The Reckoning

The Pain in Spain is Our Ball and Chain

hq of Bankia

Spain’s troubled Bankia savings bank. If it falls, Americans will definitely notice. 

Photograph by Denis Doyle/Getty Images

Back in the early days of The Reckoning (well, yes, back in November), a good number of my readers – perhaps even a majority – pooh-poohed the idea that what happened in Europe could possibly have any bearing on the performance of the US economy.

Similarly, I was told in rather harsh terms that the results of Eurozone economic policy held no lessons for America. The fact that Europe’s austerity policies were causing depression in many of the Eurozone’s smaller economies – and threatening to topple the banking system in larger ones – should not be seen as relevant to America, these voices insisted. Indeed, Angela Merkel, the austerity queen, was described as a “hero.”

“Here in France, I am pretty comfortable with Angela in charge,” wrote ‘Jonathan in Euroland.’ “And I don’t give much of a centime for these alarmist screeds appearing from the other side of the herring pond.”

Unfortunately, Europe’s dysfunction is not confined to Jonathan’s side of the herring pond. The drama engulfing Spain’s banks may not make good television, and it leaves most Americans cold. What, after all, does Spain have to do with the US economy?

Yet the seeming inability of Spain to find the funds to rescue its third largest bank has pushed the world dangerously close to a new “Lehman moment.” If we’re lucky and realistic in our hopes, Europe likely will do just enough to push the problem off by a few more months.

Americans need to use that time to acquaint themselves with what is happening in Europe and grasp its deep and very real implications for us.

In short: Austerity is killing the world’s largest economic union, and sucking the life out of global growth as it does. The predictable – and widely predicted – result of austerity-based policies championed by Germany and a handful of northern European Eurozone members (not to mention the GOP) is a rolling collapse of economic activity across the planet, not just in Europe.

Even Germany and China, at this point, are sputtering as a “flight to safety” – i.e., US government bonds, other low-yielding but safe havens for capital – bleeds other economies of fuel. China and Brazil have other factors weighing on their economies right now. But the Eurozone crisis and the uncertainty it has bred hovers above them all. As the Barcelona-based economist Edward Hugh noted recently, purchasing managers ‘indices (PMIs) for the world’s great economies have shrivelled, producing a picture that is “scarier and scarier.”

“PMIs for Germany, France, Italy, Spain, the Netherlands and Greece all signalled contractions. Ireland saw a modest expansion, while Austria edged closer to stagnation,” Hugh writes. “But beyond this activity in Eastern Europe weakened, as it did in Asia and the Americas. New business continued to contract, with the rate of contraction especially marked, according to the report, in the case of export orders. Manufacturers in Europe, China and Japan all reported reduced levels of new export business, while growth in new exports slowed sharply in the US.  …. Roped in together through the various trade channels, the worlds industrial base is now, even in the best of cases, barely ekeing out growth.”

Now, no one is saying the structural deficits and ballooning debt-to-GDP figures in the US and other industrialized economies are sustainable. My book and this blog argues for tackling these long-term threats in a decisive way, and that will involved paring back government spending eventually.

But destroying short-term growth – the clear result of the budget cutting mania that has taken hold in Europe – is precisely the wrong way to reverse the swelling of the national debt mountain. This lesson just refuses to penetrate the skulls of most American voters, however, who remain as incapable of seeing the analogy between the Eurozone’s plight and our own as my readers did back in November.

If they need another piece of evidence, they could simply look at non-Eurozone Britain. The Tory-led coalition government there has adopted spending cuts in some ways even more draconian than those on the continent. The result: Britain sank like a stone back into recession – a dreaded double-dip – and contributed to a continuation of the longest period of stagnation in its economic history (yes, longer than that which prevailed in the 1930s during the Great Depression).

In the United States, this fate has been avoided – ironically – because of the modest and now vilified economic stimulus of 2009-2010, plus the gridlock that exists in the US Congress, which prevents the Tea Party and its minions from adopting the same amputation-crazed approach to the American economy.

Yet so deep is the dysfunction in Europe right now that America’s own accidental wisdom cannot protect us from the fallout. Besides being the market for about 13 percent of all US goods sold abroad, the combined EU-US relationship accounts for 54 percent of global GDP. With the BRICS also sputtering, this is no time to shut down the fire hydrants.

But that’s precisely what the GOP will do once it takes the Senate in November (and, sadly, that appears likely). While I think Obama will hold on to his job, shorn of a reasonable leverage in Congress, the desperately needed shock the American economy needs – not shock austerity, but shock liquidity – can only come from the Fed in the form of quantitative easing (known in financial circles as QE III).

This, simplified, means printing money. There’s nothing wrong with that, either, because inflation is non-existent in spite of the howls of right-leaning economists that we face a new Weimar moment.

Even still, pumping more newly minted money into the banking system rather than to ailing but sophisticated sectors like construction, research and development or health care is not going to provide much help. We’ve seen the results of confining stimulus to the Fed: banks that have an endless line of credit and households who must survive the nightmare of deleveraging without help from public or private sector.

Perhaps a second “Lehman” moment is what some hope for. Interestingly, Michael Tory, who ran Lehman Brothers’ particularly profligate European investment bank, makes precisely that recommendation in the Financial Times

“The Lehman moment decisively addressed the second problem by providing a good stare into the abyss,” Tory writes. “The political will to implement a comprehensive solution was almost immediately mobilized. For all their flaws, the measures achieved their primary goal of preventing further big failures and so stabilised depositor and investor confidence – contrast the health of the US banking sector today with that of Europe.”

This, of course, goes beyond austerity to masochism. But just as many refused to see the link between the Eurozone crisis and America’s economic underperformance, many, too, in 2010 refused to face up to the fact that Greece was bankrupt. Now that fact is a given – and a Greek exit – Europe’s looming “Lehman moment” – has become almost impossible to avoid.

A final note to those of you who write Europe off because you think they’re from Venus. Wrong again - they’re from Earth, just like us. And thanks to globalization, the US financial system is as intertwined with their crisis as they were to our own sub-prime variety in 2008.