The world’s three biggest economies are all fighting deep-seated, long-term problems. But there is something remarkable about the United States, the European Union, and China in 2012. Each is trying to solve those problems on its own accord, without being forced into action by financial markets or domestic unrest.
The stakes are unimaginably huge. If leaders of these nations succeed at preemptive strikes against their deepest troubles, it could create a stable and prosperous 21st Century. If they fail, the consequences could be dire.
China is the most straightforward example. The elevation of Xi Jinping to lead the Communist Party and military of the world’s most populous nation Thursday took place at a time of slower growth than years’ past. Yet instead of responding to the slowdown by immediately flooding the banking system with money, the government is taking a longer-term view, trying to encourage a shift toward a more consumer-driven economy rather than one overwhelmingly dependent on exporting to the rest of the world, and nurture the creation of a more liberal financial system that funnels capital to enterprises with the best business prospects, not those favored by politicians.
In the United States, the looming austerity crisis—a “fiscal cliff” that hits Jan. 1, when taxes will rise and spending be slashed absent policy changes to avert it—is entirely self-inflicted by the nation’s domestic politics. It is true that the nation has large budget deficits and that costs for Medicare and other entitlements are on track to spiral upward in the years ahead as the baby boom generation retires. But financial markets are not forcing a reckoning with those issues; rather, global investors are flinging money at the U.S. government at some of the cheapest interest rates on record. This is a political crisis, not a fiscal crisis. It is not sparked by a run on the nation’s bonds or currency, but by a series of political calculations by Congresses and both the Bush and Obama administrations that led to Jan. 1, 2013 as a day of reckoning on a wide range of policies—and a decision to use that fact to try to force the United States to get ahead of its medium-term fiscal problems.
Europe might seem to break this pattern; it has, after all had a rolling crisis for the past three years, and several nations on the continent can, unlike the United States, accurately be described as having experienced a fiscal crisis. The problem for Europe as a whole, though, is not debt per se, but the fact that its nations are tied together under a common currency but without some of the key pressure valves that allow a currency union to work, like ongoing fiscal transfers between states, commonly issued debt, and centralized banking system guarantees. For most of the last three years, it was pressure from financial markets that forced politicians to make progress on resolving these problems and form a more durable union. Unfortunately, that financial crisis also drove much of the continent into recession (as was confirmed by new GDP data Thursday). In September, the European Central Bank said it will deploy potentially unlimited supplies of euros to combat spikes in government borrowing costs caused by investors betting the euro will collapse, which has succeeded in keeping bond yields relatively contained—but now leaves it to politicians to make progress to form a banking union and continue progress on fiscal integration without markets forcing them to.
Here are three numbers that quantify these mega-trends: 8.7 percent is the amount that the Chinese government has allowed its currency to appreciate against the dollar since 2010, trying to wean its economy from a pattern of loading up on American assets to keep the value of the currency down and, in effect, subsidize exports. 1.61 percent is the current yield on a 10 year Treasury bond, reflecting the U.S. government’s ultra-low borrowing cost even at a time that discussion in Washington is centered on reducing deficits. And 5.9 percent is the current yield on 10 year Spanish debt; it had spiked above 7.5 percent earlier in the summer, which would have been unsustainable.
If pressure isn’t coming from the marketplace for these big-picture reforms, where is it coming from? Each country has its own unique story, a long series of events that led to the current moment. (If George W. Bush had enacted tax cuts that didn’t automatically phase out back in 2001, for example, or House Republicans had demanded less in exchange for raising the debt ceiling in 2011, the fiscal cliff either wouldn’t exist or the negotiations would have a vastly different power dynamic).
But the results are a contrast with how nations have commonly dealt with such deep-seated economic problems in the past. In the United States, it took 12 percent inflation in the late 1970s to bring the kind of deep reforms—and deep recession—needed to conquer it. In Japan in the 1990s, it took a decade-long economic downturn to bring about reforms to a sclerotic banking sector (reforms still underway).
In many ways, the jobs that Chinese, American, and European leaders are doing now is about fixing the deep-seated global imbalances in saving and spending patterns around the world that were a root cause of the 2008 panic. Interventions by the global central banks were crucial to keeping that wave of crisis from spiraling out of control, and now the world is in a place where financial markets aren’t putting acute pressure on the world’s great economies.
The question now is whether they can proceed with these longer-term fixes without that pressure. Will Xi, the new Chinese leader, be able to guide his nation through a few years of weaker growth in order end up with a more consumer-driven economy? Will the fiscal cliff be enough to make American leaders chart a path toward more sustainable public finances? Will Europe continue its long road of integration even as the ECB protects its nation from bond market pressures?
The answers add up to the economic future of the world.