Why should we care about Europe's fiscal crises?

McClatchy NewspapersAugust 10, 2011 

WASHINGTON — Wall Street's roller-coaster ride shows no sign of slowing, in part because events unfolding in Europe are renewing fears that in a financially intertwined world, a crisis on one side of Atlantic Ocean will migrate to the other.

What's happening in Europe is nothing short of monumental, if at times difficult to comprehend for many Americans. Here are some answers to questions about what's going on there.

Q: U.S. stocks on Wednesday erased the gains from a day earlier because of Europe fears. What's up?

A: After last Friday's downgrade of U.S. government bonds by Standard & Poor's, investor eyes are on France, which also could lose its gold-plated AAA rating. Investors worry that French banks are vulnerable to the broader European debt problems, and one bank in particular is at the height of worries, Societe Generale. Share prices of U.S. banks tumbled Wednesday because of fears that they're on the other side of a range of business deals with French and European banks.

Q: How are European leaders reacting?

A: Unlike the U.S. Congress, French President Nicolas Sarkozy, Spanish Prime Minister Jose Luis Zapatero and British Prime Minister David Cameron have interrupted their August vacations to attend to the problems. Sarkozy is expected to propose later this month a mix of tax hikes and spending cuts to boost France's budget trajectory.

Q: Aren't U.S. banks less exposed to European debt problems?

A: They certainly are thought to be, since they don't own lots of European bonds. U.S. banks have been subjected to "stress tests" that were far more rigid than similar tests applied to European banks. While there are 7,575 banks in the United States, there aren't much more than a handful in many countries in Europe, so problems there are concentrated in institutions that are tightly woven into the economies of these countries. If a European bank collapses, there'll be a more direct hit on a country's economy. And in a financially interconnected world, some of those problems will become the problems of U.S. corporations and banks.

Q: Wasn't Europe's problem really a problem of Greece defaulting on its debt?

A: Initially it was, but Greece's troubles have spread to other nations and exposed the structural weaknesses in the 27-member European Union. Seventeen of the EU members use a common currency, the euro. They're under the umbrella of a common monetary policy, run by the European Central Bank, but they still have their own individual tax and spend policies — fiscal policy. It's meant that healthier, more responsible economies such as Germany are paying for the sins of weaker ones, and Germans aren't happy about it.

Q: What can Europe do about it?

A: They can either break apart or move faster to common tax and spend policies. For now, it seems the move is to integrate further. It means countries such as France, Spain and Italy ceding some of their sovereignty to a broader euro-zone power. There have been fiscal targets for member countries, but that's different from iron-clad requirements.

"It's been recognized for a long time that the economic and monetary union in the euro zone was incomplete if they didn't have the fiscal federal framework," said Nicolas Veron, a visiting scholar at the Peterson Institute for International Economics. "Now there is market pressure to make it more complete, and that involves some form of fiscal federalism."

Q: Is that federalism like here in the United States?

A: Here, the federal government has overarching supremacy and what isn't expressly granted as a power is the purview of the states. Europe is composed of nations, not states, so it isn't embracing U.S.-style federalism. But it's reluctantly moving toward stronger common fiscal policies that'll take away some of the discretion of member countries.

This is happening already as a condition for the European Central Bank providing emergency lending to struggling countries. In exchange for purchasing Italian bonds, the central bank has demanded labor reforms, a balanced budget by 2013 and a number of other painful steps. It hasn't spelled out what it will require of Spain, but it's expected to be equally tough and politically unpopular. Technocrats in a Europe-wide institution will have greater sway over the lives of people across 27 nations.

Q: So technocrats will run Europe. What about accountability?

A: Stay tuned. This hasn't become a big issue yet, but it's unlikely that countries will give up their own decision-making without some form of political accountability for actions taken. How this evolves isn't yet clear; that's a fight for later.

"On a more short-term basis, it's really about building a credible fiscal federal framework," Veron said.

Q: Still, why should I care about these changes in Europe?

A: While the dollar is the world's reserve currency, the euro has emerged as the alternative reserve currency. Business is done globally in dollars and euros, particularly the oil business. Central banks around the world hold dollars and euros in deposit. So anything dramatic that affects the euro is going to matter across the globe.

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