The European threat to the US recovery


German Chancellor Angela Merkel and Finance Minister Wolfgang Schaeuble wait to vote on financial help for Greece at the lower house of parliament, the Bundestag, in Berlin November 30, 2012.

Article Highlights

  • Three years into the Eurozone crisis, the Greek economy keeps going from bad to worse.

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  • European policymakers are posing great risks not only to their own economic prosperity but to the US economic recovery.

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  • The sad reality is that there is very little that US policymakers can do to influence the European economic outcome.

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Albert Einstein famously observed that a sure sign of insanity was when someone kept repeating exactly the same experiment but expected to get a different result. Yet that appears to be what European policymakers are now doing in the way that they are handling Europe's sovereign debt crisis. And in so doing, they are posing the greatest of risks not only to their own economic prosperity but also to the U.S. economic recovery.

Among the more distinguishing features of the European sovereign debt crisis is that, almost three years after the crisis began in Greece, European policymakers keep applying very much the same policy approach to the afflicted countries of the European periphery as they have done from the start. They keep offering to bail out those countries with large financial support programs from the IMF, the European Union, and the European Central Bank. However, they do so on the condition that the recipient countries commit themselves to policies of severe fiscal austerity and fundamental structural reform within the Euro straitjacket. And they do so despite the clearest of evidence that this policy approach is not working.

From Bad to Worse

Three years into the crisis, the Greek economy keeps going from bad to worse. Greece's GDP has now fallen by more than 20 percent from its peak while its unemployment rate has risen to over 25 percent. Yet the IMF and EU persist with very much the same policy recipe of fiscal austerity for Greece that they have been applying with such disastrous results since May 2010. And they themselves acknowledge that these policies will cause the Greek economy to contract by yet another 4-1/2 percent in 2013, which will almost certainly further complicate the attainment of Greece's budget targets and Greece's efforts to put its public debt on a more sustainable path.

More disturbing yet, the policy of large scale bailouts subject to severe fiscal austerity has not prevented the crisis from progressively spreading from Greece to Portugal, Spain, and Italy. Far from turning the corner as had earlier been hoped, the economic recessions in these countries have significantly deepened. And the most recent economic indicators offer little comfort that there might be light at the end of the tunnel. Rather they suggest that, if anything, the pace of decline of those economies is accelerating. As a result, unemployment in Spain has now surpassed 25 percent while it exceeds 15 percent in Portugal.

What should be giving European policymakers serious pause is that the worsening economic picture in the European periphery is seriously undermining those countries' political stability. Greece is well on its way to becoming ungovernable with the rise of political parties on both the extreme left and the extreme right of that country's political spectrum. This has prompted Mr. Samaras, the Greek prime minister, himself to draw comparisons between Greece today and the German Weimar Republic of the 1920s.

Meanwhile in Italy, Portugal, and Spain social unrest has become the order of the day, which is undermining the political authority of those countries' elected governments. To make matters worse, secessionist forces are now very much on the rise in Catalonia and the Basque country, Spain's two very troubled regions.

Europe Just Doesn't Get It

The European periphery's bleak economic and political outlook should be raising a number of basic questions for European policymakers. How much sense does it make to have the European periphery sink ever deeper into recession as a result of severe fiscal tightening in the context of a European credit crunch and a Euro straightjacket that precludes currency devaluation to promote exports? Might the countries in the European periphery not need sovereign debt relief to reduce the amount of fiscal adjustment that they need to undertake? How much sense does it make to keep a country like Greece in the Euro at such an enormous economic and social cost to that country?

Sadly, as Europe's most recent handling of the Greek crisis would attest, the chances are minimal that these questions will be seriously raised by European policymakers before the German presidential elections scheduled for September 2013. Rather, one has to expect that Mrs. Merkel will keep trying to get Europe to kick the can forward in an effort to avoid having to admit to the German electorate ahead of those elections that her strategy is not working.

The consequences of Europe sticking next year to the same policy mix as in 2012 are not encouraging since fiscal austerity would be being applied in the context of a less favorable external economic environment. Consequently, at best one must expect a marked deepening in the European economic recession. At worst, one might expect that a further deterioration in the European social and political conditions might force a disorderly exit of some countries from the Euro with untoward consequences for the global economy.

All of this is of considerable moment for the U.S. economic recovery since Europe remains the United States' main trade partner. However, the sad and frustrating reality is that there is very little that U.S. policymakers can realistically do to influence the European economic outcome.

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