G-20 Tells U.S. to Avoid Fiscal Cliff as Focus Widens

Australian Treasurer Wayne Swan
Australian Treasurer Wayne Swan. Photographer: Jerome Favre/Bloomberg

Global finance chiefs pressed the U.S. to avoid harming the fragile world economy with excessive austerity, widening their focus on fiscal challenges beyond concerns over Europe’s debt woes.

On the eve of the U.S. presidential election, Group of 20 finance ministers and central bankers meeting in Mexico City pushed for swift action to prevent the $607 billion in tax increases and spending cuts that will hit in January unless lawmakers act.

As President Barack Obama and Republican Mitt Romney tussle for the White House, the fear of foreign officials is that failure to limit the damage of the so-called fiscal cliff would tip the world’s largest economy into recession and drag their countries down with it. Europe, the subject of the G-20’s ire for the past three years, remained under pressure amid calls to take promised crisis-fighting steps.

“I expect each country to voice its hopes for firm efforts toward a resolution of the fiscal cliff problem,” Bank of Japan Governor Masaaki Shirakawa told reporters late yesterday. “It’s important for each country to work toward stabilizing its own economy.”

A draft of the statement to be issued by the G-20 today identifies the potential for a sharp fiscal pullback in the U.S. and Japan as a danger to an already modest expansion, said an official from one of the countries who declined to be identified because the text hasn’t been finalized.

Crisis Respite

While Europe is enjoying some respite from its debt crisis after the European Central Bank pledged to buy bonds, the official said the draft cautions against delaying efforts to deliver a permanent solution.

The fiscal frailties threaten to offset glimpses of economic improvement that followed a mid-year worldwide slump. Data last week showed American employers hiring more workers than forecast in October and Chinese manufacturing expanding for the first time in three months.

“There is nothing more important to the global economy than to lift growth in the world’s major advanced economies,” Australian Treasurer Wayne Swan said in a statement today.

The G-20 represents the world’s leading industrial and emerging economies. Underscoring the limits of policy coordination when national action is required, several key officials, including U.S. Treasury Secretary Timothy F. Geithner and ECB President Mario Draghi, are skipping the meeting. Other topics being discussed include banking regulation and reform of the International Monetary Fund.

Hogging Spotlight

A shift from previous G-20 talks is that Europe’s travails are no longer hogging the spotlight as attention is split with the U.S. The IMF estimates the fiscal tightening on track there is equivalent to 4 percent of gross domestic product, the most since the 1940s and about double the U.S.’s current growth-rate.

“In the near-term, clearly the U.S. situation is the higher risk” compared with Europe, Canadian Finance Minister Jim Flaherty told reporters.

Assuming the cuts pass through entirely to the economy, a 4 percent consolidation would be enough to shrink the U.S. economy 0.5 percent next year as well as generate a 2.2 percent contraction in the euro area and limit Chinese expansion to 4.4 percent, according to a model created by Dario Perkins, a former U.K. Treasury official now at Lombard Street Research in London.

‘Austerity Light’

The G-20 members are confident a bipartisan deal can be struck, an official from a G-20 nation said. Even if a worst-case scenario is avoided and the U.S. cuts run a third of the total, the resulting “austerity light” will still be enough to slow the U.S. economy, said Rich Clarida, global strategic adviser at Newport Beach, California-based Pacific Investment Management Co.

Morgan Stanley analysts see a one-in-three chance of a political spat bad enough to cause a U.S. recession. Democrats led by Obama want to allow scheduled tax increases on the wealthy, while Romney opposes any increase as Republicans focus on reducing spending.

Highlighting the growing unease toward the U.S., 42 percent of investors polled last month by Bank of America Merrill Lynch identified the fiscal cliff as the main threat to their strategies, up from 26 percent in August. By contrast, 27 percent branded European debt their main concern, down from 65 percent in June.

Policy Uncertainty

The upside is that any financial market fallout could pressure both parties into a bargain, according to Deutsche Bank AG economists led by Peter Hooper in New York. After policy uncertainty depressed U.S. growth by a percentage point or more in recent years, a successful resolution could boost expansion by as much as two points, they said in an Oct. 31 report.

Still, Europe isn’t off the hook, as evidenced by a U.S. Treasury official telling reporters on Nov. 2 that it remains the “greatest headwind” to international recovery. While the ECB has calmed markets, Greece’s government will this week try to piece together political support for further austerity needed to keep aid flowing. Meantime, Spain is holding out on tapping a bailout, and there are differences over the speed of a continent-wide banking union.

“We may have to brace ourselves for occasional new waves of crisis,” said Holger Schmieding, chief economist at Berenberg Bank in London.

Japan, which has a debt of 237 percent of GDP, is also facing fresh budgetary challenges. Its Ministry of Finance is warning that a refusal by lawmakers to authorize 38.3 trillion yen ($476 billion) in borrowing risks leaving the government unable to hold debt auctions as planned.

Budget Pledges

Whether the route to lasting economic recovery lies through austerity or measured stimulus remains an evolving debate within the G-20. Just two years ago, the group’s advanced nations, with the exception of Japan, vowed to cut their budget deficits in half by 2013 and stabilize or reduce government debt as a share of GDP by 2016. IMF forecasts show only Germany, South Korea, Canada and Australia largely on course to meet both goals.

Flaherty said while the G-20’s credibility is at stake if it doesn’t reaffirm its deficit commitments, there may be some “modification” given they may no longer work for the Americans. The IMF forecasts a U.S. budget gap of 7.3 percent of GDP next year versus 11.2 percent in 2010.

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