European Weakness Is Fuelling U.S. Profligacy

The European debt crisis has demonstrated the painful costs of fiscal profligacy and short-sighted Keynesian stimulus. In the words of financial historian Niall Ferguson, “there is no such thing as a Keynesian free lunch,” warning that a “greek crisis” could come to America.

The Washington Post columnist Robert J. Samuelson says the European crisis should be a wake-up call for America, though, so far, that does not seem to be the case:

“You might think that Europe’s economic turmoil would inject a note of urgency into America’s budget debate. After all, high government deficits and debt are the roots of Europe’s problems, and these same problems afflict the United States. But no. Most Americans, starting with the nation’s political leaders, dismiss what’s happening in Europe as a continental drama with little relevance to them.”

Even worse, the European crisis could push the U.S. fiscal trajectory in the wrong direction, towards even more profligacy. The reason for this paradoxical situation is that the weakening of European economies and public finances leads to a “flight to safety” into the dollar and U.S. Treasuries. As pointed out by Financial Times columnist John Plender, “As the hegemonic power in the global monetary system it is acting as a safe haven despite being fiscally debilitated.”

However, this situation cannot go on indefinitely. At some point international bond holders will start questioning the sustainability of U.S. finances, pushing up bond yields, dragging down ratings and increasing the borrowing costs of the U.S. government.

Thus, even though the European debt crisis in the short run is helping the U.S. government fund its never-ending appetite for borrowing, in the long run this will lead to a further weakening of the U.S. fiscal position. In the words of Plender:

“In effect, European weakness is increasing the threat of national decline and imperial overstretch in the US. Addressing that threat requires firm leadership and wise policy. Yet, especially since the Gulf of Mexico disaster, we have had populism and panic from the Obama administration, with BP acting as the punchbag.”

Strong and principled leadership is hardly what we are experiencing in Washington right now—neither in Congress nor in the White House. Rather, the agenda is as always one of short-term political gain, leaving the long-term damage to some future day of reckoning.