Plain Sense Economics

Jasen Hartford, a friend and past student, recently asked me,

As we all know, the European Union has recently been under the lime light with their budget deficit problem – causing a lot of anxiety for investors in the U.S. I’m curious if there’s a reason why the even greater deficit in U.S. isn’t being publicized as much?

Crumbling Parthenon

The quick and honest answer is that I don’t have any special insights into the minds and souls of investors – not being one myself. Still, there are some characteristics of the European economic crisis that are different from the United States, but can provide cautionary tales for our own economic policy.

As of today the US national debt stands at $12,988 billion (that’s almost $13 trillion). In 2009 our Gross Domestic Product was $14,256 billion. So our debt is about 91% of GDP.  From news sources Greece has debt of around $368 billion, and a 2009 GDP of $357 billion – a debt load of 103%. So somewhat higher than the US but not by multiples.

So, just to repeat my earlier disclaimer – I don’t know what makes international investors tick. Here, though, are some of my concerns about Greece and Europe, and what distinguishes them from the U.S.

Greece is a member of the Euro community – i.e. they no longer have their own currency, but use the Euro instead. This should provide stability in foreign exchange markets, compared with maintaining their own currency. On the other hand, Greece no longer has sovereign control over its own monetary policy. The Euro central bank can change the supply of euros, and the Euro community in general impacts the value of the euro on the foreign exchange market. In sort Greece is dependent on others to apply some traditional rescue strategies. What Greece has in common with the United States is the need to balance government revenues and government expenses in the long run.

The concern about Greece seems to be bigger than Greece. Policy makers and observers worry about other country members of the euro community, including Spain and Portugal. They see a domino effect that threatens most of Europe. For the U.S. that means worrying about some of our best customers and understanding that the global financial structure is interdependent, with a credit crisis in Europe spreading here quickly.

I also think confidence in the central banking and political system plays a role in investor perception. We’re quick to criticize both the Federal Reserve and Congress for their actions or inactions. The world has a more sanguine view of these institutions, though. The value of the U.S. dollar has been rising in recent weeks, as investors switch to dollar-denominated securities – in particular U.S. treasury bonds. Those investors have more confidence in the U.S. than in Europe – for better or for worse.

None of this means that the U.S. debt situation is nothing to worry about. While I may not be confident in the economic policy process in Congress, I do have faith in the Federal Reserve. And in contrast to the deficit hawks I believe we still need to be spending government money to stimulate our recovery.