Are the U.S. and European economies decoupling?

A Cypriot woman gets emotional during a protest outside the parliament building in the capital Nicosia on March 22, 2013. Cyprus' two biggest lenders urged lawmakers to adopt a tax on bank deposits, a controversial deal with the EU that the MPs rejected this week, as their employees protested outside parliament. AFP PHOTO/YIANNIS KOURTOGLOU (Photo credit should read Yiannis Kourtoglou/AFP/Getty Images) AFP

(MoneyWatch) As European officials try to contain the fallout of a banking crisis in Cyprus that threatens to contaminate other states in the region, the U.S. seems like an oasis of economic stability.

Why?

Experts largely attribute the divergence in the European and American economies to the massive government spending cuts, wage reductions and tax hikes that eurozone states have embraced in recent years to ease their debt crisis. For these countries, such "austerity" has been a disaster, slamming economic growth and actually putting some of them deeper in debt as revenues plunge.

"Europe has pursued this path of austerity, and the predicted result has been textbook," said Dean Baker, co-director of the Center for Economic and Policy Research, a Washington think-tank. "When an economy is weak and you cut spending and raise taxes, you throw that economy into the gutter." 

The eurozone's GDP fell throughout 2012 and is expected to shrink an additional 0.3 percent this year, according to research firm IHS Global Insight. Demand in many countries remains anemic, as shockingly high unemployment and falling wages keep a lid on personal consumption. Credit is tight. Consumer and business confidence also remains low, while the problems in Cyprus have re-ignited fears of a broader banking crisis that depositors fear could hit them directly.

"You've got this crisis of confidence in whether debt is sustainable in some countries and whether the financial system is strong enough to cope," said Paul Ashworth, chief U.S. economist with Capital Economics. "The ongoing austerity is also a big restraining factor on these economies. You're raising taxes and cutting spending, which negatively impacts GDP."

If the U.S. economy remains weak, by contrast, it is at least showing signs of improvement. As the Case-Shiller report showed Tuesday, a closely watched gauge of the housing sector, home sales and prices are rebounding. That in turn is boosting manufacturing and construction, two other industries that are key to the nation's economic health. The stock market also has reached record highs, while a boom in oil and gas production has kept energy prices in check and lifted economic activity.

Meanwhile, Americans have continued spending despite concerns about the impact of the sequester, the mandated federal spending cuts that took effect in March, along with a January hike in payroll taxes. Retail sales have risen five straight months.

Economist Ed Yardeni, president and chief investment strategist for institutional investor advisory Yardeni Research, notes that economic growth is also helping boost federal tax receipts and trim the deficit. 

The Federal Reserve has helped prime the pump by keeping interest rates low, which supports spending and business investment. The Fed's counterpart on the other side of the Atlantic, the European Central Bank, has been much more restrained in using monetary policy to energize growth. Unlike the U.S., which can "print" dollars to offset the spending declines that occur in a depressed economy, countries in the 17-member eurozone cannot adjust their currencies as conditions dictate.

Another factor that helps explain why the U.S. has at least plodded forward while Europe slides backward is that the American economy is more self-sustaining. Exports accounted for only roughly 11 percent of of U.S. GDP, compared with upwards of 40 percent for some European countries.

The U.S. economy's strength shouldn't be overstated. Some 12 million Americans remain unemployed, with millions more working in part-time or other "contingent" jobs that offer little economic security. Many have given up finding work altogether and no longer show up in monthly employment figures. Deeper structural issues, such as rising income inequality and soaring education costs, also raise questions about long-term economic growth. Growing numbers of people say they are worried about being able to afford retirement. Perhaps not surprisingly, consumer confidence remains fragile.

Even more troubling to some: U.S. policymakers are ignoring the vivid lessons of austerity in Europe to focus on deficit-cutting, when history shows that the federal government should be increasing spending, not finding ways to slash it. Political leaders across the aisle "are all singing the same tune on this, saying 'deficits, deficits, deficits,'" Baker said. He argued that Obama should have taken more of a leadership position, explaining to the public why the government should be spending more.

"I blame Obama," he said, adding that the economy has suffered for the White House's acquiescence to deficit hawks.

That views squares with the White House's own Council of Economic Advisers, which noted in its recent annual report that the "recovery was slower than expected."

  • Alain Sherter On Twitter»

    Alain Sherter is an award-winning business journalist who has written for The Deal, MarketWatch and Thomson Financial Media.

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