Co-founder and co-editor, 'The American Prospect'
How Europe Could Sink Obama
FORGET THE potential for an unpleasant October surprise emanating in
Iran, Afghanistan, Israel, Pakistan or North Korea. The biggest threat
to Barack Obama's re-election is the economic folly of our good
friends in the European Union, who seem determined to snuff our their
economic recovery -- and ours.
America's own recovery is making very fragile progress. We don't know
whether the economy will keep generating jobs well in excess of
200,000 a month, as in January and February, or only a bit more than
100,000 a month as in March. But we do know that exports have been one
of our economy's surprising sources of strength, and that Europe is
one of America's biggest customers.
But Europe is even more committed to austerity economics than the
United States, and as a result Europe is right on the edge of a
If the American recovery slows even slightly, unemployment could start
creeping back up. It is hard to imagine an incumbent president winning
re-election with joblessness in excess of eight percent and rising.
The following key differences between austerity politics in the U.S.
and the E.U. are worth noting.
First, we have a real central bank, the Federal Reserve. Whatever the
Fed's other sins, it is usefully keeping interest rates very low and
buying government and other securities as necessary. Consumer debt
service expenses, for instance, are falling -- primarily because of
record low interest rates. This is good for the recovery.
The European Central Bank (ECB), by contrast, is explicitly prohibited
from buying the bonds of EU member governments. With private financial
markets speculating against the sovereign bonds of several European
countries, the ECB can only help prop up sovereign bonds indirectly.
The ECB makes cheap credit available to Europe's banks and the banks
in turn buy sovereign bonds.
Since Mario Draghi took over last fall as ECB president, the bank put
up about a trillion euros in cheap loans to Europe's banks. The banks
have invested most of that money in European government bonds.
But that leaves real enterprises struggling to get bank credit; and as
hedge funds bet against sovereign bonds, the banks with their large
bond holdings risk losing a lot of money. After several weeks of
interest rates on government bonds falling for Italy, Spain, and
Portugal, rates are rising again, signaling a new stage of the
sovereign debt crisis.
Second, in the fiscal ring of the European circus, the Germans
continue to be unrelenting in their refusal to European-ize the debts
of smaller nations. Instead, pressure continues on nations such as
Spain and Italy to reassure private markets by pursuing stringent
It should be clear by now from the Greek experience that this strategy
backfires. The latest case in point is Spain. The new Spanish
conservative government is dutifully cutting Spain's budget. This only
reduces the projected growth rate, widens the projected deficit,
spooks money markets, and increases the interest costs Spain has to
pay to finance its debt. Spain chases its tail, and chases the economy
Deflating your way to prosperity is a fool's errand. It depresses the
real economy, and there is no reward from the speculators of the
private money markets no matter how much austerity you pursue.
At last week's meetings of the International Monetary Fund and the
World Bank, IMF director-general Christine Lagarde cobbled together
pledges totaling about $430 billion to help Europe contain its debt
crisis. But the European Central Bank and the German government under
Angela Merkel insist coupling the support for the debt of member
countries with even more budgetary austerity.
This policy is simply insane. Even Germany, with its large export
surplus and low unemployment rate of 6.7 percent, will suffer if the
rest of Europe keeps sinking into recession.
Should Socialist Francois Hollande be elected president of France in
the runoff election on May 6, that will help create an antidote to the
austerity politics that are dominating Europe. It will break the
Franco-German conservative axis known as Merkozy. But France is just
one country, albeit one of Europe's most important ones. And France
alone can't dislodge Europe from the austerity path. Indeed, if France
pursues growth while the rest of Europe sticks to austerity, that will
just widen France's trade deficit and invite speculation against
French government bonds.
A left government in Berlin would help, but the German elections are
more than a year away.
In the U.S., at least, Fed Chairman Ben Bernanke has discarded his
predecessor Alan Greenspan's notion that the price of a sensible
monetary policy is fiscal austerity. The Fed is providing easy money
because Bernanke knows that the economy needs it, not because Congress
is embracing any of several austerity plans.
And although President Obama is under severe pressure to pursue an
austerity policy -- from the Republicans, from too many commentators,
and from Democratic deficit-hawks such as Senate Budget Committee
Chairman Kent Conrad -- Obama for now is stressing recovery and growth
Last week at the spring meetings of the Fund and the Bank, however,
Treasury Secretary Tim Geithner declined to commit a penny of U.S.
support to the I.M.F's new war chest to help Europe.
American leverage over Europe is admittedly limited, but some
additional aid would have been a nice neighborly gesture. If Europe's
misguided belt-tightening policies lead Europe back into recession,
Europe could easily drag the U.S. recovery down with it.
Robert Kuttner is co-editor of The American Prospect and a Senior
Fellow at Demos. His latest book is A Presidency in Peril.