We hear today of the upcoming row between those puritan Europeans – slash the deficits – and those cavalier Americans – stoke the recovery. Mr Spend and Borrow himself, Mr Obama, has warned Europe not to overdo the cuts. So who is right?
They are both right. As we have seen in the Euro zone, failure to control deficits in countries like Greece, Ireland, Portugal and Spain leads to higher interest rates and market forces pushing the states to even bigger cuts. High deficits and surging debt levels undermine confidence and come to impede recovery. No highly borrowing state with the possible exception of the US can ignore the need to rein in their borrowing and maintain or regain the confidence of markets. The US will get away with more borrowing for longer because the dollar remains the world’s reserve currency and China still has some appetite for it.Even the US one day has to repay the debts and put its budget into shape.
Just cutting state spending and borrowing will not of itself generate recovery. Countries emerging slowly and fitfully from a deep recession need to promote private sector led recovery. This requires lower taxes on enterprise and effort, and a plentiful supply of credit at realistic rates for business to grow and invest.
The best combination from here is gradual tightening of the fiscal stance, bringing down the build up of state debt, and relaxation of the monetary stance through credit being offered to the private sector.
If the G8 and G20 want to make a contribution to economic recovery the US and the EU should not waste too much breath on disagreeing, when their two proposals could be married into a coherent whole. What they need to do instead is to examine the state of the world’s banking system again, and seek ways to allow more private sector credit creation. The danger is the sound of bolting the stable door on the banks long after the horse has bolted, and demanding more cash, capital and tax revenue from banks at the wrong stage of the cycle.
The single most important thing the G20 could do to help recovery is to persuade world markets that no country will renege on its debts. That would be a boost to confidence and a reason to be less worried about certain banks.