Friday, May 14, 2010

Update on the European Debt Crisis

There has been an increased amount of discussion since my post last month, The Decline of the European Monetary Union, of either eliminating members from the European Monetary Union or abolishing the euro altogether. Financial experts are acknowledging the fundamental weakness of a single currency without a single monetary policy, a situation that has allowed states like Greece to overspend without the ability for such states to print more of their national currency in order to monetize their debt. Instead, Greece has sought a bailout from the European Union and the International Monetary Union, the latter of which is funding partially by the United States, which has also overspent.

I fear that the European centralizers will conclude that the solution is to adopt a single monetary policy at the loss of sovereignty for the individual member states instead of abandoning altogether the single currency that was intended more for political than fiscal or economic reasons. In other words, they will conclude that the prescription for the problem produced by centralization is more centralization, just as in the United States centralizing liberals like President Barak Obama and the Democratic Congress have concluded that the solution to economic problems caused by government interference in the economy is more government interference.

The Euroscepticism of the British Conservatives has been vindicated. The British parliamentary elections have produced a coalition that is unlikely to give up pound sterling and bring the United Kingdom into the Eurozone, as a left-wing coalition would have. The British thus have retained the sovereign right to address their fiscal problems their own way, although the European debt crisis is affecting the world economy.

The difference between Greek and British fiscal policy is interesting. Both the Socialist Greek government and the new British coalition government will cut spending, but the former will also raise taxes while the latter will not and might even lower them. Raising taxes will reduces economic growth, which, paradoxically, lowers revenue to the government, while cutting them increases economic growth, which increases government revenue. The Greek debt crisis is more severe than that of the U.K. The Greeks must, therefore, make larger budget cuts than the British, but the difference in tax policy will demonstrate which strategy is better economically and, in turn, fiscally.

So far, the United States under President Obama and the liberal Democratic Congress has increased spending while mostly keeping taxes at current levels, but its decision to allow the tax cuts signed into law by President George W. Bush expire will effectively raise taxes, including on many small businesses, as well as the various tax increases enacted as part of the federalization of health insurance. The Obama Administration’s spending spree still has not produced as much of an economically stimulative effect as was intended, at the cost of undermining confidence in the ability of the United States to service its debt owed to its bondholders and in the American economy, as well as the long-term increased cost to the Treasury for the hundreds of billions of dollars in increased spending. Thus, the U.S. is following the model of the Greek Socialist instead of the British one.

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