Ask the Experts: William Gruver on the European debt crisis, and what it means for America
February 16, 2012
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LEWISBURG, Pa. — William R. Gruver, Bucknell University's Howard I. Scott Clinical Professor of Global Commerce, Strategy and Leadership, examines the European debt crisis and what it means for America.
Question: What are the major factors contributing to Europe's debt crisis?
Answer: When the European Monetary Union was formed and the participating nations agreed to establish the euro as their currency, those nations gave up control of their monetary policies, which allowed them to control their interest rates. That's all done centrally now, much like it's done in America at the Federal Reserve System. But the nations' fiscal policies — which include setting tax rates, the equivalent of Social Security payments, retirement ages and welfare payments — are still done at a national level. So all of these countries have the same interest rate policy but different tax rates, retirement ages and fiscal policies.
That's a problem with regard to a country like Greece, which has benefited from its more disciplined, diligent colleagues to the north. Greece has run budget deficits to support its more generous social benefits, and it has financed its deficits by borrowing more than it can afford to repay. Because of the monetary union with its northern neighbors, it has been able to borrow money more cheaply than it would have as a standalone country. Greece has borrowed its way into this financial crisis and can't repay its debt, and now its northern partners are being asked to bail it out.
Q: What's the strongest economy in the European Union?
A: Poland's economy has grown by 2 or 3 percent per year while other European countries are slipping into recession. It hasn't yet adopted the euro and has allowed its currency to depreciate — that's the historic means of countries coping with financial struggles like the one Greece and other European countries are facing. That's what America has done. We've let our dollar depreciate, allowing us to sell our services and products at cheaper prices in overseas markets and repay our debt in dollars worth less than when the debt was issued. Countries using the euro cannot do that because, again, they've given up their individual currencies in favor of the euro.
Q: How do Europe's financial problems affect America?
A: Our direct, one-on-one exposure to southern European debt is minimal. Even our exposure to the European banks that hold a lot of that debt is way down. But there's a contagion risk. Europe is the world's biggest economy, and as political paralysis continues on, it could go into recession. Then Europeans won't be able to buy our services or Chinese goods, and the whole world economy could slow down. That would hurt our growth.
We should keep in mind another aspect of how our own country and the European economies parallel. Consider that the value of the euro is worth as much in American dollars now as it was when the crisis began, within 1 or 2 percent. You would've thought that the dollar, with all Europe's problems, would've strengthened. It hasn't. Why?
Ben Graham, a legendary professor at Columbia University, referred to the financial market as "Mr. Market." Mr. Market was omniscient. Mr. Market knew more than any economic forecaster. Mr. Market is saying to us, since there hasn't been any change in the euro/dollar exchange rate, America's problems are just as bad as Europe's problems. And what has happened has been a flight out of the two largest most freely traded currencies, the euro and the dollar. The only major currency that has benefited from the move away from the dollar and euro is the Swiss franc. It has replaced the dollar as the safe-haven world currency.
The extraordinary appreciation in the price of gold testifies to Mr. Market's fear of any paper currency because it seems that neither European nor American politicians are in control of their economic miseries. In Europe, the Germans don't want to finance a lifestyle in Greece that is unavailable to their own citizens, so they insist on fiscal control of bailed-out countries, while the Greek people riot when their politicians pass laws to begin the process of harmonizing social benefits and beginning fiscal union.
In America, there's a similar political paralysis between a president who continues to want to deficit spend and a Congress insisting on debt reduction. These crossed goals result in no fundamental improvement in our national finances, while our debt rating gets lowered from AAA for the first time in history and our unemployment rate is still above 8 percent. The Tea Party and the Occupy movement both give voice to the economic angst of the average American, and that is definitely an emotional cousin of the uncertainty and lack of confidence in political leadership being seen in the Greek streets.
Q: Will the financial crisis in Europe lead to the end of the euro zone?
A: Europe is at a fork in the road, and euro zone countries either have to integrate or they have to disintegrate. If Europe is going to survive as a monetary union, then the nations will have to integrate fiscally as they have integrated monetarily. The problems won't be fixed overnight. It will probably take 10 years to harmonize some of those fiscal measures such as retirement ages, social security and pensions. If countries try to equalize those issues overnight, they end up with riots in the streets — just as we're seeing in Greece today.
My guess is that the International Monetary Fund, the European Central Bank and the European Commission authorities will continue to have a series of bailouts, agreements to take losses on debt repayments and more aggressive actions on re-buying bad loans such that they'll muddle their way through the next two or three years. They'll buy time to work toward fiscal harmonization and fiscal union. That's probably the most optimistic forecast I can give, but it's better than going back to a worldwide financial crisis.
Interviewed by Andy Hirsch
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