updated 6/22/2010 4:50:38 PM ET 2010-06-22T20:50:38

A trans-Atlantic rift over the right medicine for Europe's financial crisis is brewing as world leaders prepare for the G-20 meeting in Canada — with Britain on Tuesday announcing its steepest cuts in decades and Germany defending its tough austerity measures after a warning by President Obama that too much budget slashing could threaten the global recovery.

Britain's emergency budget is the latest in a string of savage public spending cuts and reflects Europe's newfound resolve — since markets pushed Greece to the brink of bankruptcy and even threatened the bloc's economic union — to tackle debt before worrying about growth.

But Europe's single-minded focus is worrying the U.S., prompting Obama to write a letter to world leaders on Friday warning against excessive spending cuts.

German Chancellor Angela Merkel fought back this week, defending her government's $80 billion (euro 65 billion) savings plan even as British Treasury chief George Osborne forged ahead with his own grim austerity budget.

Many European analysts agree the more urgent priority is taming deficits.

Obama "has a point, but there are some countries that don't have a luxury of a choice, they have got to get a grip and start cutting quickly because the alternative of becoming the next Greece is not palatable to them," said Jonathan Loynes, chief European economist at Capital Economics in London.

Britain's emergency budget aims to sharply reduce record public debt and fall hard on most people. Shoppers will pay higher sales taxes, wealthy people will be hit for higher capital gains taxes and banks will be charged a new levy on profits, a move that has already been approved by France and Germany. Even Queen Elizabeth II accepted a freeze in her support from taxpayers.

In Germany, a spokesman for Chancellor Angela Merkel said she talked on Monday with U.S. President Barack Obama on the phone about a letter he wrote to the G-20 leaders in which he cautioned against hurting a fragile global economic recovery by trimming spending prematurely.

The letter was seen as a criticism of Germany's plan to reduce the country's deficit, but the spokesman said Obama did not pressure Germany to continue stimulus spending by piling up more debt. He spoke on condition of anonymity in keeping with government policy.

Europe's leaders are struck in a quandary: They must bring down mammoth debt through spending cuts to ward off economic panic, but the measures are bound to stunt growth. And no one will likely know for years whether they chose the right medicine and the right dosage.

"My suspicion is that it will be a major drag on the economy for a few years, and it may be we decide in the future whether they went too aggressively, but the political and market climate right now is such that they had no choice," said Loynes from Capital Economics.

The realization that Europe is bound to implement spending cuts that will hurt growth for years to come has weighed on the euro, pushing it to four-year lows below $1.19 earlier this month. On Tuesday it traded at $1.2274, down somewhat from Monday.

Economic stagnation in Europe would hurt the U.S. by crimping its exports just as America is trying to limp its way out of its own slump. But Obama's concerns are trumped by Europe's desire to stabilize the European Union and the euro.

"The EU accords priority to budget-cutting, because that is what its leaders believe is needed to preserve the euro and the political construction of a united Europe," said Stephen Lewis of London's Monument Securities.

The new bank fee authorized that Britain, France and Germany committed to on Tuesday will charge banks based how much they earn to shield taxpayers from the cost of resolving financial crises. But their call for a global tax is unlikely to find much response at the G-20 summit.

In a joint statement, the three nations said they aimed to ensure that financial institutions are making a "fair contribution" to reflect the risks they pose to the financial system and "to encourage banks to adjust their balance sheets to reduce this risk." Germany is already drafting legislation for such a tax, and France promised to do so in its next budget.

Merkel and French President Nicolas Sarkozy are expected to lobby hard at the G-20 meeting in Toronto for a separate global financial transactions tax, but Loynes said there is little chance of approval and that their effort is aimed at shoring up their political support at home.

"They are fully aware that their stance has little chance of influencing the course of global economic policy," he said. "This is in line with the Continental European tendency to assert the primacy of political over economic concerns in policymaking. This, indeed, underlies the division between the U.S. administration and EU authorities over fiscal policy."

But Obama expressed support this week for a Spanish proposal passed in parliament Tuesday to shake up the labor market by making it easier for companies to lay off workers. Spain had already pushed through an austerity plan to convince markets it will not need a bailout to manage its debt, as happened with Greece.

Some are not convinced the Spanish reforms will prompt companies to hire en masse, which is what Europe's fourth largest economy needs desperately after recently crawling out of two years of recession. Unemployment now stands 20 percent in the nation of 45 million.

Bank of Spain governor Miguel Fernandez Ordonez welcomed the labor reforms as a good first step but said they do not go far enough.

Sandalio Gomez, professor of management at IESE Business School in Madrid, said the government is trying to conceal that it is making it easier and cheaper to lay off workers — something it had repeatedly said it would not do.

"They've missed a perfect opportunity — and there are few like this — to transmit confidence to the labor market, a push forward that would allow jobs to be created," he said.

Copyright 2010 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.


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