The European countries seem to be facing a road with no easy exit. One on side they are facing fiscal deficits. On other side they are already dealing with an important debt amount that can hardly be sustained, as the case of Greece is showing these days. On even another front, governments are facing strong opposition on part of their citizens, like the “indignados” in Spain, to not cut spending. Too high debt over one shoulder and fiscal deficit over the other, revenue cannot be easily increased and the citizens oppose to cut spending. Certainly not an easy dilemma to solve.
The United States, however, is not free from this problem either. The following chart from The Economist shows “what it would take governments to reduce gross debt to 60% of GDP by 2026.”
The picture does not look good in general, and neither does for the United States. Social protests cannot change the underlying economic situation. Politicians cannot talk away the problem. If governments have been spending more that what they can for a long time, then sooner or later an adjustment will be needed. To conceal the problem with further debts does not help to solve the problem. Perks and social programs provided by the governments to their citizens are hard to take away one the people got used to them, especially if how these benefits are financed is not clear for the public.
Does this situation imply default? Not necessary. As Prof. Steve Horwitz points out at Coordination Problem, a default happens when one stops paying his debts, not when one reaches his credit limit. If we reach our credit card limit we’re not in default, we’re in default the day we stop paying our credit card obligations. If we reach that point, then we need to reallocate spending from consumption to pay our debts. The same with the government, if no further debt can be obtained, then a reallocation of resources would avoid default; but this is because the government has been spending too much for too long, not because banks where hit by a kind of perfect storm. If the Congress can change the debt cap limit for the government, then it can also allow for resources reallocation. The point at hand is if the problem is going to be dealt sooner or postponed to be solved at a later date in the middle of a more delicate situation.
It is for this reason that the financial crisis is a manifestation of a fiscal problem. When we talk about the financial crisis it seems as if the problem where just a financial one, but the underlying problem is chronic fiscal deficit on part of the government. It is not the banks, but the governments the one who cannot pay their debts. And if they don’t, then the banks are affected hit. To bailout the banks, then, can be an attempt go over the fiscal deficit problem and attack a symptom rather then the main problem. The following chart, also from The Economist, shows the exposition of European banks to sovereign debt.
A lot of effort will be needed on both sides of the Atlantic Ocean to solve this problem. And it seems to be likely that the problems that Greece is facing these days may just be the first of a series of similar issues that the U.S. and the European countries will have to sooner or later deal with.
It doesn’t matter which monetary regime we have, if there’s no fiscal balance on part of the government, sooner or later problem arise. When a choice was to be made between the Gold Standard and fiscal stability, the former was gone. Will the Euro face the same fate?
Nicolas Cachanosky is a doctoral student in economics at Suffolk University, as well as a previous Sound Money Essay Contest winner.
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