European debt talks pivotal for US economy — and Obama’s reelection bid

High-level talks aimed at resolving the European debt crisis could go a long way toward deciding the outcome of the 2012 presidential election.

Financial officials from around the world gathered in Davos this past week to try and put a stop to the long-running debt crisis, which has rattled financial markets and dragged down the global economy. 

The U.S. recovery — and President Obama’s chances at reelection — could take a hit if the talks don’t succeed.

“If the [International Monetary Fund] gets the $500 billion they are seeking … then I think we could be very close to a resolution of the European crisis,” Jacob Kirkegaard of the Peterson Institute said.

“This could be a significant potential boost to the president. I would certainly think we would get a big boost to the stock market.”

Economists say the debt crisis is the single biggest threat to the U.S. economy in 2012. Alan Blinder of Princeton University warned that continued turmoil in Europe has the potential to wipe out all the gains the U.S. economy has made since the recession.

Treasury Secretary Tim Geithner and other U.S. officials are playing a game of high-stakes poker where they have little real leverage, experts say.

The U.S. is trying to broker a deal between European and developing countries such as China to shore up the International Monetary Fund [IMF] so it can bail out countries hit with a debt crisis. But Geithner isn’t able to lead by example, since House Republicans have resisted allowing the U.S. to contribute to a bailout.

The U.S. is also leaning on Germany to accelerate the creation of a European bailout fund, known as the European Stability Mechanism [ESM].

While experts are divided on how long the European crisis will last, or how much risk remains, they say the U.S. would reap dividends if the Davos talks succeed — an economic jolt that would also help Obama.

“I don’t consider it to be a coincidence that congressional Republicans are the ones most opposed to U.S. funds being used” in a bailout, Kirkegaard said, adding that he personally agrees with the GOP that the EU should pay for its own crisis.

While Geithner cannot offer U.S. funds, there are things he can do to make a deal happen.

One of them would be to help China get additional voting power within the IMF in exchange for contributing new resources to the IMF to use for future a EU bailout, Kirkegaard said.

“It is easy for the U.S. to do it,” said Desmond Lachman, a former IMF official now with the American Enterprise Institute. He noted that any new voting shares for China would come out of the EU’s 33 percent stake, a voting share he said was too large, rather than from the U.S.’s 17 percent stake.

“I don’t know how much leverage the U.S. has on them,” Lachman said.

Lachman agreed that establishing the IMF and ESM funds “would be construed as a positive” by the U.S. stock market. He disagreed with Kirkegaard on the depth of the crisis, however, arguing that it would persist longer and continue to damage the global economy.

He said the bailout funds and other guarantees by the European Central Bank “helps you buy time, but it doesn’t really help you solve the problem.”

The problem is structural, he argued. Tied to the fixed currency of the Euro, Spain and Italy will be forced to take austerity measures that will weaken their economies, increase their budget deficits and then require more austerity, he said. He predicted Portugal and Greece would end up leaving the Euro.

Kirkegaard acknowledged that if the statistics for the Italian economy begin to sour in May or June, then the outlook would darken.

Carlo Bastasin of the Brookings Institute took a rosier view, noting that Ireland, Portugal, Spain, Greece and Italy have new governments that are pro-EU and in favor of fiscal discipline.

He said the IMF bailout fund is less important because countries such as Italy will find it politically too embarrassing to seek an IMF bailout.

“I don’t think the solution will come from the IMF,” he said. “If they can put some money on the window and show it and it may sound like a guarantee. It is not exactly the solution.”

Bastasin said far more important is the stability mechanism, which the U.S. has played an important role in setting up.

Germany has gotten agreement from the EU nations, with the exception of Britain, to treaty changes requiring greater fiscal discipline. Bastasin expected these changes to be adopted by June and the ESM to be functioning by July.

The Treasury Department stresses it is not considering more resources for the IMF, and says the U.S. will simply act as an advisor in Davos.

“Europe of course has the resources to solve their problems. We continue to strongly encourage and advise them to strengthen the foundations of their monetary union, build a framework for further fiscal and financial integration, and put a credible firewall in place,” a Treasury official said Friday.

“Europe is our largest trading partner and its recovery is of great importance to the global economy. The U.S. has therefore been active in offering up the lessons we learned in our own crisis to our European counterparts.”

Kirkegaard said finance ministers like Geithner are could resolve the IMF issue by the time of a G-20 finance ministers meeting in Mexico City on Feb. 25 and Feb. 26.