Within the next 24 hours, observers say, we are likely to see an agreement reached among Greek political parties that will clear the way for a second bailout from Europe and the IMF. Observers have been saying this for two months now, but never mind. It is certainly possible that the members of the Greek ruling coalition will meet the demands of "the troika" of lenders -- the European Commission, the European Central Bank, and the International Monetary Fund. And even plausible suggestions of a crisis resolution have tended to bring a feeling of euphoria to markets -- a good Greek word.

There are optimists and pessimists about Euro zone prospects. I'm in the latter camp, but it's interesting to see where the analyses diverge. You would probably get broad agreement that the essence of the euro zone problem is that a number of countries on Europe's periphery have racked up unsustainable levels of debt. There is also a general consensus that if those peripheral countries followed the traditional prescription of devaluing their currency (by leaving the euro zone), this would be a large economic shock for Europe and, thus, for the rest of the world (note, though, the different views among Northern European leaders on whether Greece alone might be expendable).

The divergence in opinion really comes in the analysis of potential solutions. Here are three ways one might look at fixes:

1. Could Europe as a whole handle the debt issue?
This is the question the optimists ask. The answer, they find, is yes, Europe could. While individual countries within the euro zone have debt problems, the zone as a whole is roughly in balance. If everyone agrees that the money is there and that failure to find a solution could be very costly, then it's just a matter of a little obligatory posturing before the money is reshuffled and the matter solved. Another way of putting this would be that economic hurdles are difficult to overcome, but political hurdles are trivial.

2. Could current national leaders in the Euro Zone handle the debt issue? Posing the question this way takes political constraints a little more seriously. While there are certainly now phone numbers and interlocutors for an apocryphal Kissingerian call to Europe, the major players are still national. Chancellor Merkel ultimately answers to a German electorate, President Sarkozy to a French citzenship, and Prime Minister Papademos to a Greek. Those German voters are distinctly unenthused about bailouts and a central bank that is willing to print money to solve problems. Those Greek voters are distinctly unenthused about austerity programs in the face of 19 percent unemployment. With these political constraints, the problem looks significantly harder. The question becomes whether these leaders can overcome the reluctance of their respective electorates and 'do what must be done.' Those who analyze at this level are hanging on every report out of Athens and Berlin.

3. Can countries commit that all future governments will follow the paths agreed today?
This is the pessimists' playground. What happens when leaders fail to persuade their electorates that their unpopular measures were really necessary? They're usually ousted in the next election. There are certainly some policies that, once undertaken, are very difficult to revoke. But the central issues in Europe now revolve around annual national budgets, for which commitments are eminently reversible. One can try to lock in good behavior at a constitutional level -- as much of Europe just did with its brand new fiscal pact, and as it did at the zone's inception with the Stability and Growth Pact. These have proven exceedingly difficult to enforce in practice.

A story on Greek politics in the New York Times nicely captured the essence of this last problem.

"After years of turning its back on its social welfare platform, the Socialist Party, known as Pasok and Greece's dominant political force since 1974, has virtually disintegrated, falling to fifth place with 8 percent support, according to a poll that the firm Public Issue released on Tuesday.

...The most probable winner of future Greek elections would be New Democracy, which held power from 2004 until 2009, when Greece's debt soared from slightly more than 100 percent of its gross domestic product to at least 127 percent.

Its leader, Antonis Samaras, has been criticized repeatedly by European leaders as irresponsible, but with every new tax increase in Greece, some voters are warming to his constant critique of austerity in the absence of growth measures. The party is leading in opinion polls, with Public Issue putting its support at 31 percent of the vote."

The story also noted that "the hard left and extreme right are rising."

Thus, Greek acquiescence today guarantees nothing after the next vote. The magnitude of this problem is not lost on the major European players. In fact, the quest for a solution can be seen as the unifying theme behind Northern European proposals to address the crisis: the fiscal austerity pact, fiscal union, Brussels oversight of national budgets, even political union. Each of these would insulate future tax and spending decisions from the whims of Greek voters.

Barring a momentous development along such constitutional lines, Greek voters still have a say. So if, in the near future, there is an announcement of an accord among current political leaders, the question will be which Greek word is most pertinent: euphoria, or democracy.

In his 2012 State of the Union address, President Obama jumped from issue to issue. At times, in all this leaping, he found himself on the opposite side of a stance he had taken minutes before.

Early on, he claimed success on his bailout of the auto industry (continuing a policy launched by Pres. Bush) and claimed it was a model that could be replicated:

"On the day I took office, our auto industry was on the verge of collapse. Some even said we should let it die. With a million jobs at stake, I refused to let that happen...We bet on American workers. We bet on American ingenuity. And tonight, the American auto industry is back. What's happening in Detroit can happen in other industries. It can happen in Cleveland and Pittsburgh and Raleigh."

Then, minutes later:

"It's time to apply the same rules from top to bottom: No bailouts, no handouts, and no copouts. An America built to last insists on responsibility from everybody."

One of the most striking themes of a generally hodgepodge speech was strong skepticism about trade. The president fully embraced the "lump of labor" fallacy, in which one imagines a fixed number of jobs in the world that are simply slung back and forth across oceans.

"Let's remember how we got here. Long before the recession, jobs and manufacturing began leaving our shores…we have a huge opportunity, at this moment, to bring manufacturing back. But we have to seize it. Tonight, my message to business leaders is simple: Ask yourselves what you can do to bring jobs back to your country, and your country will do everything we can to help you succeed."

The strong implication is that the rest of the world has been booming, enjoying all those factory jobs they swiped from us. It's difficult to find that in the data. But the president promised to chase down foreign wrongdoers with a new Trade Enforcement Unit.

He claimed previous efforts at trade enforcement, such as his tariffs on Chinese tire imports, had saved American jobs (1,000, in that case). This is interesting on several counts. First, he made the claim in the context of saying that "I will not stand by when our competitors don't play by the rules." Yet the Chinese tire tariffs case never even alleged wrongdoing on the part of the Chinese. They were just selling at low prices.

Second, other observers have generally found no evidence those tariffs did anything to help American workers. The U.S. China Business Council, in a study, concluded:

"U.S. imports of the low-end tires involved in the case have actually increased substantially since the tariffs were imposed -- but have shifted from China to other countries. And, there is no objective evidence that the tariff boosted U.S. tire manufacturing jobs."

A Wall Street Journal report last week reached a similar conclusion. In order to be fair, the Journal offered the administration the chance to rebut, but reported: "Spokespeople at the ITC, the Commerce Department, and the Office of the U.S. Trade Representative say they have no comprehensive analysis yet of the broad effect that the tariff has had." That was last week. So how did the President determine that 1,000 jobs were saved?

The third point on this illuminating case is that -- even if his numbers were right -- the president thinks it would be a successful policy to charge tens of millions of Americans more for their tires if it protected 1,000 jobs. That's a fairly stark statement in favor of protectionism.

So much for what the president did say. What about the things he did not say? He made no mention of his vaunted Trans-Pacific Partnership. Recall that two months ago, in Hawaii, this was a pillar of his administration's turn back to Asia. It is a highly ambitious undertaking and would require a huge administration effort, in close collaboration with Congress, if it were to conclude this year. The State of the Union is traditionally where an administration sets out its priorities for the year ahead. Yet not a mention.

Nor did the president say anything about the economic crisis in Europe. One hears that the White House considers it the biggest threat looming over a nascent U.S. recovery. If the president were truly trying to describe the State of the Union, Europe's predicament would seem to deserve some serious mention.

But it would fit awkwardly in a campaign speech and was thus, presumably, omitted. The topic, after all, seems to highlight the potential dangers of excessive borrowing, as Indiana Gov. Mitch Daniels demonstrated in his response:

"In our economic stagnation and indebtedness, we are only a short distance behind Greece, Spain, and other European countries now facing economic catastrophe. But ours is a fortunate land. Because the world uses our dollar for trade, we have a short grace period to deal with our dangers. But time is running out, if we are to avoid the fate of Europe, and those once-great nations of history that fell from the position of world leadership."

That's certainly not an image the president wanted to invoke, as he moved on to a grab bag of new spending proposals and as his administration delays the release of his budget.

Thus, the state of our union: we're in campaign mode.

President Obama flew west, met with Asia-Pacific leaders, and trumpeted his intention to strike a high-standards trade deal with other committed trading partners in the region, the Trans-Pacific Partnership (TPP).

That paragraph could describe either this last weekend or Nov. 2009, when the president first revived the TPP (it was initially launched in Sept. 2008 under the Bush administration and set aside by the new Obama team). Perhaps that's why the story about the weekend's APEC leaders' gathering in Hawaii was buried in the inner pages of the Washington Post and failed to make the front page of the New York Times. The papers may have learned, with this president, to duly note the statements of grand intentions, but to save the gaudy headlines for actual accomplishments.

There has been some movement over the last two years, of course. The nine nations currently involved in the TPP negotiations have been meeting and hammering out a "framework" for the agreement. The Obama administration, over that time, moved from a tentative "intent to engage in discussions" to a full-fledged embrace of the TPP. New countries are now clamoring to join in the negotiations.

But enormous obstacles remain:

• Core structural issues of the TPP remain undecided. Will the TPP be a ragged quilt of existing agreements stitched together with new patches? Or will it be a new seamless fabric designed to cover existing and future participants? If the latter, it offers two great virtues: simplicity for businesses trying to trade across the region, and a clear high standard that any newcomers will have to meet (think China). But the United States has held out for the former. It already has FTAs with a number of the TPP participants and the idea of refighting all of those market-access battles is daunting for an administration that took almost three years to pass three already-completed FTAs.
• Will new members make significant commitments? Reports from APEC that Canada and Mexico want to follow in Japan's footsteps as new applicants to the TPP were described as a coup for President Obama. Perhaps. It certainly would heighten the economic significance of the TPP, if and when it is concluded. But the new entrants will make an already elusive agreement even more difficult to reach. Japan is more than reluctant to liberalize its agricultural sector. New Zealand has previously objected to Canada's illiberal approach to dairy imports. It is not hard to imagine an extreme in which one has a very large number of participants who engage in endless talks that never conclude (this has recently been known as "Doha" in the WTO context).
  Read on

As President Obama prepares to meet other G-20 leaders in Cannes later this week, he previewed his pitch with an op-ed in the Financial Times. It read a bit like a half-time locker room pep talk to a team that had gotten knocked around on the field.

"C'mon guys! We saved the world once, we can do it again! Heck, I've been through much worse than this and I did great. Here's the game plan..."

Perhaps it is inevitable that such pep talks exaggerate past accomplishments and take on a tone of forced cheerfulness (particularly when the coach is entering his contract year). The danger, though, is that this approach can undermine credibility and invite scorn (David Nakamura in the Washington Post today describes the potential for such a reaction).

Unfortunately, the world appears distinctly unsaved at the moment.

• The president trumpets the success of coordinated stimulus in 2009. Yet U.S. unemployment hovers around 9 percent and roughly three-fourths of the country thinks it's on the wrong track. European stimulus practitioners, like the United States, have encountered severe budget problems. China faces serious concerns about the repercussions of its bank-lending approach to stimulus.
• The president trumpets his passage of the recent FTAs as a pro-growth achievement. That's fair, but it's hard to justify his four year delay. What's more, the repeated pledge of earlier G-20 meetings to conclude the much more significant WTO Doha Round seems to have been dropped altogether. The U.S. role has recently been to explain to fellow countries just why their proposals won't work.
• The president tactfully applauds his European counterparts for reaching agreement last week on a plan to address the euro crisis. That will likely get him a warmer reception than his past admonishments. Unfortunately, after a brief post-summit euphoria, significant doubts have emerged about the European plan. The most telling and concise critique has come from the Italian bond market, which has pushed and held bond yields above 6 percent on Friday and today. Europe is still teetering.

The president concludes with a call for renewed efforts to achieve balanced, sustainable growth. Last week's developments in Europe are doubly troubling in this regard. While previous Treasury efforts under G-20 auspices to push for redressing global imbalances have been laudable, they largely came to naught. China and Germany resisted proposals for how to identify problematic imbalances. Now that Europe is seeking China's funds for its bailout, the odds of it joining in any concerted effort to press China on rebalancing (e.g. via currency appreciation) seem remote.

The most glaring difference of approach lies in the area of spurring economic growth. The president repeats his enthusiasm for his American Jobs Act, which attempts to boost demand through another round of stimulus. Europeans have taken an approach more akin to that of Congressional Republicans: focus first on fixing structural problems.

There are a couple reasons one might opt for a structural reform focus over a stimulus approach. A skepticism about the efficacy of stimulus and a concern about the impact of untended growing structural problems can argue for the primacy of reform (see Ed Lazear's excellent Wall Street Journal piece along these lines). Or one can note that the coffers are beyond empty and decide that stimulus is no longer affordable.

In either case, the President is likely to meet the same sort of skepticism in France that he has at home. It's not clear that a pep talk will do much good.

This week, global economy mavens are waiting once again for European leaders to emerge with a panacea. Tradition dictates that financial panaceas should be presented on Sunday evenings, before Asian markets open. The Europeans actually scheduled their panacea accordingly, but whiffed. The cure-all was rescheduled for Wednesday.

There has been much gnashing of teeth and rolling of eyes over eurozone leaders' repeated inability to solve their financial crisis once and for all. U.S. Treasury Secretary Tim Geithner traveled to Poland last month and told a gathering of European finance ministers to Just Do It. Oddly enough, the gathered Europeans did not really appreciate the admonishment.

So President Obama joined in and added further encouragement: "In Europe, we haven't seen them deal with their banking system and their financial system as effectively as they needed to." Quoth the coverage: "Obama didn't specify what steps should be taken."

And therein lies the problem. There has been a presumption that if only German Chancellor Merkel and French President Sarkozy could stop bickering and summon the political resolve, they could take the decisive set of actions to put everything right. The rest of the world can best help, the reasoning goes, by shouting exhortations at Europe to just try harder.

But what, exactly, are Europeans being urged to do? The grand fix must address a knot of interconnected problems. First, there is the issue of Greek debt; it's huge and the Greeks can't pay it. That leads to worries about what will happen with other larger highly indebted countries around Europe's periphery; such worries mean that lenders demand higher interest rates and worry turns to panic. This sovereign debt crisis, in turn, stirs fear in those who hold all that debt; since many of the debt holders are European banks, that stirs fear in pretty much everyone -- or it should.

Now consider some candidate solutions.

1. The leaky lifeboat solution: start bailing.

This was Europe's first response, with the creation of the European Financial Stability Facility (EFSF), with a lending capacity of roughly $600 billion. Although Greece's debt is huge relative to the size of the Greek economy, it is certainly small enough to be handled by the fund. Why not just pay it off and be done with all this? There are three problems. First, that wouldn't solve Greece's problems. Although the country has significantly cut its budget deficit, it would still need to borrow even if its old debt were wiped out. Second, there is the moral hazard of rewarding miscreants. Cutting budget deficits is painful and politically treacherous; if Europe will ultimately pick up the tab, why go through the agony? Third, Greece is not alone. Ireland, Portugal, Spain, and Italy have all drawn the suspicion of bond markets. To cow those markets into submission would take a bailout fund of trillions of dollars, not just hundreds of billions.

Could Europe just swallow hard and provide the cash? Obstacle: the borderline state of French finance. France currently has a AAA credit rating, but has substantial debt of its own. If it were to join Germany to backstop such a large fund, its credit rating could be downgraded, as Moody's warned last week. Without a top credit rating behind it, the finances of the bailout would not work.  

Read on

For those who believe it is just a matter of time before China rides its commercial success to global hegemony, this week offered some compelling imagery: Europe, on its knees, reeling from political discord, rising bond yields, and bank downgrades; China, sitting atop its $3.2 trillion hoard of foreign exchange reserves, condescending to dictate the terms of European surrender.

Of course, Chinese Premier Wen Jiabao was not so tactless as to describe it as surrender. He actually expressed a "readiness to extend a helping hand and a readiness to increase (Chinese) investment in Europe." It wouldn't hurt, he went on, if Europe should decide to grant China market economy status, effectively lowering trade barriers.

Fareed Zakaria translates this into great power politics terms:

In a world awash in debt, power shifts to creditors. After World War I, European nations were battered by debts, and Germany was battered by reparation payments. The only country that could provide credit was the United States. For America, providing desperately needed cash to Europe was its entry into the councils of power, a process that ultimately brought a powerful new player inside the global tent. Today's crisis is China's opportunity to become a 'responsible stakeholder.'"

That's a twist on the original conception of what it meant to be a responsible stakeholder, but no matter. This interpretation falls apart as soon as one scratches at it a little.

The idea that a big infusion of Chinese cash would set Europe aright misinterprets the problems facing the Eurozone. Although the troubled countries there -- Greece, Ireland, Portugal, Spain, and Italy -- each took their own paths into difficulty, they are all in unsustainable fiscal situations. These require difficult choices about future taxes and spending, not just a quick bridge loan. Oddly enough, Zakaria recognizes this early in his piece, when discussing the implausibility of a "eurobond" solution, under which France and Germany would effectively co-sign loans taken out by their neighbors:

The minute such bonds are floated, Italy, Greece and the others would lose all incentive to make painful reforms; they could borrow all the money they need at German-subsidized rates, so why go through the dreary work of restructuring? The Germans know this -- hence their opposition."

Read on

As global stock markets tumbled over the last few trading days, pundits fell all over each other to assign blame. Not only can the finger-pointing be diverting -- and perhaps politically advantageous -- but it is natural to search for reason and understanding in such a harrowing time. The problem is a surfeit of suspects. Here are a few:

Was it the S&P downgrade?
On Friday, after markets closed, the United States lost its AAA rating, at least in the eyes of one beholder (and not the first). It was a clumsy process, marred by math errors, that seemed to reinforce a lingering low opinion of the ratings agencies left over from their gullible endorsement of subprime mortgage bundles.

At the heart of S&P's critique was a pessimism about the U.S. political process. There are two facets to this: the dalliance with default in the debt ceiling debate, and concerns about the longer-term fiscal situation in the country.

There are a few problems with fingering the S&P as the reason for the market swoon. First, U.S. markets fell for a couple days preceding the downgrade. Second, the existence of U.S. political dysfunction was hardly news. Third, and most telling, the wrong markets fell on Monday. If the driving concern is that the U.S. government will be unable to pay its debts, one would expect the price of those debts to fall. Instead, it was stocks that fell while U.S. bond markets rose sharply. The 10-year bond yield, which had been 3.2 percent in the start of July, fell to 2.34 percent yesterday (bond yields move in the opposite direction from bond prices). Such a drop can signal a number of ominous things, but not generally doubts about the lender's creditworthiness.

Was it President Obama's Monday afternoon speech?
The talk, which notably failed to calm markets and drew scathing reviews, did not offer any new or promising vision. Yet despite the fact that the Dow dropped a couple hundred points after the President spoke, this explanation seems as implausible as the popular argument that it was all Republicans' fault. To spell that latter argument out: House Republicans supported fiscal responsibility (passed a budget) and opposed tax hikes. They used their constitutional power over the budget and borrowing to win a deal that would begin to impose some spending restraint and that precluded any similar default standoff for the rest of the President's term. Markets, the reasoning must go, hated all that. The standoff went on for weeks, but somehow markets only reacted once Standard & Poor's explained it all to them, days after it was resolved.

On to the next suspect.

Was it the bad news about the American economy?
The last couple of weeks have featured some weak readings on the U.S. economy, including surprisingly poor GDP numbers on July 29. The jobs number last Friday was strong enough to stave off utter despair, but too feeble to portend a reviving economy. What's more, lest anyone forget the lingering effects of last decade's housing boom and bust, Monday featured a stark reminder. AIG filed suit against Bank of America alleging mortgage securities fraud. BofA's stock dropped 20 percent for the day.

The eminent Ken Rogoff provides a thoughtful, if disturbing, overview of the economic scene in today's Financial Times. He argues that large debt overhangs are not very amenable to quick fixes, like fiscal stimulus, and suggests:

"It is better to think of the global economy as going through a ‘Second Great Contraction' (the Great Depression being the first) involving credit and housing, and not just output and unemployment."

Was it the festering crisis in Europe?
In the Washington Post, Robert Samuelson makes a case that the real troubles lie across the Atlantic. He opens:

Europe may no longer be able to save itself. Too many countries have too much debt. Its economic growth -- which helps countries service their debts - is too feeble. And nervous financial markets seem increasingly prone to dump the bonds of vulnerable countries. This is the real risk to the global and U.S. economic recoveries, far overshadowing Standard & Poor's downgrade of U.S. Treasury debt and Monday's sharp stock market decline."

Read on

The domestic incredulity over U.S. debt ceiling battles has gone global. Chinese officials have expressed concern over the prospects for their substantial bond holdings:

"We hope that the U.S. government adopts responsible policies and measures to guarantee the interests of investors," Hong Lei, a foreign ministry spokesman, said at a news conference late last week.

A less measured statement of concern came from the voluble Vincent Cable, Britain's business secretary. He offered his analysis yesterday:

The irony of the situation at the moment, with markets opening tomorrow morning, is that the biggest threat to the world financial system comes from a few right-wing nutters in the American congress rather than the euro zone," he told BBC television.

It is more than passing strange to have a British government that has made credible austerity its central focus turn around and denounce the lunacy of seeking credible austerity. Perhaps something was lost in translation.

The U.S. debt ceiling must certainly be raised. In all likelihood, it will be lifted sometime before the critical hour. But at home and abroad, there is disbelief that such an easy problem cannot be dispensed with more quickly. The festering nature of the impasse is taken as a sure sign of something deeply amiss in our political sphere. Herewith, some central misperceptions about the debt ceiling debate:

1. Just raise the ceiling, already! Problem solved.

The presumption is that there is an easy fix that is being blocked solely by partisan maneuvering for political advantage. What would such an easy fix look like? Two major candidates:

• A simple, long-term hike in the debt ceiling, unencumbered by controversial tax or spending provisions. This is the solution beloved by those who favor the credit card analogy: The time to address spending problems is when you whip out your credit card to buy something, not when the bill arrives in the mail. The implication is that one should just pay the bill now and deal later with the profligacy issue.
• The problem with this approach is that debt-rating agencies have rejected it. They have expressed concern about the trajectory of U.S. borrowing and have threatened a ratings downgrade if a debt ceiling hike is not coupled with credible plans for sustainable borrowing.

• A short-term hike to buy time. If a simple, "clean" debt-ceiling increase will not satisfy markets (as represented by S&P and Moody's), then some very difficult discussions about taxes, spending, and the size of government are looming. Why not buy time for those discussions with a debt ceiling increase that would allow for another six months of talks?
• There is ample precedent for short-term extensions. The problem with this approach is that the president has rejected it. A short-term extension would mandate a difficult political discussion right in the midst of an election. A democracy purist might suggest that elections are the ideal forum to decide difficult political questions, but this administration has consistently favored budget fixes that carry just past the polling date. The president's deficit commission, which was meant to reassure everyone that the national borrowing problem was under control, followed the plan and reported in December 2010, one month past the latest congressional elections.
• If these two simple options are off the table, the problem no longer looks like an easy one. That's not to say it's intractable, but it should be no surprise that the negotiations are difficult.

2. Republicans won't take yes for an answer.

Vincent Cable may be suffering from having read David Brooks, who wrote earlier in the month that Republicans were

… being offered the deal of the century: trillions of dollars in spending cuts in exchange for a few hundred billion dollars of revenue increases. A normal Republican Party would seize the opportunity to put a long-term limit on the growth of government. It would seize the opportunity to put the country on a sound fiscal footing. It would seize the opportunity to do these things without putting any real crimp in economic growth.

How could any party in its right mind (intended) fail to accept such a deal?

Read on