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European Crisis Threatens U.S. Recovery

Slowdown affects retirement savings and interest rates

by John Burgess, AARP Bulletin, May 26, 2010

The financial crisis playing out across the Atlantic is testing a historic half-century-old campaign to integrate the fractious countries of Europe as a single economic and political system.

Every day brings urgent news: 20,000 Greeks march on parliament to protest budget cutbacks. The euro, the common currency of 16 countries, falls again in value as investors sell it en masse. Germany grudgingly pledges huge sums of money in a gamble to restore confidence in financial markets.

For Americans, all this is more than a distant spectator event. Wall Street sell-offs driven by Europe’s troubles have already shaved the value of millions of American portfolios. Interest rates have been driven down, bad news for people who rely on bond and CD income.

And if Europe begins an extended economic slowdown, U.S. efforts to emerge from 2 1/2 years of recession will be at risk. “Europe is one of our biggest customers,” says Stephen J. Silvia, director of doctoral studies at American University’s School of International Service. “If they’re not buying, then we’re not selling.”

The situation has placed enormous stress on the cause of European unity, forged in 1951 when six countries integrated their coal and steel industries. In ensuing decades the bloc expanded to become the European Union, 27 countries in all. Today it has an economy larger than the United States’. But with disparate cultures, political systems and standards of living, the countries have often found it hard to work together.

Germany, the largest economy in the union and provider of much of its funds, took weeks to decide it would join in a bailout fund for Greece—the panic was touched off by an admission from Athens that it had been concealing the size of its deficits. That disclosure led to a mammoth sell-off of Greek assets in world financial markets, driving the euro’s value down.

Germans wondered why they should bail out a society that had shown no remorse, where people were thronging the streets to protest their leaders’ plans to cut back on very generous government services and raise the average retirement age by more than two years to 63.5.

Yet Germany ultimately came up with money, both to show solidarity with a fellow EU member and to meet a very real need to shore up the currency that Germany also uses.

European countries and the International Monetary Fund have now also set up a $1 trillion fund to defend the euro at large. Will it work? On the day the fund was announced, May 10, the answer seemed to be yes: Markets rose worldwide. Several days later, investors seemed to have a change of heart and began selling again.

Also unresolved is whether the contagion will spread to other heavily indebted countries of Europe, notably Spain, Portugal and Ireland. Spain, for one, has moved to preempt that by cutting about $19 billion from its budget. That meant reducing civil servants’ salaries by an average 5 percent starting June 1.

Flaws in the system?

Perhaps the largest question is whether the debt crisis exposes serious flaws in Europe’s postwar social contract. Europeans generally pay higher taxes than Americans, but they get a lot in return—universal health care, high pensions, free or low-cost university education. In the Netherlands, people even receive money from their government to go on vacation.

Steven Hill, author of Europe’s Promise: Why the European Way Is the Best Hope in an Insecure Age, says the model remains strong. He sees Greece’s problems as growing not from overly generous benefits but low tax receipts—Greece has a pervasive culture of income and assets being hidden at tax time.

“Countries like Germany, France, Sweden and the Netherlands show that it’s possible to strike the right balance between taxes and government spending, providing sufficient support for your people without stifling businesses or crippling the economy,” he says.

Other analysts see the current turmoil as inevitably pushing countries all over Europe to rethink whether they can afford such an array of social services. Faced with mounting government debt, slow economic growth and new competition from the rising economies of Asia, many had already been tinkering with the system.

“They can no longer continue with the hefty pensions, with the big safety net,” says Scheherazade S. Rehman, director of the European Union Research Center at George Washington University. “Europe is going to be under new pressure down the road to loosen the social contract.”

But that will not happen easily. In Britain, for instance, all major political parties firmly support the country’s National Health Service. The French government was forced in 2006 to back off from a plan to give employers more leeway in dismissing new hires.

There is often intergenerational solidarity on this issue. Older people want to keep the benefits, younger people want to get them. Rehman says the view of working Europeans is, “This was promised to us. We’re entitled to it. How can we live without it?” They direct their anger at the government, not at older people whose benefits have helped run up the debt.

Rehman predicts an eventual compromise: Europe will shed some services to move toward the American market-based model, while America will move toward Europe with such steps as the recently enacted health care law.

Silver linings

Though the European crunch is in general bad news for Americans—extreme scenarios have it triggering a whole new round of global collapse—there may be silver linings.

The downward pressure on dollar interest rates—caused as investors sell euros and buy dollars for investment here—has affected the yields of savings, but it is also making mortgages cheaper and could facilitate the start-up of local businesses.

And with the fall of the euro, you can vacation in Europe for less: Travelers stepping off airplanes in European cities can now get a euro for about $1.25, compared with about $1.50 last November.

John Burgess, a former reporter and editor at the Washington Post, is an associate editor at the AARP Bulletin.