European Leaders Working Out Plans To Balance Support Weak Countries, And Costs To The Strong

European leaders have been working together to formulate a plan to lift the burden of debt from the fringe countries of Greece, Portugal and Ireland, but the financial markets are not responding well, indicating the measures may not be going far enough.

Troubles in Europe are not just an abstraction for U.S. consumers and investors, because our economies are tightly linked. Not only are those countries are big markets for U.S. goods, European companies are big employers here, so a weaker picture in Europe could be harmful to jobs on this side of Atlantic. And of course many of us own European investments of some sort through international stock and bond funds.

The issues are complex and long-standing, and probably a preview of what will happen in the U.S. in a few years, if the economy does not recover and individual states, who rely heavily on federal funding, get into deeper hot water with their own finances.

But here is my stab at a summary. Several nations, including Portugal, Ireland and Greece, have fallen on hard times and have huge piles of government to pay back. Those governments have been downgraded, sending the prices of their bonds over a cliff. That debt is owned by European banks, in sufficient quantities that it threatens the stronger economies, even France and Germany.

The political leaders of Europe are working for some sort of deal that shores up the peripheral countries' bonds, and in turn the banks that own them, but at the same time have to put in place their own economic austerity programs, so that France and Germany don't get marked as not creditworthy. (Italy and Spain have already been given a good whupping in the bond markets, although the EuroStoxx 50 index has recovered by about 10 percent in the last few days.)

The New York Times covers the negotiations for us:

President Nicolas Sarkozy of France and Chancellor Angela Merkel of Germany called for each nation in the euro zone to enshrine a "golden rule" into their national constitutions to work toward balanced budgets and debt reduction, a level of discipline well beyond the current, oft-broken commitment.

...

The much-anticipated meeting at the Élysée Palace here produced little that would seem to quell the nerves of bond traders, who are becoming increasingly worried that the economic slowdown in both Germany and France will make it harder to overcome Europe's debt crisis.

Lately the Eurozone economy has not been that strong. There is a great graph in the Financial Times but I can't get a digital version -- here it is in words:

Rich nations had a horrible second quarter. The annualised percentage growth rates for gross domestic product - 1.3 for the US, 0.8 for the eurozone and UK, 0.5 for Germany, 0 for France, minus 1.2 for Japan - are well below the 1.5-3 per cent regarded as sustainable over the long term.

The size of the economies of the U.S., Europe, Japan and the U.K all are below their 2007 peaks. The U.S. has had the best recovery by far.

It's a difficult maneuver -- coming up with a short-term rescue that will save Greece and the others, while trying to keep the cost to a level that will send the larger economies down the drain, and balance the short and long term considerations that gives the stock and bond markets some to be confident in.

I'll close with a quote from the FT:

The paradox [of spending cuts reducing economic growth] is particularly dangerous in the eurozone, where a slowing economy is adding to the difficulty of solving the sovereign debt crisis. The absence of growth makes it likely that Germany and other creditor nations will be even more reluctant to continue bailing out Greece and other debtors.

All rich nations face something of the same dilemma, however. The addition of ever more government debt through short-term stimulus might only prolong their Lesser Depressions. If growth does not pick up strongly fairly soon, it may be necessary to start thinking about a more radical financial reset - such as higher inflation or large debt writedowns. Such policies are objectionable and risky, but the alternatives could be worse.