financial markets.
Of course all European countries offer substantially more generous social benefits to their citizens than does the United States – including universal health care. But Italy and Greece do not have bigger welfare states than other countries that are doing quite well financially. Before the crisis, social expenditure spending was lower in Greece and Italy than it was in Germany – and a good deal lower than in Sweden where GDP has been growing throughout the crisis.
Meanwhile, Canada, which has universal health care and much more robust social safety net programs than the United States, did a much better job weathering the financial crisis of 2008 and the years since than did the United States.
No, other factors are at work here.
Fundamentally --no matter what Standard and Poor’s says about the unreliability of the Federal Government’s financial decision-making --world financial markets still consider U.S. Treasury Notes the safest investment in the world. In fact, in a perverse sense, troubles elsewhere make U.S. Treasuries more attractive.
Whatever you think about the issues underlying the European financial market crisis, its facts simply cannot be denied. The numbers are there for everyone to see.
There are a number of key factors that contribute to the relative security of U.S. Treasuries– and they are likely to make it so well into the future.
The critical difference between the financial structure of the United States and Europe is that we have our own national currency, and the countries of the Eurozone do not.
The U.S. Constitution not only gives the United States the ability to decide – country-wide – how much the largest player in the Government bond market will borrow. It also gives us the ability to handle differences in the economic circumstances of our states without threatening the collapse of the entire national economy – or the financial system --and to prevent the internal political problems that result.
Economic problems in Mississippi do not require, for instance, that the government of New York vote to “bail out” Mississippi. In Europe, the other governments of the Eurozone – especially Germany and France – had to make that very unpopular political decision.
While the common European currency worked fine so long as the zone – and the world – experienced sustained growth, the lack of common fiscal policy makes it particularly vulnerable in periods of economic stagnation or recession. And it deprives the Eurozone of the fiscal and monetary tools to dampen the effects of recessionary economic forces.
In a period of recession or economic stagnation there is a natural and desirable increase in government debt as a percentage of Gross Domestic Product (GDP), since there are more demands on governmental social safety net programs – and less tax revenue.
That increase in government deficit spending offsets the decreased private economic demand that is the root cause of recessions. It provides an important means of ending the downward recessionary spiral – preventing depression – and restoring an economy to long-term economic growth.
In the United States, as deficits increase during a recession, the Federal Reserve has the ability to increase the money supply and keep interests rates low – in both the markets for private and for government debt.
Because the U.S. has its own currency – and because much of the world’s transactions are denominated in dollars – our government can borrow money denominated in our own currency and control overall interest rates in our economy.
In the United States, the Federal Reserve has the ability to “monetize” the federal debt. It can directly purchase government bonds without having to borrow the money to pay for them. That helps drive down interest rates on government or private debt by expanding the money supply – by “printing money.”
The power – and willingness – of the Federal Reserve to control interest rates and the money supply – is a critical factor that helps make U.S. Government debt such a safe bet to private investors. Investors who buy U.S. Government bonds are much less prone to panic if they know that the Fed can step in to provide a market for U.S. government debt.
The system has some of the same effect on financial markets as the Federal Deposit Insurance Corporation does on bank depositors. There are less likely to be run on a bank that causes it to go out of business, if you know that the FDIC will cover your losses if there ever is a bank collapse. That in turn becomes a self-fulfilling prophecy – fewer banks collapse because there are fewer bank panics, or runs on the bank.
In the case of the Fed’s ability to buy government bonds, a run on U.S. Treasury bonds is less likely because the Fed can – and will – step in to stabilize the government bond market.
Not so in Europe.
The European Central Bank (ECB) is forbidden by its charter from buying government bonds directly from participating countries. And it has been unwilling to take the intermediary step of buying large numbers of government bonds on the private market.
To make matters worse, none of the participating countries has any direct control over the value of its own currency whatsoever.
In a recession, when the percentage of Government debt to GDP goes up automatically, that makes it impossible for any individual government – like Greece or Italy – to “monetize” its government debt. They have given up the power to do so to the European Central Bank that is controlled by all of Europe, and as a practical matter, by the biggest players and particularly Germany. Each individual country has zero ability to independently control interest rates in its own economy.
There have been growing calls in Europe to change the ECB charter – or at the least for the ECB to intervene forcefully in the private market for government bonds and hence “monetize” the debts of member countries by increasing the overall money supply in Europe. Without this kind of backing Eurozone member country debt is ripe for speculative panic and attack. If the ECB took this kind of action, the European “financial crisis” would likely end.
Or as the New York Times analyst Jack Ewing wrote this morning, “What markets want to hear, though, is not only prescriptions for long–term overhauls but also assurances that the central bank will do whatever it takes to prevent near-term panic.”
In fact, you could argue that much of this “crisis” has in fact been manufactured by “austerity hawks” in Europe who want to use market pressure to force austerity measures on member governments. In fact, last week the ECB actually cut its overall purchases of government bonds on the private market at precisely the time that Italy’s bonds were spiking to 7%. Jens Weidmann, head of the German Bundesbank and German representative to the ECB governing board is quoted in Tuesday’s Washington Post arguing that the ECB “cannot and should not solve the financial problems of states.”
Europe faces another problem we don’t have in the United States. If countries that control their own fiscal and monetary policy have their own currencies, then economic imbalances between them often appear in changes in the values of those currencies relative to each other. That’s true at least if they are allowed to float on world currency markets. Note that one of the big disputes between the U.S. and China today is that the Chinese don’t allow their own currency to float relative to the dollar, resulting in relatively lower prices for Chinese goods in the U.S. and higher prices for U.S. goods in China.
But when different countries without common fiscal or monetary policies have a common currency, those economic imbalances aren’t reflected in the value of discreet currencies – since all of those countries have the same currency with one value against all others. The result is that these imbalances come out in other ways. We’re seeing one of those in the default crisis in the Eurozone.
In addition, the European banking system is more fragile and vulnerable to market fluctuations because bank regulators in Europe have been less prone to demand higher capital requirements for European banks than regulators in the U.S. – despite heavy lobbying aimed at their European counterparts by the Obama Administration. That creates yet another factor enhancing the instability of Eurozone finances.
Finally, the Congressional Budget Office’s baseline estimate is that public debt in the United States will rise to and level off at no more than 74% of GDP. The CIA world fact book estimates that last year public debt hit 142% of GDP in Greece and 119 % of GDP in Italy.
The level of public debt in the United States is qualitatively lower than it is in Greece and Italy.
Of course a full out meltdown of the European financial system would send shock waves throughout the world economy. That could be the result of the brinksmanship being played by Europe’s “austerity hawks.”
But if the “austerity hawks” are successful at forcing more draconian cutbacks, that will have bad consequences as well.
For decades, the International Monetary Fund (IMF) has preached the need for fiscal constraint and austerity. According to the Washington Post, now even the IMF is warning that, “austerity may trigger a new recession,” and is urging countries to look for ways to boost growth.
Because they have no Eurozone-wide fiscal policy, countries in Europe like Greece and Italy are forced into “austerity” policies by the financial sector to avoid default. That will simply make matters worse in the near term, and certainly over the long run.
Not one of the European countries that has tried to cut its way out of recession has been successful. In Ireland, where government spending was slashed to appease financial markets, unemployment is now 14% and interest rates on Irish bonds are higher than Italy’s – about 8%.
If you want to lay a foundation for long-term economic growth in Europe or America, the last thing you would do is reduce the income going to ordinary citizens – even over the long run. That’s not the problem – just the opposite. The concentration of economic wealth in the top 1% prevents everyday consumers from having the money to buy the goods and services that an increasingly productive economy produce. We do not need ordinary people to “share in the sacrifice.” We need policies that will increase the share of income going to ordinary people to reduce the exploding inequality between the 99% and the 1%.
And it is critical to remember that in the end, economics is not about interest rates, or even prices or trade flows. These are just means to an end.
Economics is ultimately about two things:
· The production of goods and services by living, breathing human beings.
· The distribution of those goods and services among the population.
The United States has a talented, willing workforce with abundant natural resources. Our problem is not our inability to produce a bigger economic pie. It is that the system that organizes the workforce – and deploys those resources -- has broken down. As a result, one out of ten Americans who wants to work can’t find an organization that will deploy their talent and time to produce goods and services.
That system has not broken down because we spend too much on government. It has broken down because there is not enough economic demand to incentivize private employers to hire workers. Business doesn’t need more “confidence,” it needs more customers.
To get the economies of the U.S. and Europe moving again, government needs to step in to provide that demand – to jumpstart economic activity. We do not need an “austerity proposal” from the Super Committee. We do need to pass the American Jobs Act.
We know this is true from everything in economic history. And we can’t afford to be confused by ideologues from the right who demand that we “cut government spending” so we won’t be “like” Greece or Italy.