The news on both sides of the Atlantic has been challenging of late, to put it mildly. In the Old World, more and more governments have struggled with growing deficits. For the moment, the Greek funding crisis has been defused. But Europe is clearly not quite out of the woods yet. In the New World, politicians grappled for weeks about the debt ceiling before finding a last-minute compromise. But a more fundamental issue looms: rating agencies are demanding that a more aggressive, long-term deficit reduction plan be implemented soon.
No doubt financial markets are uncomfortable with these lingering uncertainties. But it is important to keep things in perspective. Europe, eventually, will grind its way towards stability, most likely by edging into a closer fiscal union. The richer, more robust economies will end up supporting their weaker neighbours. The political implications of this are profound, and, therefore, a quick fix to the continent's fiscal problems always appeared unlikely.
In the United States, a rating downgrade, should it occur, will not signal an imminent default. Japan, for one, went on to faithfully service its debt for years after losing its top rating in the late 1990s and has even seen its funding costs decline since.
So the view that transatlantic debt wobbles will soon bring down the global economy is misplaced. The West, for now, has the means to avoid default. The current obstacles are to a large extent political: Europe needs to decide how to share the burden, while the US needs to decide on how to live within its means. Such decisions take time, and the process of political negotiation is never pretty. Still, in the end, some form of compromise is bound to emerge, as the alternative of inaction would prove decidedly unpalatable to all.
But, there are long-term implications of the current debt saga to heed as well. Even if an accident is likely to be avoided in the near term, the fact remains that both Europe and the US need to come to terms with excessive levels of public debt.
As budget deficits are reined in over the coming years, growth will suffer. Deleveraging, in fact, whether in the public or private sector, is usually a slow-grinding, and painful, process; deep, sharp recessions and financial crises are a far less likely result than many years of disappointing growth. And so it will prove in the West.
