I have addressed the European fiscal crisis in several previous posts as well as a plan to deal with the U.S. fiscal crisis (see below), but more than three years have passed since the onset of the 2008 financial crisis, and the economic downturn feels as endless as ever. Any hopes that it would resolve itself have been repeatedly set back by a nasty combination of the euro zone debt crisis, rising food and oil prices, persistent unemployment in the U.S. and Europe, and the terrible weather-related destruction across the planet. 2011 even saw what could be a nuclear tragedy in Japan that’s even more widespread than was originally posited.
So, what exactly are we looking at for 2012? I hate to be the bearer of bad news, but, despite some glimmers of hope, I don’t think we’re out of the woods by a long shot. Right out of the new year’s chute, Iran and their threats to blockade the Strait of Hormuz have caused energy costs to spike.
The scattering of good news includes the U.S. economy has been creating more jobs. The last two months have produced optimistic unemployment numbers, but we all know that the “official” percentages and actual percentages are potentially vastly different and are better for determining trends than results. Additionally, there is more optimism ostensibly provided by a better than expected holiday shopping season. Emerging markets like China appear to have at least slowed their inflation problem, allowing them to ease their money supply and pursue faster growth, which is good for the global economy to be sure. But there is simply no avoiding the reality that the bad news clearly outweighs the good, and as the B.B. King song says, “Crying Won’t Help”.
In fact, we may be farther away from recovery now than we were a year ago. During any election year, it’s difficult to remain focused, much less get congress focused to take meaningful action. Because of the Republican obstructionism of this congress, there is a better chance that new growth will sprout on my long dead-bald head than there is of anything productive coming out of this congress. Actually, conditions are frighteningly similar to those in place ahead of the 2008 meltdown.
Ignoring the Facts Have Consequences
As I’ve said before, much of what happens to the global economy in 2012 will be determined by what happens in the euro zone. Unfortunately, Americans are largely ignoring, or simply do not understand the connection. I’m not implying that there is anything that the average American can do to alter what goes on in Europe, but planning for contingencies is always a good idea when based in fact. Governments just about everywhere, including China, are under pressure to cut back spending and close budget holes, despite the fact that unemployment remains high. Add to that the continued uncertainty about the future stability of the euro itself, and the mix will inevitably be toxic for growth.
Europe is facing the increasing risk of negative growth and falling into the deadly downward spiral of recession. Without demand there is no growth. Without jobs there is no demand. And without demand there are no jobs. Vicious, right?
Here’s just how vicious.
Although the unemployment picture in the U.S. is slowly, painfully, and with a whole lot of fragility improving, Europe’s is getting exponentially worse. In large measure, the strict austerity measures are exacerbating the downward spiral described above. Spain is suffering through 22.9% unemployment – double the worst of America’s unemployment during the recession, caused by the collapse of the real estate market and the ensuing Wall Street crash in late 2008. Greece is experiencing 18.8% unemployment. Across the 17 country Euro zone, the unemployment rate is 10.3%, but only because the German rate is 8.1%
Without demand that rides the coattails of growth, governments in countries like Greece, Italy and Spain will have a harder time closing budget deficits and controlling debt levels. That means policymakers will have to impose more harsh austerity measures to meet fiscal targets, which will suppress growth further, making more cuts necessary, and on and on and on.
And as it stands now, as Europe goes, so goes the global economy. Europe is a huge market for exports from the U.S. and Asia, and a recession there will dent the growth prospects for the rest of the world. An export revival for the U.S. has been a very big factor holding up domestic growth. Not only will the debt crisis in Europe limit the market for U.S. goods there, but it is unlikely that the euro will be able to maintain its surprising strength (the currency recently hit a 15-month low against the dollar). That means the greenback will appreciate and make American exports more expensive, less competitive, causing further softening of U.S. growth prospects and potential job creation. It is not my intention to be dramatic, but if the debt crisis truly reaches a meltdown in Europe, dragging down European banks, the ripple effect on the American financial sector would crush America’s economy as well.
So it is more important than ever that Europe’s leaders find ways to support the zone’s struggling economies. But that means we, the U.S., need to see much bolder political leadership. We need to get beyond the partisan pledges and the procession of endless euro zone summits and see some real implementation and action.
I’m not hopeful. I don’t see how Europe’s leaders can act decisively to save the euro when voters back home are increasingly resistant to heftier sacrifices. In the end, individual European sovereign domestic political concerns will trump the needs of the euro, again and again. That means the fate of the global economy in 2012 will very much rest on the democratic politics of the West. With a presidential election looming in November, it is hard to see Washington getting much done on matters like fiscal reform until after the American public has its say this coming November.
Even if, by some miracle, Western politicians get their act together, their ability to combat slower growth is extremely constrained. With interest rates at incredibly low levels, conventional monetary policy is nowhere in sight as long as investors are worried about rising levels of U.S. debt.
Too “Bigger” To Fail
Then there is the lurking problem that has been hiding in plain sight. Not only has the U.S. not addressed the disastrous results of repealing the Glass-Steagall Act (also known as Gramm Leach Bliley), The Commodity Futures Modernization Act of 2000, etc., the politician who’s handprints are all over those bills, is still actively lobbying for even more de-regulation on the Hill. Phil Gramm has been in the middle of every major financial disaster that has occurred in the U.S. since the early 1980’s. The results of Senator Gramm’s destruction include the Savings & Loan Collapse and Enron (through his wife, Mrs Wendy Gramm, the woman who, as a former chief government regulator of the energy business, deregulated electrical power so that Enron could speculate in electricity. She turned out to have joined the corporate board of Enron shortly after she resigned her government position. Her husband, Mr. Phil Gramm, was an enormously influential Republican senator. He received $97,000 in campaign donations from Enron in the preceding dozen years). Senator Gramm was also in the middle of the real estate / Wall St. crash at the end of 2008 where he had been employed by Swiss mega bank UBS as a lobbyist and investment banker since leaving the Senate in 2002.
The 2008 debacle involved Credit Default Swaps (CDS) that have been described as “financial weapons of mass destruction”. Unfortunately, these rebranded insurance policies are once again posing a menace to America’s “too-big-to-fail” banks. The CDS were devastating in the fall of the U.S. economy in total and in the U.S. subprime mortgage bonds that nearly brought down insurer AIG.
This time, the problem is European fiscal destruction.
Despite the fact that America’s banks have claimed that they are only minimally exposed to European government bonds, if I’m not mistaken, the same was being touted before the real estate bubble burst in 2008. Nevertheless, the same,U.S. mega banks have been using CDS as protection on those bonds, and selling them primarily to investors in the eurozone. There are very few avenues to determine the extent of their usage because they are off-balance sheet.
Exposure by six major American mega banks to CDS on Italian debt alone, for example, has been estimated as high as $200 billion. Overall, U.S. banks may hold two-thirds of the total euro-debt CDS outstanding.
Hopefully, most big banks learned the painful lessons of 2008 and no longer take either long or short derivatives positions but hedge their exposure, making their net risk close to zero. But the real concern is: How solid are the trading partners of the U.S. banks?
It turns out some of the largest sellers of protection are banks in Europe. French bank BNP Paribas has sold $4 billion in protection on French government debt, 12% of the global total. Similarly, Italy’s Banca Monte dei Paschi di Siena has sold $3 billion worth of protection on Italian government debt. If Italy, say, defaults on its debt, these banks might not be able to pay their American trading partners. “It’s the ultimate moral-hazard trade,” says Peter Tchir, CEO of hedge fund TF Market Advisors. “If a country defaults on its debts, these European banks domiciled in the same country will also default on their debts and won’t pay out, so why not write the protection now and make lots of money?”
Stock markets have soared after central banks around the world got together in a rare coordinated action to provide more dollars to Europe’s strained financial sector. But the fact that this effort was even necessary is a clear indication of just how bad things have become. There have been concerns for months that Europe’s banks were having difficulty acquiring USD financing, which is important to banks in France and elsewhere. This could certainly cause financial institutions around the world to become jittery about lending money to a sector saddled with large euro-zone sovereign debt holdings of questionable quality. For central banks to act as they did, the situation must have become extremely severe, or was at least deteriorating badly.
A Bridge Too Far?
Based on the early signs, Prime Minister Angela Merkel appears inclined to push for an “austerity union,” a way of forcing painful budget cuts, tax hikes and other measures onto euro-zone countries through stiff regulations with sanctions for non-compliance, and little offered in return. I don’t see a clear path for a way that her plan might work, but I have been wrong many times before. The euro can’t survive on austerity alone any more than the U.S. can in similar proposals that various Republicans have called for in this country. In fact, austerity is quite probably causing even more and deeper damage to the euro’s prospects, not less.
Moreover, European-style austerity is a major reason why growth is either weak or nonexistent in the indebted euro-zone countries and would surely have the same negative impact on the U.S. should it become an unchallenged rule-of-thumb. Without growth, the crisis is just too hard to solve. What economists on both continents have failed to admit is that there are two sides to the supply and demand equation. Supply-side economics has failed miserably as a LONG-TERM economic strategy in this country despite disingenuous calls from hypocritical Republicans to do so as long as their programs are not affected.
The Simple Solution To This Complex Deficit Problem
As stated in previous posts, (The Financial Transaction Tax and The One Penny Solution and A Reasonable Non-Partisan Budget Plan) in order to attack a problem the size of our federal deficit, it must be separated from all other fiscal problems, addressed and therefore resolved separately. Since both political parties have constituents to whom they must inevitably answer, the solution below is contingent on very strict conditions that must be followed in total.
Please withhold your cries of “socialism”, “favoritism”, “the evil inequities of value-added taxes”, etc., at least long enough to make it through the rest of this article.
As of the end of the government’s 2011 fiscal year, the deficit was approximately $15 trillion dollars. The U.S. can run, but we simply cannot hide given the rocky state of Europe and China’s problems. Neither can we continue to ignore our huge deficit without running the risk of total economic chaos given the facts above regarding Europe’s pending failure to effectively deal with their own currency/fiscal problem.
In yet another iteration of my suggestion, the items below again attempt to address a solution that would be inclusive of all Americans, non-citizens, and visitors who enjoy the freedoms, liberties, and advantages while in America.
- In order to make this a plan that is bullet-proof to political piracy, the law would have to stipulate that the funds collected under this assessment can be used only, and irrevocably for debt reduction, as of a static date and amount, (i.e. FYE 2011 the Federal Deficit was approx. $15 trillion) unless 80% of both houses of the Congress and the President agree to change it in any way. This plan would also muffle any “tax and spend” argument because the sole purpose of this plan would be deficit reduction and to never be used on new spending. Furthermore, once the deficit amount as determined above is paid in full, the entire plan ends.
- Part 1 of the assessment phase would place a one-penny-per-dollar Federal surcharge on all consumer goods AND services for the sole purpose of being applied to the Federal Deficit as defined in step #1 above.
- Even at today’s extremely low GDP of $15 trillion, the consumer portion of the deficit reduction tax would reduce the deficit at $150 billion per year. This is a greater reduction than was the mandate for the failed so-called “super committee”. Because the surcharge is tied to consumption, as the economy recovers and GDP increases, so too would the rate of deficit reduction increase. In Year #2, if GDP = $18 trillion, then $180 billion would go towards reducing the deficit, and so on.
- Part 2 of the assessment phase would be tied to Wall Street and is already supported by a plethora of concerned citizens, organizations and even OccupyWallStreet. Americans for Financial Reform, which is a coalition of more than 250 economic, union, and activist groups, explained why it’s backing the tax:
“The deficit problem that the Select Committee must address was to a significant degree created by the world financial crisis, a crisis caused by Wall Street speculation. It is therefore appropriate that we call on Wall Street to help address it. A small tax on financial market transactions has the potential to raise significant revenue and simultaneously limit reckless short-term speculation that can threaten financial stability.”
- No exceptions, no exemptions. No ceilings, no bottoms. Every citizen, every prisoner, every non-resident alien, every temporary worker, every single person enjoying the rights and freedoms that come with literally being on American soil, would be contributing to reducing the debt created over the last forty years that now threatens the U.S. economy. There could be no finger-pointing, no blaming “the other party”, no “class-warfare”. This financial crisis is tantamount to a world-war-time crisis. In World War II EVERYONE was rationed on sugar, rubber products, etc. This deficit reduction/demand-growth plan would be a small price to pay for not only financial freedom, but a path back to fiscal responsibility, increased growth through both higher employment and higher demand.
- As lagniappe, the actual mechanics of the plan are easily implementable, as most states are already set up for collecting and remitting sales taxes; these surcharges would merely go to Uncle Sam. This would also muffle any “tax and spend” argument because the sole purpose of this plan is deficit reduction; not ever to be used on new spending.
- By expanding the tax base to encompass all goods and services, everyone in the country would be contributing to the mess. No one could claim “tax and spend”…..”the poor pay nothing”….”the rich should pitch-in too”, etc. The wealthy could not employ armies of accountants to avoid the taxes; poor people receiving government assistance would still be contributing to the deficit; criminals, non-citizens, even prisoners who currently purchase items from correctional commissaries would be contributing to this deficit reduction.. It would virtually assure that every person in the country is contributing to the debt without placing an impossible burden on any one group.
- Normal politics could resume. Balanced budgets could be argued. Appropriations could still be based on, well, whatever the heck they base them on now. The important part of this entire plan is to remove the cover from which politicians have been hiding for far too long. If Republicans want to still make bogus claims that people earning wages over $1million per year after taxes are “job creators”, let them sell it to the public. Make a balanced budget amendment with teeth in it. None of it would be tied to this plan. Smokescreens would disappear. Cats would be sleeping with dogs. Herman Cain could go back to playing Pokemon and selling books. But by gosh the deficit would be retired, and the laws of supply and demand would once again reign supreme.
The clock is ticking.