Tuesday, February 9, 2010

U.S. Not the Only Country Facing Economic Turmoil, Growing Economic Crisis in Europe is Brewing

The United Kingdom is the world's fifth largest economy and the economic slowdown currently occurring in the U.K., to some financial experts is analogous to the economic slowdown in Portugal, Greece and Spain, which are much smaller economies. Despite the U.K.’s economic slowdown, it has the highest rating for its government debt (gilts) on the international money market. A representative from the U.K. Treasury stated that all three major credit-rating agencies had reaffirmed the U.K.'s triple “A” credit status, which allows the U.K. to borrow at very favorable interest rates because the U.K.'s triple “A” credit rating means that the U.K. has a very low risk of default. However, some economist argue that the U.K.’s excellent government credit rating is due more to the U.K.’s past legacy of good repayment history than a reflection of its current economic status, as the most excessively-leveraged country in the G7. A short documentary clip explaining the U.K's growing debt crisis is available here. Simon Johnson, a former International Monetary Fund (IMF) chief economist, points out that “the financial markets are taking a long hard look at the fiscal accounts of all these [Euro zone] countries and they don't like what they see.”

This is all very fascinating to me, because the U.K. “officially” came out of a recession in the fourth quarter of 2009 (December 2009), which ended six consecutive quarters (1.5 years) of economic decline in the U.K. Economic growth for the U.K. during the last year was a mere 0.1%, which is much less than economists expected, and more analogous to the growth rate of a developing country. Typically when a country is in an economic slowdown, the government increases spending to give the country an economic boost. This is classic Keynesian economics that was applied during the Great Depression by President Roosevelt in the United States under the New Deal Programs, and fiscally analogous to President Obama's current U.S. economic stimulus package. However, one of the major concerns about a country having large budget deficits is that it cannot spend sufficiently to boost its economy. This is precisely the issue that certain commentators have raised about President Obama’s economic stimulus plan; the plan needs to be more aggressive—more money needs to be spent to really jumpstart the U.S. economy.

A spokesman for the U.K. Treasury stated, "it is right that borrowing has been allowed to rise so that the [U.K.] government has been able to protect the economy from the global downturn.” Additionally, a representative from the British Chamber of Commerce (BCC) stated that “despite the U.K. coming out of a recession, there is still a long way to go to economic recovery.” Ironically, despite the British government’s fiscal plan to jumpstart the U.K. economy, last week the Euro reached a seven month low against the U.S. dollar. The drop in the Euro’s value could not have occurred at a worst time for two reasons. First, it made traders worry that Greece's huge government debt problems could spread to other European countries such as Spain, Portugal, and the U.K. Second, it motivated Mr. Johnson, the former chief economist for the IMF, to describe the G7 group of leading economies as "fundamentally useless." Mr. Johnson criticized the G7 organization because it “did not react quickly enough” to the global economic problem, and for “remaining in an out-of-date mindset.” He continued that "the financial markets are taking a long hard look at the fiscal accounts of all these [Euro zone] countries and they don't like what they see." I previously commented on the G20's need to require member countries to implement fiscal monetary policies in September 2009. Mr. Johnson further noted that the "[the G7] seem to show no awareness at all that much of Europe is facing a serious crisis and it's not limited to Spain, Greece and Portugal, it's also going to include Ireland. I think Italy is also very much in the line of fire. There's a very serious crisis inside the Euro zone," Johnson warned.

Mr. Johnson’s comments occurred just hours after the G7 finance ministers held a meeting in northern Canada, at which the European countries had to reassure their counterparts from the US, Canada and Japan over the deteriorating state of the public finances in some Euro zone countries. The G7 finance ministers agreed, not to involve the IMF and to leave the matter to the European Union to resolve. UK chancellor, Alistair Darling, who was at the G7 meeting, commented that the world was set for a steady but slow recovery and that the various governments' economic stimulus packages should remain in place until the recovery was assured. His final words at the meeting ended on a hopeful note, "the important thing is that we all are absolutely committed to maintaining the support for our economies until we make sure we have recovered….” The same can be said for the U.S.

10 comments:

  1. This could be the next shoe to drop. The problem is there are so many shoes out there. Elizabeth Warren just warned about commercial real estate foreclosures. Residential foreclosures were down 15% from last month but up 15% from last year.

    Then Bernanke started to discuss the Fed's exit strategy from its current monetary expansion. And, the fiscal stimulus will start wearing off this year.

    I feel like the system is still teetering. 2007 was not good, as we knew something was wrong by Christmas. 2008 just flat out sucked, especially after 9/15 (Lehman). 2009 started out with a hopeful outlook, but I was glad it was over in the end. 2010 worries me.

    When and how does this horror flick end?

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  2. I am really quite worried about all of this as well. I heard a segment on NPR the other day in which they spoke to representatives from Greece and Spain, and while they gave the standard answers it doesn't really seem like they know what to do about soaring debt and an inability to pay it back.

    I have a question for any of the experts who write on this blog. How tied are governments to the financial markets? What I mean by that is at what point does the entire system collapse? If the UK were to default on its debt for example, how does that impact the private markets? Or even if a smaller player like Greece were to default would that set of a "chain reaction" of sorts in the rest of the world market? Also I wonder how China fits in to all of this. They seem to be one of the only economies who is really growing during this whole crisis, yet they are tied into US debt and aren't there worries about the value of their currency?

    I guess what I am really curious about is the abstract idea of capitalism. Does the economy need the government to survive? Or is it the other way around? I mean governments create the rules and facilitate the infrastructure that enable people to make money, but then governments rely on money from people using those rules and systems to survive. I hope what I have said makes sense and I would love to hear some feedback!

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  3. "This is classic Keynesian economics that was applied during the Great Depression by President Roosevelt in the United States under the New Deal Programs, and fiscally analogous to President Obama's current U.S. economic stimulus package."

    The government spending, however, was highly tied to war manufacturing that took place in the USA. This is what helped to stimulate the recovery and the boom time of the 50s. There is no manufacturing base anymore in the USA for this situation to replicate itself. Government Spending linked to an increase in the federal sector or mythical "green" jobs is only going to take the economy so far.

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  4. Allan Meltzer of Carnegie Mellon, one of the most influential monetarists of the past 50 years, explains why the Obama administrations economic policies are not representative of Keynes thinking:

    If Keynes were alive today, what would he think of President Obama's fiscal policies?

    He would roll over in his grave if he could see the things being done in his name. Keynes was opposed to large structural deficits. He thought that they chilled rather than stimulated the economy. It's true that we're stuck with large deficits now. The goal should be to reduce them, not to take on new spending that makes them worse.

    How Obama got Keynes wrong, CNNMoney

    Massive borrowing and financing of the resulting federal deficits puts the government in competition with the private sector for access to capital as money that would otherwise go into private investment is diverted to the government. This competition forces up corporate interest rates making it more expensive to finance growth. It also gives businesses pause when considering their economic future as they anticipate the effects of the future tax increases necessary to sustain the governments spending.

    If the "stimulus" passed by the Democrats was meant to spur economic growth it was poorly designed since the "tax cuts" were to small to encourage consumption and not directed at job creators. Very little went into infrastructure projects, while a large part was spent supporting state budgets, as a sop to unionized government workers.

    The government cannot create economically sustainable jobs, since government jobs rely on subsidies extracted from the private sector in the form of taxes. Real wealth creating economic growth must take place in the private sector, absent government subsidy, this is why "green jobs" are a scam. Green industries require government subsidies approaching 30 percent to stay alive, that money must come from taxes on productive, profitable industries undermining their potential. The most effective way to stimulate employment is through reduction of taxes and regualtion.

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  5. I too (like Mr. Strauss) am worried about the impact of a potential long term European market downturn and its effects on the global economy. The European Union (EU) is strong but this is really their first real global downturn and its important that the stronger fiscal nations still have confidence in some of the smaller fiscal nations such as Spain and Greece to continue to seek alternative ways to keep people employed across Europe.
    The problem I see with the EU is that while large nations such as the United States can implement programs across the board for millions of people, the EU may not be able to accomplish the same types of sweeping regulations on employment and alternative ways to create wealth because of the different needs for each country because of culture, financial , agriculture and population differences between the nations.
    The real worry is if and whether the EU will decide to instill some form of economic protectionism to ensure their nations are sustainable; that decision could cause for a regression in trading between Europe and the U.S and the Far East. The potential for a global scale nationalist economic movement would severely hamper trades across the globe if this were to happen.

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  6. Tiffany S

    I wouldn't necessarily classify Spain as smaller, rather middle with UK just being a lot larger, but whose being technical;). But I do agree with you Chim to a certain degree. I think they can implement a program across the board, particularly if the euro was introduced successfully, but I agree with regard to the fact that there are various cultures and peoples clinging to their particular customs. This makes implementing one regimen more of a challenge. However, one of the benefits to having various economies is that when one is affected, the other may not be necessarily. I am particularly referring to Germany. Germany was not as affected by the downtown in the market and saw some increase, as oppose to the countries mentioned above (Spain and Greece). So the worry about the impact may not be as worrisome as imagined.

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