What Do Americans Want And What Do Europeans Want?

Includes: DIA, SPY
by: Lok Sang Ho

Here is a story about Obama's being "off on thrifty spending claim." But herein also lies the explanation for the divergent paths between Europe and America. Europe, including the U.K., was onto real "thrifty spending" and even tax raises to cut its deficits and to deal with its debt problem. America, on the other hand, merely put a lid to more government spending. Europe now has a much graver debt problem than the U.S., even though it set out to deal with the debt problem by taking serious austerity measures.

Compared to the U.S., the euro and EU27 as a whole face a manageable government deficit, which stood at merely 4.1% and 4.5% of GDP respectively in 2011. However, for the euro area the government debt to GDP ratio increased from 85.3% at the end of 2010 to 87.2% at the end of 2011, and for the EU27 from 80.0% to 82.5%. With a shrinking economy, rising unemployment, and surging interest costs, the European debt problem is sending alarming signals around the globe and is threatening to derail the global recovery. The collapse in confidence is not because of huge deficits, but largely because of the deteriorating outlook of the economy that casts doubt over fiscal sustainability.

In the latest Monthly Budget Review, the U.S. Congressional Budget Office announced that the deficit for the first seven months of fiscal 2012 was $149 billion less than the deficit reported for the same period last year. Total outlays were slightly less than in the past year, but receipts were 74 billion dollars more. Since the deficit in nominal terms has shrunk, and GDP in real terms is growing, and in nominal terms growing even faster, the deficit as a percentage of the GDP is declining -- I expect it to end up not much higher than 8%. The deficit ratio has been declining every year since it peaked at 10.1% in 2009. The U.S. debt problem now appears to be manageable because the economy is growing and debt servicing costs are low. Although debt-to-GDP ratio is still growing, it is expected to peak by 2014.

In Europe, Germany's deficit ratio has fallen to 1% of GDP last year, but in part that has to do with strong demand for German debt, which allowed the Germans to enjoy very low borrowing cost, much as the U.S. federal government enjoys very low borrowing cost when creditors lose confidence in other kinds of debt. Germany and the U.S. are also two economies that have managed to maintain moderate growth so far.

Some pundits argued that much of the 9.7 percent increase in federal spending in 2009 is attributable to Obama, that growth of Obama's fiscal spending should be relative to that in 2008. This is exactly the point: the sharp increase in 2009 was instrumental to the economic recovery after the big plunge in the aftermath of the Lehman Brothers collapse. Obama essentially kept spending at about the same level and mildly growing on average so far, and that is what kept the growth engine growing. American unemployment has fallen. European unemployment has risen. The outlook for America is positive; that for Europe is bleak.

With the impending fiscal cliff mandating spending cuts, however, the American economy could be forced to a Europe-like austerity program. Now is the time to ask: is America ready to go the European route? Similarly, taking the cue from the American experience over the last three years, Europeans should ask themselves if they should go the American route as per the last three years.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.