Tags: EU | Europe | Financial | Crisis

Europe's Tough Budget Cuts Expose Trans-Atlantic Rift

Tuesday, 22 June 2010 02:42 PM

A trans-Atlantic rift is growing over the right medicine for Europe's financial crisis, with Britain announcing its steepest cuts in decades Tuesday and Germany defending its own austerity measures after a warning by President Barack Obama that budget-slashing could threaten the global recovery.

Britain's emergency budget is the latest in a string of deep cuts in public spending and reflects new resolve in Europe, after Greece was pushed to the brink of bankruptcy and even threatened the bloc's economic union, to tackle debt before worrying about growth.

As leaders of the Group of 20 economic powers prepare to assemble later this week in Canada, that single-minded focus is worrying the United States. Obama wrote a letter to world leaders Friday warning against excessive spending cuts.

German Chancellor Angela Merkel fought back this week, defending her government's $80 billion savings plan as British treasury chief George Osborne forged ahead with his own grim budget.

Many European analysts agree that taming deficits is the more urgent priority.

Obama "has a point, but there are some countries that don't have a luxury of a choice, they have got to get a grip and start cutting quickly because the alternative of becoming the next Greece is not palatable to them," said Jonathan Loynes, chief European economist at Capital Economics in London.

The British budget aims to sharply reduce record public debt. Shoppers will pay higher sales taxes, wealthy people will be hit for higher capital gains taxes and banks will be charged a new levy on profits, a move already approved by France and Germany. Even Queen Elizabeth II accepted a freeze in her support from taxpayers.

In Germany, a spokesman for Merkel said she talked by phone Monday with Obama about a letter he wrote to G-20 leaders in which he cautioned against hurting the fragile global economic recovery by trimming spending prematurely.

The letter was seen as a criticism of Germany's plan to reduce its deficit, but the spokesman said Obama did not pressure Germany to continue stimulus spending by piling up more debt. The spokesman spoke on condition of anonymity in keeping with government policy.

Europe's leaders are stuck in a quandary: They must bring down mammoth debt through spending cuts to ward off economic panic, but the measures are bound to stunt growth. And it will probably take years to determine whether they chose the right medicine and dosage.

"My suspicion is that it will be a major drag on the economy for a few years, and it may be we decide in the future whether they went too aggressively, but the political and market climate right now is such that they had no choice," Loynes said.

The realization that Europe is bound to implement spending cuts that will hurt growth for years has weighed on the euro, pushing it to four-year lows earlier this month. On Tuesday it traded at about $1.2304, down somewhat from Monday.

Economic stagnation in Europe would hurt the U.S. by crimping its exports just as America is trying to limp out of its own slump. But in Europe, Obama's concerns are trumped by a desire to stabilize the European Union and the euro.

"The EU accords priority to budget-cutting because that is what its leaders believe is needed to preserve the euro and the political construction of a united Europe," said Stephen Lewis of London's Monument Securities.

The new bank fee committed to by Britain, France and Germany will charge banks based how much they earn to shield taxpayers from the cost of resolving financial crises. But their call for a global tax is unlikely to find much support at the G-20 summit.

In a joint statement, the three nations said they wanted to make sure financial institutions are making a "fair contribution" to reflect the risks they pose to the financial system and "to encourage banks to adjust their balance sheets to reduce this risk." Germany is already drafting legislation for such a tax, and France promised to do so in its next budget.

Merkel and French President Nicolas Sarkozy are expected to lobby hard at the G-20 meeting in Toronto for a separate global financial transactions tax, but Loynes said there is little chance it will be approved. Their efforts are aimed at shoring up political support at home, he said.

Obama expressed support this week for a proposal expected to pass the Spanish parliament Tuesday to reduce labor costs and boost hiring. Spain had already pushed through an austerity plan to show markets it will not need a bailout to manage its debt, as happened with Greece.

But not everyone is convinced the Spanish reforms will actually lead companies to hire. Europe's fourth-largest economy needs jobs desperately after crawling out of two years of recession. Unemployment now stands 20 percent in the nation of 45 million.

Bank of Spain governor Miguel Fernandez Ordonez welcomed the labor reforms as a good first step but said they do not go far enough.

Sandalio Gomez, professor of management at IESE Business School in Madrid, said the government is trying to conceal that it is making it easier and cheaper to lay off workers — something it had repeatedly said it would not do.

"They've missed a perfect opportunity — and there are few like this — to transmit confidence to the labor market, a push forward that would allow jobs to be created," he said.

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A trans-Atlantic rift is growing over the right medicine for Europe's financial crisis, with Britain announcing its steepest cuts in decades Tuesday and Germany defending its own austerity measures after a warning by President Barack Obama that budget-slashing could...
Tuesday, 22 June 2010 02:42 PM
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