US, EU debt crisis escalates in the face of political gridlock

By Spencer Kimball

Long after the bailouts of Wall Street and Greece, the US and EU face an escalating debt crisis. Political gridlock on both sides of the Atlantic prevents the implementation of controversial but necessary solutions.

The United States and the European Union have faced a financial onslaught this summer as stock markets and credit ratings tumble due to declining confidence in the political will of Washington and Brussels to implement the controversial but necessary steps to reduce ballooning sovereign debt.

For the first time in history, the US - the world's leading economy and only political superpower - has lost its AAA credit according to the rating agency Standard and Poor's, indicating a deteriorating faith in America's gridlocked political system and still stalled economy.

In Europe, a debt crisis that began in the peripheral states of Greece, Ireland and Portugal has spread dangerously close to core countries such as Italy and Spain, the eurozone's fourth and fifth largest economies respectively, placing the very future of the European project in question.

The parallel escalation of the debt problems on both sides of the Atlantic has raised concerns that the global economy could slide back into recession.

"The underlying weaknesses that are also revealed by these crises …have something in common in terms of the difficulty of putting your fiscal house in order," Jean Pisani-Ferry, director of the Brussels-based economic policy think tank  Bruegel, told Deutsche Welle.
Fiscal mess

The EU and the US have lost control of their fiscal house for different reasons, according to Bruce Stokes, an expert on the American and European economies with the George Marshall Fund in Washington D.C.

"In Europe the rise of debt has been associated more with the strengthening of the social safety network, the ageing of the population and some mismanagement of public finances as we have seen in Greece," Stokes told Deutsche Welle.

Although the US entered the 21 century with a budget surplus of over $200 billion (140 billion euros) and a positive fiscal outlook for the ensuing decade, political fallout from the September 11 attacks and declining revenue put Washington's budget in the red.

"In the United States, the debt is more a product of inopportune tax cuts that wiped out a budget surplus that George Bush inherited, two major wars that added greatly to the defense budget that were not paid for by taxes for the first time in American history," Stokes said.
Gridlocked Washington

In the aftermath of the 2010 midterm elections, which gave Republicans control of the House of Representatives, the partisan debate over the debt escalated. Although both parties agree that the current $1 trillion deficit is unsustainable, they fundamentally disagree on how to put Washington on a path toward solvency.

"In the US there is this fundamental disagreement about the level of taxation and the role of government that prevents what would be needed," Pisani-Ferry said. "What would be needed is very clearly an agreement over the medium term to restore some stability - some fiscal discipline concept."

Republicans, energized by the fiscally conservative Tea Party movement, first locked horns with Democrats over spending cuts last April. Only in a last minute deal did the two sides manage to rise above partisan bickering and approve a budget, narrowly avoiding the first government shutdown in 15 years.

The budget and debt wars reached their climax in July, when partisan gridlock over raising the $14.3 trillion debt ceiling pushed the US to the brink of default. Once again, a last minute deal ended the political crisis. The economic damage, however, had already been done - Standard and Poor's downgraded the US top-notch credit rating, citing political instability in Washington as the deciding factor.

"The US was unable to move rapidly to deal with the debt issues," Stokes said. "We have a very deliberative political system - consciously designed that way when the country was formed - but this system was designed in the 18th century to slow things down, in a world where things are moving very rapidly and political decisions need to be made very quickly."


Leaderless Brussels

While Republicans and Democrats in the US face off over a centuries-old ideological question about the size and role of government, the EU is grappling with an existential question over whether Europe should move toward political unification or remain a loose affiliation of nation-states.

Currently, 17 EU countries share a common currency - the euro - but they lack a common institution that can implement policies to promote the stability of that currency.

"In Europe you have a single monetary policy but not a single fiscal policy for understandable political reasons," Stokes said. "People don't want to give up that sovereignty."

While many northern European states maintain a measure of fiscal discipline, states such as Greece have spent well beyond their means, placing their national economic health in jeopardy and undermining confidence in the shared euro.

Political disagreements among the leading European states, meanwhile, have led to a faltering response as the debt crisis spreads and now threatens to overtake Italy and Spain as the rates on bonds rise and stock markets tumble.

"Market participants are telling the Europeans: Tell us what you want to do, tell us what you are about," Pisani-Ferry said. "Tell us whether you want to have a fiscal union, or a decentralized system, what degree of solidarity you want to have."

"The pressure from the markets and the reason why markets are so nervous about the euro area is that they don't understand what the rules of the game are," he added.
Global shift

After a decade of financial de-regulation, the EU and the US are often reacting to market pressure instead of taking a pro-active role in shaping economic policy. Implementing new controls to slow markets down in order to preserve democratic deliberation may be necessary, according to Stokes.

"The market has no central organizing principle other than making short-term returns on financial decisions and those decisions may not reflect the best interests of the society broadly," he said.

Although markets may not always act rationally, officials in the EU and US have failed to adopt sustainable long-term fiscally policies. As developing nations such as China and India make their presence felt in the global market place, western nations have an interest in reducing their debt levels in order to remain competitive with young and fiscally strong emerging economies.

"This debt crisis is the illness of the advanced countries unlike what happened in the past in the 1980s with the Latin American crisis," Pisani-Ferry said. "Now it is the crisis of the advanced countries and the more this crisis aggravates the more it accelerates the shift toward the emerging world."