Europe nominally has a public debt crisis. But the Continent’s real crisis is of central political and social planning, done not through overt decree but stealthily, through the supposedly free global financial markets. Americans shouldn’t look on with too much smugness, because our policymakers are creating the same slow-motion disaster at home.
Starting last fall, global investors provoked the gradually unfolding emergency. They stopped funding Greece’s attempts to paper over its unsustainable deficits with more debt. Since Greece had joined the euro common currency a decade before, bondholders had financed the Mediterranean nation’s debt at interest rates only slightly above the rates at which Germany could borrow.
If investors had priced Greece’s debt based on economic or market fundamentals, they would have demanded a bigger return as compensation for higher risk. After all, Greece, with much higher debt levels, a lower credit rating, and an inefficient labor market, was never Germany.
But investors disregarded these factors in favor of a cruder political truth. They gambled that the stronger euro nations would never let a member of the 16-nation euro zone default on its sovereign debt, because allowing such a default, in the eyes of Germany and France, would risk the future of the euro and of European integration.
So far, the world’s investors have proven correct. In late 2009 and early 2010, Europe tried to wish the problem away. The European Central Bank continued to accept Greek debt as collateral from the Continent’s banks, hoping this artificial liquidity would keep banks lending to the strapped country. But Greece’s crisis seeped across borders to Portugal, Spain, and Italy, as investors demanded a stronger sign that Europe would save them if needed.
In May, Europe gave investors what they wanted. The Continent’s leaders, chiefly French President Nicolas Sarkozy and German Chancellor Angela Merkel, announced, in addition to a EUR250 billion ($305 billion) International Monetary Fund package, a new, EUR440 billion ($537 billion) “European Financial Stability Facility” (EFSF). Over a three-year period, the EFSF is supposed to lend money to European nations that can’t borrow cheaply in the capital markets. France and Germany hope that because the EFSF will boast national guarantees, it will garner its own AAA rating and thus be able to raise its own funds cheaply.
To American observers, it may seem like Europe is going through contortions to delay the obvious: Greece is insolvent. As NYU professor Nouriel Roubini, author of Crisis Economics, wrote in June, Europe’s rescue will leave Greece “with a public-debt-to-GDP ratio of 148 percent by 2016,” a level of indebtedness that, even if “stable” by then, is still “unsustainable.”
Europe, then, rather than face up to its problems, is delaying their resolution and making the inevitable day of reckoning even more painful. With a rescue package in place, for example, European nations lose some leverage that they could use with intractable labor unions, keeping their job markets hobbled. As European economies remain stagnant, Greece and other weak nations will continue to pile on debt that they can’t reasonably repay at artificially cheap rates, with bond buyers comfortable that Germany will be there to rescue them on demand.
Moreover, the weak only bring down the strong, as investors in German and French debt must consider not only the two nations’ own prospects for growth, but the likelihood that the two will have to assume hundreds of billions of dollars’ worth of their neighbors’ debt.
Meanwhile at Home
America could use Europe’s blunder to its great advantage. As Europe tries to avoid dealing with its economic reality, we could be facing up to ours. Washington could admit, for example, that Americans have borrowed and spent too much for years, based on unrealistic bubble-era housing values; that government policies have long directed too much scarce investment capital to the housing and finance industries; that our financial sector is too big relative to the rest of the economy, thanks to a quarter century of “too big to fail” policy coming from Washington; that public-employee salaries and benefits are too high and were based on unrealistic bubble-era tax revenues; and that we’ve severely neglected our physical infrastructure for decades now, meaning that we don’t even have much in tangible results to show for all of our bubble-era profligacy.
In short, we’ve got to go through a painful fiscal and social retrenchment after which we’ll make, sell, and invest more — rather than borrow and buy more.
But America is leaving this opportunity on the table. Instead, our politicians are making the same mistakes that Europe is making. Even as Americans have bowed to reality and cut back on their consumer spending, Washington wasted nearly a third of last year’s $787 billion stimulus package on printing up one-time checks to encourage Americans to spend more.
Even as house prices still need to come down to levels within reach of the average middle-class family, Washington has directed policy to keeping prices up. Until April, it offered tens of billions of dollars in $8,000 tax credits to home buyers, with the extra buying power keeping house prices higher than they otherwise would have been. And even as the financial industry needs to shrink, Washington has propped it up, too, with serial bailouts and zero-percent interest rates allowing Wall Street to start to rake in the profits again.
And even as state and local governments have tried, in fits and starts, to come to terms with their own public-labor unions, Washington spent nearly another one-third of last year’s stimulus on cash subsidies to states, so that they could keep pushing their public-labor costs up. Further, we continue to do without the modern infrastructure that the private sector needs to grow. Only 5 percent of last year’s stimulus has gone to real infrastructure investments.
America, then, has been trying to thwart the economy’s healthy adjustment — just like Europe. Just like Europe, too, America has no compunction about doing so through the supposedly free financial markets. Just as the ECB created artificial demand for Greek debt even before Europe created the EFSF for that purpose, the Federal Reserve has created artificial demand for housing, by purchasing $1.25 trillion worth of mortgage-backed securities in an effort to keep mortgage rates at record lows.
And as investors have started to balk at buying traditional municipal bonds issued by states and cities over the past year, Congress has created the federally subsidized “Build America Bond” program so that states and cities can sell debt for the first time to overseas investors — investors who likely believe that the American government will back them up in a crisis (the word “America” is right in the program’s name, after all). It’s kind of like a “European Financial Stabilization Facility” for “America” — but the difference is that America is still trying to get away with not putting any cash down up-front.
On both sides of the Atlantic, then, politicians and bureaucrats are trying to harness markets to achieve political and social ends. In Europe, nobody wants fully to admit that welfare-state benefits and labor inflexibility in the periphery states — and in some bigger states, too — are unsustainable.
In America, nobody wants Americans to figure out — among other things — that their houses really are worth a lot less than they think, even today; that they haven’t saved enough for retirement; and that absent government guarantees, hundreds of thousands of high-paying financial jobs likely would disappear forever.
Politicians can outwit markets only for so long. Eventually, investors will figure out that even the world’s strongest sovereign governments, America’s and Germany’s among them, can’t shield the citizenry from economic reality forever. The sooner that happens, the better. Until then, we’re just using borrowed money to double-down on bad bets.
In the meantime, though, investors face a serious handicap. They still cannot base their decisions on what to do with their own and their clients’ money on market fundamentals: which companies and industries are most likely to succeed, and where? Instead, investors are stuck predicting the arbitrary actions of terrified governments and predicting, too, for how much longer such actions can distort the marketplace.
Nicole Gelinas, contributing editor to the Manhattan Institute’s City Journal, is author of After the Fall: Saving Capitalism From Wall Street — and Washington.