G8 meeting focuses on European economic contagion

The Group of Eight (G8) meeting over the weekend (May 18-19) was especially important for President Barack Obama who fears the contagion from Europe’s financial crisis could hurt the U.S. economy and his chances of re-election.  Europe’s leaders must take bold action to avoid economic meltdown.

President Obama hosted the annual G8 meeting at Camp David, Maryland to provide the leaders of some of the world’s largest economies opportunities for candid conversations about daunting global issues like the crises with Iran, Syria, and North Korea.  But most of the time was spent prodding and cajoling Europe’s leaders to make tough decisions across the 17-country euro currency union (eurozone). 

Already Europe’s economic crisis is having a global impact.  Last week world stocks sank after credit downgrades on Spanish banks unnerved investors and the growing uncertainty precipitated a “flight to safety” by investors abandoning European stocks for the U.S. dollar and German government bonds.

Further, Obama warned the “political and economic crisis facing Greece” could spill over to other deeply indebted European countries.  He acknowledged in his closing remarks at Camp David “Europe is our largest economic partner” which is why “we’ve collaborated closely.” 

Europe’s deepening economic crisis is illustrated by the challenges facing Greece and Spain which threaten the entire eurozone.

Greece faces default because it lived beyond its means for many years, a period marked by declining revenues, rapidly rising government wages, and massive government borrowing.  Today it has the biggest debt load in the eurozone, depositors are withdrawing life savings, banks can’t borrow money, and the recently elected lawmakers failed to form a unity government in the face of strict austerity demands imposed by European bailout lenders.

Now Greek voters are preparing to vote again next month for a new government which could decide to abandon the eurozone.  Specifically, an anti-bailout party (Syriza) is surging in the polls in response to lender-imposed austerity measures.  The blowback against austerity measures gave rise to the word “Grexit” which is shorthand for the idea that Greece may soon exit the eurozone.

If Greece exits the eurozone other European nations might follow which could seriously disrupt world financial markets, especially the safety of European government loans.  Spain is right behind Greece.

Spain, Europe’s fifth-largest economy, faces a severe banking crisis directly related to its boom-bust housing market of the last decade.  The economic reality came like a slap to the face last week when the credit ratings agency Moody’s cut its ratings for 16 Spanish banks, reflecting the risks they suffer because of non-performing loans. 

Spanish banks hold 300 billion euros ($383 billion) in real estate loans and roughly 60 percent are deemed “troubled.”  The U.S. closes banks when their “troubled” loan ratios exceed 5 percent.

Spain’s banking nightmare is piled atop the country’s other economic woes.  The Spanish economy is several years into a recession which is expected to shrink another 1.7 percent in 2012.  Spain is also racked by the highest unemployment in Europe – 24 percent, which forced the Spanish government to borrow money at high rates to pay benefits.  Meanwhile, as unemployment rises, tax revenues plummet and the government is hard pressed to meet its debt obligations.

No wonder Obama said at Camp David the global economy is “threatened once again by the serious situation in the eurozone” which is why the G8 leaders agreed “growth and jobs must be our top priority.” But are they prepared to make the hard decisions necessary to turn this crisis around?

Europe’s situation is complicated because “there are 17 countries in the eurozone that need to come to an agreement,” Obama explained.  And most of those countries are straining like Greece and Spain under high borrowing costs, government lay-offs, pay cuts, reductions in social programs, and higher taxes.  Worse, those economies have shrunk and debt as a percentage of their economies is increasing.

That is why British Prime Minister David Cameron cautioned, “The eurozone is at a crossroads. It either has to wake up or it is looking at a potential breakup.”  He warned just prior to the Camp David G8 summit that without policies that lead toward both debt reduction and growth, the region is in “uncharted territory,” which “carries huge risks for everybody.”

Obama said the G8 leaders at Camp David made “some genuine progress” and they “understand the stakes.”  Even though they failed to announce a plan before leaving the summit, a plan might be announced this week when they re-assemble again in Europe.

Any plan to address this “complicated” economic crisis must include the following four actions.

First, they should energize the eurozone’s economies by reducing regulation for small businesses.  Entrepreneurs freed from burdensome regulation will increase employment and private sector production that provides more tax revenues to pay down debt.

Second, relax barriers that countries have created to protect their industries.  This is especially important for troubled nations like Greece which need eurozone partners to purchase more Greek goods.

Third, they should reorganize some of the European Union’s (EU) structural funds to be more focused on growth projects.  This fits Obama’s admonition “to promote growth and job creation” while moving forward with “fiscal and structural reforms.”

Finally, the EU should increase the capital base of the European Investment Bank in order to finance some projects with cheap loans.  This is what debt-ladened countries like Greece need and responds to French president François Hollande’s call to take the edge off austerity, something German Chancellor Angela Merkel demands.

The G8 meeting also addressed “core issues that affect our common security,” Obama said at Camp David.  He summarized the leaders’ consensus regarding several geopolitical crises but provided no real news.

The leaders acknowledged Iran’s “right to peaceful nuclear power” but they are unconvinced Tehran “is not pursuing the weaponization of nuclear power.”  Obama said “all of us are firmly committed to continuing with the approach of sanctions and pressure” and hope “we can resolve this issue in a peaceful fashion.”

Obama said the group prefers a “peaceful resolution and political transition in Syria.”  But he acknowledged the violence continues and expressed anxiety about the slow pace of the United Nation’s ceasefire plan.

The G8 leaders agreed North Korea “is violating its international obligations” and reaffirmed “there is a path for them to rejoin the international community.”   But Obama said that will not be “achieved if they continue with provocative actions.” 

President Obama hosted the G8 summit at Camp David primarily to promote “intimate” discussions focused on Europe’s economic crisis.  Time will tell whether those discussions sufficiently cajoled Europe’s leaders to take bold action to contain the economic contagion that could impact the U.S. economy and Obama’s re-election chances.