Eurozone leaders emerged from their latest all-nighter with a plan that sent the markets into paroxyms of relief: The German and French stock markets were up more than 4 percent Friday. The key heralded result was a commitment to move toward a banking union. This was taken as a critical concession by German Chancellor Angela Merkel and a key move toward resolving the crisis.

As the good folks at Foreign Policy have helpfully documented, this is not the first time European summiteers have stepped out, bleary-eyed, and announced there would be economic peace in our time. It's roughly the 20th. I warned before about celebrating any European plan to have a plan, and that's what this is. But how good is the plan? Is it a significant step toward solving the euro crisis?

The most striking move was the promise of a banking union. The European Central Bank would be given new regulatory powers over eurozone banks and European bailout funds could be sent directly to ailing banks to support them, without adding to national indebtedness. It would be nice to be able to dissect the details of how this new scheme will operate, but there aren't any yet. The bailout funds cannot be tapped until the ECB is empowered, and that will take at least a few months.

In theory, a move to bolster Europe's ailing banks could help. As the 2008 financial crisis aptly demonstrated, the financial sector provides the lifeblood of an economy; cut it off and the economy turns distinctly blue. Europe's economies are notably more dependent on bank finance than the U.S. economy and the banks of the troubled economies on the periphery have had trouble raising funds and retaining deposits. A move to bolster them could potentially stop a direct drain on the funds of impoverished sovereigns and move toward restoring normal functioning and growth in those economies.

There has been a clamor for such moves, partly on the well-established theory that banking panics can be self-fulfilling. The normal operation of banks is risky. If everyone tries to get their money at once, even a healthy bank will succumb. This is the rationale behind deposit insurance. Let all those small savers know their money is secure, restore calm, and the insurance may never even need to pay out.

So that's the hope. If the eurozone banking troubles are just the result of unfounded panic, a new backstop could restore calm. If there are a limited number of banks troubled by past lending into now-burst real estate bubbles, a well-funded cleanup could set things aright.

But the potential problems are enormous. Here are five sets of questions facing the new European banking union plan:

1. Politics of operation. In the story above, banks are just going about their ordinary business when an unfounded panic attack strikes customers. But banks can make choices about how much risk to take on. Riskier projects can offer higher returns. This is why the bailout has been coupled with regulation; Chancellor Merkel does not want a situation in which "Heads Bankia wins, tails Brussels loses." Bank regulation is difficult in ordinary circumstances (banks are big and complicated and even they may not realize the risks they are running). The situation is even more complex when you have close relationships between banks and politicians and bank lending is used to further political or industrial policy ends. Will Germany or France tolerate that kind of interference from the ECB?

2. Back door fiscal union? One of the risky behaviors that European banks have recently engaged in has been lending to the governments of Greece, Spain, and Italy. If the banks are allowed to keep purchasing government bonds, then direct lending to the banks looks like a back-door fiscal union, only without controls on government spending, a point made by James Mackintosh of the Financial Times. That would also beg the question of where the money will come from, since the summit proposed no new resources and existing ones would not cover those countries' needs. If a new bank regulator cuts off the flow of funds from the banks to the governments, that raises the question of who will be left to lend to the governments. When bond buyers disappear, interest rates soar.

3. Politics of resolution. All of the political questions apply even more strongly when it appears a bailout has failed. Who decides to pull the plug? Will powerful governments let national champion banks be disassembled by eurozone technocrats? Who decides how the losses are allocated? There are already lawsuits from small Spanish shareholders who claim they were misled into funding Spanish banks. If such shareholders or bondholders are wiped out - normal in a bankruptcy - that can have an economic and psychological impact.

4. What about London? Britain is not in the eurozone, of course, but London is the financial center of Europe. The EU is supposed to have a single market in financial services. Omitting Britain entirely would be like saying that we would regulate finance in the United States, except in New York. But on what grounds could the ECB hold sway over behavior in London?

5. Which risk are you insuring against? In the standard deposit insurance story, some banks get unlucky with their loans and their depositors are rescued. Europe's problem is that there is another sort of risk lurking: euro departure. Imagine two Greek depositors, one of whom keeps his money in his Athens bank, the other who moves her money to Frankfurt. If Greece were to leave the euro, our two depositors would have drastically different experiences. He would be much worse off than she would be, since his savings would be in depreciated drachmas. Would deposit insurance compensate him? It is hard to believe it would, particularly when one hears Europeans talk about how a departure would be an unacceptable violation of European law. Even if Europe were tempted toward forgiveness and inclined to reimburse such losses, the cost would be enormous. This would be covering virtually all bank deposits in a departing country, not just an unlucky few. The latest summit did not propose any new funds, much less the trillions of euros this could cost. If you do not insure against this risk, then insuring against the lesser, idiosyncratic bank risk is completely futile. If you do insure against this risk, the promise has to be credible to do any good.

In sum: another European summit; a burst of euphoria; a plan to have a plan; and many questions left unanswered. Eurozone leaders have expressed their good intentions, but in mid-crisis it is the seemingly-obscure particulars of banking practice that will determine whether or not the markets' relief was merited.

More than any other economic danger looming on America's immediate horizon, including a possible break-up of the eurozone, sequestration poses the greatest single threat to American recovery in the near term. This arcane process came into force when the congressionally-mandated "super-committee, "officially known as  the Joint Committee on Deficit Reduction, failed in its mission. As a result, the sequester calls for reductions in government spending totaling $1.2 trillion over the next nine years, of which $984 billion, or $109 billion annually, will be realized from across-the-board budget reductions.

Although defense accounts for only 14 percent of the budget deficit, when entitlements are taken into account, the annual $109 billion dollar cut will be evenly divided between defense and non-defense reductions, with some small reductions in entitlements contributing to the non-defense side of the ledger. Put another way, once the sequester comes into effect, defense-related appropriations will have to be reduced by $55 billion annually. And these reductions will be of the sledgehammer variety: Every "program, project and activity" will be reduced by the same percentage, regardless of its relative importance to the overall enhancement of national security.

It gets worse. The sequester does not begin to bite until January 2, 2013 -- that is, until the beginning of the second quarter of the upcoming fiscal year. That means that the entire $55 billion must be found from programs that had not yet been obligated during the first quarter of the fiscal year. To the extent that such commitments will have been made, the amount of funding susceptible to reductions will itself be reduced, and the percentage of reductions will accordingly increase. Finally, because President Obama is expected to exempt the military personnel accounts, which total some $141 billion, and Congress is expected to exempt the contingency-related accounts (which are the major source of funding for the war in Afghanistan), there will remain some $375 billion, from which $55 billion will have to be found, resulting in a 15 percent reduction in all other defense programs. 

The impact of that reduction will be highly disruptive to both the current and longer term defense program. It will result in massive reductions in weapons systems, though not in personnel. It will render the pivot to Asia meaningless; any plans for increasing our military muscle in that region will be completely undermined by the reduction in shipbuilding, aircraft, missile, drones, and a host of other acquisition programs. Our presence in the rest of the world will at best fare no better, and, in light of the so-called pivot, will probably suffer even more.

All the foregoing has long been well-known to Washington's defense cognoscenti and especially its bean counters. What is less well-known, and at least equally alarming, is the impact of the sequester on the economy as a whole. As the recently released study by the Bipartisan Policy Center points out (full disclosure: I am a member of the Center's Task Force on Defense Budget and Strategy), the sequester will result in the loss of about a million jobs in 2013 and 2014 and America's GDP will decline by half a percent. Moreover, of these million lost jobs, it can safely be asserted that at least half will come from the non-defense sector. In other words, the sequester is not just a defense problem that should agitate only hawks. It is a national problem, and it demands immediate relief. 

Despite the urgency of the sequester's challenge, the administration continues to sit on its hands. No draft legislation has emerged from the White House that would at least postpone the sequester for a reasonable period to enable Congress to try its hand at another effort to reduce the deficit. The administration's allies on the hill, particularly in the Senate, have been equally nonchalant about the coming programmatic and economic disaster.

Such nonchalance carries with it a very high risk, however, and not only for the economy. In addition to its impact on the government's budget, the sequester will also trigger the WARN Act, which requires employers to give a minimum of sixty days notice to private and public sector employees whose jobs are being targeted for possible termination. Those politicians seeking re-election to national office should take note that Nov. 2, 60 days before Jan. 2, when the sequester comes into force, is just four days before election day. They may find it very uncomfortable having to explain to potentially hundreds of thousands of people who have been given WARN Act pink slips why they deserve to be returned to office after they did nothing about the sequester. America's economic house is burning; the Neros of Washington had better act soon, or they may find that their political fate will echo that of their ancient Roman namesake.

Europe did not collapse this last week. That was something of a pleasant surprise, since portents of the economic grouping's demise have been accumulating for years now. In lieu of collapse, there were just more troubling signs: the fall of the government in the Netherlands; unemployment approaching 25 percent in Spain and a credit rating downgrade; French elections that featured growing nationalist strength and a likely split with Germany over austerity.

This raises a question. Given all the analyses proclaiming "the end is nigh," when, exactly, might we expect it? Some European friends would argue that this is the point -- we shouldn't expect it. This sort of brinksmanship is the way of Europe. Crises loom, there is wailing and lamentation, a summit is held, someone makes a concession (the Germans a likely candidate) and the crisis is averted. Thus it has been and thus it shall always be, they say. This is largely a matter of faith, but one must admit that it is a reasonable description of the recent European experience.

Here, though, is an alternative interpretation, presented in the form of a parable:

Imagine a friend who earns $3,000 a month, but has an unhealthy tendency to spend $5,000 a month. You observe this and remark to yourself: "This is unsustainable; it's got to stop." You wait for your friend to realize this.

But it turns out your friend has some savings he can use. These savings tide him over for a while, but when he burns through those, you once again figure his time has come. Surely he must now change his behavior.

But your friend finds he can take out a home equity loan. This funds his lifestyle for months more until, at last, those funds are exhausted, too. Time's up, you think. 

But your friend announces that he still has plenty of borrowing room on his credit cards. The good life continues (albeit at a rather high interest rate). Sooner or later, of course, he maxes out his cards. This has got to be the end of it, you think. But then your friend mentions that he has heard about this loan shark downtown...

So what's the moral of the story? Is it not to worry -- your friend always finds a way? Or is it that a difficult adjustment can be postponed at ever-increasing cost? And what of the original question -- at what point does "the end" come? Is it when you first recognize that the situation is non-viable? Or is it when the loan shark finally shows up with his truncheon to collect?

This is an imperfect parable for Europe's situation in a number of ways. First, not all troubled European countries got there because of profligate spending. Spain and Ireland, for example, saw good fiscal positions go bad when they had to backstop troubled banks. Nor can one argue that Spain and Greece are continuing to live 'the good life' -- they're suffering real pain. It's just that the major adjustments they have made appear insufficient. And Europe's crisis is multifaceted; in addition to sovereign debt there are faltering banks and uncompetitive economies.

The real problem with the parable is that it tends to suggest that the growing costs are all financial. The more troubling costs may be political. Part of the way Europe has pushed past previous decision points has been to shunt aside democratic input -- as when new governments were installed in Greece and Italy, or when the major Greek political parties had to pre-commit to support an austerity plan, or in the push for a zone-wide austerity pact to be enforced from Brussels. Here the "loan shark with a truncheon" takes the form of more extreme movements in these countries taking up a nationalist cause and winning growing support, as with Marine Le Pen's Front National in France, or the slipping support for New Democracy and Pasok in Greece. Indebted and shamed nations in Europe, pushed around by their neighbors, rallying to a nationalist cry, what could go wrong? Europe does have a history along these lines.

The euro zone has bought itself time and may continue to do so for a while, but the costs seem to be mounting.

Many of the news reports on Argentinean President Cristina Kirchner's landslide reelection victory this past weekend contained a healthy dose of skepticism on the sustainability of her populist economic model. The skepticism is well-founded. We've all seen this movie before, and know exactly how it ends.

Heavy state intervention in the economy, massive subsidies, and the redistribution of income -- the hallmarks of economic populism -- have a way of playing themselves out, proving time and time again that lasting prosperity can never be built on acquiring unlimited debt or just printing more money.

As UCLA economist Sebastian Edwards, a Chilean, writes in his brilliant takedown of Latin American populism, Left Behind: Latin America and the False Promise of Populism, all populist experiments begin with great euphoria and surges in economic growth, but invariably lead to rapid inflation, higher unemployment, and lower wages -- and soon thereafter, stagnation and crisis.

There is no question that right now times are good in Argentina. Since the country hit rock bottom in 2002, when it defaulted on $100 billion in debt, the largest sovereign debt default in history, the country has undergone a seemingly remarkable turnaround under the stewardship of the late Nestor Kirchner and now his widow, Cristina. The economy is expected to grow by 8 percent this year and unemployment is at a 20-year low.

But the problem is that Argentina's economic success has been built not on strong fundamentals, but on a tenuous foundation of heavy government spending, high commodity prices, and strong demand from China and Brazil for soy and other agricultural products. And what goes up in economics can always come down.

Other troubling signs are double-digit inflation, which private economists put at 25 to 30 percent; capital flight ($9.8 billion was pulled out of the economy in the first half of this year, compared with $11.4 billion in all of 2010); and plummeting foreign investment (down 30 percent in the first half of 2011).

The other elephant in the living room is the fact that Argentina has been shut out of credit markets since it left bondholders holding the bag in billions of dollars of unpaid debt from its 2002 default. Not only has there been no reconciliation, but the Kirchner government has gone out of its way to reject lawsuits and other claims from creditors. As a result, the Obama administration and multilateral lenders have refused further loans until Argentina begins to repay what it owes investors and settle with holders of defaulted debt, as well as adhere to its obligations with institutions such as the International Monetary Fund.

Yet despite warnings by economists that the government's profligate spending, coupled with a global economic slump, could spell disaster, the Kirchner administration soldiers on. Indeed, why wouldn't it see her overwhelming reelection victory as anything but a mandate to continue its unorthodox ways? "After a lifetime of pushing those ideas," she said after her victory, "We now see that they were not a mistake and that we are on the right path."

On the other side, former President Eduardo Duhalde, who unsuccessfully challenged Kirchner, said, "We're happily dancing on the Titanic."

Given the prevailing capital flight and declining investment in Argentina, the smart money is obviously on Duhalde. Fortunately, those players are in a position to avoid the risk; what's unfortunate are the millions of poor and middle-class Argentineans who will once again pay the price for Argentina's populist folly when the inevitable day of reckoning returns.

In recent weeks, civil unrest in much of the Middle East has reminded many Americans of the very uncertain world in which we live. Repressive regimes that appear stable one day can just as quickly be overthrown the next, altering the strategic landscape and impacting U.S. interests.

This is an important lesson for the members of the 112th Congress as they debate ways to reduce the United States' spiraling deficit. As the search for savings has begun, some members have gone after areas of the federal budget that have nothing to do with our fiscal woes to pay down the debt.

In recent months, Secretary of Defense Robert Gates faced pressure from the White House to find more savings in the defense budget despite being the one cabinet secretary who has already carried out multiple rounds of cost cutting. Republicans in Congress weren't much kinder. The House approved an FY11 continuing resolution late last week providing $15.9 billion less for the core defense budget than President Obama requested. The House's FY11 continuing resolution would also cut the FY11 international affairs budget by nearly 20 percent from FY10 levels. The debate shifts to the Senate when Congress returns from recess next week.

This pressure to cut international affairs and defense is coming not just from Congress, but also from several blue-ribbon commissions that recently produced deficit reduction recommendations.

As Secretary Gates observed after deficit commission co-chairs Erskine Bowles and Alan Simpson proposed $100 billion of cuts to the defense budget, these recommendations represent "math not strategy." Several task forces have combined a dire assessment of the impact of the financial crisis with questionable proposals about bringing troops home from overseas, closing embassies and consulates, and canceling weapons programs. The long-term implications of these proposals represent nothing less than a rethinking of the U.S. role in the world even though the commissions were ill-equipped to analyze the implications of their proposed cuts.

Defense and international affairs have ended up on the chopping block despite the fact that the 2010 midterms were not a referendum on U.S. foreign policy. In fact, even in the midst of two wars and continuing terrorist threats to the homeland, congressional campaigns were marked by very little discussion of national security. In a late October 2010 poll done by the Pew Research Center, only 12 percent of respondents said that the war in Afghanistan was the first or second issue most important to their vote, and only 9 percent cited terrorism.

As recent events in Egypt and elsewhere in the Middle East have shown, the United States will continue to face strategic challenges in the coming decades that will require significant diplomatic and military expenditures. For most Americans, the need to adequately fund the military, the country's most-respected institution, is clear. For conservatives looking to downsize government, the case for a robust international affairs budget may be less apparent.

In the post-9/11 era, funding via the U.S. State Department and affiliated agencies increasingly goes toward civilian missions in war zones. These programs are essential to our long-term success in front-line states such as Afghanistan, Iraq, and Pakistan. These targeted funds go toward U.S. efforts to support democracy and human rights abroad and help train and equip allied militaries around the world. Such security assistance is pivotal amid the increased threats of rogue states and terrorist organizations and allows an already overstretched U.S. military to focus on more immediate threats.

U.S. aid programs provide the United States with tools to counter emerging threats from weak and failing states. Often thought of solely as evidence of American goodwill and values, these programs are in fact key components in the battle against extremism, battling the conditions that often fuel anti-U.S. sentiment.

As President George W. Bush recently wrote in his memoirs, "After the attacks [of 9/11], it became clear to me that this was more than a mission of conscience. Our national security was tied directly to human suffering. Societies mired in poverty and disease foster hopelessness. And hopelessness leaves people ripe for recruitment by terrorists and extremists."

It is also important to remember that America only spends roughly 1.4 percent of the federal budget on international affairs. In polls, Americans routinely overestimate the amount spent on such programs, perhaps contributing to the temptation of lawmakers to look to such programs first when drawing up constrained budgets.

Like any part of the government, there are certainly wasteful programs and inefficiencies that should be targeted and eliminated, but the deficit is not going to be paid off by savings generated from gutting the international affairs budget.

Although the amount spent on defense is significantly larger, it too is not the source of our current fiscal predicament. Oddly, given the now frequent proposals in Washington to cut international affairs and defense, it is not apparent that the American public supports this agenda.

It was, in fact, outrage over the Obama administration's runaway domestic and entitlement spending that drove many voters to the polls last November. It is thus these areas of the federal budget that lawmakers should focus their attention on first. Targeting our military and diplomatic capabilities will only serve to put the country at greater risk.

The 112th Congress faces some tough choices about how to improve America's fiscal situation without sacrificing our standing in the world. Unfortunately, thus far, many have skirted over the strategic debate and jumped directly to the budget cutting. The United States' current economic woes are concerning, but abdicating the global responsibilities of the United States is not the solution.

Well, that was awkward. The world's leading economic authorities just gathered in Washington for a weekend session of policy glowering. Heading into the regular fall meeting of the World Bank and International Monetary Fund, there was some hope that some constructive, multilateral dialogue could defuse tensions and calm talk of currency wars. It was not to be.

What happened? The United States went into the meetings pushing for multilateral solutions, in particular an enhanced role for the IMF. In a speech at the Brookings Institution last week, Treasury Secretary Tim Geithner addressed the issue of global misalignments:

This problem exposes once again the need for an effective multilateral mechanism to encourage economies running current account surpluses to abandon export-oriented policies, let their currencies appreciate, and strengthen domestic demand.

He noted that this was part of the long-standing mission of the IMF, then went on to argue that the world's powers had already agreed to address these issues:

Read on

Advocates of a strong national defense ought to be thinking seriously about entitlement reform. Whatever one thinks of our current policies, recent reports by the Congressional Budget Office and testimony by Federal Reserve Chairman Ben Bernanke make clear our current course is unsustainable. The most frightening description to date of our problem is that if we continue as we are, "by 2058, the economy enters a free-fall, beyond which the catastrophe cannot be measured: CBO cannot model the impact because debt rises to levels the economy cannot support."

This has important effects not just for our national solvency, but also for our national security. Our current national indebtedness and its projections based on the president's budget will increase spending to $5.1 trillion by 2019, nearly a full quarter of the nation's economic resources. As CBO points out, "deficits never fall below $633 billion in the next 10 years, and exceed $1 trillion by the end of the decade." With non-discretionary spending constituting an increasing proportion of federal outlays, defense, diplomacy, and foreign assistance will inevitably be squeezed.

The United States' Joint Forces Command (JFCOM) sounded the alarm earlier this year by naming federal debt and deficits as a major threat to the continued strength of our American military. JFCOM's Joint Operating Environment 2010 states that "interest payments, when combined with the growth of Social Security and health care, will crowd out spending for everything else the government does, including National Defense."

As Representative Paul D. Ryan of Wisconsin stresses in his "Roadmap for America," the threat to adequate defense spending is entirely from the price tag for domestic programs. Defense spending isn't even addressed in the roadmap, because it is not material to the debt picture. That is, before we fight about what defense spending should be (and I've argued here it should be reduced), we ought to be arguing about a long-term program for bringing our national spending into alignment with our revenue.

The "Roadmap for America" is a terrific place to start. It proposes sweeping changes to our tax code, provision of medical insurance, retirement programs, and process of budgeting for entitlements. It would raise the age of retirement and reduce benefits for those under 55. But it would also expand our choices -- and not simply by keeping entitlement programs solvent. The roadmap would allow individuals to determine for themselves what they value and want in their medical plans, retirement programs, and would even allow a choice in type of taxation.

It is often work to read, with sections on the investment and labor force participation effects of taxes, calculation of the fiscal gap, unfunded liabilities and third-party payer health care.  But it is a genuine delight to see a major public policy proposal argued passionately for, with assists from Thomas Jefferson, John Locke, and Alexander Hamilton's "Federalist No. 12." The driving philosophy of Ryan's approach is empowerment of the individual. And on the whole it explains in plain language the current state of our public finances, and the choices available to us to remedy our problems.

Importantly for conservatives, Ryan's plan recaptures our proud legacy of fiscal prudence without sounding reckless about what government should and does contribute to our lives.  

He makes a sound fiscal argument for acting now by demonstrating the cost of delay: "waiting just 11 years to take action increases by nearly 20 percent the amount of spending reductions or tax increases (as a percentage of GDP) needed to close the fiscal gap. Waiting until 2030 increases the amount by about 50 percent; and waiting until 2040 nearly doubles the spending cuts or tax hikes needed to close the gap."

There will be many who denounce Ryan's plan as radical. They should be rebutted by CBO data showing that under his proposals, "the standard of living for a child born today would double (i.e. per-capita output would rise from $45,000 to more than $90,000) by the time he or she reached middle age, just after the middle of the century." What a fantastic legacy for us to leave our children and with which to strengthen our nation. Unless we get our spending in line with our revenues, we will not only leave our children worse off than we have been, but we will be unable to afford a strong military.

Watching Greeks fire-bomb their banks, shut down their airports and ruin the tourist trade that is their economy's main prospect, I can't help but hear Virgil reprised. In that Roman poet's great narrative The Aeneid, survivors of the Trojan War seek a place to start anew, after much difficulty founding what will become the Roman Empire. It's rough going, and after much hard luck and stormy seas, the Trojan women burn the ships in order to prevent the men returning them all to sea.

They knew the Sybil (a rough approximation to an oracle for the Greeks) had prophesied that when they "quit at last of the sea's dangers / for whom still greater are in store on land... wars, vicious wars / I see ahead, and Tiber foaming in blood." Seeing the fleet in flames, Ascanius' reaction is "but your own hopes are what you burn!" And so it is with the Greeks -- they burn their own hopes by such unwillingness to do the unpleasant but necessary belt tightening.

Tourism provides one in five jobs in the Greek economy and a full sixteen percent of its gross domestic product. Being tied to location, it cannot be manufactured elsewhere. Being tied to history and culture, it is inherently Greek. And the best way to attenuate the effects of the austere cutbacks in government spending necessitated by Greece's financial crisis is to grow their economy as fast as possible. The debt to GDP ratio goes down both by reducing the numerator and increasing the denominator. Yet the Greek riots against the austerity program are sure to diminish tourism.

It is difficult not to sympathize with German hesitation to bail Greece out. Germany has labored for nearly 20 years to bring the former East Germany up to par with the West. Greece leapt into the euro on questionable accounting and proceeded to splash around the cheap credit that German stolidity in finances extended to the rest of the eurozone. One in three Greeks is a government employee. Hairdressers can retire at age 50 with full pensions because their jobs are categorized as hazardous.

But now much more outrageous is that than our Foreign Service Officer's Union refusing rewarding diplomats that serve in war zones? When Secretary Rice tried to give preferential promotion to diplomats that volunteered for service in Iraq or Afghanistan, the union representatives argued that every posting is dangerous -- as though volunteering to serve in Iraq took no more courage than volunteering to serve in Costa Rica. Currently two-thirds of foreign postings are designated as hazardous duty posts.

The state of our public finances is not as bad as Greece's, but we'll get there fast. Current and future obligations already incurred by our government amount to 500% of our GDP. And President Obama's budget will triple our already staggering national debt by 2020.

What may -- may -- save America from Greece's fate is that public outrage is building at our government spending money we don't have. When California governor Arnold Schwarzenegger tried to move against public sector unions in 2005, voters rejected his ballot initiatives. Californians cannot yet bring themselves to make the hard choices Greece is now having imposed on it by the IMF and its EU allies. New Jersey governor Chris Christie seems more successful, perhaps aided by greater public awareness of the parlous state of government finances. The hold of "entitlements" and public sector unions over government finances needs to be broken -- otherwise we really will be Greece.

Markets will not bankroll U.S. profligacy forever. No one can say when the chill will start, but once it does -- as Greece's example demonstrates -- the effects are dramatic. The longer we stall before facing up to the unpleasant reductions we must make, the more draconian will be the demands. As the spiraling cost of reassuring markets of the EU's commitment to support Greece demonstrates, it's much better to beat markets to the reckoning.

Here again Virgil offers sound advice. As the Sybil gives Aeneas instructions to Hades, she cautions:

The way downward is easy from Averinus.
Black Dis' door stands open night and day.
But to retrace your steps to heaven's air,
There is the trouble, there is the toil.

It's easy to become Greece. But it's very hard to get out of their predicament.

Europe's financial difficulties were predictable, but they have been unfolding at a startling clip. This has brought out different reactions in different commentators. Paul Krugman, for example, is preparing to hide under a table. I am no less impressed by the potential for disaster, but I am also struck by the undemocratic nature of major deliberations in Europe and by parallels here in the United States.

The pace of Europe's response to Greece's mounting woes has been rather stately. This is in spite of some fairly blunt calls for urgent action. From the Financial Times:

"Far too much time has been wasted on inaction," said Angel Gurría, secretary-general of the Paris-based Organisation for Economic Co-operation and Development. "We should have intervened two or three months ago. The markets have developed negatively since then, unnecessarily. That's why we have to act now, quickly and decisively."

And yet Europe's summit meeting appears set for May 10. Why the delay? There is an important German election on May 9. From the New York Times:

The North Rhine-Westphalia election has the potential to upset the existing balance of power. At stake is not only the state legislature, but also control for Mrs. Merkel's coalition over the little-watched upper house of Parliament, the Bundesrat, which has to sign off on legislation. Billions of dollars in assistance for Greece may not play well with voters in a state with its own financial problems.

"May not play well" is an understatement. A German poll found that only 16 percent of Germans support a Greek bailout while 65 percent are opposed. I am not an advocate of governing by referendum (a number of years living in California clarified the problems with that approach). Yet the avoidance of the electorate on such matters is deeply problematic.

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By Daniel Twining

It is a quality of human nature to extrapolate the present into the future. What else explains the pervasive gloom about America's future in the international system? Headlines around the turn of the new year were full of learned and normally astute commentators bemoaning the inexorable diminution of the West by the ever-growing economies of Asia in the wake of the global financial crisis and what many perceived to be a lost decade from 2001- 2009.  Surveys show that three in five Americans believe their country is in decline. A little more New Year's cheer is in order.

The United States today enjoys a share of global GDP no different than it did in the 1970s. The spread of democratic capitalism to large parts of the world that, during the Cold War, suffered from closed economies of scarcity is an enormous victory for American power and principles, and has made this country -- not to mention billions of people across Asia, Latin America, Central and Eastern Europe, and at least parts of Africa and the Middle East -- decisively better off.

This outcome, no less than the end of the U.S.-Soviet balance of nuclear terror, is the ultimate victory of the Cold War, and its final chapters have yet to be written -- as China's leaders, consumed by domestic insecurities even as the world lauds their unprecedented ascent to world power, seem to understand.

The United States remains the world's indispensable nation, even if President Obama has cast off the bracing language of American primacy in favor of a more subtle and understated poetry about American purpose. Washington's security commitments continue to order Asia, deter aggression in the Middle East, and make possible Europe's historic experiment in regionalism. The United States remains the international system's core convening power -- as seen most recently at Copenhagen-- and no solution to any pressing international problem is possible without American leadership. 

The same cannot be said of China, so often conflated to be America's global equal despite possessing an economy one-quarter of America's size and political, demographic, and economic challenges that dwarf those of any other great power (with the possible exception of Russia, whose future appears bleak). China's passive acquiescence may be necessary on a host of international challenges, from stemming Iranian proliferation to (not) agreeing to climate change targets. But where is Beijing forging international solutions on the hard issues of the day? More often it is free-riding on the leadership of others, or belatedly consenting to decisions after being forced to take a position by the more active leadership of the West.

Uniquely within the developed world, America possesses a population that does not face a demographic crisis over the coming few decades, thanks in part to our historical tolerance for immigration. U.S. universities continue to educate the global elite -- and if they go back to India or China to start software companies rather than staying in the United States, that is in part an indictment of our tough controls on highly skilled immigration that deter the world's best talent from staying.  At the same time, while it would be better to import than to export talent, we shouldn't diminish the value of the latter in extending American influence into these important new centers of power and seeding economic growth there that benefits us, too. 

The United States is well-placed to compete in a globalized world -- we always have been, which is why generations of American presidents have pursued free trade and freedom of the seas as enduring national objectives. Half the S&P 500's earnings come from abroad, which means every American who owns a retirement fund in stocks, even if not invested internationally, benefits from the economic "rise of the rest" (as does every American who doesn't own a retirement fund but shops at Walmart and chooses to consume cheap imports).  And it's worth pointing out that economic growth in the BRICS relies in part on the soft infrastructure of trade and finance that is dependent on the security of the global commons, still policed overwhelmingly by the U.S. military and our allies.

The United States suffered calamitously from the financial crisis of 2007-2008, which started here at home from our own Schumpeterian excesses of capitalism. But the United States also appears poised to lead the developed world out of recession and into sustained, if moderate, growth. It is true that China, in contrast to the West, had a good financial crisis.  But its extraordinary stimulus spending combined with its artificially undervalued currency is creating a different set of financial and economic risks. The country's opaque and underdeveloped banking system, not to mention its rigid and non-transparent political regime, will be hard-pressed to manage these with ease. 

More broadly, as Thomas Friedman has said, the 21st century cannot belong to a country that doesn't let its citizens use Google. Americans (and our friends abroad) should have a little more confidence in the values and purpose that have inspired us to help make the new world we live in. We have plenty of problems at home, from inadequate infrastructure to an underperforming educational system and, perhaps most disturbingly, a growing burden of national debt that, if not corrected, will increasingly undermine our welfare at home and our leadership abroad.

That said, I wouldn't trade America's problems for those of any other country. For his part, President Obama certainly doesn't want to spend four or eight years presiding over American decline. It doesn't pay to bet against the United States. We should have faith in our political leadership -- and actively involve ourselves in the political process -- to shape a coming decade and century that prove the skeptics wrong.

Happy 2010.

By Phil Levy

The dollar has been drooping. This week, a broad measure of the dollar's value against other currencies fell to a 14-month low. Depending on the commentator, this is either a global vote of no-confidence in the United States; or it is good news, a return to normality as worldwide fears subside. Without exactly leaping between Paul Krugman and his latest sparring partners, there are a number of questions one might ask about the dollar's recent decline. This post kicks off a short series to consider four of them, beginning with: Is the drop in the dollar "natural" currency depreciation or the result of "manipulation?"

The dollar has fallen roughly 15 percent from its recent high this spring. When we see sharp movements in a price, it's natural to look for an active protagonists driving those movements. Every now and then in the past, we've found some. There have been attempts to corner markets in silver, wheat, and even salad oil. Each of these instances involved attempts to drive up a price and some were spectacular failures, but that's not what sets them apart from the case of the dollar. The market for currency absolutely dwarfs these other markets.

The last time statistics were gathered on this (late 2007), the average daily turnover in foreign exchange markets was $3.2 trillion and growing rapidly (up 69 percent since the 2004 survey). To put this in perspective, if we divide U.S. GDP over 240 business days in a year, it was about $0.06 trillion ($60 billion) in 2008. So every business day, the value of currency transactions averaged about 50 times the total value of U.S. output. 

The implication is that it's very hard to manipulate the value of the dollar. In fact, this enormity of the market for dollars is one of its great strengths as a reserve currency; no one wants to keep their wealth in a thinly-traded currency that can be easily manipulated. As a general rule, the U.S. government doesn't even try to move the dollar around, and it gets to print the stuff. Every Treasury secretary since Robert Rubin has chanted the mantra "a strong dollar is in the U.S. interest" to avoid making any news that might move the markets in unpredictable ways. 

But how can it be "natural" for the dollar to drop as far as it has in the last six months? Ever since the dollar was de-linked from gold almost four decades ago, the value of the dollar is determined continually in those massive global markets. The markets are populated by investors and traders, some with business ideas, some with money to save, some with goods to buy and sell. Some of them want to turn their dollars into euros to buy some French wine, others wish to turn their yen into dollars to buy some oil, a Treasury bond, or an American office complex. Exchange rates balance dollar buyers against sellers.

That means, in part, that we can have many explanations for what happens in these markets. The dollar could go up because American vinophiles turned to Sonoma Valley, or because the U.S. commercial real estate market became more attractive. One popular explanation for the dollar's rise and fall in the recent crisis is offered by Paul Krugman: "the dollar rose at the height of the financial crisis as panicked investors sought safe haven in America, and it's falling again now that the fear is subsiding."

That certainly seems to be part of the explanation. But it gives the impression that all is well, that we have returned to normal and there's little to worry about on the currency front. In fact, there is no indication that we've reached a long-term equilibrium and there is a serious basis for worries about the dollar's fall. That, though, will be the subject of the next post in the series: Has the dollar stabilized or is there risk of a further plunge in its value?

PAUL J. RICHARDS/AFP/Getty Images

By Will Inboden

Here in London, as I write, the G-20 proceedings have recently ended, and local attention remains split essentially across three fixations:

• 1) The substance of the G-20 summit itself, and the question of whether the actions that came out of it will be at all meaningful (with many competing meanings of "meaningful");
• 2) The domestic political question of how the G-20 will affect Prime Minister Gordon Brown's standing and electoral prospects;
• 3) A somewhat morbid but nearly irresistible voyeurism around the mind-boggling array of protests, protestors, counter-protests, and riot police.

On #1, the emerging narrative of the inchoate Merkel-Sarkozy pro-regulation/anti-stimulus alliance against the Obama-Brown pro-stimulus camp was intriguing as political sideshow, but unsettling both in terms of economics and geopolitics, with one ironic by-product being the creation of even more maneuvering room for China and Russia to position themselves as global leaders on economic policy. Given the alternatives, perhaps the "best" outcome was the sort of anodyne statement that failed all of these tests, which is what we got, seriously sweetened with $1 trillion in pledges to the IMF.

On #2, April is a pivotal month for Brown, bracketed as it is by the G-20 at the beginning and the unveiling of his government's budget at the end of the month. Early returns seem to regard Brown's meeting and press conference with President Obama on Wednesday as a success and a much-needed boost, though given the painful optics from their first meeting last month, the bar of expectations was set very low. 

On #3, mindful of reports that some protestors might throw eggs or target spray paint at business attire-wearing capitalists, I wore an old suit just in case of any uncivil encounters with the agitators down the street - but thankfully it was a quiet walk to the office.

Meanwhile, many voices (including my Shadow colleagues Philip Zelikow and Phil Levy) have rightfully decried the global lurch towards protectionism, exemplified by the 17 leading nations that have adopted protectionist measures just months (sometimes even days) after pledging not to at the last G-20 summit in November. The pro-free trade and anti-protectionism rhetoric from yesterday's G-20 statements was to be expected, but trade policy embodies the wisdom of watching what nations do rather than what they say. It is doubtful that "naming and shaming" violators will be sufficient.

So Wednesday's release of a letter defending free trade and warning against protectionism, signed by over 2,000 economists (and a number of non-economists as well, including yours truly) will hopefully continue to speak to the G-20 leaders even - especially - as they return to their home countries and face fierce domestic pressures otherwise. Even allowing that group letters signed by economists don't automatically equate with wisdom (for example, the notorious example of the 364 economists who denounced Thatcher's economic policies in 1981), this letter's message deserves to be heeded. 

While Norman Angell remains the paragon of benighted optimism that economic integration will obviate military conflict, the 1930s offer the ominous counter-warning that protectionism can accelerate the risk of war. Or to take a lighter comparison, if 50 million Elvis Fans Can't Be Wrong, then surely 2,000 economists can't be wrong either?

By Philip Zelikow

The next step toward a better agenda for the G-20 summit is this:

On financial regulation, don't fall for the dumb dichotomy of global vs. national; adopt a smart synthesis, a global framework for coordinated national regulation.

The papers are playing up an issue for the G-20 summit of Europeans emphasizing the need for new financial regulation vs. Americans talking up stimulus. This would be a truly terrible way for the debate to evolve. The Europeans would be all about attacking bad bankers (like the Wall Streeters they want to scapegoat) while the Americans would seem wedded to their preferred panacea. And the biggest issues get lost both ways.

Fortunately, the U.S. side has moved adroitly to develop an agenda for future regulation (important but not critical right now) that should help answer the European mail. Geithner laid out a set of ideas on this point in the statement he issued last week. They seemed plausible. But Bernanke did an even better job of discussing this issue in an address he delivered to the Council on Foreign Relations on March 10. Here is his four part outline:

First, we must address the problem of financial institutions that are deemed too big--or perhaps too interconnected--to fail. Second, we must strengthen what I will call the financial infrastructure--the systems, rules, and conventions that govern trading, payment, clearing, and settlement in financial markets--to ensure that it will perform well under stress. Third, we should review regulatory policies and accounting rules to ensure that they do not induce excessive procyclicality--that is, do not overly magnify the ups and downs in the financial system and the economy. Finally, we should consider whether the creation of an authority specifically charged with monitoring and addressing systemic risks would help protect the system from financial crises like the one we are currently experiencing.

Bernanke added, crucially, that it is "self-evident that, in light of the global nature of financial institutions and markets, the reform of financial regulation and supervision should be coordinated internationally to the greatest extent possible." In other words, the U.S. side is clearly developing a constructive approach toward the topic of regulation.

One red herring, though, is the "mark to market" issue. The SEC and others are being pressured by Congress (e.g. Barney Frank) to revise these accounting rules. Conservatives like Steve Forbes have jumped on this too, arguing that this is a relatively recent deviation from good old traditional accounting rules. Well, the problem is that in the good old days accountants weren't being asked to sign off on the asset value of hundreds of billions of dollars in collateralized debt obligation derivatives whose asserted value was based on statistical modeling rather than the ability to assess the quality of individual loan performance. These CDOs were also being traded in, shall we say, a rather murky marketplace. As the trading of these derivatives skyrocketed in the last decade, honest accountants tried to cope.

Here again the administration's instincts seem right to me. Geithner in particular has resisted devices to cheat on assessing the asset value of troubled banks, while everyone acknowledges being open to smaller adjustments in the ways the rules work. My only footnote is to observe that, here again, the United States would be well advised to coordinate its regulatory framework with the one being developed by other leading states, like the participants in the G-7's Financial Stability Forum.

By Philip Zelikow

The next step toward a better agenda for the G-20 summit:

The proposal to expand U.S. contributions to the IMF is good and important.

Not to be confused with Secretary Geithner's call for global stimulus spending (about which more below). Geithner's call for expanding IMF "New Arrangements to Borrow" is timely and important. The proposal is to add $500 billion of emergency credit facilities for countries trying to stay afloat, like Ukraine. The money is not for stimulus; it is for fiscal survival and sustaining international trade. Indirectly, the plan might also help mitigate the growing exposure of the European banking system which, incidentally, is one of the reasons that leading European countries are against the stimulus part of Geithner's proposals.

This move should get bipartisan support, showing the United States will do its part in fashioning an international approach to an international crisis. Japan has also stepped up with some large financial commitments to expand the IMF. Its new finance minister, Kaoru Yosano, looks like he is prepared to be a lively, constructive player.

Europeans are already uneasy about the corollary part of Geithner's proposal, the need to update, ahead of the usual schedule, the voting powers in the IMF based on current contributions. Such a review is bound to increase Asia's voice at the expense of Europe. This review is the right move, though, and would not happen -- in the U.S. proposal -- until 2011.