Economic Domino Theory in the Eurozone, Part 1

In 1992, the thirteen nations of the European Communities met in Maastricht, Netherlands to sign the Maastricht Treaty.  By doing so, these nations, which included Italy, France, West Germany, the United Kingdom, and Greece, bound themselves in an association known as the European Union, now comprised of 17 nations.  In the process they created a unified currency—the euro—which forever linked the fortunes of these economies, whether good or bad, in an essentially unbreakable chain.

Douglas J. Elliot, a Senior Fellow at the Brookings Institute, wrote on CNN Money that “the road into the Eurozone ran only one way.”  What he meant was that the Eurozone countries made it almost impossible to dump the euro without leaving the European Union; there is no mechanism in place for such an act.  The fear was that if a country like Greece were to dump the euro as its currency, they would set a weaker exchange rate leading to a run on their banks and a domino effect rushing through the Eurozone. 

At this moment, however, the very foundations of the European Union are buckling under the weight of debt and instability.  The governments of Greece and Italy have both been ousted after promising substantial austerity packages.  The euro itself is in danger of folding and the nations of the Eurozone watch as each domino continues to fall.  How bad is it?  Simon Wolfson, the CEO of European retailer NEXT is offering a $400,000 prize for a plan to break up the euro peacefully.  

The root cause of this crisis is essentially government debt, a prescient warning for American technocrats. The Maastricht Treaty mandated that annual government deficits not exceed 3% of GDP while government debt not exceed 60% of GDP.  Most European nations, however—particularly Greece and Italy—used complex currency and credit derivatives to mask the realities of their debt situation. 

Currently all the major Eurozone nations have debt to GDP ratios over 60%: the United Kingdom (77.8%), Germany (75.7%), France (83%), Italy (118.9%), and Greece (140.2%).  These staggering ratios—particularly those of Italy and Greece—have strained the relationships between banks and clients, investors and business, government and business, and government and citizens.  As a quick aside (and a story for another day), the American debt to GDP ratio is 99.6% for the year and ironically crossed the 100% plateau on Halloween according to projections by the International Monetary Fund. 

German Chancellor Angela Merkel and French President Nicolas Sarkozy have led the efforts by the more structurally sound European nations to maintain stability and find a long-term solution.  But experts worry that they are playing a losing hand.  The fiscal monstrosity that is the Greek and Italian bond market, combined with their astounding levels of government debt, has led some to fear the “doomsday scenario.”  

On Tuesday, the yield on 10-year Italian government bonds reached 7.039%, a rate at which economists believe the refinancing of Italy’s debt becomes unsustainable.  Were Italy and Greece unable to refinance their debt and default, economists and heads of state alike worry that the domino effect will spread through Europe and beyond—quickly.  Spain and Portugal would fall, followed by Ireland, and eventually the cancer would reach France. 

While France may not be a dominant geo-political power, they do dominate the banking sector of the Eurozone.  Germany, the most reliable of the bunch, houses almost all of its capital in French banks.  France also holds approximately $1 trillion in American money.  Meanwhile, the French banks have overleveraged themselves in the unpredictable Eurozone market resulting in France’s rocky fiscal infrastructure and dim economic outlook.  As rating agency Standard & Poor’s stated in downgrading the French banking sector, “we see weaker economic prospects for Europe, including the peripheral countries to which some French banks are significantly exposed.” 

Eurozone leaders have taken action.  At a summit in October, they decided to write down—essentially reduce in value—the Greek debt held by the private sector by 50%.  Meanwhile, Lucas Papademos has replaced George Papandreo as interim Prime Minister of Greece and promised a strong effort to pass a significant austerity package. 

Last week in Italy, the Parliament voted to approve an austerity package—which includes cutting 300,000 public sector jobs, increasing the retirement age for government benefits, simplifying the tax code, creating incentives for venture capital investment, and reintroducing the property tax—paving the way for Silvio Berlusconi to resign as Prime Minister. 

But there are flaws to these measures.  The write down of Greek debt makes very idyllic assumptions.  An article in The Economist after the deal was struck commented that the Eurozone’s main rescue fund, the European Financial Stability Facility, “does not have enough money to withstand a run on Italy and Spain” while other sources of liquidity—Germany and the central bank—have ruled out further bailouts.  The Italian austerity package is vague—such as when it outlaws deficit spending “except in the case of exceptional events” and fails to define “exceptional events”—and the country itself currently lacks a government. 

As the dominos continue to fall, the worry shifts from the collapse of the European bond market and banking sector to the impact on American markets.  The universality of the worldwide financial system means that the economic domino effect does not stop at the water’s edge. 

America, the Case For Hope

Writings about our country have long been dominated by benign, soporific eulogies to the greatness of America past.  We are the country that evicted the domineering, imperialistic behemoth that was the British Empire.  We successfully created a representative democracy outlined in the redoubtable words of the longest lasting constitution in world history.  We settled the west, fought for equality for all, defeated totalitarianism in Europe and Asia, went to the moon, and invented the microchip, the internet and a cure for polio.  But…

The malaise of the last few years has set in so that every comment about the greatness of America past ends with a “but”.  But now we are in a lost decade.  But now capitalism has failed and our economy cannot recover.  But now our political system is defunct, never to regain its ideal form.  But our people have lost their moral core.

These are all valid concerns and valid challenges.  Our economic recession, resulting from the financial crisis of 2008 which illuminated serious flaws in the financial system and its inter-related relationship with government, has now spanned three years.  A lost decade like Japan’s 1990s is not out of the question.  The hyper-polarized nature of our political system, which culminated in the debt ceiling debacle this summer, has done harm to our external political reputation and our internal political confidence. 

Americans, however, are a people of resilience.  As political philosopher Alexis de Tocqueville commented, “the greatness of America lies not in being more enlightened than any other nation, but rather in her ability to repair her faults.”  In our history, we faced the challenges of economic disaster and emerged stronger than before.  We confronted atrocities abroad and emerged victorious.  We foresaw the changing landscape of the turn of the millennium and developed the greatest technologies in the world.  And we can do it again.

On the great seal of the United States are three Latin phrases.  Novus Ordo Seclorum, translated as “a new order for the ages,” represents the unique nature of the American experiment.  This experiment combined the political philosophies of ancient Greece and Rome, a Judeo-Christian legal foundation, and the practicalities of the British Parliamentary system into a government never before seen in world history. 

Annuit Coeptis, translated as “providence, [or God], favors our undertaking,” represents the spiritual foundation of the American experiment.  We are an inherently spiritual people, bolstered in our spiritual foundation by the success God has shined upon us in our history. In some ways, we have lost our spiritual fervor, but the moral infrastructure is still in place, ingrained in every aspect of public life.  Tocqueville stated that “Americans combine the notions of religion and liberty so intimately in their minds that it is impossible to make them conceive of one without the other.”  It may not always seem to be the case but I still honestly believe that it is. 

The third phrase on the great seal is E Pluribus Unum, translated as “out of many, one.”  The diverse nature of the American population has always been a sign of the great success of the American experiment.  Greater yet, however, is the fact that through that diversity has come one voice, one rallying cry for the values on which this nation was founded: freedom, liberty, unity,  suffrage, morality, leadership.  These values have been challenged—as they were during the Civil War—but the strength of American convictions has always been sustained.

As the challenges of the Civil War commenced, the dome of the US Capitol, the great exclamation point on the temple of American liberty and deliberation, sat unfinished.  With the future of the Union unknown, President Lincoln ordered the dome to be finished, stating “if people see the Capitol going on, it is a sign we intend the Union shall go on.” 

The future of our American Union may be unknown, but as Lincoln ordered in the 1860s, we should continue to seek and strive for a “more perfect Union.”  Discussions of America should no longer be benign, soporific or elegiac.  If history has revealed anything, it is that there is no challenge we cannot face, no conflict we cannot overcome, no task we cannot complete. 

The Great Seal of the United States cannot and will not be broken.  We are one nation born from many peoples, religions, ideologies, and cultures.  Our diversity makes us stronger and it will make our successes greater.  The success and consistency of our history changed the world forever.  In the next few years, we can and we will do it again.  It may not yet be morning in America, but the dawn is not far off.    

Jobs, Taxes, and the Republican Primary

Economic factors are always paramount in presidential elections.  But in a year when the unemployment rates remains above 9% and the Eurozone debt crisis looms, the importance expands exponentially.  With the first Republican primary less than two months away, each of the potential candidates has outlined a tax and jobs plan that will, according to them, bring the United States out of this recession and restore it to its once great position as the only viable superpower.

Mitt Romney, the unflappably stagnant former governor of Massachusetts, introduced his 49 point jobs plan last month in Las Vegas.  It entails cutting corporate tax rates from 35% to 25%, eliminating the estate tax, and extending the so-called Bush Tax Cuts.  He also recommends reducing the regulatory burdens on business by repealing Obamacare and Dodd-Frank (the financial reform bill) and expanding drilling in areas such as the Gulf Coast, the Plain States and Alaska. 

Texas Governor Rick Perry, the unflappably flappable candidate, introduced his tax and jobs proposals in recent weeks.  His jobs plan focuses mainly on increased energy production in oil and natural gas which he states will “unleash 1.2 million American jobs through safe and aggressive energy exploration at home.”  His tax plan proposes creating an opt-in flat tax, meaning those who choose to do so, can have their taxes reduced to a flat rate. 

Former Godfather Pizza Executive Herman Cain, the ever-present attention seeker, has infamously proposed his 9-9-9 plan to reform the tax code.  It would throw out the existing tax code and replace it with a 9% corporate tax rate, 9% individual income tax, and 9% national sales tax.  Cain has not explained his plan much beyond that except to say that his advisors have crunched the numbers and it will be deficit neutral.

Former Utah Governor and Ambassador to China Jon Huntsman (disclaimer, I volunteer on Huntsman’s campaign) has proposed a tax and jobs plan that synthesizes many aspects of Romney, Perry and Cain’s proposals.  He calls for tax reform in which loopholes and deductions for corporations and the rich are eliminated and the base is broadened.  The corporate tax rate would then be reduced from 35% to 25% and the personal income tax would be reduced to flatter, fairer rates of 8%, 14%, and 23%.  He has also called for expanded oil and natural gas exploration, regulatory reform, free trade expansion, and stronger relationships with foreign nations.

Other candidates have made various similar and sometimes outlandish proposals.  Rick Santorum, has proposed cutting the tax rate for manufacturing to 0%, an interesting thought.  Ron Paul has proposed eliminating the Departments of Education, Commerce, Energy, Interior, and Housing and Urban Development.  Michelle Bachmann has not been able to formulate a sentence that does not end with “repeal Obamacare.” 

Many of these proposals are seriously flawed.  Romney’s tax plan leaves the existing tax code, loopholes, deductions, and all, in place allowing for companies like GE to continue to make billions of dollars and pay no income taxes.  Perry’s tax plan also leaves the existing loopholes and deductions in place because those benefiting from them will not choose to opt-in to the proposed flat tax.  Cain’s plan is simply simplistic; as a tax lobbyist I spoke to recently put it, “I have serious questions about a tax policy that can be summed up in a catch phrase.”

 Santorum’s proposal concerning tax rates on manufacturing is intriguing but has little chance of success in Congress.  Paul’s proposals are simply ludicrous; maybe in a perfect world we could do away with five Executive Agencies and be fine, but that is not this world.  Huntsman’s jobs and tax plan was called “big and bold” by Reuters and “as impressive as any to date in the GOP presidential field, and certainly better than what we’ve seen from the front-runners.”  Because of my stake in the Huntsman campaign I will let you decide for yourself.

What is clear is that the Republican candidates for president have displayed many similarities and many differences in these proposals.  The distinctions may seem minute, but they are clear and integral in this time of economic woe.  The candidates now have approximately eight weeks to distinguish themselves from each other and from President Obama.  It should be interesting to watch.  

Putin in Power: Continuity and Complexity

The amiable yet complex diplomatic relationship between the United States and Russia has taken another turn in the last week.  Former Russian President and current Prime Minister Vladimir Putin has announced that he will seek reelection in 2012 to the Presidential office, which he held from 2000 to 2008.

Putin, a former KGB operative and Communist Party member, has maintained a love/hate relationship with the United States during his time in public office. American representatives and leaders have perceived a Cold War attitude from the post-Cold War presidency.

Over the past few years, United States Presidents and President Putin have butted heads over issues such as the unofficial reunification of Soviet bloc countries, the use of natural resources—particularly natural gas—to detach Germany from the Atlantic Alliance, and the Russian invasion of Georgia in 2005 for which former President Bush called the Russian leader “cold-blooded.” 

Putin has also been criticized for instances which many considered violations of human rights.  In 2009, Russian attorney and anti-corruption activist Sergei Magnitsky suffered a gruesome death after being in police custody for 358 days.  In 2003, billionaire Mikhail Khodorkovsky was arrested and charged with fraud, embezzlement and money laundering after giving financial support to multiple opposition parties. 

Putin seems to be attempting to adapt to 21^st century geopolitical realities while remaining a Cold War leader at heart.  Ralph Peters of the Washington Post maintains that Putin is a successful leader in that he has somehow mastered this balance.  “Not one of his international peers evidences so profound an understanding of his or her people, or possesses Putin’s canny ability to size up counterparts.” 

Peters goes on to lay out Putin’s general strategy—which he calls genius—of reconciling the tactics of the Soviet Union and the realities of the current world.  “You need control only public life, not personal lives.”  In other words, the KGB has been replaced by the Press Service.  While the instances mentioned above may prove to be counterarguments to that statement, Putin’s successful reign as President and Prime Minister are evidence of his competent leadership. 

In 2008, Putin was disallowed from running for reelection in Russia due to their mandated term limits.  He was replaced by Dmitry Medvedev who subsequently appointed Putin Prime Minister leading to the belief that Medvedev was merely a puppet of the former President.  Walter Russell Mead, in American Interest, describes Putin’s announced run for president as the “Russian decision to take off the Medvedev mask and put Prime Minister Putin back in the top spot.”

Putin’s efforts to become president once again have put the United States in a difficult position.  There are diplomatic conflicts with Russia and there are personal conflicts with Putin.  But there are also areas of agreement and mutual benefit.  Neither the United States nor Russia wants China to dominate Eurasia.  Neither wants Islamic fundamentalists to destabilize the region. 

Russia, led mainly by Putin, has used its excess of natural resources to gain influence with multiple Western countries.  As Peters states, “seduced by Kremlin policies—from oil and gas concessions to cynical hints of strategic cooperation—Western leaders have too many chips in the game.”  The United States and other Western countries are now dependent on Russia for natural resources, geopolitical stabilization, and United Nations support.  But they must now deal once again with Vladimir Putin.

Putin’s popularity in Russia is more one of image than policy.  According to Peters, he has “renewed Russia’s confidence in the country’s greatness.”  He is loved and admired because he is a nastoyashi muzhik, a “real man.”  A Putin presidency may be great for Russian morale, but is it good for the world?