The world economy dodged a bullet today. Parliamentarians in Greece voted in favor of a painful package of austerity measures aimed at reducing the government’s yawning budget deficit, controlling its ballooning debt and convincing the rest of the euro zone to continue to support the country with rescue funds. The vote paves the way for a second EU-led bailout and probably holds off a default, at least for now. It probably also will quiet fears that Greece’s debt crisis would spread turmoil throughout global financial markets (though perhaps not for very long).
The tragedy unfolding in Greece means even more than that. With much of the developed world – including the U.K., Japan, and yes, the U.S. – facing heavy state debt burdens, the events taking place in Greece are a glimpse into the future for many of the global economy’s most important nations. As politicians in Washington wrangle over the debt ceiling, budget cuts and taxes, we have to ask the question: Is the U.S. heading in the same direction as Greece?
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I should state right at the state that the U.S. is not Greece. In many important ways, the situations these two countries face are extremely different. First, the debt burden of the U.S., relative to the size of its GDP, is not nearly as large – just under 94% compared to 147% for Greece at the end of 2010, according to the OECD. Secondly, the level of U.S. debt is considered sustainable; Greece’s isn’t. Generally, there is a widespread belief among those who follow European finance that Greece is unlikely to be able to pay off its current debt load. Those very divergent perceptions are reflected in bond yields, a sign of the risk investors believe they take on by holding the bonds. Ten-year Treasuries are trading at a yield of only 3%; Greece’s are at 17%. Third, the U.S. has far more flexibility in how it deals with its debt than Greece. The U.S. can devalue the dollar or inflate its way to a lower debt burden. Those measures have their own consequences, but they make an American default much less likely than a Greek default. Since joining the euro zone, however, Athens has lost control over its monetary policy – it can’t devalue the euro or control its supply. That means the adjustment for Greece will potentially be much more painful than the one America faces. And lastly, the U.S. still has control over its own fate and can choose the course it takes in tackling its debt and deficits. Greece is at the point of no return. The Greeks have the EU shoving austerity measures down their throats. They don’t have options; the Americans do. Whether or not the U.S. ever ends up like Greece depends on what Washington does with those options.
And Washington will have to do something, and soon. That’s because there are similarities between the American and Greek debt problems. First, the government debt of both countries is expected to continue rising – to 107% of GDP for America and 159% for Greece by 2012, estimates the OECD. Secondly, both governments have credibility issues in regard to their ability or willingness to confront the problem. Greece may have passed its austerity package today, but whether or not its politicians will be able to actually implement it is an open question. Washington politicians do a lot of blabbering about the budget deficit and debt, but very little doing. There is no credible plan in place to deal with the debt situation, and the political polarization in Washington is only making the formation of such a plan less likely. Third, both countries seem to be living in a state of denial about the need for adjusting national finances. We can see that on the streets of Athens, where people are protesting against austerity measures they can’t avoid. We see the same attitude among Americans, who, poll data tells us, don’t want to see any significant government programs cut. Fourth, as my colleague Rana Foroohar smartly pointed out in a column in this week’s magazine, both countries are facing the prospect of cutting spending in a weak economic climate. So both are confronting the key challenge of fixing their national finances while not completely killing off growth.
That’s not easy. The Greeks are in a position where there may be no way of meeting that challenge. The austerity plan approved today will impose new taxes, cut public sector spending and sell off large swaths of the government’s assets. In an economy still contracting, there may be no source of growth to counterbalance that downsizing. However, the U.S. is in a position to chart its own course. How do Americans avoid a Greek fate? Here are a few suggestions:
First, come up with a plan, a real plan. I think market sentiment would be improved if Washington simply set down a credible program for reducing the budget deficit and stabilizing government debt, one that is bipartisan, and one the world would believe can be achieved.
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Secondly, don’t rush to the exits. Financial markets are telling us that the investor community does not see the U.S. debt problem as urgent. Otherwise, yields on Treasuries would reflect more concern. So Washington enjoys a luxury the Greeks don’t have – time. That credible plan to fix the nation’s finances should be a long-term one. The U.S. can afford to stretch out budget-cutting over the next decade, maybe even further.
And if we cut too deep, too quickly? That could tank an economy already reeling. Unemployment is still obscenely high, the housing market is far from repaired and there’s even talk of a double dip. In other words, the private sector is not ready to step into any hole left by reduced government spending. Until it is, Washington’s politicians have to be extremely careful when closing the deficit. Not only would reduced expenditures cause a direct hit to economic growth, there will also be a knock-on effect that would dampen other spending. Say, for example, Medicare is restructured so that Americans in the future won’t enjoy the same level of benefits. That would force families to save more now to cover expected medical expenses tomorrow, reducing their spending power today, and dampening growth prospects. The best way to fix American finances is through growth. More growth means higher tax revenues and smaller deficits. Slower growth would make closing the budget gap that much harder. The U.S. would end up like a dog chasing its tail.
Third, cut smart. The government has to think about fixing the budget while supporting U.S. competitiveness. For example, education might need even more funding if the U.S. is to compete with a rising China. Maybe we should buy fewer fighter jets and keep schools open? The U.S. also has to cut in ways that lessens the pain of austerity for the greatest number of people. In other words, Washington has to cut fairly. That’s my biggest worry right now. The Republican approach to budget cutting seems to be turning the U.S. government into a perquisite machine for the privileged and connected. The GOP apparently has no problem with the deficit when it comes to tax breaks for the richest Americans, but the party has a big problem with the deficit when it comes to extending benefits to the unemployed or providing healthcare to the poor. That is not only morally repugnant, it is bad economics. The U.S. economy is built not on the bankers of Wall Street but the folks on Main Street. It’s the hard-working middle class that needs to be kept employed and spending if the U.S. economy is to repair its national finances without destroying growth. That doesn’t mean programs like Medicare and Medicaid don’t require reform – they do – but it does mean the interests of the majority of the population can’t be sacrificed for the interests of a few. The biggest danger I see in the American budget cutting process is that it will be based on the power of special interests and ideological idiocy, not pragmatism and fairness.
So is the U.S. facing a Greek future? Only if Americans choose to.