We must accept austere reality which lies ahead
Who is right? The Americans want to see other parts of the world offering more economic stimulus. The Europeans |think there's been too much stimulus already.
The arguments on either side are easy enough to spell out. The US believes it has kept the world economy afloat over the last couple of decades. By running an ever-widening balance of payments current account deficit, the US has imported more than it has exported and, hence, has offered a stimulus to the rest of the world.
In the process, however, the US has become over-burdened with debt. The results of this debt addiction include the housing bubble, its subsequent bust, the sub-prime crisis, the credit crunch and the highest level of long-term unemployment in the post-war era. For President Barack Obama and his colleagues at the US Treasury, it's time for someone else to do the heavy lifting to keep the global economy's head above water.
For the Europeans, it's a different story. For them, the crisis stemmed from an earlier period of binge borrowing, associated with excessively rapid money supply growth, low interest rates, reckless government borrowing and a failure to recognise the massive growth in leverage. They have no desire to follow the American model of old because they can see the unfortunate results.
The US may not have been the worst-hit country during the |financial crisis but the US was, nevertheless, the epicentre of the crisis. Why should European policymakers emulate a model which has so clearly ended in failure?
For them, now is a time for austerity. It's payback time for years of ill-discipline.
These contrasting positions partly reflect differing abilities to tap the world's capital markets. The US enjoys the huge benefit of having the world's reserve currency. At times of financial distress, investors typically flock to buy dollars, selling more or less everything else in the process. As a result, it's proved relatively easy for the US to fund what is now an absolutely huge budget deficit.
Foreign purchases of Treasuries have risen substantially over the last 18 months, driving 10-year yields down to a paltry 3%. Budget deficits across Europe are mostly a lot lower than America's yet, for many countries, borrowing costs are a lot higher.
But there's a lot more to this difference of view than the ability to tap capital markets. The Germans, for example, are able to borrow at a remarkably low interest rate of only 2.6%, yet Angela Merkel and her colleagues have no wish to follow America's road to perdition, as they see it.
It's partly a matter of history. America's 20th-century economic crisis was the Great Depression, a time of collapsing activity, mass unemployment and deflation. Germany's crisis was its hyperinflation of the 1920s, when people carted money around in wheelbarrows and when cigarettes became an important alternative medium of exchange. The Americans are prepared to take monetary and fiscal gambles to prevent a collapse in activity. The Germans fear that such gambles will simply see the return of excessive inflation.
The US, the UK and others have been living beyond their means for many years and will probably have to accept that the level of output and its growth rate are now permanently lower than they appeared to be before the crisis began. The case for austerity rests on accepting this new reality.
Austerity is hardly pleasant, but it might just prevent a repeat of the problems which, two years ago, culminated in the worst Western recession since the 1930s. That in itself would be some achievement.