Global markets have issued a vote of no confidence in the management of the world’s two largest economies, the U.S. and the euro area. To regain credibility, leaders on both sides of the Atlantic need to recognize the magnitude of the crisis they face.
The outlook reflected by the market rout is not encouraging, coming as it does after European and U.S. officials thought they were doing enough to fix their similar -- and overlapping -- fiscal problems. The U.S. is growing at a rate too slow to withstand a serious shock, and that shock could easily come from Europe’s resurgent financial crisis. So far, politicians’ efforts have been far too timid to convince the world that they have the situation under control.
This week’s deal to raise the U.S. debt ceiling is a case in point. Given the exceedingly weak recovery, the U.S. government should stand ready to provide more stimulus. To prevent larger deficits from harming its credit standing, the U.S. must also convince investors that it is capable of putting its long-term finances on a sustainable path.
Instead, partisan brinkmanship has undermined confidence. The deal that Congress and the White House ultimately struck doesn’t come close to solving the government’s long-term problems, but threatens spending cuts that could weigh heavily on economic growth in the short term.
Europe’s leaders have also lacked urgency. Markets need to see that German Chancellor Angela Merkel, French President Nicolas Sarkozy and other officials can rise above national politics to fix the euro area’s glaring flaws, which include the lack of a unified fiscal authority. Instead, a series of half-measures has mainly served to exacerbate the crisis, allowing its spread to the large economies of Spain and Italy and to banks that hold Europe’s sovereign debt.
Thursday’s moves in the markets gave a taste of how costly politicians’ dithering can be. The drop in world stock markets represents hundreds of billions of dollars in lost value. Italy’s cost of borrowing, as measured by the yield on its 10-year government bond, rose to a new euro-era high of 6.18 percent.
What needs to be done? Europe’s leaders should demonstrate that they stand together, ready to do what it takes to restore confidence. This would involve issuing jointly backed euro bonds to replace most or all of the debts of struggling governments, and simultaneously recapitalizing banks that would suffer losses from debt restructurings. It also would include setting up a finance ministry with enough taxation power to service the euro bonds and provide stimulus to weaker economies.
In the U.S., the government must be prepared to boost consumer demand, and that means putting people back to work. Ideally, a comprehensive plan to fix the country’s long-term finances could be combined with a shorter-term stimulus. President Barack Obama is already promising to pivot from debt talks to a national jobs program. But having just completed punishing negotiations over spending cuts, he has very little hope of finding new money -- and little time to waste.
Barring a major new stimulus program, some steps can be taken. Obama could ask Congress to quickly adopt a jobs tax credit, renew clean energy tax breaks and temporarily waive federal environmental, labor and other requirements that delay public works programs, all moves that would put workers back on private payrolls.
The president could ask Congress to allow states to channel some of their federal unemployment compensation into job-sharing programs, which have worked well in Germany and a few American states. He could encourage Fannie Mae and Freddie Mac to allow homeowners who are current on their mortgages, but who owe more than their houses are worth, to refinance into lower-rate loans, thus freeing up more cash to spend.
When the Federal Reserve meets on Aug. 9, it should signal that it’s ready to do its part, too. Among the stimulative tools at its disposal: Pledging to hold onto the U.S. Treasury bonds it has accumulated in its quantitative-easing programs, and to reinvest the proceeds from any maturing securities in government debt. It could announce that it plans to keep its key interest rate near zero for a longer, more defined period. It could lower the 0.25 percent interest rate it pays banks that park excess reserves at the central bank, to prompt more lending and investing. And it could replace the shorter-term securities it holds on its $2.9 trillion balance sheet with longer-term ones, to push down those rates as well.
Ultimately, markets may force politicians and policy makers to implement all these measures and more. The world will be much better off if they find the will to get ahead of the curve.
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