When delay on deficits means more pain

David Ignatius writes in the Washington Post:

It’s a truth of economics and life that if you have bad news coming, take the hit early and get it behind you. You can’t start building until the debris is out of the way.

Modern illustrations of this “pain, then gain” approach start with Paul Volcker, Mr. Tough Guy , who as Fed chairman sharply raised interest rates starting in 1979 to break the inflationary psychology that had a grip on the United States. Volcker’s decisive move brought on a recession, but he built the foundations for prosperity that lasted 25 years.

Ben Bernanke earned a place on the list when he let Lehman Brothers fail in 2008 — allowing the bubble economy to burst with agonizing impact — and then created an innovative new set of monetary facilities to provide liquidity to the markets. The recovery of the U.S. financial system from that near-death experience has been remarkable, at least for banks, even though it hasn’t yet delivered on growth and employment.

Among contemporary politicians, British Prime Minister David Cameron deserves credit for “taking the hit” early with an austerity budget that helped Britain escape its own financial crisis. When he took office, Britain’s debt problem, as a percentage of its gross domestic product, was comparable to Ireland’s or Portugal’s. Cameron bit the bullet and slashed ministerial budgets an average of 19 percent. Bond traders took Britain off their target list, and a slow recovery began.

For a counterexample of the costs of taking nasty medicine in small doses, look elsewhere in Europe — especially at its most flagrant debtor, Greece. For a year now, Greece and its euro zone partners have been dancing around the fact that the country must restructure its debts or default. All the interim facilities and special funds and gimcracks haven’t changed that reality. According to the Financial Times, the markets last week were pricing the probability of a Greek default over the next five years at 67 percent, compared with 55 percent a month ago.

But Greek restructuring means pain for private banks that still hold Greek debt and for the European Central Bank. So it’s delayed and delayed, even though most analysts assume “a haircut” is inevitable.

The result of this waiting game is a death of a thousand cuts. Investors keep betting that the soothing talk is nonsense. Spreads widen, the crisis grows and measures that might have been sufficient six months before become inadequate. It’s a rolling cascade of concessions, never sufficient to stop the contagion.

To state the obvious: Attempts to avoid the pain of restructuring just make it worse in the end. That’s why many analysts now question the survival of the euro zone itself. Without a central pain dispenser in the form of a binding common fiscal policy, a common currency may be impossible.

What’s the lesson for the United States as President Obama and the Republicans maneuver for position on the budget fight — with the clock ticking toward an early July deadline for raising the debt ceiling? You wouldn’t know the answer by watching Obama bantering last week with Facebook chief executive Mark Zuckerberg, as if this were just a problem of assembling enough “friends.” No, it’s about pain — and how to share it in a way that’s fair and also acceptable to retro-populist Republicans.

The longer Obama waits to hammer out his budget deal, the greater the collateral damage is going to be. David Smick, a leading financial analyst, says that some foreign central bank regulators are cautioning about the risks of U.S. Treasury securities. Last Monday’s warning by Standard & Poor’s that it might cut America’s AAA bond rating will increase such concerns. Wall Street was also buffeted by rumors that a slowing China may reduce its purchases of Treasuries.

The market jitters are the first cuts of the knife, but many more will come until Obama and the Republicans reach an agreement. In a global economy, traders who sense weakness will keep selling until they see decisive action.

“Cut your deal, get it done,” advises Smick. “Present a downward-sloping trend line that gets to a compromise endgame,” with a mix of spending cuts and revenue increases. Obama’s task is a bit like shaping an Israeli-Palestinian peace settlement: Everyone knows what the basic elements will be; the challenge is transforming these unspoken requirements into a formal deal.

What’s crazy in this budget season is the hope that you can buy some relief with just a little harsh medicine. To quote Shakespeare’s “Macbeth”: “If it were done . . . then ‘twere well it were done quickly.”