By Mark C. Partridge, Contributor
As markets try to sort through the news that Greece will be saved by their European Union neighbors, commentators are looking forward to where the next sovereign debt crisis will emerge.
In a column for the Financial Times, historian Niall Ferguson laments the state of the West’s finances, and sees the current troubles in the Aegean spreading across the Atlantic. “It began in Athens. It is spreading to Lisbon and Madrid. But it would be a grave mistake to assume that the sovereign debt crisis that is unfolding will remain confined to the weaker eurozone economies.… It is a fiscal crisis of the western world.”
Ferguson correctly puts the crisis down to the deficits that have ballooned in the wake of the Great Recession. He points to the massive spending in the UK and U.S., forecasting that it is only a matter of time before the market puts similar presses onto these countries for the profligate ways.
He has particular umbrage for fiscal stimulus, noting that “there is no such thing as a Keynesian free lunch,” because spending can lead to higher real interest rates and tamp down future growth. He goes further stating that “[d]eficits did not ‘save’ us half so much as monetary policy—zero interest rates plus quantitative easing—did.”
Maybe so, but it is question of what was “saved.” The coordinated monetary steps that were taken by the Federal Reserve and central banks around the world certainly stabilized financial markets and the much-talked-about credit crunch was turned back. However, even here, it was governments stepping in with taxpayers’ money that saved many firms from collapse: AIG, Fortis, GM, Goldman Sachs, RBS, and the list goes on. Lehman Brothers’ implosion shows how vital these funds were. (It should be noted that the losses from these stabilization programs are now much lower than originally projected.) Policies do not work in isolation; nor did the monetary policies.
And it seems that the dull science is not without a sense of humor: It is the very firms that benefited from Western governments’ extraordinary measure to draw the poison from their balance sheets and remove their “moral hazard” that now wax scathingly “that the whole ‘bail-out’ scenario constitutes a double-edged sword, with assistance only serving to undermine the euro’s interests in the long run.” This banker’s employer, Bank of New York Mellon, received $3 billion in TARP funds.
While burses rebound and bonus money flows much as it always did, few U.S. citizens would say that the economy has been saved. To the average person, unemployment continues to rise and salaries are stagnating. There is a prevailing disconnect between the profits being reported on a quarterly basis and what regular people are feeling. This is not uncommon, that employment gains lag behind economic growth in the wake of a recession, but that makes it no less of a problem. Only when job creation picks up and “Main Street” is on the rise will the economy truly be saved.
Ferguson’s implication that the booming U.S. deficit is down to fiscal stimulus and recent government spending is most problematic, though. Certainly, these play some role. However, as James Kwak of the influential Baseline Scenario blog has pointed out, much of the growth in the deficit is the result of falling tax revenues as people lost their jobs and/or cut spending. (This is hardly surprising given that consumption accounts for nearly 70 percent of the U.S. GDP.) Acknowledging that the Administration’s plans add over $1 trillion of spending between 2009 – 2018 Kwak writes that “the big whopper is on the revenue side, where revenues are projected to be $4.6 trillion lower [this year].” He also notes that the projected future growth in the deficit is mainly a result of exploding Medicare and Medicaid costs—not fiscal stimulus.
Certainly there are high deficits in the West. In 2009, the U.S. debt to GDP was 54.6 percent; in Greece, it was 113 percent; while Spain, Portugal, and Italy came in at 54.3 percent, 77.4 percent and 114.6 percent, respectively. And though the U.S. enjoys greater flexibility through control over the dollar’s exchange rate—the world’s reserve currency—and near unlimited credit as a “safe haven,” pressures could soon be leveled against America. Ferguson states that only two things have stopped the U.S. from being punished for its dramatic increase in spending: purchases of Treasuries by the Federal Reserve and reserve accumulation by the Chinese monetary authorities—both of which are being pared back.
But as governments look to balance their books, surely the why matters as much as the what. Understanding that it was lost revenue and not fiscal stimulus that has taken the biggest chunk out of the U.S. budget will help policy makers take appropriate steps to revive the economy—not just that of Wall Street, but every street, which will in turn help alleviate their sovereign debt problems.
