Business

G20: Why Europe and US split on cuts

US Treasury Secretary Timothy Geithner has made quite clear his fear that European efforts to cut national deficits could actually make the current rocky economic situation much worse. And he isn't alone.

President Obama fired a shot across European bows in a letter he sent to G20 leaders last week reminding them that in the past "stimulus was too quickly withdrawn and resulted in renewed hardships and recession".

In other words, let's not go back to the 1930's, when the economic orthodoxy actually turned the Wall Street crash into an horrific depression.

But President Barack Obama and Timothy Geithner have one less thing to worry about than European leaders, especially German Chancellor Angela Merkel - and that's a shaky currency.

"The problems with Greece and Spain were not supposed to happen," says Daniel Gros, from the Centre for European Policy Studies.

"Europe is not like the United States, [we don't] have a Federal Reserve which can underwrite deficits of any size and the euro is no longer a reserve currency."

The prospect of Greece dragging the euro down has undoubtedly unsettled Germany's political elite and lead to the announcement of an 80 billion-euro programme of cuts to the federal budget at the start of June.

But Mr Gros argues that Germany's cuts have been overstated

"The plans are really gradual. 0.5% cuts [as a proportion of GDP] in the first year and the same the next year."

But he also argues that even if Germany was to keep borrowing, the effect of that spending power on boosting other economies is minimal.

He points to studies which have shown that for every 1% of GDP that Germany borrows, other eurozone countries only sees a boost in growth of around 0.1%.

So German debt doesn't contribute nearly as much as some might suppose to the economies of its neighbouring countries.

And he isn't the only one to jump to Germany's defence.

"Look there is no option here, the markets have lost their confidence, the bond vigilantes are back with a vengeance and what the financial markets see are Government financial positions that represent fiscal insolvency," says Julian Callow, chief European economist at Barclays Capital.

"America preaches free markets and capitalism but the longer Europe is going on running these high budget deficits the greater the cost.

"And that will lead to a greater degree of taxation in the economy."

Instead, Mr Callow sees the biggest danger not of cutting down on debt but of a lack of cohesion amongst European countries:

"Americans can best help Europe by encouraging political integration and avoiding petty squabbles."

As leaders of the G20 countries gather in Toronto there may be several squabbles over fears the EU has overreacted to the Greek debt crisis.

But from the European perspective the consequences of drastic cuts are less worrying than the economic fire storm that nearly engulfed the region just a month ago.

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