Maybe the United States really is the world's most dysfunctional democracy.
For the last 18 months, Americans dismayed by the follies in Washington have been able to console themselves with this thought: At least it's worse in Europe. But now, it seems to be better in Europe, and it's getting hard to find any other country that makes America look good.
The recent deal to forgive some of Greece's debt and move toward an ultimate resolution of Europe's wider financial problems came after numerous incremental moves that everybody knew fell far short of what was needed. It defies the expectations of many professional investors, who girded for the worst. The euro zone, after all, is comprised of 17 nations, each with its own convoluted politics and egomaniacal leaders. There's no centralized fiscal authority, and the European Central Bank has had feet of clay compared to the aggressive moves of our own Federal Reserve. There were farcical moments when demands from tiny nations like Finland and Slovakia seemed likely to scotch a deal. In Italy, Prime Minister Silvio Berlusconi has been dealing with his nation's debt crisis one day and his own personal sex scandals the next. Wringing tough decisions out of this quarrelsome crowd seemed a task beyond the most gifted statesman.
Yet European leaders have managed to subordinate their parochial concerns to a deeper common interest. The Greek deal is far from perfect and it could still unravel. It doesn't do anything, for example, to stoke growth in big, stagnant economies like those in Italy or Spain, a perennial problem that still hamstrings the overall European economy. And there remains a huge disparity between the rich nations of northern Europe and poorer ones to the south, which will continue to cause political friction over who should bear the cost of painful reforms.
But the deal pushes Europe over a critical threshold because it will finally require banks holding Greek debt—mostly in France and Germany—to accept significant losses on their troubled investments. The 50 percent "haircut" borne by Greek bondholders will reduce Greece's overall debt to a more manageable level and give some breathing room to a besieged government that's been forcing harsh austerity measures on its citizens. Europe will also beef up a bailout fund—similar to the U.S. TARP program in 2008—that will help to recapitalize troubled banks and prevent a widespread bank run. While imperfect, the deal shows new political resolve that should boost confidence in Europe's ability to solve problems.
Americans can only look on this with envy. Washington's debt problems aren't as severe as those in Europe—yet—but members of Congress, so far, seem more inclined to dither and parry than to put their nation on sounder financial footing. President Obama, for his part, has treated debt reduction as an afterthought, with his own plan for addressing the problem coming way too late to count as leadership.
The debt deal reached over the summer fell far short of the $4 trillion in debt reduction budget watchers--and the markets--felt was necessary. The last-second brinksmanship also showed a willingness among some prominent politicians to risk damage to the nation's economy in pursuit of their own political goals. Washington's reckless behavior alarmed investors, caused the first-ever cut in the nation's credit rating, depressed the stock markets, and pushed consumer confidence down to levels last seen during the worst moments of the 2009 recession.
As a consolation prize, the summer debt deal also created a 12-person congressional "supercommittee" that's now trying to come up with another $1.5 trillion in debt reduction by the end of November. Not surprisingly, its proceedings so far have been rancorous. Bloomberg reports that the supercommittee "remains at an impasse," with the odds of failure rising.
That may be premature, since deals on highly contentious issues tend to coalesce toward the very end of negotiations, when maneuvering room runs out. Yet there's good reason to expect failure. All six Republicans on the panel have signed tax activist Grover Norquist's pledge to oppose any increase in business or personal income taxes. And the six Democrats on the panel are unlikely to agree to big spending cuts if tax hikes are off the table. So negotiations began with seemingly intractable positions that will prevent compromise, and the amount of debt reduction needed is far too large for marginal maneuvers or accounting gimmicks to do the trick.
Business leaders are more disgusted with Washington than ever, with many of them now viewing political ineptitude as the biggest risk to the economy. Merrill Lynch recently told its clients that the supercommittee will probably fail, which will trigger a fresh shock to the economy, including further downgrades of the U.S. credit rating. Meanwhile, just 13 percent of Americans approve of the job Congress is doing, an all-time low.
If the supercommittee fulfills the nation's low expectations and produces a hollow outcome, automatic spending cuts will kick in, a pathetic scenario that would promptly reduce GDP growth and kill any hope of political solutions from Washington. Within six months, the United States would probably have a lower credit rating that France, Germany, the U.K., Canada, Singapore, and a dozen other top-rated nations. At some point, investors may decide to park their cash in newly resurgent euros instead of dollars, which would drive up U.S. interest rates and Uncle Sam's borrowing costs. Those kinds of developments would make a new recession more likely and prolong a period of stagnation that's already forcing down American living standards.
Maybe then, American politicians will ask their European counterparts for advice on how to get something done. And for once, listen.