Tags: Europe | Cavalry | us

Europe Holds Out for the Cavalry

Monday, 14 Nov 2011 10:38 AM

By Tom Hutchinson

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The world is anxiously watching to see if Europe can avoid a full blown debt crisis. They may manage to avoid disaster – for now.

But, even if Europe finds a way to stem the contagion and avoid a crisis, it will only be a temporary fix to hold down the fort until the cavalry arrives. The cavalry is the United States — not in the form of a bailout or expert advice, but through economic leadership provided by strong economic growth.

As the world's largest and most open economy, nothing can replace the positive influence of strong U.S. growth on the global economy. China can't pick up the slack. It's difficult to penetrate its markets and China's still relatively poor population cannot consume anywhere near the exports that the United States can. Other emerging markets can help the global economy but they too will be pulled down by hemorrhaging western economies.

Basically, the United States needs to refill the void in economic leadership that was created in the financial crisis and its aftermath.

Without the United States as the most powerful and driving economic force in the world, the glue that holds together the current world order will come undone.

The basic problem for Europe's troubled states is that they simply cannot afford to pay promised entitlements with the tax base they have. It's like an individual who does not have the income to support a lavish lifestyle — but much worse. An individual can simply sell properties and cut back on expenses until he can live within that income. However, it is much trickier for a county to get its fiscal house in order.

An individual can cut back on expenses and still maintain the same income. But an entitlement laden economy where the government is omnipresent in the private economy will be hard pressed to maintain the same level of tax revenue after the disruptive economic effects of austerity.

When the government impedes the flow of money into the economy, the short term effect will be to reduce overall spending and economic activity. Unemployment would likely increase as the need for both government workers and employees of companies that benefit from government spending is reduced.

So, even if a country like Italy manages to implement the necessary austerity measures it will simultaneously reduce its tax revenues in the near term. It will be difficult for the country to turn things around if it just reduces both sides of the ledger.

A series of measures will be necessary to spur private sector growth in order to boast revenues. However, in a world where Europe in languishing in recession and the United States is mired in tepid economic growth, Italy will be hard pressed to export the amount of goods necessary to significantly lift its tax revenues and avoid slipping back into crisis.

In short, even if the European Central Bank is able to backstop the banks and stave off crisis, it is only buying time until there is hopefully a sufficiently robust global economy where Italy could realistically turbo-charge its private sector. Such a growth catalyst can only come from the United States.

Europe might be able to buy time. But unless the United States can get its house in order and unleash strong economic growth and leadership, Europe will not be able to avert a financial crisis in the years ahead. It will split. Its trouble states will flounder with near worthless currency and social unrest.

The stakes are huge and the world is waiting — waiting for the United States to again fill the economic leadership role it has vacated in the last several years.

U.S. economic leadership is the glue that has held the current world order together. Unless the United States rises to the occasion and gets its fiscal and economic house in order, a new world order will be forged amidst crisis and desperation in the west.

The stakes couldn't be higher and time is running out.

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