IE 11 is not supported. For an optimal experience visit our site on another browser.

Europe sees US debt crisis as dire as its own

Now it’s Europe’s turn to worry about U.S. economy.

American officials have been wringing their hands for the past two years about the heavy burden of government debt piling up in Europe. On Tuesday, Europe’s Organization for Economic Co-operation and Development warned that the U.S. "fiscal cliff" threatens prospects for the eurozone’s economic recovery.

“We’re talking here about the medium and long-term viability of the United States economy,” OECD Secretary General Angel Gurria told CNBC. “Not only to avoid the fiscal cliff but then get to a moment where (U.S.) debt stops rising and the debt to GDP starts coming down to an area where we call all breathe more comfortably.”

In its latest Economic Outlook, the influential Paris-based think tank said that with the eurozone’s economy already headed in reverse, the United States faces the same fate if lawmakers fail to agree a deal to avoid a combination of tax hikes and budget cuts that will otherwise take effect next year.

“The US ‘fiscal cliff,' if it materializes, could tip an already weak economy into recession, while failure to solve the euro-area crisis could lead to a major financial shock and global downturn,” Gurria told reporters in Paris.

Even if a deal is reached, the OECD joined other forecasters calling for a continued global economic slowdown in 2013. For the U.S., that means expansion of just 2.0 percent, versus the OECD's 2.6 percent forecast in May.

The eurozone economy is expected to shrink by 0.4 percent this year and another 0.1 percent next year, before recovering at a weak 1.3 percent growth rate in 2014, the forecasters said.

Negotiations in Washington continued this week on a broad range of alternatives to the current budget law, which would impose roughly half a billion dollars in government spending cuts and tax increases starting Jan. 1. Uncertainty over the outcome has depressed hiring and investment by businesses, some economists say.

On Monday, White House economists estimated that the budget measure, unless altered or postponed, would carve some $200 billion out of consumer spending, which accounts for about two thirds of the U.S. economy. Together with deep cuts in government spending, the package would wipe out the current weaker recovery and shrink the U.S. economy by about 0.5 percent in 2013, according to the non-partisan Congressional Budget Office.

Congress and the White House have been deadlocked on solutions since the law was enacted after a bitter battle in July 2011 over increasing the government’s legal borrowing authority. Though President Barack Obama and Republican leaders have made conciliatory comments since the November election, there has been little in the way of concessions needed to reach a compromise.

Most observers believe that the worst of the tax hikes will be avoided – if only because they would be so politically unpopular. The so-called Alternative Minimum Tax, for example, would ensnare some 28 million households with new taxes next year unless Congress once again agrees to a “patch.”

But broad compromise on reforming the thicket of deductions, exemptions and other breaks in the tax code, along with restructuring the massive Medicare and Social Security entitlement programs, will be much harder to pull off.

“I think it is a romantic hope that to believe that these politicians can agree to a grand bargain that will fundamentally fix our budget deficit issue,” said Richard Hoey, chief economist at BNY Mellon. “ I think that is totally unrealistic.”

That kind of sweeping fundamental reform has eluded European governments for years.

On Monday, facing the latest precipice in their two-year saga trying to head off a Greek debt default, European leaders hammered out yet another bailout package that calls on the Greek government to pare down its debt in the coming decade.

But while the latest plan appeared to buy more time, the threat of the longer-term crisis remains.

“Athens’ cash reserves must be down to vapors,” said Carl Weinberg, chief economist at High Frequency Economics. “Any interruption in implementation of this scheme could cause an ugly default, with little or no warning.”

The details of the latest “solution” are murky, and the plan still faces opposition from both individual eurozone governments and potential legal challenges.

Terms of a proposed buyback of Greek debt that would leave some bond holders with losses haven’t been worked out. And the 44 billion euro ($53 billion) bailout payments over the next two months will be made in stages – with each new payment conditioned on Athens meeting milestones called for by its European benefactors. 

The longer term solution to Europe's debt crisis is even murkier - a possible portent of what U.S. lawmakers face if they can't work out a broad tax and spending compromise soon.